Japan: a rising or waning sun?

Then came ‘Abenomics’ with its ‘three arrows’, Prime Minister Shinzo Abe’s grand plan to revitalise an economy which – let us not forget – is still the world’s third largest.

" The live question is not so much whether Japan will have a technical recession… but whether the much-needed reform of the economy is on track.” 

Many previous such plans had collapsed, throttled by bureaucratic sclerosis, vested interest, a lack of political will and corporate rigidity. But in the final quarter of 2015, Japan’s economy grew.

Abenomics was working. And Japan kept growing for nine quarters straight, the best run for 28 years – until this year.

In the three months to March 31 Japan’s economy shrank at an annualised rate of 0.6 per cent. Whether that’s the end of this run of sunshine is debated – the weight of economic opinion is it’s not, that a rebound is already evident, and the weak quarter had much to do with a particularly bleak winter.

According to Goushi Kataoka, policy board member of the Bank of Japan, in a speech just before the latest data were announced, Japan’s annual real growth rate for 2017 was 1.6 per cent, the highest level since 2013.

“The breakdown by component during this period shows that private business fixed investment and exports are the major driving forces of the growth,” he said. “With regard to the outlook, in fiscal 2018, Japan's economy is likely to continue growing at a pace in the range of 1.0-1.5 per cent, exceeding its potential.

“This is because business fixed investment will increase, reflecting improvements in corporate profits and business sentiment, and exports will rise on the back of robust growth in the global economy. These positive developments will then transmit more strongly than before to households through a rise in wages, which will lead to some acceleration in the pace of growth in private consumption.”

Growth will slow after that, reflecting a consumption tax increase and a peaking in demand related to the 2020 Olympics but the central bank continues to see real growth.

But the live question is not so much whether Japan will have a technical recession this year or next – two successive quarters of negative growth – but whether the much-needed reform of the economy is on track.

Need it

There is no doubt Japan needs reform: much of the economy, particularly the domestically focussed sectors, remain unproductive; the working population is shrinking; the nation is ageing; the economy needs to become more global to offset flat domestic opportunity.

Ironically, according to Miki Tsusaka, senior partner and managing director of The Boston Consulting Group in Japan, what the relatively long period of growth under Abenomics did was allow a certain complacency to set in - despite the enormous reform agenda still ahead.

“It is a bit unfortunate we have lost this sense of panic,” she said in a recent discussion with bluenotes in Tokyo. “The economy was being driven to change by a certain anxiety. The average Japanese companies have margins, earnings, way, way lower than their global peers.”

Tsusaka said – and again this is a longstanding phenomenon – the export-focussed, globally exposed Japanese companies are vastly more efficient than the domestic ones, particularly in the small to medium-sized enterprise (SME) sector.

Her colleague, BCG partner and managing director Yasuhiro Yamai, said this focusses attention on the third arrow of Abenomics – restructuring of the economy. While the first two arrows, fiscal stimulus and monetary policy, had relative quick and measurable impacts, they are only short to mid-term palliatives. It is the third arrow which is essential for sustainable growth.

“And some say it is stuck, some say it is ongoing, it is not clear,” Yamai said. “But the government believes the future for Japan Inc. is in IT, digital – the problem is in this area we are not moving fast enough. China is moving ahead. The EU, Nordic countries, Singapore, are moving ahead.”

Areas

From the BCG perspective, Japan has the opportunity as well as the challenge. The firm singles out three areas in particular:

• Corporate vitality

With record profits companies need to focus on investing in new technology and next-generation manufacturing. The question is whether enough is being done on this front and whether Japan Inc’s corporate mindset and strategic focus is right.

• Diversity and innovation

Neither is a strong point today in Japan. Diversity has never been, a particular challenge now given the growing evidence of how strongly it is linked to innovation.

BCG found companies which broaden their approach to diversity – including age, gender, industry background, nationality, career path—see bigger benefits. The diversity effect is also greater for digital innovation.

• Value-based health care

According to BCG, Japan enjoys relatively good health care outcomes at a reasonable per capita cost, thanks to universal access, a single payer system, and strict cost control.

But the population is ageing. Value-based health care, where the costs and outcomes of different interventions are measured, shared, and used to guide the selection of therapies across the health care system, is very challenging but the firm notes Japan has every incentive to be a pioneer.

Innovation

Japan of course does have a history of innovation and crisis response, never more evident than in the economic miracle following defeat in World War II.

Moreover, the track record of Abenomics to date is very encouraging. Since the program of reform kicked off in 2013 nominal GDP hit a record level, corporate profits a record high, unemployment is the lowest in a quarter of a century and both private non-residential investment and tax revenue have increased more than 10 per cent.

After the latest set of disappointing figures, Economy Minister Toshimitsu Motegi confirmed “there is no change in our view that the economy is recovering moderately”, adding an anticipated pickup in private-sector demand will help the economy return to growth.

Private consumption, which accounts for about 60 per cent of GDP, was flat in the March quarter after heavy snow in January and February while higher fresh-food and energy prices made consumers reluctant to spend.

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Source: https://www.japan.go.jp/abenomics/about/

Long-term observers of Japan do believe there has been a fundamental shift in the Japanese mindset compared with the more superficial responses to the economic crisis of 1998 and the financial crisis of 2008.

Ross Rowbury, the president and chief executive of Edelman Japan, who has lived in Japan for four decades and seen several “revitalisation campaigns”, said “looking back, I don’t think I have seen so much change as I have in the last five years – and it is real change, it is mindset change”.

Key to the change according to Rowbury is the realisation in corporate Japan the country cannot remain inwardly focussed. Not only because the domestic economy offers limited growth compared with offshore but even domestically looming labour shortages and technology demand a more global perspective.

“Even five or six years ago, if I took a non-Japanese speaking person to a meeting, there would be this undertone of that person is just slowing the meeting down, what are they here for, no engagement,” he said.

“Now more and more companies are really happy to take these meetings, they have more English speakers, they are looking for insights. The allergy against English-speaking foreigners has gone and some companies like Rakuten (the Japanese ecommerce giant) even demand all their staff speak English.”

Urgency

Rowbury also sees a far greater sense of urgency; recognition that when strategic decisions are made they have to be enacted quickly.

In recent years, even when Japanese companies have been world leaders, they have lost the advantage. The highest profile example is the loss of global leadership in consumer electronics to Korean companies.

But few remember the first smartphone, featuring integrated email and web-browsing on a mobile data platform, was i-mode, created in 1999 by NTT DoCoMo. Now the most popular smartphone in Japan is from Apple.

BCG’s Tsusaka said underlying this waning of innovation has been a loss of corporate vitality. Japan still invests heavily in research and development but the corporate world needs to recover the ability to reinvent itself, both strategically and managerially.

“Gender diversity is just one element of this – a very important one – but now at least we are seeing a certain embarrassment when we go to meetings and there are only males in the room,” she said.

Abenomics does recognise how fundamental this is. The program talks of “providing grounds to drive innovation and realise Society 5.0”. While it’s not clear what happened to 3.0 and 4.0, 5.0 looks at a regulatory sandbox, open data, an ecosystem for startups and collaboration between industry and academia.

There is also a growing body of evidence to support Japan’s more outward looking mindset. Expatriate workers are being encouraged, foreign tourist numbers – amplified by the looming Rugby World Cup and Olympics - growing, there is concerted effort to sign more Free Trade Agreements and a recognition Japan can play a far greater role in bridging the infrastructure deficit in emerging Asia.

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Meanwhile, even though Japan has long had an ‘open’ economy, in reality the vast majority of capital flows were internal – ordinary Japanese savings went into the Post Office bank where they were used to buy Japanese government bonds to raise debt for often unproductive domestic investment.

In equity markets, corporate and financial cross-shareholdings produced a corporate sector insulated against market forces.

Now there are signs of markets opening more widely, notably in the corporate bond market. For example, S&P Global Ratings believes partially revised guidelines at Japan's gargantuan government pension fund may pave the way for diversification of Japan's corporate bond market, creating diversity.

Previous Japanese economic revivals have indeed been driven by a sense of crisis – hence BCG’s concerns about complacency.

Survival

Previous Japanese economic revivals have indeed been driven by a sense of crisis – hence BCG’s concerns about complacency.

That’s probably wise. Another long-term Japan resident and president of Dale Carnegie Training Japan, Dr Greg Story, is confident the country recognises reform is now a matter of survival.

Having first been in Japan with Austrade, which he later headed, then working for financial institutions, Story sees the shift not just inside Japan but in examples like wealth management and insurance giant AXA shifting its regional headquarters from Singapore to Tokyo.

Closer to home, Story sees this attitude in his work with Dale Carnegie.

“I’ve done a few books now but this time (with his latest book, Japan Sales Mastery, a number-one seller on Amazon Japan) I was really overwhelmed by the desire from within Japan to gain greater insight into what’s going on in the world – and from the world into Japan,” he said.

There is a cyclical element to the current period of growth and even the foreign interest: the Great Tohoku earthquake and tsunami of 2011 saw an outflow of foreign individuals and investment but then the rebuild added to economic growth.

“That’s washed through now and the foreign interest is even greater, it’s almost impossible to find places in the international schools, for example,” Story said.

“Another element of that is not only is Abe probably the most-travelled Japanese prime minister but he and several of his senior ministers are very comfortable with English. It’s really a symbol of the opening of Japan.”

Ironically there’s also some upside to the ageing population according to BCG’s Yamai: it is driving intense interest in artificial intelligence and robotics – to help the elderly – while those ageing Japanese are called the “silver” generation because of their accumulated wealth. Which they are now spending.

The world will be closely watching Japan’s next set of economic data to see if the Land of the Rising (Waning) Sun has slipped back into yet another recession. But for once there is confidence that even if that is the case, the underlying story is positive.

Andrew Cornell is managing editor at bluenotes. He was previously Tokyo bureau chief for the Australian Financial Review and co-authored, with Manuel Panagiotopoulos, Japan: Beyond the Mainstream, for the Australia-Japan Foundation.