JAPAN
22 February 2024
How to fix Japan
Embracing the lost art of “creative destruction” will allow the once booming economy to flourish again.
There is no advanced economy more in need of fixing than Japan. Three decades of economic stagnation have been caused by relatively weak productivity, poor demographics and world-record public debt. This is undermining economic prosperity. South Korea’s GDP per capita has now overtaken that of Japan. And China has overtaken Japan as the world’s leading motor vehicle exporter as Japanese producers have been slow in moving into the electric vehicle space.
The stagnation is also constraining Japan’s commitment to lift its military expenditure, against a background of heightened geopolitical tensions, including among its neighbours North Korea, Russia and China. Umpteen policy recommendations to fix Japan have been made over the years by the International Monetary Fund (IMF) and the Organisation for Economic Cooperation and Development (OECD). And the administration of former prime minister Shinzo Abe (2012–20) adopted an ambitious program for economic revitalisation — dubbed “Abenomics”. But overall, not enough has been done to shift the dials.
Perhaps the most interesting proposals for a Japanese economic revival have been recently made by Richard Katz in his new book The Contest for Japan’s Economic Future: Entrepreneurs vs Corporate Giants. According to Katz, a well-known analyst and author of books such as Japan: The System that Soured, Japan’s main economic problems are political, as the government has been impeding the process of “creative destruction”. The challenge for Japan is not in reinventing itself but in rediscovering its old self.
One of the key drivers of Japan’s high-growth period from 1953 to 1973 was entrepreneurship, which saw the creation of companies such as electronics giant Sony, and motorcycle and motor vehicle producer, Honda. Katz writes that while there was a high birth rate of new companies, unsuccessful companies were allowed to fail, leaving space for the rise of new companies.
But the government deliberately slowed down this process of “creative destruction” following the 1973 oil shock and the financial crisis that started in the early 1990s. In the interests of social stability, the Japanese government propped up moribund “zombie” companies, rather than letting them fail and cause unemployment. In other words, the government created a de facto private-sector safety net rather than a government-funded one.
One consequence is that both the death and birth rates of companies have plunged. Japan’s small and medium enterprises are the oldest of the OECD countries and also have the lowest rate of growth. And only one of the country’s top two dozen electronics manufacturers was created after 1959.
The Japanese economy has thus been robbed of new ideas and entrepreneurial dynamism with the result that Japan’s labour productivity is only about 60 per cent that of the United States, and the lowest of the G7 countries. In sum, Japan suffers from the “old company disease”, where management and staff are set in their ways, in part due to the lifetime employment system that promotes people with the same ideas.
The good news is that Katz sees some signs of a resurrection of an entrepreneurial Japan. Recent years have seen a flurry of new business creation by entrepreneurs with international experience and who have studied abroad. And growing numbers of workers are renouncing the security of the hidebound lifetime employment system in traditional large companies by switching mid-career to new firms. One byproduct of the ageing society is that labour shortages have given workers greater bargaining power, and they are willing to take more risks in their careers.
There are also signs that the tight labour market is breaking down workplace discrimination against women in Japan, especially among newer firms. Japan’s very well educated women are an underappreciated resource on offer for the nation’s economy, as reflected in Japan’s ranking of 125 out of the 146 countries in the World Economic Forum’s latest Global Gender Gap Report.
Technology also offers Japan great opportunities for doing better. Katz reports that while Japan came in dead last for “digital agility” in a 64-country ranking by IMD Business School, e-commerce is now taking off, notably through Rakuten, Japan’s flagship internet “mall”. This is helping erode big company dominance of the distribution system.
Despite these positive signs, new Japanese companies still face many barriers, especially securing financing. Japan has few angel investors, and Japanese conservative banks – who are often in the same sprawling conglomerates as the corporate giants – are reluctant to lend to new firms, especially those with female founders. And not everyone is happy about these new positive developments. Powerful traditional companies fear the prospect of creative destruction.
Katz argues that Japan’s new positive trends need to be amplified by government action, and there is much the government could do, including removing disincentives for angel investors. The government could give new firms a bigger slice of research and development funds, 90 per cent of which currently go to big, old companies. A share of government procurement contracts could be reserved for new enterprises. For Katz, the goal should be to have a better balance between old and new companies; both are necessary. But at present, the system is rigged against newcomers.
In Japan’s virtual one-party democracy, the ruling Liberal Democratic Party has every incentive to act. Frustration with the country’s continued economic stagnation and the growing sense of geopolitical vulnerability could well see an opposition party unseat the government, as occurred in 2009. Moreover, Japan has reached the point where the future of the nation is at stake, as is its role as a key pillar for peace and security in the Indo-Pacific.
Katz’s recommendations to foster the burgeoning rival of entrepreneurship may not provide Japan with a complete fix. Many other measures are necessary, like improving corporate governance and encouraging a higher fertility rate. But they could go a long way to lifting Japan’s productivity and improving the nation’s sense of geopolitical security.
The stagnation is also constraining Japan’s commitment to lift its military expenditure, against a background of heightened geopolitical tensions, including among its neighbours North Korea, Russia and China. Umpteen policy recommendations to fix Japan have been made over the years by the International Monetary Fund (IMF) and the Organisation for Economic Cooperation and Development (OECD). And the administration of former prime minister Shinzo Abe (2012–20) adopted an ambitious program for economic revitalisation — dubbed “Abenomics”. But overall, not enough has been done to shift the dials.
Perhaps the most interesting proposals for a Japanese economic revival have been recently made by Richard Katz in his new book The Contest for Japan’s Economic Future: Entrepreneurs vs Corporate Giants. According to Katz, a well-known analyst and author of books such as Japan: The System that Soured, Japan’s main economic problems are political, as the government has been impeding the process of “creative destruction”. The challenge for Japan is not in reinventing itself but in rediscovering its old self.
One of the key drivers of Japan’s high-growth period from 1953 to 1973 was entrepreneurship, which saw the creation of companies such as electronics giant Sony, and motorcycle and motor vehicle producer, Honda. Katz writes that while there was a high birth rate of new companies, unsuccessful companies were allowed to fail, leaving space for the rise of new companies.
But the government deliberately slowed down this process of “creative destruction” following the 1973 oil shock and the financial crisis that started in the early 1990s. In the interests of social stability, the Japanese government propped up moribund “zombie” companies, rather than letting them fail and cause unemployment. In other words, the government created a de facto private-sector safety net rather than a government-funded one.
One consequence is that both the death and birth rates of companies have plunged. Japan’s small and medium enterprises are the oldest of the OECD countries and also have the lowest rate of growth. And only one of the country’s top two dozen electronics manufacturers was created after 1959.
The Japanese economy has thus been robbed of new ideas and entrepreneurial dynamism with the result that Japan’s labour productivity is only about 60 per cent that of the United States, and the lowest of the G7 countries. In sum, Japan suffers from the “old company disease”, where management and staff are set in their ways, in part due to the lifetime employment system that promotes people with the same ideas.
The good news is that Katz sees some signs of a resurrection of an entrepreneurial Japan. Recent years have seen a flurry of new business creation by entrepreneurs with international experience and who have studied abroad. And growing numbers of workers are renouncing the security of the hidebound lifetime employment system in traditional large companies by switching mid-career to new firms. One byproduct of the ageing society is that labour shortages have given workers greater bargaining power, and they are willing to take more risks in their careers.
There are also signs that the tight labour market is breaking down workplace discrimination against women in Japan, especially among newer firms. Japan’s very well educated women are an underappreciated resource on offer for the nation’s economy, as reflected in Japan’s ranking of 125 out of the 146 countries in the World Economic Forum’s latest Global Gender Gap Report.
Technology also offers Japan great opportunities for doing better. Katz reports that while Japan came in dead last for “digital agility” in a 64-country ranking by IMD Business School, e-commerce is now taking off, notably through Rakuten, Japan’s flagship internet “mall”. This is helping erode big company dominance of the distribution system.
Despite these positive signs, new Japanese companies still face many barriers, especially securing financing. Japan has few angel investors, and Japanese conservative banks – who are often in the same sprawling conglomerates as the corporate giants – are reluctant to lend to new firms, especially those with female founders. And not everyone is happy about these new positive developments. Powerful traditional companies fear the prospect of creative destruction.
Katz argues that Japan’s new positive trends need to be amplified by government action, and there is much the government could do, including removing disincentives for angel investors. The government could give new firms a bigger slice of research and development funds, 90 per cent of which currently go to big, old companies. A share of government procurement contracts could be reserved for new enterprises. For Katz, the goal should be to have a better balance between old and new companies; both are necessary. But at present, the system is rigged against newcomers.
In Japan’s virtual one-party democracy, the ruling Liberal Democratic Party has every incentive to act. Frustration with the country’s continued economic stagnation and the growing sense of geopolitical vulnerability could well see an opposition party unseat the government, as occurred in 2009. Moreover, Japan has reached the point where the future of the nation is at stake, as is its role as a key pillar for peace and security in the Indo-Pacific.
Katz’s recommendations to foster the burgeoning rival of entrepreneurship may not provide Japan with a complete fix. Many other measures are necessary, like improving corporate governance and encouraging a higher fertility rate. But they could go a long way to lifting Japan’s productivity and improving the nation’s sense of geopolitical security.