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Proposal for Strengthening the Competitiveness of Japan's Defense Industry: Shift from the "Family Type" to the "Strategic Keiretsu-Type" System

Yuzo Murayama

Japan's defense industry is booming thanks to increased defense spending, but its development and production system remains the old "family type" established after the Pacific War. This system stands apart from the trend in the global defense industry, and is unsuitable for incorporating civilian technology into the military sector. Under this system, there is a large likelihood that Japan's defense power will not improve as expected; that even if a massive investment is made to develop cutting-edge technology, the result will not be utilized for national security, falling short of strengthening economic security. In this paper, we propose a shift to a "strategic keiretsu-type" system to replace the "family-type" system and outline the path to enhancing the competitiveness of the defense industry and to strengthening economic security.

1. The "Family-type" System and the Defense Industry

In postwar Japan, the overriding challenge was to restore the domestic infrastructure devastated by the war. The urgent issue in the communications sector was to restore the telephone network, which registered a massive drop in the number of subscriptions down to half the prewar level. The Nippon Telegraph and Telephone Public Corporation came into existence to address this challenge. In the space sector, where Japan was lagging far behind other developed countries, the National Space Development Agency of Japan (NASDA) was established to put space to practical use for economic and social purposes. Thus, efforts began to promote the use of space in the fields of broadcasting, communications, and meteorological observation. Regarding the defense sector, the 1957 Basic Policy on National Defense called for "building up rational defense capabilities." In 1976, the government formulated the guidelines for strengthening basic defense capabilities.

Japan rallied its expertise, technology, and production power to achieve this goal of infrastructure development. In the communications sector, companies close to NTT formed the "Den-Den family." In the space sector, development started under the cooperation of related manufacturers and user companies, including NHK, the Nippon Telegraph and Telephone Public Corporation, and the Japan Meteorological Agency. Defense-related companies that had developed weapons before the Pacific War gathered to form the "defense family." Thus, technological development for restoring infrastructure began under "family-type" systems.

These "family-type" systems had the same features. First, in terms of technological development, they actively introduced technologies from overseas. In those days, Japan's technological level was low among developed countries, and the government tried to close the gap by introducing technologies from overseas companies. Through the reverse engineering of overseas technologies, the "families" attempted to produce substitute products and increase the proportion of production at home, with full domestic production in view; they aimed to possess autonomous technologies independent of external factors.

Under the "family-type" systems, member companies received payment with a certain amount of profit added to the cost and, in some cases, received development funds in advance. The companies were guaranteed profits, and the government's infrastructure development plan made it easy for them to predict the number of orders and growth rates. The family companies enjoyed a good business environment.

The "family-type" systems were effective in helping to elevate Japan's technological level up to overseas standards. While gathering indigenous technological capabilities within each "family" to share and standardize technologies, it was also arranged to maintain a certain level of competition within the "family" to preserve industrial strengths, thereby contributing to improving Japan's overall technological capabilities related to infrastructure development.

However, the "family-type" systems were subject to the waves of globalization and external technological development from the 1980s. First, in the communications sector, the breakup of AT&T in the United States (1982) marked the beginning of an era of full-scale free competition. Concurrently, the digitalization of communications progressed, breaking down the boundary with the computer industry and throwing the world into global competition, transcending the computer-communications boundary. Under such a market environment, the "family-type" systems grouping traditional communications-related companies became inefficient and made no sense in the subsequent Internet era. In response to such global trends in the industry, corporate technological development patterns changed, and the "family-type" system in the communication sector ended.

The "family-type" system in the space sector collapsed due to the US-Japan trade friction in the 1980s. The inter-governmental negotiations focused, among other things, on the Japanese government's procurement of satellites; as a result, the Japanese government became bound to procure satellites for practical use under free competition. Thus, the Japanese government's strategy of nurturing the space industry under the "family-type" system sustained by government assistance collapsed; Japan's space industry was suddenly subject to global competition. Afterward, the government turned to encouraging the civilian sector to join the space industry, and new companies entered the fields of small satellites and satellite services. JAXA backed the move financially and technically and the government also established a space strategy fund of 1 trillion yen in FY2024, launching a system to support more openly research institutions, including universities and private companies.

The story is different in the defense sector. In the 1990s, the world's defense industry underwent restructuring and integration in response to reduced defense spending after the end of the Cold War. Large defense companies emerged and launched their businesses on a global scale. Meanwhile, the United States actively promoted military-civilian integration to utilize civilian technologies in the military field from the mid-1990s; this move spread to China and other countries.

Japanese defense-related enterprises stayed away from the trend of the post-Cold War global defense industry restructuring. In Japan, military-civilian integration did not go beyond, for example, the sale of NISSAN's rocket business to IHI and some other small cases. Many dual-use technologies possessed by Japan were competitive in the international market but were not utilized as in other countries.

Japan's defense technology development and production system deviated from global trends during this period. There were several reasons for this. The primary reason was the Three Principles on Arms Exports. In the 1990s, under the influence of the binding principles, Japan could provide weapons technology to the United States alone but could not even participate in international joint arms research and development projects. Public opinion, which has an aversion to the military in general, also had an adverse influence, and companies sensitive to reputational risk hesitated to utilize dual-use technology. Furthermore, in the 2000s, the Yamada Yoko incident occurred, and public-private collusion in the defense sector became a major social issue. As a result, public-private dialogue in the defense industry ceased, while politicians did not try to resolve issues associated with the defense industry.

In the 2020s, the defense industry drew attention, with changes in the security environment as background―to the deterioration of the Taiwan situation amid US-China tensions and the Russian invasion of Ukraine. The government increased defense spending significantly and took legal measures to strengthen the defense technology and production base. However, the development and production system that supports them remained intact―the conventional "family-type" system.

2. The "Lock-in" System

This is what economists define as a "lock-in" situation. "Lock-in" refers to a state in which an inefficient old method persists despite the existence of a more efficient approach or technology. An often-cited example in this context is the keyboard character layout in use today, unchanged from the days of manual typewriters. In old manual typewriters, the arrangement of the letters was intentionally spaced out to prevent the metal bars that strike the characters from colliding with each other. This layout has been carried over to electric typewriters and even to modern computer keyboards. A more efficient character layout suitable to the electronic age was once proposed, but it was not adopted, and the old layout is still in use today. This is because users accustomed to the old layout disliked the trouble of changing it and continued to use it despite its inefficiency; the keyboard layout became "locked in" the old system.

A similar "lock-in" situation is occurring in Japan's defense industry. It is the world defense industry standard that companies adopt cutting-edge civilian technologies for defense technology development and expand their business globally, seeking a larger market. Yet, as for Japanese defense companies, their use of civilian technologies is limited, and their global business operation has hardly progressed. This is because the Japanese defense industry is "locked in" to the old system, and even if defense companies have the willingness to implement reforms and advance in a new direction, the practice they have built up so far constitutes an obstacle, making them hesitate to change. If technology development went on in this old way in any industry other than the defense industry, products manufactured in this way would be non-competitive and would be removed from the market. However, the only buyer in the Japanese defense market is the Japan Self-Defense Forces; since the JSDF ordinarily has no opportunity to use equipment in warfare or conflict, the lack of competitiveness of equipment matters less. Due to these circumstances, the outdated "family-type" system still exists in Japan's defense sector.

Bad practices that the "family-type" system produces are still rampant. It became apparent in July 2024 that Kawasaki Heavy Industries Ltd. had provided money and goods to Japan Maritime Self-Defense Force's submarine crew members, using slush funds that the company had made by placing fictitious orders with subcontractors. The company raised 1.7 billion yen through this offence in just the six years up to FY2023. This practice has continued for the past 40 years, suggesting that a close "family" relationship has long existed between the defense-related company and the Self-Defense Forces, and defense procurement has also been done under such circumstances.

When Japan's Maritime Self-Defense Force procures diving suits, they must acquire them through open tenders. However, the equipment's specifications are so complex that only one company can bid, and its monopoly has lasted for many years. (Sankei Shimbun, January 14, 2025). This suggests that the Ministry of Defense also wants to maintain a continuing relationship from the past. A similar trend occurred in selecting a successor company for armored vehicles after KOMATSU withdrew from the market. Ultimately, Japan Steel Works, Ltd. was chosen by a foreign manufacturer as its licensed production partner in Japan. Many Japanese companies, such as automobile manufacturers, are equal to the licensed production. Yet, in this case, a company within the defense family that has never produced any vehicle was chosen.

On the other hand, a law that would help maintain the "family-type" system took effect in June 2023. It is the "Act on Enhancing Defense Production and Technology Bases." This law stipulates that defense companies should submit a document plan for approval of the Minister of Defense when they want to receive subsidies for strengthening supply networks, streamlining manufacturing processes, enhancing cybersecurity measures, or business succession. Although this is a necessary procedure to obtain government subsidies, it could lead to a further fixation in the defense family, as only prime contractors directly contracted with the Ministry of Defense and their subcontractors can get approval. For this reason, if a significant amount of defense spending is allocated under this framework, the traditional family-type system may still over-develop.

3. Problems with Organization and Incentive Structure

In the period of basic defense buildup, the top priority was to secure a budget for necessary equipment, use it for the defense industry, and ensure that the ordered equipment would be delivered without delay. The "family-type" development, production, and procurement were suited to this purpose. The problem, however, is that a system effective at one point in time becomes "locked in" and too developed, regardless of the change in time. In particular, the security environment surrounding Japan is changing, and to respond to this, the "defense production and technology bases" are emphasized as "defense power itself." Nonetheless, if the defense technology development and production system sustaining them is outdated, Japan will not be able to achieve the primary goal of strengthening its defense power.

How can we overcome this "lock-in" system? Economists who deal with "lock-in" situations (New institutional economics) suggest that the cause of this situation is not the industry itself but rather the institutions that sustain it.

Applying this analysis to Japan's defense sector brings to light the problem of the division of ministries and agencies in charge of Japan's defense industrial policy. The procurement of equipment is under the jurisdiction of the Acquisition, Technology & Logistics Agency of the Ministry of Defense, while the industrial aspects underpinning defense are under the jurisdiction of the Aerospace and Defense Industry Division of the Ministry of Economy, Trade and Industry. In this organizational division, equipment procurement has been prioritized due to its high necessity, while the perspective of strengthening the defense industry's competitiveness has tended to be neglected.

In the current situation where the security environment surrounding Japan has deteriorated, and the boundary between economy and security is technologically disappearing, a divided institutional framework can no longer make sense. It is desirable to introduce competitive private sector technologies, develop effective equipment for actual combat use, and export it abroad. To achieve this, it is essential to enhance not only defense procurement but also the competitiveness and export capabilities of the defense industry in an integrated manner. To this end, the functions of the Ministry of Defense (procurement) and the METI (strengthening industrial power) must be integrated. The two ministries are endeavoring to incorporate civilian technologies and venture businesses into the defense sector and to export equipment. Nonetheless, their efforts are not driven by a sense of exigency as is the case in other countries because of this organizational division.

There are also institutional issues in the contract system between the government and the defense industry. With a contracting method that imposes severe financial constraints and adds profits to costs, defense contractors are inclined to prioritize keeping development and production costs within budget. This reduces the incentive for contractors to take risks in promoting technological innovation and making products more competitive to earn a corresponding return. In ordinary business, it is only natural that a company can obtain a return if it makes management efforts for technological innovation and produces commensurate results; this ordinary business practice must be valid also in the defense sector.

Furthermore, while addressing the institutional issues related to organization and incentive structure, we must conceive a new system of defense development and production to replace the old "family-type" system and make a necessary shift. The dilemma in this context is that implementing drastic reforms in the current worsening security environment might undermine the defense development and production system that has lasted for many years, which could cause problems in the deployment of defense forces and deterrence in emergencies. Likewise, reforms that involve major legal amendments will take considerable time in the current political situation in Japan. Given the current security environment surrounding Japan, there may not be enough time for this to happen.

4. Shift to a "Strategic Keiretsu-Type" System

This paper proposes a "strategic keiretsu-type" system of technological development and production as a solution to the above-mentioned issues. The "strategic keiretsu-type" system is a measure to modify Japan's defense industry to adapt to the current trends of the global defense industry by creating new affiliated relationships associated with equipment while considering Japan's politics and defense industry environment.

This measure stems from Articles 29-31 of the "Act on Enhancing Defense Production and Technology Bases," enacted in June 2023. Articles 29 and 30 allow the government to own manufacturing facilities; while paying for the facilities, the government can contract out operations to defense contractors. This framework is known overseas as GOCO (Government Owned, Contractor Operated); it is a measure to increase the incentive for companies to work on corporate management and technological innovation by arranging for the government to pay for the facilities and for contractors to operate them. A similar system is adopted for Japan's Shinkansen, with the national and local governments bearing the cost of tracks and the railway companies taking care of operations. If the railroads make the management effort to achieve results, the return will go to them. This incentive structure works well in the railway business, as can be seen from the fact that JR companies are making huge profits from the Shinkansen operations.

Therefore, if defense development and production adopting the GOCO model can be implemented by using a framework based on the "Act on Enhancing Defense Production and Technology Bases," the incentive structure of the defense industry will change for the better. In that case, by comparing and considering the reduction of GOCO facility usage fees and the required performance of the equipment to set the final purchase price, while taking into account the international prices of similar equipment, it would be possible to break away from the conventional contract method of adding profit to costs.

Also, Article 31 of the same law allows the parties concerned to use the designated equipment manufacturing facilities for purposes other than originally intended, which means that those equipment manufacturing facilities could be used to manufacture civilian products. Therefore, a positive interpretation of Article 31 and Articles 29-30, which provide for GOCO, would allow Japan to create dual-use facilities using the GOCO scheme.

Herein lies the key to building a new system to replace the "family-type" one. In other words, the government will conduct thorough technical research when developing and producing defense technologies, identify promising related private-sector technologies, design and develop these civilian technologies for integration into equipment, and then link this to production at GOCO facilities. For example, when developing a next-generation defense radar system, it would be a good option for the government to invite a private AI company to joint development and production.

This new combination of defense-related companies and other private companies is the essence of the "strategic keiretsu-type" system, which could allow Japan to catch up with the prevailing trend in the global defense industry of bringing in private technologies. The GOCO scheme enables new entrants to reduce capital investment, produce civilian products incorporating technology used for military products, and put them on the civil and defense markets. This will have the effect of increasing the incentive for private companies to enter the defense industry.

What we need to think about next is which equipment should be developed and produced under this new system. In Japan, the production of defense equipment involves reputational risk for participating companies; in the initial stage, they should select the equipment that could minimize such risk. In this sense, focusing on "defensive" pieces will make it easier to gain understanding from society and will help reduce reputational risk for participating companies. Moreover, since "defensive" equipment can actually be used in Japan's defense, it may achieve more competitiveness through a cycle of practical use and improvement. On the other hand, to strengthen the international competitiveness of equipment, it is essential to ensure that equipment produced in Japan can be exported without restrictions. To realize this, the government must clear beforehand all regulatory obstacles to the export of that equipment so that it will be smoothly exported, which will ultimately help the export of equipment in general.

Even if the "strategic keiretsu-type" system has the potential of solving various issues inherent to the defense industry, there will be a lot of pain in changing the current system that has been "locked in" for many years, and there will also be significant resistance to change. Therefore, it is advisable not to shift directly to the "strategic keiretsu-type" system but to proceed with the transition by increasing the number of new projects under the new system while maintaining the existing system for the time being. It may not be too late to try to restructure the defense industry, waiting for a cluster of projects to emerge that can be implemented under the "strategic keiretsu-type" system. Incidentally, the supplementary resolution to the "Act on Enhancing Defense Production and Technology Bases" submitted by the opposition parties also suggests the direction of strengthening the competitiveness of Japan's defense industry through reforms. The "strategic keiretsu-type" system may be a politically acceptable concept both in government and in opposition.

By shifting to a new system through step-by-step reforms from a long-term perspective, the defense industry may turn to strengthening its competitiveness. Since the proposed system provides a node to connect competitive civilian technologies with defense capabilities, adopting the new system will, no doubt, lead to improving Japan's economic security capabilities.

(Professor Emeritus, Doshisha University)

(Translation by Tsutomu Inuzuka)

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