Economy, No.2  Aug. 6, 2010


On June 18 the cabinet of Kan Naoto, Japan’s new prime minister, approved a growth strategy for “a strong economy, robust public finances, and a strong social security system.” Kan’s Democratic Party of Japan suffered an embarrassing setback in the July 11 House of Councillors election, when it was unable to garner a majority of the upper house seats, but his administration remains determined to incorporate the strategy’s policy measures, including a cut in the corporate tax rate to strengthen the competitiveness of Japan-based companies, in the budget for fiscal 2011 (April 2011 to March 2012). The hope is to rescue the nation’s economy and society from the two decades of stagnation that have followed the bubble boom in the second half of the 1980s. Through the combined efforts of the public and private sectors, the administration seeks to realize an average 3% nominal growth rate and 2% real growth rate over the period through fiscal 2020. The target is the construction of a new Japan that will develop together with the rest of Asia, strengthening its economic collaboration with other Asian nations.

Kan’s growth strategy is a fleshed-out version of the new growth strategy adopted in December 2009 by the administration of his predecessor, Prime Minister Hatoyama Yukio. Setting targets in seven strategic areas and specifying 21 national strategic projects deemed likely to make a major contribution to economic growth, the authorities propose to use these areas and projects to provide Japan with a revitalized economy for the twenty-first century.

The following are the seven strategic areas of the new growth strategy: (1) strategy for becoming an environment and energy power through “green innovation” (create over ¥50 trillion in new environment-related markets and 1.4 million new environment-sector jobs), (2) health power strategy for “life innovation” (foster industries to meet the demand for medical care, nursing care, and other health-related services, creating ¥50 trillion in new markets and 2.8 million new jobs), (3) strategy for establishing the FTAAP, the Free Trade Area of the Asia-Pacific, (4) strategies for promoting a tourism-oriented nation and local revitalization, (5) strategy for making Japan a leading science and technology power with first-rate information technology (increase total public and private R&D investment to over 4% of gross domestic product), (6) employment and human resources strategies, and (7) financial strategies (supply growth capital and secure a position for Japan as a main market and top player in Asian finance).

Among the 21 national strategic projects, the following are representative examples: (1) expand the supply of renewable energy, (2) build ecological “future cities” (and export the know-how for creating them), (3) revitalize forests and forestry, (4) expand high-level medical care and make it widely available, (5) establish an international position as a provider of medical care (increase the entry of foreign patients, introducing a system of medical-care visas), (6) secure a position as a major player in the global infrastructure business, (7) reduce the effective corporate tax rate and make Japan an Asian industrial center, (8) foster global human resources and expand the acceptance of highly skilled foreign personnel, (9) implement a strategy for intellectual property and promote “cool Japan” overseas, (10) strengthen economic partnerships through the FTAAP, (11) introduce a system of “comprehensive special zones,” (12) promote R&D investment, (13) establish an integrated exchange handling securities, financing, and commodities (with the aim of creating a major financial center drawing in funds from the world and investing especially in Asia), and (14) double the size of the existing housing and remodeling markets.

Japan’s Version of the Young Report

After the Hatoyama administration adopted the new growth strategy, the Industrial Structure Council under the Ministry of Economy, Trade, and Industry set up the Industrial Competitiveness Committee to formulate more specific policy guidelines. The committee released a report titled “Industrial Structure Vision 2010” shortly before the Kan administration approved the detailed version of the strategy. Drafted from the microeconomic perspective of companies and industries, the vision depicts a scenario for boosting Japan’s international competitiveness. It is the first full-fledged policy proposal METI has put forward in quite some time. The committee’s reading of the situation in which Japan finds itself and most of the measures it recommended were incorporated into the latest version of the new growth strategy.

Itoh Motoshige, a professor at the University of Tokyo, is the chair of the Industrial Competitiveness Committee. “We put the vision together,” he states, “with the intention of creating a Japanese version of the Young Report.” The reference is to “Global Competition: The New Reality,” the 1985 report of the US President’s Commission on Industrial Competitiveness, which was chaired by John A. Young, then chief executive officer of Hewlett-Packard. Young’s commission had been charged with preparing a policy proposal for the administration of President Ronald Reagan to deal with a perplexing situation. Since the second half of the 1970s, the United States had been wrestling with stagflation (a combination of stagnation and inflation), the twin deficits in the federal budget and current account, and a decline in the competitiveness of American businesses. Sensing that the United States had a crisis on its hands, the commission made an appeal for action to the public in addition to presenting its advice to the Reagan administration. Its recommendations were incorporated into industrial revitalization measures and became one spur of the US economy’s comeback.

As can be inferred from Itoh’s comment, the Industrial Competitiveness Committee is also motivated by a sense of crisis, and in “Industrial Structure Vision 2010,” it seeks to focus minds on Japan’s difficult situation. The report begins with this statement of the committee’s stance: “The Industrial Competitiveness Committee has been discussing the future sources of Japan’s income and employment. Our examination has sought above all to directly confront the realities of Japanese industry in the world. The discussions that have taken place up to now have tended to lapse into fine-sounding praise of Japan’s strengths, head off toward pessimistic views of the unproductive, masochistic type, or consist of entirely spiritualistic theses and eloquent prose divorced from economic realities. In our report on this occasion, we indicate first how the governments of the major countries are dealing with the vast changes in the world’s leading players and growth markets and in the key factors that govern competition. Building on this foundation, we examine the direction Japanese industry needs to move in to come up with added value. We then identify strategic areas with great growth potential and offer cross-sectional measures by which Japan, in the context of globalization, can create added value and secure employment.”

But precisely what are the realities that the drafters of the vision urge us to confront squarely? First, Japan’s ranking in the world measured by per capita GDP fell from third in 2000 to twenty-third in 2008. Second, Japan’s share of global GDP dwindled from 14.3% in 1990 to 8.9% in 2008. Third, in the world competitive power ranking compiled by the International Institute for Management Development, Japan held first place in 1990 but slipped to twenty-seventh place in 2010. Fourth, in all of the major criteria companies consider when selecting a site to set up a business, Japan has lost ground to other Asian industrial centers over the last two years. Fifth, whereas the advanced countries as a whole have cut their effective corporate tax rates by about 10 percentage points over the past 10 years in order to attract global corporations, Japan has left its rate unchanged at about 40%, a high level. This has opened up a gap of about 15 percentage points between Japan’s rate and the average rates of Asia’s newly industrialized and emerging countries, as well as of the developed countries in the Organization for Economic Cooperation and Development. Sixth, foreign companies that had been using Japan as a base for their Asian headquarters or R&D centers have relocated to other Asian countries one after another, and even Japanese companies, which were already moving production offshore, have begun to use other countries as the base for their home office or R&D facilities.

The vision stresses that an immediate response is required. In the market for manufactured products, the problems are not limited to specific industries or specific products. Japanese companies have lost one battle after another, causing Japanese market shares to shrink rapidly. And the speed of the shrinkage has been accelerating. We need to note, however, that these realities are not new developments. They began to emerge long ago. This is, in other words, a crisis that has been fully evident for years, but nobody wanted to confront it. It seems that something in the psychological makeup of Japanese society has made even those who were aware of the realities unwilling to admit their existence.

Rechanneling Pessimism into Action

As a result of this mind-set, the Japanese version of the Young Report is not completely devoid of the sense that the battle has already been lost. What the vision seeks to do, though, is to convert the overblown pessimism that has been gripping society into a sense of crisis. If that can be done, the vision may be able to serve as a catalyst, as the Young Report did, one that sparks a fundamental restructuring of the Japanese economy. Attitudes of pessimism and crisis are worlds apart. Whereas pessimism prompts withdrawal and becomes an excuse for not doing what needs to be done, a sense of crisis unleashes powerful energy that can break through barriers.

In its presentation of recommended steps for Japan to take, the vision provides concrete examples of related measures, systems, and practices in other countries. This approach seeks to drive home the sense of crisis by exposing the reality of Japan’s lag behind other countries, both on the level of government policy and in the realm of corporate management strategies. In the area of industrial policy, it notes that the US government is concentrating its investment in specific fields. One of the targets is clean energy, a field that extends from smart grids to solar power, wind power, batteries for next-generation automobiles, and energy-saving technologies. For example, subsidies with a value of $2.4 billion are provided to cover half the cost of acquiring plants to manufacture batteries and parts for next-generation cars, while $3.4 billion has been earmarked for the Smart Grid Investment Grant Program. The German government, similarly, is stepping up investment focused on the environment and energy fields, such as photovoltaic power generation. For example, it plans to spend €46.5 million on 22 R&D and other projects to enhance the reliability of lithium-ion batteries for use in electric vehicles. China, meanwhile, is concentrating its support on 11 major industries, including autos, steel, and the culture industry, and it applies a lower corporate tax rate to qualifying high-tech companies. In this way, other countries have introduced national strategies, including fiscal measures, in a bid to utilize private-sector vitality for transforming the industrial structure.

To deal with this situation, the vision calls for four shifts. The first is a shift in the industrial structure. The idea is to replace the existing unipolar structure, which is overly reliant on just one industry–automobiles–with a multipolar structure based on several key areas, thereby facilitating a flexible response to such developments as external shocks. The second is a shift in the business models of companies to link technological capability with business operations. The third is a shift in thinking away from the either/or assumption that Japan can either globalize, which is assumed to mean moving operations offshore, or secure domestic employment. In fact, Japan should also be able to create jobs by making itself more attractive to foreign companies and responding more skillfully to globalization. And the fourth is a shift in the government’s role. The aim is to make use of public-private partnerships to secure a larger share of the global market. The government and the private sector could team up, for instance, to secure business in the global infrastructure market.

Industrial Policy Makes a Comeback

This set of recommendations amounts to a proposal to strengthen Japan’s industrial policy in a comprehensive, strategic fashion. For many years now METI has held back from this kind of call for a proactive industrial policy. Back in the 1980s, when intense friction was generating heat in Japan-US trade relations and economic ties, the US government lashed out at various Japanese ministries and agencies, especially MITI, the Ministry of International Trade and Industry, METI’s predecessor. Tokyo’s industrial policy, Washington complained, was an unfair tactic aimed at grabbing markets by giving assistance to designated industrial sectors. Thereafter the ministry viewed the term industrial policy as a dirty word and drew back from discussion on how this policy might best be applied. But then everything changed. These days countries around the world are energetically deploying strategic industrial policies of their own, steering a course that might be called neomercantilism, and arguing that their actions are in the fine cause of preserving the global environment. Japan was slow to make this shift, and its delay has become conspicuous.

Recently many countries are applying industrial policy on an enlarged scale, partly to deal with the recession triggered by the global financial crisis. In the United States, the administration of President Barack Obama adopted what it portrayed as an economic recovery plan but has the nature of a “green New Deal.” This Obama green energy plan entails active government involvement in efforts to secure growth industries and technologies for the twenty-first century, and it is, in fact, a strategically designed industrial policy. The very country that in the 1980s criticized Japan for using an industrial policy has introduced its own industrial policy on a grand scale.

In Japan’s case, however, targeting just a few industries and technologies would be insufficient for revitalizing the economy. A suitable model for growth and development in the twenty-first century must be assembled. Toward that end, the first need is a reexamination of the causes of the long slump and persistent deflation that have plagued the nation since the 1990s, turning what was called the lost decade into two lost decades. We need to begin with an accurate grasp of where Japan stands today, taking into account the conjunction between the long historical flow of its economic development and the recent current of rapid change in the world economy. Any growth strategy slapped together without this kind of reexamination would lack the necessary historical orientation; it would be no better than a smorgasbord of growth-enhancing measures with something to please everyone.

The growth rate of the Japanese economy has been in decline since the 1960s. Average annual real growth during that decade came in at 10.5%, but the rate dropped to 5.2% during the 1970s, 4.4% during the 1980s, and 1.5% during the 1990s. In the first decade of this century, moreover, the average fell further to a level under 1%.

The shock waves from the 2008 bankruptcy of Lehman Brothers did not seriously destabilize the Japanese financial system, but the ensuing economic downturn hit the Japanese economy much harder than the economies of Western countries, even though Japan was far from the epicenter of the financial upheaval in the United States. By the start of 2009 Japanese exports had fallen nearly 50% below their level a year earlier. Industrial production quickly slowed down, and the capacity utilization rate fell almost all the way to 60% before it bottomed out. The domestic corporate goods price index also moved sharply down, recording a year-on-year decline of more than 8% for a while. Companies stepped up their efforts to cut costs; downsizing of workforces spread widely; household income contracted; and Japan alone among the advanced nations experienced a worsening of deflation. Even before the Lehman shock, however, Japan was already suffering from persistent slow growth and falling prices. We must confront the reality that apart from any temporary dislocation that the global economic crisis may have caused, the Japanese economy has been hobbled by long-term structural weaknesses.

Getting Ready to Rejoin the World

Some of Japan’s structural problems are peculiar to this country. As a latecomer among the industrial nations, Japan embarked on economic development using systems and practices of the catch-up type in the hope of overtaking the more advanced nations of the West. When the catch-up process eventually came to a successful conclusion, the catch-up model ceased to match the needs of the time. There was no failure in the model; it had performed just as it was supposed to. But its historical mission had come to an end.

At that point Japan needed to construct an original post-catch-up model and adopt new systems and practices in order to keep its economy growing and developing. By the second half of the 1980s, not only had Japanese technology and production capacity reached the level of other advanced countries, but the yen had surged in value. The yen gained so much strength, in fact, that Japanese per capita income measured in dollars became the world’s highest, saddling companies with heavy wage costs. Clearly this was a situation calling for the construction of a new model.

It was just at that time, however, that Japan’s bubble economy began to inflate. This came about as a result of an inappropriate response to both the high-flying yen, which was sent aloft by the 1985 Plaza Accord on currency realignment, and mounting trade friction with other countries. In the euphoria of the bubble years, companies grew overconfident and succumbed to the illusion of success. Surely, they thought, the Japanese model of growth and development, including the approach to corporate governance, must be more fully developed than and superior to the models of the forerunners in industrial development. When the bubble collapsed at the start of the 1990s, accordingly, the work of building a post-catch-up model had not even begun. The process was then further delayed by a series of complicating factors, notably the piles of bad debts that needed to be cleared away, and it has continued to be put off to this day.

Even as the Japanese economy fell into stagnation following the bubble’s collapse, the emerging markets were recording spectacular growth. China, India, and other countries got a helping hand from some of the world’s best corporations, which selected them as sites for foreign direct investment. Enthusiasm for attracting investment then spread widely, and Western nations joined the FDI game. The Soviet Union, meanwhile, was unraveling. It came undone in 1991, the very year when Japan’s bubble burst, and its demise led to the rejection of the command economy model. Countries around the world began vigorously competing in the field of systemic reform, seeking to come up with systems that would put them out in front in the race for growth potential. Japan, however, had no leeway for action. With chronic deflation complicating its economic stagnation, it had its hands full just dealing with the crises it kept stumbling into. When we Japanese finally aroused ourselves, we came face to face with the new realities presented in “Industrial Structure Vision 2010.”

This is a world in which companies select countries. A country like Japan with high corporate taxes will not find itself being selected by foreign corporations as a suitable base for operations. Indeed, even Japanese corporations are having second thoughts, and some are moving R&D centers and even home offices to other countries. Many Japanese politicians are making a big fuss about how the reforms the government has initiated are causing social disparities to widen, but compared with what other countries have done, Japan’s reform process has barely begun. Now that the administration has come up with a new growth strategy and METI has unveiled its vision, we may say that the day of postponing action, of steering clear of the global current of competition to create the best systems, is drawing to a close. Japan is finally beginning a serious debate on structural reform.

We have no time to waste. The Japanese population is aging at the fastest pace in the world. The postwar baby-boom generation is approaching age 65, and in another 10 years or so its members will be entering the ranks of the older senior citizens, where they will drive up the costs of nursing care and place a heavy load on public finances. Instead of looking back at decades lost in the past, we must look forward to the time we have remaining. It is said that if nothing is done, Japan is sure to encounter a fiscal crisis within 10 years at the longest. In this remaining time, we will be put to the test of completing the construction of an effective growth strategy and using it to produce results.

Translated from an original article in Japanese written for Japan Echo Web. [August 2010]