“Japan’s Telecommunications Regime Shift: Understanding Japan’s Potential Resurgence”

Kenji Kushida*

University of California Berkeley, Political Science DeptBerkeley Roundtable on the International Economy

* I am greatly indebted to Robert Cole, John Zysman, Steven Vogel, and Stephen Cohen for feedback on this draft and in its conception. I am also indebted to Yukio Noguchi, Daniel Okimoto, T.J. Pempel Toshihiko Hayashi, Steven Vogel, Ethan Scheiner, Kaoru Shimizu, Kenneth MacElwain for feedback on an earlier version of this paper. I offer my sincerest thanks to all the Japanese government and industry participants who have tolerated my interviews and conversations. All errors, factual or otherwise, are my own.

The Broad PuzzleThe development of Japan’s telecom sector since the early 1990s raises fundamental

questions about how we understand Japan’s comparative institutional advantages, and how Japan’s domestic markets function in international competition.1 The broad puzzle has two parts. On the one hand, Japan went from a strong player to a virtual non-player in international markets for high-tech telecommunications equipment. On the other hand, telecom services in Japan suddenly developed to offer some of the most sophisticated services at the cheapest prices worldwide.

This flies in the face of conventional wisdom about the competitiveness of Japan’s political economy, known for its internationally competitive high-tech export sectors, with domestic service sectors lagging behind. In fact, much of Japan’s economy still does comply with the conventional wisdom – sectors such as autos and consumer electronics remain strong in international competition, while the performance of sectors such as finance and insurance lag behind many of Japan’s fellow OECD nations. The broad motivation for this study is this puzzling and deviant performance of the telecom sector since the early 1990s.

Telecom is certainly a deviant sector, not only in its performance but also in its composition, since it is a complex sector involving manufacturing, infrastructure networks, and services. It also has special sectoral properties, such as an incumbent carrier and government concerns about geographically equitable service.2 But telecom is more than “just” an outlier. Much can be learned from this particular outlier, since new, sophisticated services may lead to new sources of value-creation, since telecom is central to transaction costs in the overall economy, and since the sector in of itself accounts for a large piece of the economy.3

1 By comparative institutional advantage, I refer to advantages in international competition enjoyed by a particular country through the institutional configuration that shapes market dynamics. Starting from Polanyi’s recognition that markets are created and continually supported by government policy and institutions, I draw from the basic framework articulated by Zysman, et al, that national production systems are a product of features of a country’s political economy. (see Karl Polanyi, Great Transformation: The Political and Economic Origins of Our Time (Boston, MA: Beacon Press, 1944).; the Introduction to this volume; and Chalmers Johnson, Laura Tyson, John Zysman, ed., Politics and Productivity: How Japan's Developmental Strategy Works (Harper Business, 1989). A discussion about how to define institutions is beyond the scope of this paper, but will consider them broadly to be incentives and constraints upon actors, along the lines of North. See Douglas North, Institutions, Institutional Change and Economic Performance (Cambridge University Press, 1990). My conception is thus slightly broader than the conception by Hall and Soskice, since they see institutions only as supporting coordination between firm-level actors. In their conception, comparative institutional advantage is determined by the coordination mechanisms available in certain countries due to their institutional configuration. Peter Hall, and David Soskice, "An Introduction to Varieties of Capitalism," in Varieties of Capitalism: The Institutional Foundations of Comparative Advantage, ed. Peter Hall, and David Soskice (New York, NY: Oxford University Press, 2001).2 Government interests in geographically equitable service can be divided into two types of concerns. On the one hand, government can have strong concerns for universal service, in which the service and price across all areas are equivalent between urban and rural areas. On the other hand, governments can be less interested about price and performance equivalence, and more concerned about ensuring that market dynamics in urban areas leading to outcomes such as low priced, high performance broadband networks, are available to some degree in rural areas. (Imagawa, Takuro. Personal conversation. Ministry of Internal Affairs and Communications, Tokyo, Japan. Dec 24, 2004.) 3 In 1995, the ICT sector accounted for approximately 8.6% of Japan’s total GDP, growing to 12.0% by 2002. Average growth of the sector averaged 7.1% over this period, while the overall economy averaged 1.0% growth. “White Paper: Information and Communications in Japan 2004” Ministry of Public Management,

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At the very least, a study of the telecom sector forces us to reexamine our understanding of Japan’s comparative strengths and weaknesses, and the institutions shaping them, keeping in mind the differences across sectors.

The Decline in International Telecom Manufacturing The first part of this broad puzzle – why Japan’s telecom industry lost international

competitiveness in high-tech equipment manufacturing, and whether this should make us rethink our understanding of Japan’s comparative institutional advantage – is easily answered with Cole’s analysis in the previous chapter. We can conclude that Japan lost competitiveness in telecom equipment manufacturing due to exogenous shifts in technology on the one hand, and the mismanagement of standards on the other, rather than a loss in overall manufacturing prowess.

First, the drop in network equipment exports is best understood as a situation in which Japan was following the existing technological trajectory with considerable success, only to be blindsided by a exogenous new technological trajectory. This new technological trajectory originated in the US, and involved TCP/IP and other software, hardware, and networking paradigms surrounding the Internet. Given that everywhere else in the world was also blindsided by this new technological trajectory, Japan’s performance seems inferior only when compared to the new players from Silicon Valley such as Cisco. When compared to most of the rest of the world, such as European firm and even older US firms such as AT&T, Japan does not seem particularly slow to adjust, especially given that its performance along the previous trajectory was strong.4

Second, the decline of Japan’s position in 2nd generation cellular equipment was the result of mismanaged standards rather than a decline of manufacturing capabilities. Japan’s domestic market was perhaps the most technologically sophisticated in the world, and Japanese handset component manufacturers continued to have a heavy presence in global markets.5 Japan did indeed shift from a proprietary closed analog standard to an “open-but-owned” digital standard, in line with trends in the “Wintelist” era.6 However, the standard adopted by Japan did not reach beyond its shores, preventing sophisticated Japanese handsets from being exported without costly design changes.

In sectors such as autos that were not as affected by the shifts in IT technology, and in which this particular mismanagement of standards had little effect, Japan’s strengths in manufacturing was relatively unaffected.7 In short, Japan’s loss of competitiveness in

Home Affairs, Posts and Telecommunications. p.41. 4 See Cole’s chapter in this volume 5 Since components of cellular phones such as semiconductors, LCD displays, batteries, amplifiers, and antennas are unlikely to be classified as telecommunications equipment, they would not be included in figures for telecommunications equipment exports. A Nikkei Business article argues that Japanese components comprise a large proportion of Nokia’s handset components, with Nokia enjoying over a third of the global cellular handset market. "Hinomaru Katsuyou, Tsugiwa Deokure Bankai E," Nikkei business, September 8 2003.6 see Introduction to this volume, Steven Vogel, and John Zysman, "Technology," in U.S.-Japan Relations in a Changing World, ed. Steven K. Vogel (Washington DC: Brookings Institution Press, 2002).; Michael Borrus, and John Zysman, "Globalization with Borders: The Rise of Wintelism as the Future of Industrial Competition.," BRIE Working Paper #96b (1997).; Stephen Cohen, J. Bradford DeLong, John Zysman, Tools for Thought: What Is New and Important About the "E-Conomy" (Berkeley, CA: Berkeley Roundtable on the International Economy, University of California at Berkeley, 2000).7 Japan’s strength in manufacturing being lean production, the Toyota model, or any of the labels that observers have given Japan’s production systems. For examples, see Masahiko Aoki, Towards a Comparative

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international in telecom equipment markets was a sectoral development, due to exogenous and domestic factors specific to the telecom sector. Thus, this part of Japan’s experience in telecom equipment does not require us to rethink Japan’s comparative institutional advantage in manufacturing.

It is the second part of the broad puzzle – the rapid development of services in telecom – that we focus on in this chapter.

Japan’s Decline in Telecom as Causally Distinct from Economic Problems of the 1990sHowever, before turning to examine the development of Japan telecom services, it

is important to briefly but clearly state that Japan’s decline in international competitiveness of telecom equipment was not a direct result of Japan’s broader economic problems of the 1990s. Japan’s asset bubble of the late 1980s, its collapse, and the ensuing economic crisis and stagnation of the 1990s, all had different causes from the technological trajectory shift and Japan’s mismanagement of standards.

Problems in the broader economy are attributed by most observers to some combination of Japan’s difficulty in adjusting to the post-Bretton Woods international financial system, institutional rigidities within Japan, bad macroeconomic policies, and political factors.8 These are very different from the causes of the technological trajectory shift in IT, which was a result of the political economic environment in particular regions of the US,9 and Japan’s mismanagement of standards, which had more to do with specific institutions and decisions in the telecom sector.10

The timing was unfortunate for Japan, because the exogenous technological trajectory shift and Japan’s mismanagement of standards coincided with these broader economic problems. The interplay between these sectoral and national-level problems merits a separate inquiry of its own, since national-level economic problems no doubt constrained sectoral corporate strategies, while the sectoral technological trajectory shift prevented manufacturing exports in telecom from providing a much-needed boost to the national economy.

It is worth recapping the structure of this study in the table below. Of the two broad puzzles, Cole’s argument provides us an explanation for the first. The implication on international competition is that there was no real shift in Japan’s comparative institutional advantage. In this chapter, we focus on explaining the second puzzle, and whether an

Institutional Analysis. (Cambridge, MA: MIT Press, 2001).; Johnson, ed., Politics and Productivity: How Japan's Developmental Strategy Works. However, one must always be clear in stating that the lean production model pioneered by Toyota was not as pervasive as many outside observers assume. Quality Japanese manufactured products are not all products of lean production. 8 For examples of such arguments, see Adam Posen, Restoring Japan's Economic Growth (Institute for International Economics, 1998). (bad macroeconomic policies); William Grimes, Unmaking the Japanese Miracle: Macroeconomic Politics 1985-2000 (Ithaca, NY: Cornell University Press, 2001). (institutional factors constraining macroeconomic policy choices); Richard Katz, Japanese Phoenix: The Long Road to the Economic Revival (ME Sharpe, 2002). (general institutional rigidities); T.J. Pempel, Regime Shift: Comparative Dynamics of the Japanese Political Economy (Ithaca, NY: Cornell University Press, 1998). (difficulty of Japan adjusting to the post Bretton-Woods financial system, combined with domestic shifts.)9 See Introduction to this volume, Vogel and Zysman (2002).10 See Cole’s chapter in this volume. He attributes Japan’s failure to deal creatively with NTT, institutional rigidities within NTT, the lack of initiative by equipment manufacturers, and the non-strategic management of standards as primary causes for Japan’s decline in telecom manufacturing.

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implication is that we should rethink Japan’s comparative institutional advantage, at least in telecom.

Table 1: the structure of this inquiryBroad Puzzle Explanation Implication 1. Japan’s retreat from

international markets in high-tech telecommunication equipment

Exogenous shifts in technology Japan’s mismanagement of

standards Not simply a function of

Japan’s poor economic performance in the 1990s

Not a shift in Japan’s comparative institutional advantage

2. Japan’s sudden development of sophisticated services at low prices

[the objective of this study] A shift in Japan’s comparative institutional advantage?

The Unexpected Development of Services in Telecom Telecom services in Japan began to develop rapidly from the late 1990s. At least

two characteristics in the trajectory of their development call into question our existing understanding of Japan’s comparative institutional advantages. First, until recently, Japan’s telecom services had been known for their sophistication, as exemplified by the costly nationwide ISDN infrastructure deployment extending to public pay phones – but certainly not for their low consumer prices.11 Yet, Japan’s consumer prices for sophisticated and high-speed broadband networks became the lowest in the world by 2002 – hinting at a possible shift in Japan’s developmental model from its well-known producer-oriented model to a more consumer-oriented one. Second, until the late 1990s, Japan’s telecom services lagged behind many OECD countries according to the conventional cross-national indicators for ICT development. However, after the late 1990s, Japan’s telecom services developed in ways that are no longer adequately captured by these indicators.

These two new trajectories of development can potentially allow businesses and consumers to find new ways of creating value, or to add value to existing products or services in new ways.12 The implication is that Japan may find a new comparative institutional advantage for adding value in the digital era.

Our task is therefore to understand how and why Japan’s telecom services developed in the unexpected ways that it did. I examine Japan’s development according to three indicators: Internet usage, broadband penetration and price, and cellular service users and price. These are three of the most common, and perhaps most used indicators in cross-national comparisons of development in telecom. In each of these services, Japan’s level of development went from a low to high. At the same time, the sophistication of each of the services went beyond what the conventional indicators capture. Internet Penetration

First, I examine the diffusion of Internet usage in the population. It is clear that overall Internet usage surged, as the population penetration of the Internet grew from

11 By the mid to late 1990s, Japan boasted the most extensive ISDN buildout worldwide (OECD Telecommunications Database 2004) and a large proportion of public telephones around the country had ISDN ports. Observers noted, however, that they were seldom used. See Cole’s chapter on figures for the cost of nationwide ISDN deployment. Also note that Japan had one of the highest consumer prices for ordinary telephony in the OECD. (OECD Telecommunications Database 2004)12 See Cohen, DeLong, Zysman (2000).

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approximately 9 percent in 1997, to over 60 percent of the population in 2003. A tripling of Internet penetration in the four years from 1999 to 2003 is rapid growth by any measure.

Table 1: Population penetration of Internet and Proportion of cellular subscriptionsYear (end of FY) 1997 1998 1999 2000 2001 2002 2003Population Penetration of Internet (% of total Pop)

9.2 13.4 21.4 37.1 44.0 54.5 60.6

Proportion of Internet Subscriptions via Cellular (%)

0.85 0.93 0.90 0.85 0.81

Source: MIC White Paper 200413

What is striking about Japan’s pattern of Internet diffusion is that since 1999, over eighty percent of Japan’s Internet subscriptions were via cellular phones. It is clear that most of Japan’s Internet penetration growth is accounted for by a growth in cellular Internet subscribers.

Japan’s path of development is clearly different from that of the US and most of Europe and Asia, leading to the point that conventional indicators do not adequately capture Japan’s development. There is a good argument that Internet access via PCs and “Internet” access via cell phones should not be lumped together in the same indicator because differences in user experiences, application possibilities, and network architecture, as well as the potential implications for finding new ways to add value, are significantly different.

Taking the two components separately, first, we have the puzzle of the rapid deployment and widespread penetration of cellular Internet services. Decreases in the price of Internet access is usually the main explanation for a rapid growth of Internet subscribers, but the packet-based pricing of cellular Internet services requires a different analysis from that of landline. It is well known that business model innovations, rather than technological innovations, were the driving force behind Japan’s pervasive cellular Internet services.14 The question is whether or not there were institutional factors supporting or fostering this development, since it is also well known that an NTT subsidiary was the unexpected pioneer in developing the business model.

The growth of landline Internet subscribers was nowhere near as dramatic as wireless. However, an overwhelming proportion of the growth of landline Internet access was due to the growth of broadband subscriptions, and Japan went from having one of the highest prices of Internet access among G8 countries in 1999, to having the lowest prices in 2002.15 This price decrease was from the availability of low cost broadband. This leads us to a separate focus on broadband penetration and price.

13 White Paper: Information and Telecommunications in Japan, 2004. Ministry of Internal Affairs and Communications, and Ministry data.14 For example, see Jeffrey Funk, The Mobile Internet: How Japan Dialed up and the West Disconnected (Kent, UK: ISI Publications, 2001).; Takeshi Natsuno, I-Mode Sutorateji: Sekai Wa Naze Oitsuke Naika (Tokyo: Nikkei BP, 2001).; Mari Matsunaga, I-Mode Jiken (Tokyo: Kadokawa Shoten, 2000). 15 OECD data cited by Cole, shows that the US, Finland, and Canada had the lowest prices among the OECD countries, and Germany, followed by Japan, have the highest prices among G8 countries, well below the OECD average. See OECD, A New Economy? The Changing Role of Innovation and Information Technology in Growth. (Paris: Organisation for Economic Co-Operation and Development, 2000).

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Broadband Diffusion and PriceOur second observation is Japan’s rapid increase of broadband diffusion, and the

unexpectedly low prices of broadband services.

Table 2: Landline Internet Subscriptions by Type (millions)Year (end of FY) 1999 2000 2001 2002 2003DSL <0.01 0.07 2.38 7.02 11.20FTTH - - 0.03 0.31 1.14CATV 0.22 0.78 1.46 2.07 2.58Dialup 1.13 1.63 1.91 1.93 1.79Note: changes in data collection methods in 2001 account for most of the increase, according to MICSource: Ministry of Internal Affairs and Communications

Among the various types of broadband technologies, it is clear that DSL was the primary driver of the rapid landline Internet subscription growth in Japan after 2000. Until 1999, Japan’s level of broadband penetration was well behind many of the OECD nations.16

Before 1999, DSL had yet to be introduced to Japan though it was thriving in parts of Europe and the US, and the fastest Internet access technology to household consumers was ISDN. ISDN was slower than DSL, priced by the minute, and users incurred substantial monthly fees and substantial fees for the initial deployment.17 After 2001, DSL subscriptions in Japan grew rapidly, overtaking all but Korea and the US by 2002 in the number of subscriptions.18

Table 3:Number of DSL Subscriptions Across Countries (thousands) 　　 1998 1999 2000 2001 2002

Canada - 103 466 1,060 1,643

France - - 64 430 1,409

Germany - 5 162 1,870 3,195

Japan - 0.2 10 1,524 5,646

Korea 0.01 278 3,870 5,178 6,387

United Kingdom - 2 38 140 590

United States - 370 2,429 3,948 6,472 *discrepancies between Table 3 and Table 2 largely from difference between FY (end of March) and Calendar YearSource: SourceOECD Telecommunications Database 2003

In terms of broadband price, according to the OECD, Japanese firms comprised eight of the ten services that have the lowest prices for basic monthly fees for flat-rate 16 For example, see OECD, "The Development of Broadband in Oecd Countries," (2001).17 Since the copper line to a residence needed to be replaced by an ISDN line, users incurred the equivalent of several hundred dollars in construction fees, and monthly fees ran approximately 10,000 yen per month (approximately 90 USD at an exchange rate of 1USD = 110 yen)18 We do need to remember in making this comparison, however, that the ratio of proportion of DSL versus cable for broadband access differs across countries, and that US has a higher ratio of cable via broadband. One should not, therefore, hastily conclude that Japan’s number of subscriptions was overtaking the US. Also, in comparing broadband penetration across countries, one must think in terms of proportions of the population rather than absolute numbers of subscriptions. The comparison here is intended only to give a sense of the rapidity of aggregate growth in DSL subscriptions in Japan. See Sherille and Irene Wu Ismail, "Broadband Internet Access in Oecd Countries: A Comparative Analysis," (Staff Report of the Office of Strategic Planning and Policy Analysis and International Bureau, Federal Communications Commission, 2003).

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broadband services in 2003.19 According to the ITU, Japan has had the lowest prices per 100kbps of broadband connection since 2002.20

However, conventional cross-national measures of broadband, including broadband penetration, prices to access the Internet, and total bandwidth available, do not adequately capture the price-performance of services that became available to Japanese consumers. Fiber-to-the-Home (FTTH) service providers began offering consumers connections of up to 10 times the speed of DSL (100Mbps versus approximately 10Mbps) at one and a half to two times the price of the cheapest DSL services. IP telephony services bundled with popular DSL and FTTH subscriptions have led to a rapid diffusion of IP telephony. Finally, flat- rate 3G cellular services allow high speed data transfers via cellular networks at comparatively low prices. In sum, the price-performance as well as the sheer performance of Japan’s landline and wireless broadband services is higher than most other places in the world. The implications of this high performance and low price are significant, because the possibilities for value-creation in an environment with a large installed base of consumers with high-speed broadband access in both landline and mobile platforms is likely to be different from that of an installed-base of low-speed access users.

It is not surprising that Japan deployed new broadband infrastructure at a rapid pace, especially once it identified itself as requiring catch-up, since channeling resources towards targeted infrastructure development has been considered one of Japan’s traditional institutional strengths.21 Nor is it particularly surprising that Japan deployed costly, but high-speed fiber optic infrastructure extensively, since high-cost and high-performance telecom has been the norm. What is surprising is that Japanese consumers enjoy the lowest prices worldwide for broadband, with cutting-edge services such as IP telephony being bundled with many broadband subscriptions at no additional cost.22 The question is whether a significant change in Japan’s institutional environment was responsible for this seeming shift towards a more consumer-oriented trajectory of development. High Speed, Flat-Rate Mobile

Third, we examine the development of Japan’s cellular services. If we look at typical indicators, we see that the number of cellular phone users increased, while prices

19 Documents from the OECD show that Japanese firms comprise eight of the ten services that have the lowest prices for basic monthly fees for flat-rate broadband services ranging in speed from 10Mbps to 100Mbps.20 Documents from the International Telecommunications Union places Japan as having the lowest prices per 100kbps of broadband connection. (“Information and Communications in Japan 2004” Ministry of Internal Affairs and Communications, p. 3.) 21 Vogel and Zysman (2002). Mark Tilton also points out that this is not surprising. See Tilton, Mark, “Neoliberal Capitalism in the Information Age: Japan and the Politics of Telecommunications Reform,” Japan Policy Research Institute, JPRI Working Paper No. 98, February, 2004.22 The Asia-Pacific Telecommunications Indictors 2004, published by the International Telecommunications Union, place Japan as having the lowers broadband subscriptions prices in the world as of July 2003, and put Japan as having the lowest cost per 100 kbit/s as a % of monthly income, and the MPT White Paper on Communications cites Japan as having the lowest absolute cost for 100kbit/s of data. See ITU, "Asia-Pacific Telecommunications Indicators 2004," (International Telecommunications Union, 2004).; “White Paper: Information and Communications in Japan 2003” Ministry of Public Management, Home Affairs, Posts and Telecommunications White Paper, 2003. The Ministry claims that by the end of 2001, 95% of the critical areas (defined as metropolitan areas and cities the size of prefecture capitals) were covered by FTTH, a national average coverage of 59%, up from 10 percent in 1994, and 54% of all cities with more than 100,000 people. (“Kanyushakei Hikari Faibaa mo no Setsubi Joukyou” Ministry of Internal Affairs and Communications. http://www.johotsusintokei.soumu.go.jp/field/data/gt3005.pdf last accessed on 12/1/2004)

became somewhat lower.23 However, these measures of the cellular market are clearly inadequate. They do not capture the explosive growth of cellular Internet services, the migration towards high-speed, third-generation (3G) services, or the low prices for 3G cellular Internet services. Again, Japan’s rapid deployment of 3G networks, which required massive spending on infrastructure is not surprising. However, flat-rate subscriptions for 3G cellular Internet services in a market with few competitors is not what we would have expected from Japan’s well-known producer-oriented development of the past. Explaining the Development of Japan’s Telecom Services

In sum, the core objective of this chapter is to explain the following developments in Japan’s telecommunications services: the innovation in cellular services; the low prices and high speeds of broadband; and the rapid deployment and low prices for 3G cellular Internet services.

Table2: Shifts in the Performance of Japan’s Telecom SectorIndicators Pre-2000 Post-2001 Not captured by the indicatorInternet usage Low High Internet via cellular Broadband Diffusion Low Growing High-speed Broadband (FTTH), IP

telephony, flat-rate 3G cellularPrices High Lowest High Price-performance of broadband

Cellular Diffusion Growing Slowing down Growth of cellular Internet, 3G

Prices High Slowly falling Flat-rate 3G cellular Internet services

Expectations: More Competition, More Entrants, and Fewer Rules?These questions lead to a few initial expectations about how the sector might have

changed to produce these developments. First, since the experience of areas such as Silicon Valley suggest that increased opportunities for new entrants into a sector can be conducive to innovation and dynamic markets, we might expect that new entrants played a large role in the business model innovations at the core of Japan’s cellular Internet services. Second, since, from a neoclassical economics perspective, increased competition should lead to lower prices and overall increases in consumer surplus, we might expect that an increase of competition in broadband led to the lower prices and bundled services. Third, we might reasonably expect that in a highly regulated sector such as telecom, deregulation was the cause of the increase in competition.

Findings: A Regime ShiftThe central finding of my analysis is that a regime shift is taking place in Japan’s

telecom sector, consisting of policy outcomes on the one hand, and market outcomes on the other. On the policy side, a set of core policies formulated by the state is reorganizing institutions and reshaping the regulatory environment in the sector, thereby altering incentives and constraints on firms, and how they coordinate with one another and the state. In terms of market outcomes, the new institutional and regulatory environment profoundly affected market dynamics, as various firms took advantage of the new environment to engage in activities that had been hitherto impossible. While the state did not micromanage market developments, and was indeed surprised by many developments in the sector, a

23 See OECD Telecommunications Database 2004.

significant portion of policies driving the regime shift were part of a deliberate push by the Japanese government to catch up in IT infrastructure.

In testing my three initial expectations, I found the following. First, the role of new entrants differed by subsector and function. They played a critical role in shaping Japan’s broadband services and creating commercially successful content for cellular Internet services, but not in creating the business model for the service itself. The innovative business model was developed in a pre-regime shift environment, dominated by large firms that took advantage of existing comparative institutional strengths and unintended consequences of industrial policies in wireless created the market environment. New entrants played a role in discovering value-added content that ended up popularizing cellular Internet services as a whole.

Second, increased market competition in broadband, notably DSL and Fiber-to-the Home, was largely responsible for Japan’s low broadband prices. However, the increase of competition was not caused by a full-fledged retreat of the state from the sector. A new regulatory environment built upon an increase of regulations created a new market environment resulting in new entrants, price wars, and IP telephony services bundled to many broadband subscriptions.

Third, in its deregulation, the state was selective about the actors over which it gave up control. It weakened control most over new entrants and foreign firms, maintained similar levels of control over cellular carriers via spectrum allocation, and actually strengthened control over the incumbent carrier, NTT. At the same time, the state was also selective in the markets it liberalized, using both deregulation and reregulation to foster increased competition in markets such as broadband, long distance, and international services, doing much less in markets such as local telephony and cellular services. Implications for Japan’s Comparative Institutional Advantage

The main implication of these findings on the broader questions are as follows: the regime shift is altering the comparative institutional strengths and weaknesses of Japan’s ICT industry, but only in particular sub-sectors, and for particular functions.

In terms of sub-sectors, Japan has a new advantage in experimenting with creating value from services that rely on high-speed cellular Internet and broadband networks, and high levels of IP telephony penetration to households. At the same time, Japan also maintains much of its traditional comparative institutional advantage in manufacturing equipment. However, Japan’s institutional weakness continues to be in the political bargains reached to deal with NTT – dealing with incumbent carriers is a difficult issue everywhere, but in Japan, the problem is exacerbated by NTT’s size and political clout.

In terms of functions, Japan is gaining a greater ability to finance new ventures via equity markets, breed entrepreneurs, and promote competition, but more in some subsectors such as broadband and cellular Internet services than others. At the same time, it continues to enjoy capabilities to forge labor-management cooperation, provide stable finance via the banking system, train engineer, manage competition, and achieve incremental improvements in production, but in a different set of sub-sectors – mainly equipment manufacturing, cellular carriers, and R&D undertaken by NTT and its subsidiaries. Integration into Global Market on New Terms: The Changing Function of Japan’s Domestic Markets in International Competition

Japan’s shift of comparative institutional advantage is significant in international competition because its domestic market is being integrated into global markets in new

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ways. As part of the regime shift, the state’s strategic selection of cellular standards and its deregulation of FDI have begun to alter the function of Japan’s domestic market in international competition. Japan’s domestic market is shifting away from simply being a platform for exports protected from foreign capital penetration. Foreign firms have begun to: derive short-term profits through M&A activity; gain expertise on services offered in Japan to transfer elsewhere; attempt to harness Japanese equipment manufacturing prowess in to their advantage by offering broader international markets. Japanese firms have begun to: strategize about re-enter global markets without the lead of NTT; strategically realign production capacities to this end; and add value to existing strengths in production that can lead to exports.

In sum, Japan’s domestic telecom regime is shifting as it adapts to the new technological paradigm of IP and Internet-related technologies, alternating Japan’s comparative institutional advantages in some functions and subsectors, which is becoming significant in international competition as Japan’s domestic market is integrated into global markets on new terms.

This chapter proceeds as follows. First, I present a set of variables that can be traced over time to understand how Japan’s domestic telecom regime has shifted. Second, I analyze the core policies driving the regime shift, followed by the market outcomes. Finally, I conclude by pointing to new policies directions proposed by the government, and the implications of this regime shift on scholarly understanding of the fit between technological paradigms and sectoral institutional configurations.

A Model of Regimes – Operationalizing Institutional Change: To understand developments in the telecom sector, we need to systematically

examine characteristics of the sector which determine how sector functions. I propose to trace a set of variables over time, which include the primary government and industry actors, how they relate to one another, and the source of standard-setting. Taken together, I label this set of variables as a telecommunications regime.

Japan has had at least three distinct telecom regimes since the inception of the sector.

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THE REGIMES Regime 1: “Bureaucratic Monopoly” Regime 2:

“Controlled Competition” (1985- mid/late 1990s)

Regime 3“Limited Liberalization and Strategic Integration”(mid/late 1990s – present)

(late 1800s to 1954) (1954 – 1985)

Gov’t Actors Ministry of Communications (MoC), which became NTT

Nippon Telegraph and Telephone Public Company, (State-owned monopoly), National Diet, MPT

Ministry of Posts and Telecommunications (MPT)

MPT* (MPHPT from 1999), Cabinet Office, Dispute Resolution Commission, FTC (Fair Trade Commission), possibly Judicial system

Industry Actors

MoC, cartel of OEM equipment manufacturers (NEC, Hitachi, Fujitsu, Oki Electric)

NTT, KDD, NTT “family” equipment manufacturers (NEC, Hitachi, Fujitsu, Oki Electric)

NTT, New Common Carriers (NCCs), NTT “family” firms

NTT, NCCs, startup firms (eg. Softbank), NTT “family,” firms, non-family equipment manufacturers, foreign firms (eg Vodafone)

Gov’t Industry Interactions

Government ministry (MOC) directly operates communications industry, equipment procured as OEM

Formal oversight by MPT and Diet, but actual control rests mostly with NTT

MPT wields classic “Industrial Policy” tools (Licensing authority, discretionary administrative guidance, etc), MPT interprets law and mediates conflict between carriers.

Increased legalization of rules. FTC, judicial system play larger role in enforcement. New formal institution for dispute resolution between firms.

Intra-Industry Interactions

Equipment manufacturers competing on the basis of quality for volume of OEM work.

Same as before. NTT providing large procurement demand.

NTT dominates competitors with interconnection rates. Actions of NCCs carefully controlled by MPT. NTT provides stable demand for equipment manufacturers; not all on OEM basis, but advantages to NTT “family” firms. Standards force NCCs to procure equipment from NTT “family”.

NTT has less control over interconnection rates. NCCs no longer tightly controlled by MPT. Shift to non-NTT standards allow NCCs to procure equipment from outside NTT “family.” New dynamics such as price wars, legal battles, use of Dispute Resolution Commission, and complaints to the FTC.

Standard-setting

MoC NTT (nominally MPT) NTT, MPT De facto (eg., Cisco’s routers), MPT, IETF, ITU

* The Ministry of Posts and Telecommunications (Yuseisho) was reorganized in the reshuffling of Ministries in 1999 to create Soumusho. Soumusho initially had the English name Ministry of Public Management, Home Affairs, Posts and Telecommunications (MPHPT), renamed in 2004 to the Ministry of Internal Affairs and Communications (MIC)

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The Previous Regime: “Controlled Competition” (1985 - mid/late 1990s)Japan’s telecom regime from 1985 until the late 1990s is best characterized as

“controlled competition.”24 The Ministry of Posts and Telecommunications (MPT) exercised strong bureaucratic control over an essentially closed, isolated domestic market dominated by the partially privatized former monopoly, NTT. Japan’s decline in international competitiveness of telecom equipment, as well as the business model innovations leading to cellular Internet services, occurred during this regime.

Institutions in this regime were optimized for channeling investment and R&D into particular technologies and networks, managing competition, limiting foreign control of the sector, and implementing hardware benefiting from incremental improvement in manufacturing.25 As Cole’s argument in the previous chapter shows, this regime was not optimized for discontinuous technological change, fostering entrepreneurship and market-entry, and the moves of NTT led the sector’s technology and strategy choices.

The Present Regime: “Selective Liberalization and Strategic Integration.”Since the late 1990s, the government gave up much of its control over the sector,

but in select areas over particular types of actors. It increased its regulations over NTT, maintained much of its control over the wireless sub-sector via spectrum allocation, but deregulated most other competitors and sub-sectors. The domestic market is no longer as closed or isolated. We will examine new institutional strengths and continuing strengths and weaknesses of this new regime in subsequent sections.

The Regime Shift – Causes and Dynamics Institutional changeThe dynamics driving the regime shift were essentially as follows: exogenous forces

of technological change altered the incentives, constraints, and motivations of government and corporate actors. State policies created a new regulatory environment which reshaped the incentives and constraints of firms, whose actions then informed further policy reform. Forces for Change

At the most basic level, incentives and constraints of firms and government actors were affected by the discontinuous technologies surrounding the Internet. These developments were part of the broader shift of fundamental characteristics in design (modular architecture), production (cross-national production networks), and competition (over any segment of the value chain, not just final assembly) from the era of lean production and flexible specialization to the digital, or “Wintelist” era.26 Corporate Motivations

Japanese corporations were forced to adjust their strategies, since the new technology with modular architecture and competitiveness based on software did not play to their strengths. As Cole illustrates, Japanese equipment firms followed NTT’s lead in

24 A term used by Steven Vogel in his analysis of liberalization of several sectors in several countries, which includes telecom in Japan. See Steven K. Vogel, Freer Markets, More Rules: Regulatory Reform in Advanced Industrial Countries (Ithaca, NY: Cornell University Press, 1996).25 See Marie Anchordoguy, "Nippon Telegraph and Telephone Company (Ntt) and the Building of a Telecommunications Industry in Japan," Business History Review, no. 75, Autumn (2001).Vogel 1996, Chalmers Johnson, "Miti, Mpt, and the Telecom Wars: How Japan Makes Policy in High Technology," in Politics and Productivity: How Japan's Developmental Strategy Works, ed. Chalmers Johnson, Laura Tyson, John Zysman (Harper Business, 1989).26 See Introduction to this volume, Borrus and Zysman (1997), Cohen, DeLong, and Zysman (2000).

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technology and standard-setting, and were therefore unable to adapt quickly enough to ride the popularity of the Ethernet and IP-switched networks. Cisco, Jupiter, and other American startup firms enjoyed first-mover advantages in international markets and at home. As the stable demand provided by NTT dropped off after 2000, the Japanese equipment firms realized the need to formulate competitive strategies that differentiated them from one another and allowed them to compete on international markets.27

The discontinuous technologies also provided new opportunities for start-up firms and other firms to enter the sector. Ownership of extensive physical networks was not necessary for new Internet Service Providers or DSL service providers. 28

Government MotivationsThe perceived value of the Internet shifted national performance indicators for

telecom, creating bureaucratic and political incentives to promote policies to facilitate broadband and Internet penetration.

Japan had never been known to be a leader in low-priced telephony, but the high reliability and performance of its telephony network was unquestioned. However, once indicators such as Internet penetration, broadband availability, and the proportion of businesses utilizing IT networks became popular measures for assessing the level of development in telecom, Japan found itself far behind the US, many parts of Europe, and notably, South Korea.29

The situation Japan found itself in gave rise to political and bureaucratic concerns about Japan’s future trajectory of development – especially as the country’s overall economic performance continued to languish throughout the 1990s. In addition to concerns over national development, politicians and bureaucrats found new politically and institutionally self-serving opportunities. Political initiatives to promote catch-up in IT could not be unpopular with the public, and regional developmental plans also had the allure of serving pork-barrel interests. Bureaucracies faced a chance to expand their jurisdiction to new areas. Thus, for both political and bureaucratic actors, a perceived need to catch up in IT could be leveraged to drive their own agendas.

InteractionsThe interaction of firm-level actors and government actors was iterative, to a

degree, since policies at the core of the regime shift occurred over several years. New policies, at time strategic attempts by the state to affect markets, provided the environment in which corporate strategies were formulated, and market outcomes, at times surprising to the state, affected subsequent policies to a degree. These new policies then further shaped corporate strategies.30

27 For an account of the drop in demand for routers and switches, and how NTT’s investment plans have sustained the market, see "Kokunai Nettowaku Kiki Shijou 2003-2004nen: Ip Denwa, Musen Lan No Kyuushin De Zennen Nami Kakuho," Nikkei Communications, December 22 2003. 28 The number of firms registered to provide telecommunications services without ownership of infrastructure, categorized as General Type II carriers by the government until 2003, increased from 529 in 1988 to 10,442 in 2002. Many of these were startup firms providing services as ISPs, 7527 in 2002. (MIC documents.)29 For example, see OECD (2001) 30 The conception behind this model of institutional change is derived from Steven Vogel’s work on institutional change in Japan. See Steven K. Vogel, "The Re-Organizaiton of Organized Capitalism: How the German and Japanese Models Are Shaping Their Own Transformations," in The End of Diversity? Prospects for German and Japanese Capitalism, ed. Kozo Yamamura, and Wolfgang Streeck (Ithaca, NY: Cornell University Press, 2003).

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Diagram: the process of regime change

Analyzing the Regime Shift and the Resulting Market DynamicsThe regime shift affected the landline and wireless sub-sectors in different ways,

largely due to differences in the characteristics of technology involved, the policy opportunities arising from those differences, and the market dynamics emerging from those policies. I will therefore analytically separate the two sub-sectors, although the shifts occurred simultaneously. For landline, I first examine the policy outcomes comprising the core of the regime shift, followed by an analysis of how the market dynamics played out, allowing us to explain our initial observations. For wireless, I first show how the business model innovations for cellular Internet services occurred during the “controlled competition” regime before the regime shift. Then, I show policies at the core of the regime shift, followed by an analysis of how market dynamics played out. This analytical approach makes the analysis of each sub-sector more coherent, but it is somewhat awkward in capturing the interaction that occurred between the sub-sectors.

The Regime Shift in Landline: Policies Policies aimed at liberalization, and the process in formulating those policies,

altered several fundamental aspects of the “controlled competition” regime. Changes included: government actors involved in policymaking; the formal and informal mechanisms available for government-industry and intra-industry coordination; new incentives and the removal of constraints for new entrants and foreign firms to enter the sector.

Liberalization policies came in two waves – deregulation of the activities of firms other than NTT in the late 1990s, and the reregulation, mainly of NTT and targeted at broadband markets, in the early 2000s. 31 The latter was a conscious effort by the government to improve Japan’s level of Internet diffusion and broadband infrastructure. The government took cues from actions by Japanese firms and developments abroad.

31 I follow the in steps of Vogel (1996) in unpacking liberalization in to the components of deregulation and reregulation – reregulation being the act of increasing regulations to facilitate the function of markets.

Discontinuous Technology

Government Actors

Firm-level actors

New constraints/ incentives

Shaping environment Altering incentives and constraints

Policies and actions at the core of the regime shift

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Chart: Principal Policies and government actions at the core of the regime shift, and their effects on regime variables

Deregulation Reregulation Regime Variables Affected1997 Foreign ownership of Type I

carriers deregulated, result of 1997 WTO Telecom Agreement

Obligation for interconnection by Type I carriers, equal access as NTT

Industry Actors (A), Intra-Industry Coordination (I-I)

Formula for interconnection fees established (shifted again in 2000)

Government-Industry Coordination (G-I), Intra-Industry coordination (I-I)

1998 Entry, Pricing, Compartmentalization deregulated

G-I

2000 Collocation rules, specifying technical conditions and interconnection fees

G-I, I-I

NTT required to lease its unused fiber optic capacity

I-I

IT Basic Law promulgated by Cabinet Office

Government Actors (G)

2001 Dispute Resolution Commission established

G, G-I

2002 MPT assigned telephone number prefix to IP phones, allocated to carriers

2003 Classification, Registration, Notification requirements abolished

G-I

Deregulation A series of deregulations dismantled much of the policy apparatus MPT had used to

control the sector and keep it closed from FDI during the “controlled competition” regime. Tools for Micromanagement in the Controlled Competition RegimeMPT had managed competition by compartmentalizing and micromanaging firms

offering landline services. From the late 1990s, it began giving up these tools of control over almost all carriers except NTT. As a result, MPT was no longer at the nexus of information exchange, and was no longer in a position to exercise as much informal control.

MPT had compartmentalized competition in two ways. First, it had categorized telecom carriers into Type I, General Type II, and Special Type II carriers according to the ownership of infrastructure and regional breadth of service. Type I carriers owned infrastructure and consisted of NTT and the NCCs. Type II carriers provided value added services by leasing facilities from Type I carriers. Providers of private lines (mostly for corporate use) and Internet Service Providers were Type II carriers. Special Type II carriers could provide services to a broad area – usually more than one prefecture – while General Type II carriers limited their operations to local areas.

MPT controlled market entry, exit, and prices charged by Type I carriers. A “Supply Demand Adjustment Clause” in the Telecommunications Business Law gave MPT wide discretion over the market entry of firms. This clause allowed MPT to cite factors

15

such as “a mismatch between the business and existing demand in the proposed region of operation…” to deny an application, without needing to cite any specific criteria.32 Likewise, there were no specific criteria existed for MPT to approve price changes, allowing them broad discretion.

Despite MPT’s original intent to regulate Type I carriers that owned facilities while allowing competition to flourish between Type II carriers, by the mid-1990s observers began complaining about the rigidity of the regulations. Type II firms could not own any infrastructure at all, even if they wished to add a small amount of infrastructure to better serve congested areas. In a similar vein, Type I firms attempting to augment weaknesses in their infrastructure were prohibited from borrowing any circuits or lines.33

The second way that MPT compartmentalized competition was by dividing the scope of business activities into long distance, local, and international service. There was no explicit legal basis for this division, but in the application form for carrier businesses, MPT created a “business area” category that needed to be filled in. This led to an unwritten understanding that carriers were not to cross business lines – for example, NCCs engaging in long distance service were not to move into international service, and vice versa.34

Deregulating the Tools for Micromanagement A sweeping set of policies deregulated both forms of compartmentalization and

control. The impetus for deregulation was at least in part from a political initiative. In March 1998, the Cabinet passed a “Three year plan for deregulation” which encompassed several industries, including telecom. This overarching political support made it easier for MPT to push through its deregulation measures.35

In 1998, MPT made several changes to the Telecommunications Business Law. It relinquished control over entry into the sector by removing the “Supply Demand Adjustment Clause,” and they gave up control over price changes by Type I carriers. MPT also de-compartmentalized the competition. First, it allowed Type I carriers to lease lines, and permitted Type II carriers to own infrastructure.36 At the same time, it de-compartmentalized long distance and international services by issuing a written statement to the effect that such a division did not exist. The fact that several firms immediately crossed these business lines, which had not been crossed before, reinforces the contention that the division had existed as an established norm, and had been enforced by MPT on an informal basis.37

32 Hidenori Fuke, Joho Tsushin Sangyo No Kozo to Kisei Kanwa: Nchibeiei Hikaku Kenkyuu. (Structural Change and Deregulation in the Telecommunications Industry) (Tokyo: NTT Shuppan, 2000). p.62. When IDC, partly owned by Cable & Wireless of the United Kingdom, tried to apply for an international communications license in 1987, MPT thought that a third international carrier in addition to the former monopoly, KDD, and ITJ, a Japanese consortium, would create excess capacity. MPT attempted to deny IDC from obtaining a license, encouraging IDC to merge with ITJ. This became an international diplomatic issue, and the US Reagan administration used it as evidence of non-tariff barriers to foreign entry, in US-Japan trade disputes. (Fuke (2000) 15, “Nakasone's Letter May Open The Door A Little Wider For C&W” Telecom Markets, April 7, 1987.) However, an MPT official interviewed by Vogel argued that MPT was not opposed to competition, placing blame on the private sector (KDD and others) for opposition. The official expressed the view that MPT should be thanked since they forced the private sector to accept the entry of IDC. (Vogel 1996 p.163)33 Fuke (2000:32)34 Fuke (2000:31)35 Informal conversations with Ministry officials also favor this interpretation. 36 Fuke (2000:41)

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Changing Coordination – Removing the Ministry from the Nexus of Information Exchange

In 2003, MPT (renamed MPHPT at this time) removed itself from the center of information flows through further deregulation, which abolished the categories of Type I and Type II carriers altogether. Until then, the ministry had enjoyed a nuanced understanding of corporate activities in the sector because ministry officials had long lines of firms waiting to see them and confer about their business plans, planned price changes, and even about how to fill out forms for notification.38 Observers of industrial policy have long noted that application forms and registration requirements facilitated the dense information exchanges between the lead ministry and firms in its jurisdiction, providng an avenue to incorporate the bureaucracies into a greater network of corporate, political, and bureaucratic actors.39

By the summer of 2004, a ministry official noted that MPHPT no longer had any information about how many carriers existed, since they stopped keeping track of the number of carriers that spring. He joked that they only knew if particular carriers had gone out of business if the ministry found that their phones had been disconnected.40 Thus, after deregulation, MPT was no longer at the nexus of information exchange as it had been before.

Scope of Activity Type of Approval Required After 1998 Deregulation

Categories Abolished in 2003.

Entry Prices Exit Entry PricesType I Services owning own

facilitiesPermit Approval Permit Notify Notify

Special Type II

Leasing facilities to provide value added network services (VAN), providing services to a wide area

Registration

Notify Notify Notify Notify

General Type II

Leasing lines to provide value added network services (VAN), providing services to a regional area

Notify - Notify Notify Notify

(Fuke 14, Vogel 1996 149)

37 Examples of this include a merger between Japan Telecom (domestic) and ITJ (international), KDD’s (international) foray into domestic service, and several NCCs that had specialized in long distance being local services. Fuke (2000:81)38 Sakamaki, Masaaki. Director, Computer Communications Division, MIC, Personal interview conducted with S. Vogel, July 14, 2004. 39 For example, see Chalmers Johnson, Miti and the Japanese Miracle: The Growth of Industrial Policy, 1925-1975 (Stanford, CA: Stanford University Press, 1982).; Richard Samuels, The Business of the Japanese State: Energy Markets in Comparative and Historical Perspective (Ithaca, NY: Cornell University Press, 1987).; Daniel I. Okimoto, Between Miti and the Market: Japanese Industrial Policy for High Technology (Stanford: Stanford University Press, 1989).40 Sakamaki Masaaki, Director, Computer Communications Division, MIC, Personal interview conducted with S. Vogel, July 14, 2004.

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Deregulating FDIDuring the “controlled competition” regime, overt legal restrictions on FDI kept

Japan’s domestic telecom sector essentially closed from any significant foreign presence. Deregulation of FDI shifted the position of Japan’s domestic sector away from a protected platform for exports.

Until 1997, the Telecommunications Business Law stipulated an upper limit of one- third equity ownership of Type I carriers by foreign entities.41 There were no restrictions with respect to Type II carriers. Any foreign ownership of NTT and KDD was prohibited until 1992, when a maximum limit of twenty percent was established. Thus, in the “controlled competition” regime, Japan’s domestic telecom infrastructure was securely in Japanese hands.

In 1997, Japan deregulated control over FDI as it entered into WTO Basic Telecom Agreement. In this agreement, all FDI restrictions on Type I carriers were removed except those on NTT and KDD. In 1998, KDD was completely privatized with the abolition of the KDD Law, effectively removing the restrictions on its ownership. Except for the infrastructure owned by NTT, foreign entities were now free to own Japanese telecom infrastructure.

ReregulationThe strategic re-regulation of NTT’s activities by multiple government agencies

created and sustained new markets for broadband services.42 Interconnection and collocation rules altered the incentives and constraints for new entrants and existing competitors to connect to NTT’s local loop and offer broadband services.

Interconnection: PricingIn the late 1990s, the government created interconnection rules for firms to connect

to NTT’s infrastructure. At the same time, it adopted formulas for NTT’s interconnection fees. These two policies removed much of the market uncertainty for telecom services requiring access to NTT’s infrastructure.

Until then, there were few regulations in Japan governing the interconnection of NCCs to NTT’s last-one-mile infrastructure. MPT enjoyed wide discretion in determining interconnection rules and prices via administrative guidance.43 There were two main issues at stake: Point of Interface (POI) and pricing.

POI refers to the level of the incumbent’s network, such as regional, prefectural, and national, that competitors connect to. Initially, there were essentially no regulations governing how NTT arranged POI contracts with NCCs. Competitors wanted NTT to charge end-to-end fees so they could duplicate the least costly national infrastructure and connect only to the most lucrative prefectures.44 NTT, on the other hand, wanted to charge NCCs according to the level of the POI they connected to. In 1991, MPT stepped in to 41 The law gave MPT the authority to intervene extensively in the operations of violators. (Fuke 2000:16)42 Karl Polanyi is perhaps most eloquent in pointing out that sustained government intervention is required to create and maintain competitive markets. The implication is that competitive markets and government intervention are not necessarily always in a zero-sum relationship – more government intervention can actually increase competition. Telecommunications is one of the industries where this is most apparent, since incumbent carriers tend to own nation-wide last-one-mile infrastructure that competitors must utilize. Rules allowing competitors access, and specification regarding the terms at which they can access the incumbent’s infrastructure clearly shapes the level and nature of competition. See Planyi (1944) 43 Fuke (2000:20)44 This strategy is known as cream-skimming.

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restrict POIs to one per prefecture for each NCC, creating a competitive structure that increased competition between prefectures, but retained NTT’s monopoly within each prefecture. In 1993, MPT promulgated regulations forcing NTT to charge NCCs on an end-to-end basis.45

However, in the absence of rules governing the interconnection fees charged by NTT, bitter contentions between NTT and the NCCs occurred whenever fees were revalued – every NTT budget cycle. In such confrontations, the only recourse available to NCCs was to appeal to MPT. The Telecommunications Business Law stipulated that when carriers could not reach an agreement, the complainant could appeal, and MPT could issue an order for the carriers to reach an agreement or engage in arbitration. This allowed MPT to exercise discretion and carefully weigh the effect of every price change on competition.46 Thus, for 10 years, from 1985 until 1996, NTT and the NCCs repeated a pattern of intense contention and appeals to MPT, followed by a compromise.

In 1996 the Telecommunications Deliberation Council issued a report on interconnection rules, recommending that MPT create clear rules for interconnection and a formula to calculate appropriate fees that NTT should charge. 47 In June 1997, MPT revised the Telecommunications Business Law and did just that. Type I carriers became obliged to connect to competitors when requested, and these competitors had the right to choose the level of network (such as prefectural or local) at which to interconnect.48 The rules stipulated that NTT had to allow competitors access to its local telecommunications facilities at the same conditions, including price, as NTT’s own long distance department.49 In the same reform, MPT introduced a formula to calculate interconnection fees for the first time. In 2000, this formula was shifted to one that further favored competitors.50

These new policies, which were effectively an increase of government regulation, set up a competitive environment in Japan’s telecommunications industry that shifted the balance of power in industry from NTT towards competitors. It would seem that these measures were a coherent set of reform policies spearheaded by MPT, given political support along the way.

Collocation: New Institutional Involvement and New Rules to Foster DSL Markets Multiple government actors were involved in a series of policies and administrative

guidance measures to impose regulations on NTT to facilitate collocation – the placement of DSL equipment by competitors into NTT’s infrastructure facilities.

DSL technology, by its nature, requires a set of rules for collocation in addition to interconnection rights and pricing for competitive markets to thrive. With DSL, a high frequency signal is sent through existing copper lines on top of POTS signals. This requires equipment to be installed on both the user’s end and in the incumbent carrier’s local switching station. Of course, the incumbent has every incentive to deny DSL providers’

45 Fuke (2000) 20, 3546 Vogel (1996) 16447 The Telecommunications Deliberation Council referred to here is the Denki Tsushin Shingikai – renamed Joho Tsushin Shingikai after MPT became MPHPT in 199948 Fuke (2000) 43, 4549 The long distance department became NTT Communications in 1999, after NTT was reorganized into a holding company. (Fuke 2003:177)50 Fuke (2003) 177

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access to its facilities in the absence of rules forcing it to, especially if the incumbent provides DSL services of its own.

In Japan, although the 1997 reforms established new rules for interconnection and fees, rules for collocation were not set – it remained unregulated territory. This was a significant factor hindering NTT’s competitors from introducing DSL. By 1998, DSL had spread rapidly in many OECD countries, while in Japan it did not exist yet. Tokyo Metallic, a startup firm, decided to bring DSL to Japan, commencing DSL services in 1999. However, in the absence of clear collocation rules, it should not come as a surprise that NTT gave them a hard time. When Tokyo Metallic, as well as another DSL startup, eAccess, asked if there was space within particular NTT facilities for them to install DSL equipment, NTT took five to nine months to investigate and reply. NTT also set high prices for the startups to place equipment within their facilities without providing any information on how those figures were derived.51 Even after the equipment was installed, NTT took over three weeks to connect the lines of DSL users that Tokyo Metallic had acquired.52

Overall, the complaints lodged against NTT consisted of: NTT refusing to disclose whether lines were available for use, limiting the equipment installation work within facilities to NTT group firms, high prices, and discrimination between NTT firms and competitors in allowing access to its infrastructure.53 This is not surprising behavior for an incumbent.

Beginning in 2000, several government actors new to telecom policymaking became involved in facilitating the rapid deployment of broadband. In October 2000, the Fair Trade Commission of Japan took an unexpectedly strong stance by entering the telecom policymaking arena in response to NTT’s bullying of DSL service providers. The FTC investigated NTT on antitrust grounds – the first time the FTC had investigated a former public enterprise, let alone NTT.54 It was interesting that the FTC’s actions were more an indicator than punishment. The lack of specific rules over collocation only allowed the FTC to issue a warning, but this administrative guidance was clearly sending the message to NTT and the market that even if MPT did not or could not act against NTT, the lack of explicit legal violations would not deter the FTC from bringing the issue into the public spotlight.

Also in October of 2000, MPT (by then, MPHPT) revised several of its Ministerial Ordinances to facilitate collocation and line-sharing.55 NTT was required to clarify the conditions under which it offered collocation, including the technical conditions and interconnection fees. 56 Perhaps the most significant provision in the new ministerial

51 The Nikkei Shimbun cites the amount charged by NTT to be around 5 million yen, roughly 45 thousand dollars at 1USD = 110 yen. “Kotori, NTT wo chosa, Kosokutsushin Senryaku misu ustsusu: shinki sannyu gyosha to toraburu.” Nikkei Shimbun Oct 24, 2000, p.352 ibid.53 “NTT Higashi Nihon, Kotorii ga keikoku: yuseishou, raishun nimo tsushin kaihou he gutaisaku.” Nikkei Shimbun 12/21/2000 p. 554 ibid.55 explain Ministerial Ordinances as weaker than full-fledged laws, but more than simple orders…the Ordinances included the “Regulations for Enforcement of the Telecommunications Business Law” and “Regulations for Cost Calculation for the Interconnection Charges of Designated Telecommunications Facilities’ “ (Fuke 2003, 179)56 ITU, "Promoting Broadband: The Case of Japan," (International Telecommunications Union, 2003).28, 29

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ordinances, as we will see later, was the requirement that NTT lease its unused fiber optic capacity to carriers wishing to use them.57

In 2000 as well, the Cabinet Office explicitly involved itself as a player in IT policy. In July of that year, it established an “IT Strategy Headquarters” within the Cabinet Office, passing a new IT Law, the “Basic IT Law on the Formation of an Advanced Information and Telecommuncations Network Society (The IT Basic Law)” in November. This law benefited MPT in implementing competition-oriented connection policies because it left specifics to be determined by ministerial ordinances. 58

The Basic IT law was under the rubric of what the Cabinet Office dubbed the “e-Japan strategy.” As Tilton points out, the e-Japan strategy laid out its objectives in typical industrial policy terms, starting with the premise that Japan needed to catch up.59 First, the e-Japan strategy identified Japan as being behind in the development of information technology, specifying policy goals as “an ultra high-speed network infrastructure and competition policies.” It even gave a timeline, vowing to establish “one of the world's most advanced Internet networks within five years,” with a short-term goal to “enable all the people to have constant access to the Internet at extremely low rates within one year through the use of fixed-line, wireless and other kinds of networks by promptly taking every necessary measure.”60

Participants have noted that one should not think of the political leadership as having come first or initiated the reforms.61 The bureaucracies had already begun moving in the direction towards facilitating broadband when politicians took notice. Cole, among others, have suggested that one probable motivation for the e-Japan strategy was South Korea’s e-Korea strategy, which led South Korea to having the most extensive broadband penetration as a proportion of the population worldwide.62

A pork-barrel political agenda behind the sudden political initiative is also not out of the question. Yoshiro Mori, Prime Minister at the time, was a former college rugby player, not renowned for his technologically savvy demeanor, and ranked as one of the least popular prime ministers in Japan’s history.63 It may be more than coincidence that his Cabinet identified high speed IT infrastructure deployment as a policy goal, just when the public was loudly criticizing the government’s extensive traditional pork-barreling in the form of public works spending in sectors such as construction. In fact, during the summer of 2000, the Ministry of Construction had shown a keen interest in investigating the possibility of installing fiber optic cables in sewer systems. This predictably drew criticism from the Minister of MPHPT who argued that the MoC should not stick its head into his

57 See “Rules for Interconnection Charges (Ministerial Ordinance of MPT No. 64 of 2000)” MIC, <http://www.soumu.go.jp/joho_tsusin/eng/laws_dt03.html> . 58 "Juten Go Bunya No Kyoka: It Senryaku Honbu.," Nikkei Communications, July 1 2002. 59 Tilton uses the word “industrial policy” with implicit references to the “developmental state.” See Tilton (2004)60 See "Tsushin Kanren Hoan Ga Kakugi Kettei, Ntt "Kanshou" Ni Shikaku," Nikkei Shimbun, July 7 2001. Also, see http://www.kantei.go.jp/foreign/policy/it/enkaku_e.html for the website of the IT Strategic Headquarters, last accessed 1/29/2005. 61 Yamakawa, Takashi, NTT Docomo Mobile Society Research Institute, Personal Conversation, July 2004. 62 ITU (2004)63 A Mainichi poll found his popularity to be less than 9 percent in 2001, immediately before he was replaced by Junichiro Koizumi, who initially enjoyed an 85 percent approval rate – the highest approval rate ever. "Voters Give Record Show of Support for Koizumi Cabinet," Mainichi Daily News, April 29 2001.

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jurisdiction.64 It is also worthwhile to note that a plethora of local IT infrastructure projects sprang up all over Japan, several in regions with questionable levels of expected demand. Many plans seemed to be aimed at securing central government funding earmarked for IT infrastructure projects rather than serving the demands for high speed broadband access in areas with shrinking, aging populations.65

The Dispute Resolution Commission: New Means of Inter-firm CoordinationIn 2001, MPHPT set up a new institution, the Dispute Resolution Commission, to

handle disputes between carriers. By doing so, the ministry formally removed itself from being the mediator in conflicts between carriers, shifting responsibility to what it called an objective third party. Although the Dispute Resolution Commission was an organization within MPHPT, the decision-making process was much more open than the bargained settlements that the ministry had previously orchestrated. In its early cases, the Commission addressed several problems brought to it by DSL service providers Tokyo Metallic and eAccess against NTT, ruling in their favor.66

Finally, in an example where firms’ actions led to policy changes in favor of them, E-Access and ACCA Networks, among others, began selling ADSL on a wholesale basis in 2000, allowing ISPs without circuits to offer DSL services. Largely in response, MPHPT amended the Telecom Business Law in 2001 to include the concept of wholesale businesses.67

Thus, by 2001, the regime shift had substantially altered the opportunities and constraints facing firms in the sector when compared to around 1996. In 1996, carriers were compartmentalized and regulated on the one hand, while the lack of regulation in interconnection and collocation left them vulnerable to bullying by NTT. By 2001, carriers were free to enter or exit the market, foreign firms could directly enter the sector or buy existing carriers, and competitors had a set of rules about interconnection and collocation to formulate business plans upon, and they could expect the FTC to enforce the rules if NTT did not comply.

64 “Ministers in Japan disagree over IT strategy” Financial Times. Aug 2, 2000. p.1165 An example is in Awaji, with a population of approximately 7000 people in around 2600 households. The local government commissioned a major regional ISP to install ADSL in the town, and was required to provide service for all residents. (ITU 2000:32-34) Given the centralized fiscal structure of the Japanese government, it is highly likely that this town was receiving substantial support from the central government in this plan. 66 See annual reports of Telecommunications Business Dispute Resolution Commission, available on MIC website, <http://www.soumu.go.jp/hunso/english/index.html> 67 ITU (2003) 29, 30

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The Regime Shift in Landline: Market OutcomesMarket outcomes from the policy changes further altered regime variables. Changes

include: industry actors, as new entrants and foreign firms entered the market; government-industry coordination, as a coalition of firms sued MIC for the first time; and intra-industry interaction, as startup firms launched full-scale price wars. Our initial observations of low prices in broadband and high-speed networks were a product of these market outcomes. As we initially expected, increased levels of competition from new entrants did indeed lead to low prices in broadband. However, the explanation for Japan having the lowest prices per 100Kbps of broadband transmission, and Japan’s high price-performance of broadband networks is more complex.

Low prices in DSL were clearly a result of competition unleashed by the new regulatory environment, but Japan’s high price-performance in broadband is largely due to the widespread availability of low priced Fiber-To-The-Home subscriptions. It turns out that on the one hand, the infrastructure buildout for high-speed broadband delivered through Fiber-To-The-Home was the result of industrial policy in the old regime, which altered market incentives to facilitate firms constructing infrastructure. On the other hand, low consumer prices for high-speed FTTH subscriptions were the result of the market dynamics unleashed in the DSL market.

Finally, market developments following the liberalization of FDI fundamentally altered the role of Japan’s domestic market in international competition.

New Market Dynamics in DSL and the Softbank ShockSoftbank, a startup firm, though close to two decades older and less specialized than

Tokyo Metallic, took advantage of the new regulatory environment furthest.68 Most observers would agree that it contributed most to shaping the competitive dynamics in Japan’s broadband market, driving prices down to the lowest levels worldwide. Softbank also played a key role in popularizing IP telephony by bundling IP phone subscriptions with its DSL services.

Softbank was founded and headed by Son Masayoshi, a Korean raised in Japan who returned to Japan after attending UC Berkeley with a vision to do business at the forefront of the digital information transformation. He founded Softbank in 1981, and was notable for being one of the earliest investors in Yahoo. Softbank operated was outside any of the established Japanese corporate networks, Son became one of Japan’s favorite IT gurus during the IT bubble of the late 1990s. Even as the IT bubble collapsed, Son maintained that the objective of his firm was to add value by providing services possible only in a broadband networked environment. To this end, the Softbank holding company continues to engage in a wide range of businesses related to a networked environment, such as e-commerce, e-banking, et cetera. 69

Softbank BB, a fully-owned subsidiary of Softbank, took advantage of the new regulatory environment surrounding DSL to launch price wars. Softbank leased unused fiber optic capacity from NTT to construct a nationwide backbone that was completely based on IP – one of the first in the world, according to the company.70 When Softbank BB

68 Softbank was founded in 1981, Tokyo Metallic in 1999.69 Tabe, Koki, General Manager, Public Relations, Softbank corp. Interview with Steven Vogel, July 21, 2004. 70 Softbank Factbook 2004. Earlier networks such as that of Fusion Communications, commencing service in 2001, was only IP in the long distance portion of the backbone. “Seikatsu ga kawaru IT ga kaeru – raibaru ni

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launched an ADSL service called Yahoo! BB in September 2001, they set monthly subscription fees at approximately half of the market rate – about 2400 yen ($22 at 1 USD = 110 JPY) versus 5000 yen ($45). They also mobilized an aggressive sales force to pass out $100 DSL modems for free at train stations to people who signed up.

By 2001, when Softbank launched its price war, DSL was already growing in popularity. The new regulatory environment had led to a proliferation of DSL providers, and Japanese consumers were already familiar with “always-on” internet connections via their cell phones. Before DSL, the dominant modes of landline Internet access were via dial-up and ISDN, both of which incurred per-minute costs.71 The price shock that Softbank delivered caused other carriers to lower their prices, contributing to the explosive growth of DSL.

Thus, new entrants into the market, reacting to improved market opportunities provided by the liberalization policies, led to high levels of competition. The regulatory environment allowed firms to cheaply build their own infrastructure using mostly leased lines from NTT. Competition between firms without stakes in existing market positions in technologies such as ISDN, led to price wars sparked by Softbank. This dynamic led to Japan having the lowest broadband monthly subscription fees in the world.

FTTH: Remnants of Industrial Policy meets the New Regime The rapid growth of consumer Fiber-To-The-Home subscriptions at low prices was

a product of market dynamics created by the rapidly growing popularity of DSL that was sparked by the price wars. However, the infrastructure buildouts that preceded the introduction of commercial services were facilitated by industrial policy initiatives dating back from the early 1990s – well before the regime shift.

MPT and NTT had long set their sights on making Japan a leader in IT by installing fiber optic networks nationwide, as Cole points out in the previous chapter. NTT poured extensive resources into building fiber optic networks on a nationwide scale, rather than simply on the basis of expected returns. Even though its experience in building nationwide ISDN networks had proved financially disastrous, as Cole documents, NTT had a universal service obligation unlike its competitors.

When the discontinuous technology in the form of the IP revolution hit the sector, NTT’s plans were broadsided in two dimensions. First, as it had been accustomed to doing, NTT was preparing a proprietary service utilizing its fiber optic networks, which was rendered obsolete even before it was completed. NTT was planning to offer a service that combined voice, data, and video on fiber cables connected directly to homes. This service would have required an optical network unit on the end of the cable within households that would connect to telephones, PCs, and television sets. Unfortunately for NTT, the cost for these devices was prohibitive, especially in light of subscription and equipment prices for DSL.72

Second, and more importantly, NTT had reasonably assumed that all connections on the network would be circuit-switched. To this end, its planned proprietary service was designed to require direct connections for data transmission. When it became clear that IP networks utilizing routers rather than conventional circuits or ATM switches were the

okureruna, IP denwa (shin sangyo sosei)” Nikkei Sangyo Shimbun Dec 5, 2003, p.19. 71 ISDN was essentially just a faster dial-up service, though there were packages that did offer flat fees during midnight and early morning hours. 72 ITU (2003) 13, 14

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dominant technological paradigm, NTT found itself saddled with an incredible amount of excess fiber optic capacity. This was the dark fiber required by government policy for NTT to lease, utilized by Softbank and others in creating their own backbones for DSL.73

MPT began implementing incentives to promote investment in fiber networks in 1991.74 In classic industrial policy fashion, it mobilized the Japan Development Bank to provide special 15- year loans for carriers to build infrastructure, based on the Special Measures Law for Development of Social Infrastructure. A 1994 report from the Telecommunications Council articulated a timeframe for completing a nationwide fiber-optic network as 2010. In 1995, MPT created further financial incentives for carriers to build fiber networks by establishing the “Special Financing System for the Development of a Subscriber Optical Fiber Network.” In yet another classic industrial policy move, the Telecommunications Advancement Organization (TAO), a semipublic organization with over 90% of its funding from the government, set up a fund to subsidize part of the interest payments on DJB loans. The total amount of special loans began at 30 billion yen in 1995, growing to 72.5 billion yen by 1999.75

These financial incentives from MPT to build nationwide fiber optic networks affected the strategies of firms other than NTT as well. Usen Broadnetwork, originally a cable radio company, was the firm that most profoundly shaped the competitive dynamics in commercial FTTH services. Usen already controlled a nationwide electric-pole network, to which it added optic fiber cables in major metropolitan areas. It began offering commercial FTTH service in March 2001, setting monthly fees at 6000 yen (approx. 54 USD), for a 100Mbit/s connection (approximately ten times that of downstream DSL). TTNet, a subsidiary of Tokyo Electric Power Company as well as similar subsidiaries of other regional power companies, also begin offering FTTH services with their own infrastructure at slightly higher prices.76 NTT East and NTT West, the two local carrier companies, also began offering FTTH services in August, 2001. There is little doubt that NTT did not expect to offer FTTH services at such low prices, but they had no choice given the competition.

Thus, commercial FTTH services were the result of policy initiatives dating from the early 1990s, which altered the incentives for firms in order to facilitate infrastructure deployment. Yet the actual services offered by firms were shaped by the competitive dynamics unleashed by DSL – an outgrowth of the regime shift. The combination of these factors led to Japan sporting the lowest broadband data transfer prices worldwide.

IP Telephony as a side effect of DSL, outgrowth of the new regimeThe swift growth of IP telephony in Japan since 2003 is another area in which the

divergence of Japan’s network structure from those of the US and Europe may have significant implications for the development of value-added services. It is noteworthy that the state took cues from industry actors, and promulgated several policies that actively supported expansion of the nascent market.

73 "Hikari Faiba Ga Karirarenakunaru? Kisei Kanwa No Kouzai Wo Tettei Kenshou," Nikkei Communications, June 23 2003. 74 Tax assistance measures, MIC data (“Kanyushakei Hikari Faibaa mo no Setsubi Joukyou” http://www.johotsusintokei.soumu.go.jp/field/data/gt3005.pdf checked on 12/1/2004)75 “White Paper: Information and Communications in Japan” MPT White Paper, 1997, 1999, 2001.76 9800 yen, as of March 2003. (ITU 15)

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Voice over IP (VoIP) otherwise known as IP telephony, consists of sending voice as data over IP-switched networks. It is being hailed as the next disruptive technology in telecom, threatening to render incumbent carriers’ local circuits obsolete.77 Cross-national data on the number of IP telephony subscribers is difficult to come by, since few popular sources have been collecting systematic data.78 Looking at various sources of data, it would seem that Japan’s adoption of IP telephones as a direct substitute for conventional telephone service, installed to directly connect from telephone handsets, has occurred rapidly. Government numbers show two hundred thousand subscribers by mid-2004. This is not a large number, but given that a US investment bank estimated that 6 million users, or 12 percent of households used VoIP at the end of 2003, and that it is safe to assume that a large proportion of the 12 million DSL subscribers have DSL modems capable of IP telephony, the potential number of users is large.7980

Competition on the market provided the initial spurt of growth for IP telephony.Softbank, again, was the leader in pushing the services. Starting in April 2002, Softbank BB included free IP phone subscriptions, which it called BB Phone, along with its ADSL services. In offering IP phone services, Son intentionally delivered two symbolic price shocks. First, he made calls between Yahoo BB! subscribers free regardless of distance. Second, Son set the price of calls to the US using BB Phone at 2.5 yen per minute, less than one twentieth of the price charged by conventional carriers.81 This pricing was below costs, but in a late night meeting before the announcement, Son insisted that he wanted to break the association between distance and price consumers’ minds.82 Other IP phone service providers had little choice but to follow, with even NTT Communications offering free service between subscribers of its network and affiliated networks a year later.83

Softbank’s pricing was a shock to the Japanese public, primarily because existing circuit-switched telephony services incurred fees based on both distance and duration of calls. Flat-rate local and long-distance services enjoyed by Americans for years, had never available to Japanese consumers. However, the earliest IP telephones were criticized for their poor quality, and the fact that while IP telephones could call conventional telephones, vice versa was not possible.

Government policies supportive of IP telephony as a substitute for conventional phones took cues from the nascent market to foster its adoption. First, MIC promulgated interconnection rules that allowed conventional phones to dial IP telephones. In the fall of 2002, as the number of IP telephony subscribers in Japan was already growing rapidly, MIC announced that it would assign phone numbers with a new prefix, 050, to IP

77 Disruptive technology essentially requires firms to abandon their existing value propositions, which include suppliers, customers, revenue streams, et cetera, and which usually threaten to cannibalize existing core revenue streams. See Clayton Christensen, The Innovator's Dilemma (Harper Business, 2000). 78 Complicating the issue is the fact that there are several different forms of VoIP, including PC to PC (such as the increasingly popular Skype), circuit-switched phone line to an IP network and back to a circuit switched phone line, et cetera.79 Nikkei Communications estimates that by the end of 2003, over 3 million users out of 4 million plus users had IP-phone enabled DSL modems. "Setogiwa Ni Tatsu Ip Denwa Sougo Setsuzoku," Nikkei Communications, February 9 2004.80 MIC. This excludes business subscriptions. 81 Other carriers cost 50 to 60 yen per minute to the US. "5 Fun De Wakaru, Ip Denw to Wa Nani Ka," Ekonomisuto, Jan 6 2004. 4882 cite Nikkei Comm83 "Ntt Communications' Ip Phone Network to Be Linked to Cellphones," Jiji Press, October 4 2003.

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telephones. Both Type I and Types II carriers were allocated these numbers if they fulfilled service quality requirements.84 This allowed IP phones to take a big step in becoming functional substitutes for conventional telephones.

Second, as it has been known to do in the past, the government provided lead demand, more as a legitimizing signal of the technology than as an a source for large demand.85 In 2004, the Cabinet office ordered the central ministries to evaluate cost savings by converting to IP telephones.86

These government policies bringing IP phones closer to functionally equivalent, but far cheaper substitutes for conventional telephones sparked the interest of corporations. During 2003, firm after firm in mainstream corporate Japan announced widespread adoption of IP telephony to cut costs.87 By the end of the year, more than a quarter of Japanese firms had installed IP phones.88 Another set of key decisions by IP phone operators and cellular operators was to link their networks in late 2003, allowing IP phones to call cellular and PHS phones, and vice versa, without expensive third-party work-arounds.89

The cumulative effect of a growing installed base of IP telephony users and legitimization by the government fostered further competition in the market. FTTH providers such as KDDI began offering IP telephony services as well in late 2003, arguing that over its high transmission speeds, voice quality would be as good as traditional phones.90 NTT itself was pushed into offering corporate IP telephony services.91

Most recently, MIC announced that IP telephony services delivered over FTTH which fulfill quality of service criteria can be allocated phone numbers from the existing

84 "Seikatsu Ga Kawa It Ga Kaeru - Raibaru Ni Okureruna, Ip Denwa," Nikkei Sangyo Shimbun, December 5 2003. 85 Porter notes that one of the functions of the Japanese government in its developmental strategy was in providing lead demand, legitimizing a particular technology to trigger corporate demand. Michael Porter, Can Japan Compete? (Cambridge: Perseu Publishing, 2000).86 cite article 87 "Ip Denwa, Hontou No Shougeki: Daikigyou Zokuzoku Dounyu No Uragawa," Shukan Diamondo, March 20 2004.88 "27% of Major Japanese Firms Using Ip Phone Networks," Japan Economic Newswire, January 3 2004.This is also reflects changes in the broader economic structure – firms were no longer as committed to NTT as they had been in the past, and aggressive pursuit of efficiency gains through restructuring and streamlining was a significant focus of corporate strategies at this time. 89 "Ntt Communications' Ip Phone Network to Be Linked to Cellphones." Softbank had used an expensive, third-party work-around to connect its users to cellular phones. "Users of Softbank's Low-Cost, Internet-Protocol Phones May Call Mobiles," Kyodo News International 2003.90 However, its initial rollout was limited to urban areas, and relies on dark fiber leased from NTT. See “NTT Denwa no daigae nerau ‘hikari IP denwa’ no jitsuryoku” Nikkei Communications, Nov 24, 2003. p.58-61.91 Ibid. However, NTT is not in immediate threat of collapse at the hands of IP telephony. Due to the lack of standardization in VoIP, different carriers use different systems and standards, leading to incompatibility between different VOIP providers. The current ironic solution is to utilize portions of the NTT infrastructure, running the signal through conventional POTS switches to standardize them. This, of course, incurs interconnection fees from NTT, making the pricing for IP telephone services on a per-minute basis. In this context, IP phones are little more than cheaper telephones that cannot be used in times of blackouts. Thus, only Yahoo!BB can enjoy the network effects of having the value of its service increase with the number of subscribers – calls between BB Phone users are free, while calls to and between other IP phone service providers incur per-minute charges. It may not take too much imagination to imagine the possibility of strong political forces at work to try to create rules in favor of NTT, though whether such forces will prevail is another matter. A new political battle to determine the fate of NTT is imminent, though the timing is likely to be politically determined, as it has been in the past.?

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telephone number assignment scheme. This would allow consumers to keep their original phones numbers when converting to IP telephony, making them even more attractive as a substitute.92 Thus, the interplay of corporate strategies and supportive government policies fostered the Japan’s rapid adoption of IP telephony, given existing high prices for conventional telephone service.

Influx of FDI and the New Functions of Japan’s Domestic MarketAfter the deregulation of FDI, dramatic market developments revealed new

functions of Japan’s domestic telecom sector in international competition. Ripplewood, a US-based venture fund, made it clear that Japan’s domestic market could be a place to derive profit through M&A activity, and Vodafone, the world’s largest mobile operator based in the UK gained expertise from Japan’s domestic market to transfer elsewhere.

Within a few years after the foreign ownership limits were removed for Type I carriers in 1997, several foreign companies operating within Japan immediately raised their ownership ratios, while thirty new firms entered the sector. Japan Telecom, Cable and Wireless IDC, J-phone, and J-Com were among the partially foreign-owned companies whose principle foreign owners immediately raised their equity ratios.93

By far the most dramatic market actions were taken by Vodafone and Ripplewood. In October 2001, Vodafone bought a controlling two-thirds stake in Japan Telecom, one of the original NCCs. In buying the controlling stake from Japan Telecom’s original shareholders, Japan Railroad and Nissan, Vodafone had promised not to sell off Japan Telecom’s unprofitable landline division in order to keep its profitable cellular subsidiary, J-Phone. However, in 2003, Vodafone proceeded do just that, reorganizing the company into a holding company structure before selling off Japan Telecom’s landline division. Ripplewood, the investment fund that had sent shockwaves through Japan’s economy in its unprecedented buyout of the failed Long-Term Credit Bank, was the buyer. In July 2004, Ripplewood then shocked the sector by selling Japan Telecom to Softbank, whose founder Son had openly declared that he intended to launch a major shakeup of the sector. If anybody had suggested in the late 1990s that a foreign investment fund might purchase a domestic nation-wide network with the objective of selling it off for a profit, and that a startup firm might come to possess an entire nationwide network, it is unlikely that anybody would have taken them seriously.

This series of dramatic transactions had at least three major implications. First, Vodafone had acquired J-Phone, the cellular company through a series of M&A deals. J-Phone had pioneered the business model for camera-phones in cellular Internet services, and had much technical knowledge of the services that Vodafone was interested in. Vodafone’s cellular Internet service, Vodafone live!, launched in October 2002, gaining over 10 million subscribers by the mid 2004 in over 15 European countries, incorporated much of this technical knowledge.94 J-Phone had developed this technical knowledge on its own. Vodafone’s actions showed that Japan’s domestic market could function as a place to buy technology and expertise from, to introduce services elsewhere in the world.

92 “IP denwa demo bangou ga kawaranai riyuu: mittsu no kufuu de soumushou no jouken wo kuria” Nikkei Communications Nov 24, 2003, pp.66-68.93 "Gaishikei Jigyousha No Sannyuu Joukyou (Gaikoku Shihon Hiritsu 1/3 Ijou)," (MIC, 2003).94 “Vodafone beats subscriber growth forecasts; reiterates FY guidance UPDATE” AFX news, afxnews.com. July 26, 2004.

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Second, Ripplewood, the American investment fund, proved that Japan’s domestic market could offer lucrative opportunities for M&A activity. Ripplewood’s buyout of Japan Telecom from Vodafone was the largest leveraged buyout in Japan’s history, and Ripplewood made handsome profit of about 90 billion yen when selling it off to Softbank.95

This would seem to be one in a series of significant transitions in Japan’s economy from a “coordinated market economy,” or system of “stakeholder capitalism,” towards the direction of a “liberal market economy” or system of “shareholder capitalism.96

Third, the transaction between Ripplewood and Softbank effectively gave Softbank, a new start-up operating outside Japan’s established corporate networks, possession of nationwide telecom infrastructure. It is hard to image the original shareholders of Japan Telecom selling their shares directly to the entrepreneur Son Masayoshi. The influx of FDI facilitated the transfer ownership of capital and assets within the Japanese economy in ways that could not have easily been done previously.

Thus, the function of Japan’s domestic telecom sector in international competition clearly changed. The domestic market was already far from being the springboard for exports that it had been before the 1990s.

The Lawsuit Against MIC: New Form of Coordination Finally, a new avenue for government-industry coordination is being tested by a

coalition of firms that have undertaken an unprecedented lawsuit against MIC. In the summer of 2003, five carriers, led by KDDI, and including Japan Telecom, sued MIC over its approval of interconnection rate hikes by NTT.97 A lawsuit by corporations against the ministry with jurisdiction over its sector was virtually unheard of. A former MIC official contends that a former official who moved from MPT to KDDI was behind this movement, as he had been calling for the legal system as an alternative channel for policy formation even as he worked in the ministry.98

Before the Regime Shift in Wireless: Mobile Innovation from during “Controlled Competition”

The business model innovations leading to commercially successful cellular Internet services developed during the “controlled competition” regime, before the regime shift. Competitive dynamics within the closed and isolated market shaped the conditions from which the innovations emerged.

The Isolated Cellular Market under “Controlled Competition”Under the “controlled competition” regime, Japan’s wireless market became

isolated from international markets due to the use of proprietary standards and restrictions on FDI. 95 See “Ripplewood in landmark telecoms deal Japan” Financial Times, Aug 22, 2003. p.24 and “Ripplewood targets big bids for hefty investment returns” Nikkei Weekly, June 21, 2004.96 For a typology of economies according to the mechanisms of coordination, from which the term “coordinated market economy,” arises, see Hall and Soskice (2001), For the distinction between Japanese and German-style “stakeholder capitalism” versus Anglo-American “shareholder capitalism,” see Ronald Dore, Stock Market Capitalism: Welfare Capitalism: Japan and Germany Versus the Anglo-Saxons (New York, NY: Oxford University Press, 2000).97 “Japanese groups sue telecoms ministry” Financial Times, July 18, 2003, p. 30.98 Nakamura, Ichiya. Executive Director, Stanford Japan Center-Research. Personal Conversation, Stanford, CA. December 19, 2003.

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As with the landline sub-sector, MPT dominated policymaking in the wireless arena through licensing and discretionary authority. It orchestrated the entry of cellular competitors into the sector beginning in the late 1980s, and it had veto power over price changes and the entry of cellular competitors.

Like landline, NTT had a dominant presence in R&D in the wireless sub-sector due to its control of cellular standards as well as its extensive R&D resources.99 It is relatively well known how NTT Docomo’s control of the domestic, proprietary PDC digital cellular standard both isolated the domestic market and established Docomo’s dominant position in the domestic market. Foreign firms equipment firms were unwilling or often unable to compete in a market where Docomo’s constant upgrades to the standard allowed Docomo’s family of suppliers to roll out handsets with advanced features months ahead of its competitors.100 Overall, the domestic market was much more carrier-led than Europe and the US in terms of the power relations between carriers and equipment manufacturers in determining the direction in which services evolved.101 A sort of equilibrium developed in Japan’s domestic cellular market in which consumer paid higher prices than other countries, but consistently received highly sophisticated handsets and services in return.102

Lack of Interconnection Rules and Unintended Consequences of Industrial policy Shaping Market Dynamics

The lack of interconnection rules combined with an industrial policy drive by MPT to introduce a cheaper alternative to orthodox cellular services led to an unexpected shift of focus in Japan mobile sub-sector on data communications.

99 According to former MPT official Nakamura Ichiya, many in NTT were concerned that Docomo was getting too good a deal when NTT Docomo spun out of NTT as a result of government policy. The entire NTT wireless R&D lab was essentially transferred to Docomo for free. (Personal conversation, Nakamura Ichiya, Stanford Japan Center Director of Research, Stanford University, Oct 22, 2002.)100 In her dissertation, Emily Murase shows how despite the existence of ARIB (Association of Radio Industries and Broadcasters), a semi-public organization officially in charge of approving domestic standards, DoCoMo’s position as the only carrier with the expertise to upgrade them rendered ARIB little more than a rubber stamp in practice. See Emily Murase, "Keitai Boomu: The Case of Ntt Docomo and Innovation in the Wireless Internet in Japan," in PhD Dissertation, Communications Department, Stanford University (Stanford, CA: 2003).

Funk demonstrates convincingly how DoCoMo’s control of the standard allowed it to dominate equipment manufacturers, giving it a decisive advantage in competition against other cellular carriers. Whenever DoCoMo upgraded the standards, the changes became public once they were approved by ARIB. However, NTT “family” firms were given information about the upgrade beforehand, allowing them to roll out handsets and equipment at the same time that it became public. In exchange for early access to information, DoCoMo forced the manufacturers to delay shipping their newest handset models to other carriers by up to six months. In the context of the domestic market, in which carriers heavily subsidized the retail prices of handsets to make performance rather than price the determining factors in consumer choice, DoCoMo enjoyed a decisive advantage. Jeffrey Funk, Global Competition between and within Standards: The Case of Mobile Phones (New York, NY: Palgrave, 2002). Handset manufacturers with significant global shares, such as Nokia, Ericsson, and Motorola were effectively shut out of this market. Not only did they have to alter their handsets and base station equipment for PDC, but their advantages lay in low production costs achieved through scale economies and modular platforms. Since cost was not the issue in Japan, their handsets looked large, clunky, and weak on features compared to those on the Japanese market. (ibid, Cole chapter in this volume)101 Cite Steiner – his large book notes this as well102 For more specifics on the competitive dynamics, see Kenji Kushida, "The Japanese Telecommunications Industry: Innovation, Organizational Structure, and Government Policy," Stanford Journal of East Asian Affairs (2001).

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The Personal Handyphone System (PHS), introduced in 1995, was technologically similar to cordless phones and offered cheaper and better performing handsets, lower subscription, more extensive coverage (cheaper and smaller base stations), but is largely regarded as a failure. MPT had contributed heavily to the R&D process in developing PHS services, figuring that conventional cellular services would be too expensive for average consumers. It went so far as to project that PHS would take over as the dominant form of cellular communications. However, despite explosive initial growth, complaints about dropped signals while in motion and increasing competitiveness of conventional cellular services in terms of prices and handset performance, contributed to the rapid decline of PHS subscribers. Astel, one of the major nationwide PHS operators, decided to terminate service exit the market, while NTT’s unit was absorbed into DoCoMo. Now, most observers focus on PHS mainly as a potential source of Japanese exports to China, as certain areas have approved the technology, and because Japanese manufacturers claim that their experience in manufacturing base stations gives them a decisive advantage.103 However, relatively few observers realize that on the one hand, effects of interconnection fees and rules were critical in the unprofitability of PHS carriers, and on the other hand, that as they became desperate, PHS carriers played a role in shifting the focus of cellular competition to data communications. Aside from the fact that it was a domestic standard, the Achilles’ heel of PHS was that it was built on top of NTT’s nationwide ISDN network. NTT did have a subsidiary offering PHS services, but it had a much larger stake in the success of cellular services. Like landline, the lack of interconnection rules allowed NTT to drag its feet in connecting the PHS network to fixed-line and cellular networks. PHS carriers were also much smaller than their parent NCCs, and with the lack of regulations over interconnection fees, NTT’s high interconnection fees prevented many of the PHS carriers from becoming profitable even during the rapid subscriber growth.104

As the market for PHS began to shrink, the remaining PHS carriers turned to data communications. PHS had a higher data transmission rate than cellular networks, and since PHS networks were ubiquitous in metropolitan areas, carriers began to focus on PHS as a means to connect portable PCs to the Internet. PHS providers also began offering Short Messaging Services (SMS), which were not offered by most major cellular carriers at the time. SMS quickly became a commercial success. Cellular carriers therefore saw the demand for mobile Internet services of some sort, and the popularity of SMS services, and became engaged in a race to develop some form of cellular Internet service.

The race towards cellular Internet services and DoCoMo’s management of Disruptive Technology

NTT Docomo won the race among Japan’s cellular carriers to create a cellular Internet service. The business model innovations in their i-mode service arose from Docomo’s management of an in-house venture that given free reign to create a business model that threatened its existing core business, combined with Docomo’s extensive R&D resources and its domination of equipment manufacturers.

The business model pioneered by Docomo differs from the fully “open but owned” systems typical of leading edge technologies of the digital era.105 It is closed in the sense 103 “PHS, Chugoku zendo de kaiken he: nihonzei ni shouki, daisan sedai keitai niwa itade” Nikkei Business May 12, 2003, p.16.104 Funk (2003: 77-78) 105 Vogel and Zysman (1999)

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that Docomo owns the network, but the architecture of the system is modular to the degree that firms and individuals to add and derive value from content. Specifications for the modified html language are publicly available, and content providers can utilize Docomo’s centralized billing services, or they can work through third-party electronic payment services. Docomo controls a proprietary portal menu, but third-party content, as well as search engines, are easily accessible. The concept is closer to AOL than a service where the network provider owns and operates content. Thus, Docomo derives value from the vehicle of content provision rather than from the content itself – though it does take commissions for content that use Docomo’s billing services.

Docomo’s service, i-mode, was a disruptive technology in the sense that its business model differed from, and threatened to potentially cannibalize the profitability of Docomo’s pre-existing core business of voice-based communications106. Charging by the packet rather than for time threatened to reduce the average revenue per user, and the success of Docomo’s service would depend largely on the quality of content provided by third parties outside of Docomo’s control.

The key to development of the i-mode business model was an internal organization responsible for establishing the business model, autonomous from pressures within the company to avoid the cannibalization of Docomo’s existing core business. In the competitive context outlined above, in which the domestic PHS carriers were proving the viability of data communications, and as cellular carriers and equipment manufactures worldwide were beginning to focus on ways to connect cell phones to the Internet, Docomo’s president at the time, Ohboshi Koji, created an in-house venture, later known as the i-mode team.

However, unlike a true startup, the i-mode team had at its disposal the resources and market position of Docomo. First, the i-mode team had access to the deep pockets of Docomo, which had already constructed and deployed a packet-switched wireless infrastructure.107 Second, Docomo’s mobile R&D capabilities were arguably the most extensive in the world, and its domination of handset manufacturers allowed the i-mode team to get the R&D division to create detailed specifications for handsets, and get manufacturers to roll out handsets conforming to its specifications. This solved the chicken-and-egg problem for carriers rolling out cellular internet services. Without proven demand, manufacturers were hesitant to make models complying to a particular carrier’s specifications, and carriers were not interested in investing in services if they could not convince handset manufacturers to roll out compatible handsets.

The i-mode business model had several innovations, such as the pricing scheme and revenue-sharing, but in fact, in accounts of the creation of i-mode, an often ignored fact is that Docomo was behind its competitors for a significant part of the development stage.108 The competitive dynamics that occurred within the institutional framework of Japan’s “controlled competition” regime was where the

106 see Christensen (2000) 107 Docomo had attempted to popularize a service connecting PCs directly to the Internet via cellphone handsets, but the slow speeds vis-à-vis PHS hindered it from becoming popular. NTT Docomo, Ntt Docomo Junenshi: Mobairu Furontia E No Chousen (Ntt Docomo Ten Year History: The Challenge of the Mobile Frontier) (Tokyo: Dai Nippon Printing, 2001).108 See the series of articles published by Nikkei Shimbun between September 1 and September 5, 2001. "Contents Kakumei No Kishu Tachi (1-5)," Nikkei Shimbun, September 1-5 2003.

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The Regime Shift in Wireless: Policies The regime shift in the wireless subsector had a different focus than that of landline.

While deregulation and reregulation were the core elements of the regime shift in landline, they played less of a role in wireless because the government’s control of spectrum allocation gave it an extra tool for industrial policy. The distinctive and probably the most significant feature of the regime shift in the wireless subsector is the government’s conscious effort to use spectrum allocation and cellular standards to integrate the domestic market into global markets on new terms.

Liberalization measures Since MPT retained discretionary control over spectrum allocation, most of

sweeping deregulation of market entry, exit, pricing we saw earlier in the landline subsector had much less effect on the wireless subsector. Spectrum licenses were allocated to specific firms, and there were no regulations facilitating a secondary market for spectrum reselling. MPT therefore controlled market entry into the wireless sector, though pricing was deregulated. A shift in the process of spectrum allocation by the Ministry has been talked about for years, and would constitute a significant shift in the telecom regime, but has not occurred as of this writing.

The most significant liberalization was in the lifting of restrictions on FDI, since the 1997 WTO Telecom Agreement applied to the wireless sector as well.

“Strategic Integration” – International Standards for 3GFrom the late 1990s, Japan’s domestic cellular market began to reconnect to

international markets after its isolation during the mid-1990s. Interactions between MPT and corporate actors, and Japan’s participation in the ITU third-generation cellular standard-setting process led to Japan’s gradual adoption of international cellular standards.

In late 1996, MPT announced that it would awarding only three licenses for 3G cellular services.109 It was commonly understood that Japan would be adopt the 3G standard chosen by International Telecommunications Union (ITU), the organization within the United Nations comprised of both governments and private firms. As Aronson et al., illustrate in this volume, despite the ITU’s original intention to adopt one standard, it ended up approving two standards, W-CDMA and CDMA2000.

Even before 3G standards were deployed, MPT supported initiatives from corporate actors in adopting a non-Japanese cellular standard. According to Cole, by the late 1990s, MPT was dissatisfied with Docomo’s dominance of the mid-1990s, and was keenly aware that exports had dropped as a result of Japan’s isolation.110 DDI and IDO, DoCoMo’s main competitors, were unsatisfied with the decisive advantage DoCoMo enjoyed through its control of the PDC standard. Thus, when DDI and IDO applied for licenses to adopt the CDMAOne standard, based on Qualcomm’s technology, and which boasted higher voice quality and faster data transmission speeds than PDC, MPT quickly approved it. To facilitate the nationwide buildout of infrastructure, which was provided by Motorola, MPT

109 Policy Report, Ministry of Post and Telecommunications, 1997. <http://www.mpt.go.jp/policyreports/japanese/papers/index-98wp.html> (5 May 2001)110 see Cole chapter in this volume

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went so far as to mobilize DBJ to help fund the CDMAOne infrastructure.111 DDI and IDO jointly rolled out nationwide CDMAOne services in 1999.112

Once the ITU agreed upon the 3G standards of W-CDMA and CDMA2000, MPT approved the use of both in its domestic market. DoCoMo had been a driving force in the R&D efforts behind W-CDMA, and was eager to deploy W-CDMA as its 3G successor to PDC. DDI and IDO merged in late 2000, including KDD, to form the firm KDDI in order to obtain a 3G license. KDDI was interested in CDMA2000, which was an incremental upgrade from CDMAOne. Two other carriers using the PDC standard had merged, creating J-Phone. Thus by January 2001, the Japanese industry had consolidated into three nationally unified carriers.

It is likely that MPT’s intentions were to consolidate the industry via spectrum licenses, and distribute those licenses cheaply, to ensure that the carriers had the financial resources to build the networks. MPT had retained its policy of licensing spectrum to carriers via a beauty contest, rather than experimenting with auctions in the manner of major European players.

The Regime Shift in Wireless: Market Outcomes

Foreign Entry: A new role for Japan’s domestic marketThe dramatic market developments with Vodafone’s buyout of J-Phone in 2001

have already been elaborated upon. Since J-Phone was one of the three major cellular carriers with nationwide services, effectively one-third of the cellular carrier market suddenly became foreign owned.

Aside from showing that the Japanese market could be used as a source for acquiring technological and business model know-how to be transferred elsewhere, Vodafone began attempting to shake up the status quo in the relationships between handset manufacturers and the NTT family.

Within the isolated domestic market, handset manufacturers closely affiliated with NTT Docomo, which had a dominant market position, had privileged access to information. Newcomers such as Sharp, Sanyo, and Toshiba were not part of the in-group with NTT Docomo. Soon after assuming post as the president of J-phone (before it was renamed Vodafone), Daryl Green announced what he called a “tsunami” project. This consisted offering manufacturers access to broader markets for 3G equipment in exchange for cooperation in developing components and software for handsets compatible with its particular implementation of W-CDMA. The idea was that by collaborating with Vodafone, manufacturers would only need to make minor adjustments to convert them for exports, with Green promising the manufacturers access to its one hundred million plus consumers worldwide. To an initial meeting of this project, Green invited the firms closely associated with Docomo as well.113

111 Takata, Hirohisa, Development Bank of Japan. Personal Interview, May 3, 2004. DBJ internal documents, available upon request. 112 “NTT DoCoMo losing race for new users Sound quality, data speed fail to match new format introduced by rivals” Nikkei Weekly, June 14, 1999 p.7; “Motorola CIG Announces First Commercial Launch of Nationwide cdmaOne Cellular Network in Japan” Business Wire, July 14, 1998. 113 “Semeru Vodafone (jou), kokyaku ichi oku nin, butai wa sekai – tanmatsu kakusha torikomi isogu” Nikkei Sangyo Shimbun. May 28, 2003 p3.

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The Price Wars for 3G mobile Internet leading to flat-ratesJapan experienced the fastest third generation (3G) cellular network buildouts in the

world, with three separate nationwide networks by the end of 2002 operated by each of the three major nation-wide carriers operated their own network.114 With only three competitors, however, and before costs from deploying the costly networks were recovered, KDDI created a price shock by introducing flat-rate 3G data services in November 2003 aftern much internal debate.115 DoCoMo reluctantly followed suite in June 2004, and Vodafone followed in November, 2004.116

The possibilities for services and business uses taking advantage of flat-rate 3G cellular services are only beginning to be explored. Many business had said that they had not considered mobile data transmissions involving cell phone in their business plans on account of the variable transmission costs, but they could now begin exploring options.117

Embedding wireless capabilities in to existing products is another possibility that firms are excited about, and may lead to adding new value.

The puzzle is why a competitive environment with only three firms led to flat rates, potentially undermining the existing core profitability of the services through transmission charges per packet of data. An important point in answering this is found in the market dynamics created by the PHS services.

As PHS services shifted towards data applications, PHS PC cards that could be plugged into laptop computers became the primary driver of PHS growth. The coverage of PHS networks was almost ubiquitous, and the technology allowed transfer speeds similar to that of ISDN. The pricing, significantly, became flat-rate. DDI Pocket was the lead competitor, with NTT Docomo reacting.

The flat-rate cellular 3G services are only for the internet connection services such as i-mode – the handset cannot be connected to laptop computers and serve as a mobile internet connection device like the PHS.

Conclusion: Towards a Japanese Resurgence?

Japan’s Unexpected Development in Telecom Services ExplainedWe can now summarize our findings in explaining Japan’s unexpected development

in telecom services. First, the rapid penetration of cellular Internet services driving Japan’s growth of Internet diffusion was a product of market forces in the institutional context of the old regime. NTT DoCoMo, pressured by its competitors, effectively managed disruptive technology through an in-house venture, taking advantage of its long-standing dominance of handset manufacturers. The symbiotic relationship between carriers and content-providers in the business model led to content that proved commercially successful.

114 NTT Docomo launched its 3G service, FOMA, on October 1st, 2001 using W-CDMA. In April 2002, KDDI launched its 3G service using the competing Qualcomm standard, CDMA2000, in a simplified form, CDMA2000 1x. J-Phone launched its W-CDMA service in December 2002. By the end of 2002, Japan had three separate, competing nationwide 3G networks, when South Korea and the Island of Mann were the only other countries with 3G networks, with one each. By the end of 2003, the only new 3G network that had been installed was in Great Britain. 115 “Mobairu tsushin teigaku jidai he no kaunto down” Nikkei Communications December 8, 2003 pp.60-68.116 It should be noted that many do not consider KDDI’s service to be fully 3G on account of the standard CDMA2000 1x EV-DO being slower than WCDMA. 117 "Mobairu Tsushin Teigaku Jidai E No Kaunto Daun," Nikkei Communications, December 8 2003.

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Second, the rapid diffusion, low prices, and high speeds of landline broadband were caused by market dynamics shaped by policies at the core of the regime shift. A new regulatory environment for DSL led to increased competition, and Softbank decided to unleash a price war, charging low fees and bundling IP telephony subscriptions. Industrial policy initiatives from the previous regime had facilitated the buildout of FTTH networks, but the market dynamics in DSL markets led FTTH service providers to offer low prices, resulting in Japan having the highest price-performance in broadband.

Third, the flat-rate, high speed mobile services were a product of state-driven strategy to rapidly deploy 3G cellular networks, and market competition inspired by the low prices for DSL and flat rate PHS data services.

Implications for Comparative Institutional Advantage and a Potential Japanese Resurgence

We close this analysis by returning to our broader question of Japan’s comparative institutional advantage. Here I introduce several conceptions of the “fit” between technological paradigms and institutional arrangements in a political economy, and propose a research agenda to further this scholarship.118

In the first perspective, observers take a national-level perspective, noting that Japan’s comparative institutional advantage favors particular types of technological change. Aoki has argued that Japan’s complementary institutions created corporate organizational structures with particular types of information flows, which are conducive to incremental innovation rather than radical or breakthrough innovation.119 In their work in 1989, Tyson and Zysman show that Japan’s institutions shaped the market structures that led Japanese manufacturing firms to pursue process innovation in production, which as at the forefront of the technological trajectory at the time.120

The second perspective explicitly addresses changes in technological paradigms over time, and how institutional configurations in particular countries perform with regard to them. Yamamura takes a long historical view of technological paradigms, tracing how they have shifted since the industrial revolution. He argues that there have been three technological paradigm shifts of steam power (1760s to 1870s), mass-production (1880s to mid-1970s), and information technology (1970s to present). The two earlier paradigms went through two phases: innovation, followed by implementation. He argues that Japan enjoys a comparative institutional advantage during the implementation phase, when technological change is gradual and adaptive, while the US enjoys comparative institutional advantage during innovation phases, when technology changes rapidly and fundamentally.121

118 “Governance systems” is the term used by Vogel and Zysman (1999) to indicate institutions, and the market dynamics they create. My use of “institutional arrangement closely parallels this concept of “governance systems,” but I chose to avoid the word since institutional change has been the focus of this paper. 119 Aoki, Masahiko. “Unintended Fit: Organizational Evolution and Government Design of Institutions in Japan” in Aoki, et al. ed., The Role of Government in East Asian Economic Development. (Oxford: Clarendon Press, 1996).; Masahiko Aoki, Information, Incentives and Bargaining in the Japanese Economy (New York, NY: Cambridge University Press, 1988).120 Tyson and Zysman (1989) 121 Yamamura Kozo, “Germany and Japan in a New Phase of Capitalism: Confronting the Past and the Future” in Yamamura, Kozo and Wolfgang Streeck ed., The End of Diversity? Prospects for German and

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Yamamura argues that past decade has seen the new technological paradigm in an innovation phase, predicting that it will soon move to an implementation phase. He recognizes that Japan is reconfiguring itself to fit the innovation stage of the new technological paradigm, since the innovation stage does not play to Japan’s institutional strengths. From this perspective, he warns that Japan should not reform away its capacities for implementation.

Zysman and his collaborators have argued in several places how the shift to the digital economy shifted terms of competition in lead sectors to favor the configuration of institutions in the US rather than Japan or anywhere else – for good reason, since the paradigm shift originated in the US.122 He would agree with Yamamura and Streeck that Japan suddenly found itself at a comparative institutional disadvantage.

A third perspective, put forth by Kitchelt in reference to Japan, recognizes that conceptions of ideal-typed national institutional configurations were usually extrapolated from select industries. This perspective takes the analysis to the sectoral level, contending that institutional structures differ across, and that properties of technology vary across sectors as well.123 The “fit” between institutional configurations and technological paradigms is therefore a sectoral story.

The fourth perspective, to which this study can contribute, has been put forth by Vogel and Zysman. They posit that the fit between technology and institutional configurations can be differentiated according to function. For example, when comparing the US and Japan, US governance systems are better at fostering labor mobility, financing new ventures via equity markets, producing entrepreneurs, promoting competition, supporting basic research, and generating breakthrough innovation. On the other hand, Japan’s governance systems are better at forging labor-management cooperation, providing stable finance via the banking system, training engineers, managing competition, and achieving incremental improvements in production.124

My study of the development of Japan’s telecom services suggests that the institutional configurations at a sectoral-level can affect the functional fit between institutions and technological paradigms. The regime shift in telecom elaborated in this study can be considered as essentially a remodeling of Japan’s institutional configuration in telecom, responding to the shifting technological paradigm of the digital era.

Japan’s telecom sector is experiencing a greater ability to finance new ventures via equity markets, breed entrepreneurs, and promote competition, but more in some sub-sectors such as broadband and cellular Internet services than others. At the same time, in other sub-sector, such as equipment manufacturing, cellular carriers, and R&D undertaken by NTT, Japan continues to enjoy traditional capabilities of forging labor-management cooperation, providing stable finance via the banking system, training engineer, managing competition, and achieve incremental improvements in production. We are seeing hybridization, along the lines of what Yamamura identifies – once-coherent national models being replaced by hybrid configuration to adjust to changes in global competitive environment.125

Japanese Capitalism. Ithaca, NY: Cornell University Press 2003.122 See Introduction to this volume, Zysman and Vogel (2002) 123 Herbert Kitschelt, "Industrial Governance Structures, Innovation Strategies, and the Case of Japan: Sectoral or Cross-National Comparative Analysis?" International Organization Vol 45, no. 4 (1991).124 Vogel and Zysman (2002), 242

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It must be noted, however, that the objective should not be to ask whether the Japanese institutional configuration and functional advantage will converge with those of the US. What we should look for is a point in between the governance systems where shifts in technology may meet new functional capabilities of Japan’s new telecom regime.

The latest policy drive reveals that Japan is deliberately attempting to alter its comparative institutional advantage. The u-Japan strategy, articulated by MIC in late 2004, proposes to create a regulatory environment on top of which various services and products adding value can be developed.126 The u-Japan strategy falls under the rubric of the Cabinet Office-led e-Japan II strategy, articulated in mid-2003, which takes Japan’s high level of telecom infrastructure and service development as a starting point to focus explicitly on value-creation, aiming create and environment in which applications ranging from security to healthcare can be developed.127

In line with recent Japanese discussions about application development and value creation taking advantage of its new IT infrastructure, the u-Japan strategy emphasizes the keyword, “ubiquitous networks.” There are at least two notable features of the u-Japan strategy that suggest a sharp break in the way that the government, or at least the MIC, sees the world. First, the u-Japan strategy features a regional focus on Asia to collaborate and develop networks, services, and standards. This shift in orientation towards other Asian countries is new for Japan, following on the heels of talks with China and South Korea to collaborate in developing next-generation Internet standards (IPv6). Second, the u-Japan strategy states that the “catch-up with the West” paradigm no longer applies. The recognition that the catch-up phase is finished, and that Japan must now look for new directions to develop, is language that has not been heard much since the height of the bubble economy in the late 1980s and early 1990s – when Japan was triumphantly declaring it had caught up with the west and was pioneering a new model of capitalism.128

The u-Japan strategy thus seems to depart from previous industrial policy initiatives, including the e-Japan strategy that helped build Japan’s infrastructure. The lack of a concrete developmental target leaves the u-Japan strategy seeming very general and unfocused, as an MIC official noted. It may be a significant challenge for the ministry to figure out how to coordinate its policy objectives with other ministries whose jurisdiction some policy changes fall under, given periodic tensions between MIC and METI.129 The u-Japan strategy may also be more of a defensive move by MIC to counter threats by the Prime Minister to create a unified communications bureaucracy, similar to the Ministry of

125 Wolfgang Streeck, and Kozo Yamamura, "Introduction: Convergence or Diversity," in The End of Diversity? Prospects for German and Japanese Capitalism, ed. Wolfgang Streeck, and Kozo Yamamura (Ithaca, NY: Cornell University Press, 2003). 29.126 "U-Japan Seisaku: 2010 Nen Ubikitasunetto Shaki No Jitsugen Ni Mukete," (MIC, Dec 2004).127 "E-Japan Senryaku I I," (IT Strategy Headquarter, July 2 2003).128 For example, see Eisuke Sakakibara, Beyond Capitalism: The Japanese Model of Market Economics (Lanham, MD: University Press of America, 1993).129 For example, with MIC in charge of telecommunications, but METI in charge of consumer electronics, the convergence of these two sectors in the form of internet-enabled consumer electronics and the like have led to a new round of bureaucratic turf wars. With part of their budget allocations for 2004, the ministries have set up parallel research groups in areas such as human capital development, contents, IC tags, and information security. Firms have complained that both ministries expect them to act as though they were under each ministry’s jurisdiction. "Hyouryu It Seisaku, Keisanshou Soumushou, Nawabari Arasoi - "Senryaku Mienai" Minkan Boyaki," Nikkei Shimbun, March 19 2004.

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Communications in South Korea.130 However, whatever the motive, if some of the policy directions proposed in u-Japan are brought to fruition, it will have been the result of a conscious government strategy to alter Japan’s comparative institutional advantage.131

A critical juncture is looming in Japan’s telecom industry over the issue of how to deal with NTT, which will in turn greatly affect how the industry is structured. NTT has been complaining that its legally mandated organizational structure can no longer adequately address market developments.132 Laws determining NTT’s structure have usually been reached as a series of politically negotiated bargains between a multitude of actors, and the next negotiated bargain over NTT is likely to reshape Japan’s institutional configuration in telecom, which may in turn affect Japan’s broader comparative institutional advantage. Here we have reviewed several conceptions to analyze the fit between technology and institutional configurations, identified several variables to understand changes in Japan’s telecom regime, and traced the dynamics of Japan’s latest regime shift. They should suffice to put us in a position to understand what to look for and analyze as Japan’s telecom sector and its broader economy continue to evolve.

130 This threat led to promises to exchange personnel and establish channels for joint research between the duplicate research groups set up by MIC and METI. "It Seisaku Ritsuan De Teikei, Soumushou Keisanshou," Nikkei Shimbun, March 28 2004.131 Whether this will be considered industrial policy in hindsight depends largely on what one considers industrial policy. Chalmers Johnson, probably the most well known scholar of industrial policy, has been quoted as saying that state that industrial policy is above all, an attitude or orientation, and only after that a matter of technique, shifting with the changing needs of the time. Meredith Woo-Cumings, "Introduction: Chalmers Johnson and the Politics of Nationalism and Development," in The Developmental State, ed. Meredith Woo-Cumings (Ithaca, NY: Cornell University Press, 1999). 132 "Sakerarenai Ntt Saisaihen Mondai.," Nikkei Shimbun, December 3 2004.

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