Japan needs growth to decline ‘gracefully’

Takaaki Umezawa

Japan today appears as if it is trying to pull off a "graceful decline." This may be the most palatable alternative for a society dealing with economic contraction associated with population decline and an aging workforce. Yet, Japan is trying to remain a welfare state by eliminating disparities through income redistribution while also hoping to sustain per capita GDP and maintain comfortable living standards.

Under this "ideal" scenario, Japan would probably take the following steps:

It would continue to favor capitalism and free trade as a basic framework, while strengthening economic collaboration with China and other Asian nations. Japan would reinvent its export-oriented sectors, such as the automotive and electronics industries, as "eco-manufacturing" bases that produce eco-cars, solar cells and rechargeable, secondary batteries.

For industries catering to domestic demand, Japan would take steps to make its service industries--such as healthcare, nursing care, childcare and education--more efficient and sophisticated. It would redevelop the agricultural industry by encouraging entries of large-scale farming enterprises and partnerships with commercial businesses. This would help increase Japan's food self-sufficiency rate and improve its rural economies.

Japan would also try to bolster birthrates and prevent further population decline. By improving childcare and nursing-care services, and enhancing adult and vocational education, it would seek to increase the participation of women and senior citizens to offset the decline in the workforce.


A 'miserable decline' scenario?

While the "graceful decline" scenario sounds comforting for most citizens, it would not be easy to achieve because of four major challenges.

First, can Japan's manufacturing sector remain competitive in the global market? If the nation implements its domestic low-carbon measures, energy-dependent industries such as steel and chemicals will be in an even greater hurry to shift production overseas. While its "eco-manufacturing" sector is expected to become a world leader, it is hard to tell who will win eventually in the tough global competition since many nations, both developed and emerging ones, are trying to promote their green industries.

For example, Japan has traditionally been a world leader in solar cell technologies. Sharp Corp., however, fell from top global ranking in terms of production volume in 2006, to fourth in 2008. Even with electric vehicles, the Japanese automotive industry is not guaranteed to retain its lead as electric motors and batteries replace internal combustion engines.

Second, can the Japanese service sector achieve significant growth? In this sector, labor productivity in real terms improved at an annual rate of just 0.3 percent between 1991 and 2007. Deregulation is essential for improving productivity. But how bold can the new government be, given public skepticism over market mechanisms?

Third, can child allowances and free higher education prevent a rapid decline in the birthrate? This decline is attributable to a complex set of issues, such as unstable employment, fewer and later marriages, disorganized childcare services, and social prejudice against extramarital births. Assuming that the nation fails in its efforts to counter low birthrates or improve employment rates of women and seniors, Japan will have 4.4 million fewer workers by 2017, and 10.7 million fewer by 2030, according to a 2007 study by the Ministry of Health, Labor and Welfare. This fact alone would significantly reduce the options for the domestic economy.

Finally, fiscal problems weigh heavily. To improve welfare at a time when the nation's public debt is more than twice the GDP figure and hopes are slim for a natural increase in tax income linked to economic growth, Japan will have to raise taxes and social insurance premiums. There are grave concerns that this could rob Japan of the last of its economic vitality.

If it should stumble on these obstacles, Japan will face a "miserable decline" scenario. Society will not stop aging, and the population will keep shrinking. Domestic demand will decline, and manufacturing industries will continue to shift overseas. The domestic service sector will not grow to provide sufficient employment to the nation's workforce. Household consumption will remain permanently anemic. Underperforming industries and companies will be kept alive with injections of public money, resulting in low corporate tax receipts.

The consequence would be a society offering mediocre welfare benefits for a high national burden ratio, with taxes redistributed inefficiently and a notable absence of vigor.

Achieving a national resurgence

By aiming for a "graceful decline," Japan is at great risk of experiencing a "miserable decline." We need a more ambitious scenario for re-growth. In addition to the ideas of "eco-manufacturing" and growth of the service sector, I wish to propose three key agendas.

First, Japan needs more areas that can generate profits from overseas markets, to add to the traditional list of the automotive, electronics and machinery industries. Japan's infrastructure-related industries, in particular, have the potential to bundle their highly competitive products and systems with services in overseas markets. We could, for instance, provide a turnkey solution from installing eco-friendly electricity generation equipment to managing power generation and distribution operations. There are many other possibilities along similar lines: exporting railroad equipment and systems and running railroad operations, or selling electric vehicles and developing an "eco-city."

Japan should also foster industries that benefit from its culture. Examples would include cuisine and food, fashion, tourism, and media content such as animation and movies. Take girls' fashion, for example. Shibuya's fashion building "109" has become a center for international trends and the Japanese word kawaii (cute) has entered the international fashion lexicon.

In China, Japanese magazines like Ray and ViVi dominate the top five ranks of foreign magazines specializing in women's fashion. Yet, Japanese apparel companies--even the leading firms--are each generating revenues of only several dozen million dollars in China. Clearly, Japanese soft power is not translating into earnings. We see a similar situation in media content and food. Japan needs a strategy that leverages its cultural appeal and enables companies in relevant sectors to generate foreign earnings.

Second, Japan needs to strengthen its financial markets and associated industries. In particular, Tokyo needs to develop into a true international financial center, and this would bring several key benefits. One of them is to mobilize Japan's individual financial assets, a large majority of which are invested in domestic savings and government bonds, generating meager returns. Japan needs to shift a part of the financial assets to better investment opportunities around the world, and increase the foreign investment income as the national trade balance worsens in the long run.

Another key benefit is to draw international attention to domestic investment opportunities. Inviting more foreign capital to Japan would inject some vigor into the domestic economy, by accelerating the transformation of Japanese industries and companies. Meanwhile, having the Tokyo market as an Asian financial hub would enable Japan to make a great contribution to economic development in the region by facilitating better utilization of Asian savings for Asian investments.

To achieve this goal, Japan will need to develop its financial sector, along with its legal, accounting and other professional services. Growth in these high value-added industries would also help bolster per capita GDP.

Third, Japan must fully open up its labor market. This obviously includes bringing into Japan foreign people with advanced skills in finance, professional services, engineering and research fields. It would also involve allowing an influx of skilled workers to support the growth of nursing care and agriculture.

I believe that we should expand the current population of 2 million long-term and permanent foreign residents to around 5 million to 10 million. To do this, Japan would need to develop public infrastructure that makes life easier for foreign nationals and make social efforts to improve their skills and incomes and encourage permanent residence in Japan. This change in the society would naturally help Japanese companies become "global from within."

Upon going global, many Japanese companies face significant challenges due to a lack of human resources capable of operating businesses from a global perspective. Also, the typical Japanese approach to globalization is unilateral: namely, having Japanese personnel transfer competencies developed in the domestic market to overseas markets, but not vice versa. This inherently limits the merits of globalization for Japanese companies, compared with multinational corporations that can leverage learning from many international markets.

To overcome these challenges and become more competitive in the global market, corporate Japan must develop the organizational capabilities to effectively employ talent from around the world.

Japan still has tremendous potential. Let us hope that industry and government will collaborate to re-grow the economy based on a clear vision of national resurgence.



■The author is managing director, Japan, A.T. Kearney.