What uncertainties weigh upon the future of Japan?

April 2009

INTRODUCTION

For the last 25 years, Japan has experienced periods of strong growth (in particular so-called ‘bubble economy’), severe crisis (in particular 91-2002), uninterrupted recovery growth (02-07) and currently strong recession.This is not the first time Japan suffers from shocks, either internal such as the collapse of bubble economy or external such as the Endaka resulting from the Plaza agreement. Japan has always recovered, got stronger and managed to limit the social cost of crisis: it took for example a ‘lost decade’ to recover from the bubble collapse but at low ‘visible’ social cost, unemployment remaining low1.However, current worldwide financial and economic crisis hits Japan with such an unexpected violence and a foreseen social high cost that Japan future appears extremely gloomy and analysts wonder if Japan is ‘collapsing’. Let us see which uncertainties weigh upon the future of Japan.

1 60-70 : average growth of 10.5% // 70-80 : average growth of 5.2% (despite -0.5% in 74)// 80-90 : average growth of 3.8% (despite Plaza agreement on 22/09/85 and Endaka (from 260 Yen vs USD to 120 in 3-year time) // 85-90 period is called bubble economy (Nikkei up to 38916pts End Dec 89 vs 8595pts on April 8, 2009) // 90-2000 : heisei recession called lost decade (average growth of 1.5% but -0.1% in 93 and –3% in 98)

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THE WORST RECESSION SINCE WWII

Macro-economic indicatorsLatest forecasts are particularly worrying:

Following an unexpected drop by 12.1% during last quarter of 2008 (on annual basis), GDP has contracted by 0.8% in 2008 and is foreseen to contract by 5.8% in 2009 (worst recession since WWII and worse forecasts among developed countries)2, driven by sharp decline in exports.

Export dropped in tandem with the appreciation of the Yen (appreciation of about 40% since mid-2007 against the USD) and worldwide economic deterioration, triggering an overall trade deficit for the last 2 quarters and a reduction by 40% of overall trade.

Domestic consumption dropped by 3.5% YoY in February (in already a stagnating domestic consumption since 2002)

2 IMF source (to compare with planned recession of 2.6% in US and 3.2% in EU)

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Unemployment rate rose to 4.4% in February 2009, still remaining low if compared with western standards. Indeed, many firms traditionally respond to weaker demand by shortening working hours3 rather than cutting employment itself (corporate welfare philosophy). Decreasing numbers of job offers as well as outside pressure to remain competitive might however lead to job cutting plans among the industry. Official unemployment rate is foreseen at 6% by mid-2010 by Morgan Stanley (and up to 8% for latent unemployment rate including short-hour and discouraged workers)

Price index is flat, with a risk of deflation. Deflation is not good news in Japan as it reminds the ‘lost decade’ lengthy crisis. Deflation leads to postpone investment/consumption.

3 aggregate weekly hours worked fell by 7.5%in 2008

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Low consumer confidence rate.

Capacity utilization lower than 50%, leading to an increase of cost per unit and lost of competitiveness.

A CRISIS...BUT NOT ONLY ECONOMIC

Human assetJapanese, especially part of the younger generation, seem to have lost the mindset of ‘gambaru’ (‘resistance, commitment in working, continuous improvement’), which was the force of the country during Meiji and 1945 –1990 periods; both periods being a quest for equality with western powers and both periods showing unprecedented fast growth for a developed country.This lost in mindset can be seen in:

lost confidence in the politics4 and bureaucrats5 due to their apparent low reactions in face of the collapse of bubble economy,

lost of confidence in the Japanese economic model6 challenged by the 3K (Kooreika / aging population jeopardizing social corporate welfare, Kokusaika /internationalisation i.e economic challenges by China and Asian Tigers and need to apply global organization standards such as corporate governance, Kiseikanwa / deregulation to cope with need of international competitiveness),

feeling of insecurity since 1995: Kobe earthquake / Aum sect subway attack, and recent tension with North Korea,

lost of ‘nation’ identity and its Confucian and historic values (group, harmony, rules, constant improvement of himself) with the introduction of technology of information allowing development of personal bubble versus traditional group dependence7, as well as questioning regarding Japan’s place in Asia and the world (challenged by China for second world economy, constant debate on Self Defence Force),

lost of ‘personal’ identity (soul searching attitude called jibunsagashi or phenomenon of NEET / freeters8).

4 Popularity of prime minister Aso Taro close to... 10%5 see best seller ‘strait Jacket’ society6 economic policies in service of the nation and general interest first, beaurocrats/politics/keiretsu links, welfare country (largely patronised by large companies, not by the state- including life time employment), stable political LPD leadership since 1955, fragile coherence and balance between powers ensuring consensus and finally ‘straighjacket’ society (collective mindset in service of the nation)7 to refer to otaku8 Non Employed, Educated or in Training // Freeters  (free arbeiters) : generation of 70’s baby boomers who did not want or could not find a job during the collapse of the bubble economy and who are characterised by non-permanent job, and resistance to a system which did not manage to provide a secured job. Estimated to 3 millions people; can in some cases be referred as parasite singles

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Japan is still praised for its very selective high level of education as well as its corporate training model but it leaves more and more Japanese on the side of the road - 37% of employees are on temporary basis in 2007 (vs 15% in 1992)- and do not prepare enough Japanese to internationalization in fields of English proficiency or management. It is to be noted that Japanese worldwide leading companies consist of industrial firms only. Japan seems to be efficient in exporting its model in managing blue-collars9 but did not succeed in expand any white-collars companies despite the size of service companies such as Dentsu.

The main asset of Japan during the time of economic growth (its people!) is now replaced by a sluggish labour market with:

strong two-tier system between large companies and Small and Middle Size companies (especially in terms of welfare and training), between permanent workers and temporary ones.

aging population (fecundity rate of 1.32 in 2002 / more than 35% of the population will be 65 or above in 2025), while large immigration is not considered as a solution for Japan (better robots than immigrants)

limited access to selective and full time work for women: university-graduated ladies workforce unexploited potential is a waste of investment for Japan (due to inadequate family policies and infrastructure but also to cultural habits).

AN ECONOMIC MODEL TO REVISE

In September 2008, Japan seemed to be relatively immune from the financial turmoil. South East / East Asia was also believed to be less dependant to US and EU, looking at the multiplication of Asian Free Trade Agreements and their intra-zone trade (impressive 52% of total Asian trade is intra-Asia trade, to compare with Europe, where 68% of European total trade is intra-EU zone). Unfortunately, both theories appeared to be wrong.

Banks have indeed been relatively immune from subprimes crisis with limited exposure to toxic assets (estimated 5 trillions Yen loss vs 42 in US and 83 in Europe), after strong restructuration following the 90s crisis and their newly risk-aversion following collapse of bubble economy. Banks posted profit records in 2002-2006. Yet they now experience shrinking in revenues and capital due to their lack of diversification10. Asia zone is not as resistant as shows its intra zone trade figures above. Most of this trade actually derived from a regional assembly workshop in place in the entire region (well known as the Akamatsu Flying Geese Paradigm, model for international division of labour in East Asia). Only 32.5% of finished products are finally exported/consumed within the zone, the rest being spare parts transiting from one country to another depending of competitive advantages of each country. Japan (and China/Korea) is then still largely dependant to export to outside Asia (67.5% of trade), especially in absence of any strong regional markets.11

As per analysts, last period of growth under Koizumi leadership did not solve some of fundamental weaknesses of Japan, consequences of the opening of the country.Current two pillars of Japanese economy are: large companies (keiretsu), largely export-oriented and a supportive financial sector. Those 2 pillars are currently in difficulties: automobile sectors posted a drop of –32.4% in Feb 09 vs Feb 08, while overall industrial production contracted by 9.4% in Feb after 10.2 in January. Period of growth have indeed failed to tackle:

9 so called LEAN production, mastered by Toyota: MUDA reduction, kanban, kanzen, 0 defect, Just in Time10 banks profits largely derived from the huge amount of capital available (household savings) and not on the margin on offered loan (impossible with a ‘almost’ 0% credit policy by Bank of Japan). In one word, during the good years, bank loaned a lot with a low margin. Current shrinking of capital (household savings rate contract from 15% to 8% in 2005), plus withdraw of some –limited though- foreign capital, plus contraction of the economy.... lead to a lower amount of loans on which the margin is still very low...hence to low profit or even lost due to increasing numbers of non performing loans (NPL) during economic crisis. 11 In absence of welfare system, Chinese save more than 20% of their revenues instead of consuming

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unfinished deregulation of financial sectors, allowing them to gain revenues from other sources than ‘loan/credit’,

unprofitable economic sectors (construction work... but also retail and agriculture), which lead to a high return of Non Performing Loans (NPL) in terms of crisis and jeopardize financial system,

poor increase of wages during 2002-07 economic growth for Japan middle class: wages in large companies increased by 1.63% to 1.99%, by 1.17% to 1.55% in SME during period 2003/2008 while poverty12 improved. Japan is no longer an equalitarian country (Gini coefficient raised to 38.1 in 2002 vs 24.9 in 1990),13

inadequate continuation of a almost 0% credit rate policy by Bank of Japan despite economic recovery in 2002,

insufficient transition from industry to service, increase of public debt to more than 160% of GDP,

Those weaknesses are burden in the current time of economic crisis: Due to deterioration of financial sectors, there is no significative overall credit crunch (yet) as in

Europe/US but amount of loans granted to SME is however decreasing (higher risk of NPL), Lack of internal supportive domestic markets14 and strong dependence to export, particularly

sensitive to the value of the Yen, Strong dependence vis a vis the industry, now strongly challenged by neighbouring China

(acquiring Japanese technology outsourced there) in absence of international service sector, Limited capacity of stimulus plans due to already high public debt: latest expected stimulus plan

(aggregated to 4% of GDP) “must be must be wise but at the same time cautious giving Japan’s fiscal conditions” according to Kaoru Yasano, finance minister,

No possible further cut of interest rates to either boost investment, ‘regulate’ value of Yen vs USD or prevent resurgence of deflation.

CRISIS: THREAT AND OPPORTUNITY

12 largely media-covered and revealed at the end of 2008 with tents at Hibiya Park13 Measure of statistical dispersion to measure inequality of wealth distribution: the closest to 0, the more equal is the country. The closest to 100, the more inequal. Coefficient for France is 28 (2005), UK is 34 (2005) and USA is 45 (2007)14 explained by middle class stagnating purchasing power, propension to save, aging population. Domestic comsuption is also shrinking at an annual pace of 3-5% (Ministry of Internal Affairs : drop in comsuption by 3.5%YoYin February 2009)

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In Japanese, one way to express a situation of crisis (kiki) is to mix the kanjis related to threat and opportunity. Such as previous crisis, the current one, as severe as it might be, shall also be seen as an opportunity.Let us finish with notes of optimism... even if due to the current lack of visibility in face of a crisis which blurred most of economic known models, only might-be possibilities can be drafted for mid/long term perspectives.

First, current internal weaknesses will sooner or later need to be tackled and could be turned to an advantage in making Japan as one of the leader in below fields:

Treating the needs of an aging population could help Japan to revolution this market within 10/15 years. Current serious solution is the development of robots, capable of performing home tasks, assisting elderly people. Sci-fi movies might be soon part of our life... Japan can count on the excellence of its academic system and human dedication in terms of sciences15 and a long lasting effort in R&D, always sustained at more than 3% of GDP even during crisis…

Leaving in limited space gained to mother-nature, Japanese being proud of giving birth to the Kyoto protocol, this seems to contribute to a new ecologic conscience which appears after years of uncontrolled urbanisation. Ecology is also clearly a way in which Japan intends to take the lead...

With an aging population particularly in the countryside and farmers soon to retire, the whole archaic Japanese agriculture system might be revamped within 10 years. Instead of applying model of western productivity (impossible due to the size of the fields), Japan is thinking of bio-model agriculture.... a promising market in the future

Those three axis are included in a latest released government plan to create 2 millions jobs and demand worth 60 trillions yen over the next 3 years, split into 3 axis translated in English as ‘low carbon revolution’, ‘health and longetivity’ and ‘display of inner strenght’.

This could be supported by a better use of capital available. Japan is the second world creditor with one trillion USD, while household savings are estimated to 11 trillions USD. Investing in new models shaping the future rather than in non-quite profitable US treasury bonds or in non-needed public works (to sustain LDP historic electoral base) might be a solution than the crisis will impose... even more if LDP loses incoming lower house elections due by September.

Second, the growth might come from its rival China. It is no doubt than Asia will become the new centre of the globalization in the future, China becoming the second world economic power, while India will (but when?) rises...For the time being, both giants have limited domestic markets, due to an inexistent welfare system leading to a high savings. Current crisis is proving that China cannot only depend on export to sustain its necessary 7% growth to provide jobs to immigrants from inner China. We shall then hope that massive available capital in China (1st worldwide creditor) will be used to start working on a better welfare, which would lead to the development of a massive domestic market... For Japan, China is just next door to export.This movement shall be accompanied by the opening of Japan to Foreign Direct Investment (FDI) to create a regional integrated market... It is however unclear how Japanese would react to incoming FDI from China due to their tense recent historical relations.

15 number 2 in terms if patents after the US / Even in fundamental research, Japan has recently gained 2 Nobel prizes

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In any case, short terms recovery of Japan is not in its hands but in the hands of USA and Europe which absorb most of its exports... Yet, mid and long-term perspectives of Japan, shaping of new model of development based on possible striking innovation in above fields, are in the hands of Japanese under the guidance of –hopefully- a charismatic political leader...still to rise.

Renaud PRETET, April 2009

References :Jean Marie Buisson : Quand les sumos apprennent a danser. Jean Marie Bouissou: Japan - the burden of success AnneGarrigue/Sylvie Chevallier : le Japon contemporain Jeff Kingston : Japan Quiet Transformation Guibourg Delamotte : la lettre du Japon (Asia Centre - Sciences Po)Asahi Shimbun online – www.asahi.comLa documentation francaise : Le japon, une puissance en question (2002)Masao Miyamoto : Straitjacket society (1995)Bernard Thomann : le salarie et l’entreprise dans le japon contemporain (2008)

Morgan Stanley Research: Japan economics, April 3, 2009Nippon Keidanren : Japan 2025 (edited in 2003)Deutsch Bank Research: Japan 2020, Sept 26, 2006Asian Development bank: Asian development outlook 2009 – www.adb.org

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