Japan’s economy grew by an annualized rate of 6% in the second quarter. How did Japan, which has been mired in stagnant growth for decades, achieve this remarkable performance? What is the significance of this growth?
It is usually not a good idea to assess how an economy is doing only based on quarterly GDP growth. There are so many things that go into how that is calculated, and there is a lot of noise in that number. But even if we correct for that, it is true that many people were surprised to see that Japan was growing so much. Japan has quietly undergone a business transformation and some of the results of that transformation are manifesting now. There are always demand swings, certainly, whether it is for more input materials or more production machinery. This last quarter brought new demand for production machinery in Japan and elsewhere as companies were repatriating some of their production capabilities in response to ongoing global policy shifts. What we see with this growth, partially at least, is the long-term business reinvention of Japanese companies, which translates into a higher demand for Japanese input materials and components.
Do you think that Japan can sustain this performance in the coming quarters? What are the possible economic headwinds for Japan moving forward?
Because so many factors play into this, including the exchange rate and how expensive energy is in the summer compared to the winter, growth is difficult to forecast. One thing to pay attention to is the “China effect.” As the Chinese economy stalls, there will be a big impact on Japan. On the one hand, this impact is bad because Japanese companies can no longer sell as much on the Chinese market. On the other hand, there will be some reallocation of demand, which might benefit Japan. As more and more Japanese companies are undergoing this business reinvention, there will be more robust growth rates. Not at the 6% rate maybe, as Japan is far too advanced and steady of an economy to jump back to that level on a consistent basis. However, I would not be surprised if the growth continues to be solid over the next few quarters.
Referring to your book The Business Reinvention of Japan: How to Make Sense of the New Japan and Why it Matters, how much of Japan's recent economic growth can be attributed to the reinvention of Japan?
More or less, all of it. But note that some of the reactions to my book claimed that what I describe does not apply to enough Japanese companies to actually pull the Japanese economy out of its doldrums. In a way, that is true. The way I like to explain this is that the Japanese economy right now is an expression of the 20-80 principle, also known as the Pareto Rule. The rule states that in a given day, 20% of our efforts explain 80% of our output. Everything else is walking from A to B, having lunch or taking a nap. Or, in marketing, there is the well-known fact that in some industries 20% of customers account for 80% of revenues. This is true for phone companies, airlines or hotels. The heavy users are the ones that drive the majority of revenue. The strength we are seeing in Japan’s economy right now is produced by some small portion (maybe 20%) of companies. This is why people wonder whether that’s enough for sustained growth. I think so, in particular because my sense is that the portion of high-performing Japanese companies will be growing going forward.
The transformation (or, reinvention) in Japanese business has been going on for some 30 years now. In the second half of the 20th century, it took Japan some 30 years to catch up with the West and become a master in mass-producing consumer-end products. That story ended in the 1990s, when Japan had successfully caught up. Since then, it has taken Japanese companies some 30 years to pivot toward a new corporate identity and compete at the technology frontier. We are seeing the results of this now. You can find lots of stories of Japanese companies that are operating at the technology frontier in the newspapers if you look for it. I'm quite optimistic that there are going to be more and more companies to sustain this growth.
In what ways did the pandemic affect Japan's employment practices, business norms, and overall economic performance?
This is a super difficult question because the counterfactual is not known. Japanese business is in a process of reinvention, so how much of the change we see would have happened without the pandemic, and which parts were accelerated by it? Clearly there are many new things happening in Japanese business and employment. One immediate impact of the pandemic on the economy was the decline in tourism. But there is some debate on how big a factor tourism really was in terms of GDP. And, while Japan was of course hit by the pandemic like every other country – and suffered huge losses due to the cancellation of the Tokyo Olympics scheduled for 2020 – it fared comparatively well in terms of the health fallout.
From a business perspective, the biggest impact of the pandemic was that companies were forced to set up sufficient capacity in VPN systems to enable people to work from home. It used to be that Japanese workers were not allowed to take their computers home. This was expressed in a caring way. For example, it would be an inconvenience if workers went to the izakaya, the beer place, and got drunk, and left their computers there, or if they forget their computers on the subway. There were some very strict rules of what Japanese workers could do with their computers and working from home was not part of that equation. This meant that people had to work long hours at the office and could not have dinners with their families. Companies did not have enough VPN access, i.e., safe online access to company accounts. A lot was done on paper and in-person. The pandemic has brought about true soul-searching around whether that is needed, how it could be done better, and how much work from home people actually want to do. It has also pushed companies to set up new work systems and shift people to working more reasonable hours. They can go home, have dinner with their family and then put it in two more hours if there is a pressing deadline. This is a huge normalization of the average Japanese workday. We already can see a different traffic flow in the Tokyo subway. It used to be really crowded at 10pm or 11pm but now it is more crowded at 7pm. The normalization of workstyles is further pushed by the looming labor shortage. Companies are treating their employees very differently.
Can you briefly discuss the potential impact of economic fragmentation caused by geopolitical tensions with China? Do you have any insight into how this growth might affect Japan's leadership role in the Indo Pacific?
From an economic perspective, there are several possible scenarios. The first is that while there is some decoupling between the U.S. and Asia, the Northeast Asian countries decide that they cannot decouple their economies from each other. Over the last ten years or so, there has been a division of labor between Japan, South Korea, Taiwan, and China in manufacturing. For example, in the electronics supply chain, Japanese companies make many of the high-tech, important input materials, such as polarizer films or a brightness for computer and cell phone screens. These films, and also some production machinery, are shipped to South Korea and Taiwan, where they are manufactured into the panel that is the screen. Then, that panel gets shipped to China, where it is assembled into a phone, PC, tablet, etc. This division of labor has been stable because the chemicals that Japan provides are difficult to make and difficult to copy. Basically, both Korea and Taiwan need these from Japan to make the input parts, and China needs those parts to make the end products. This has created a fairly stable trade relationship. When faced with decoupling, it is possible that these places will decide to keep operating within this framework.
The second scenario is that the Asian countries decouple as well. In this case, Japan is one of the few countries well-positioned to build the entire supply chain within its own country. Japan used to make entire electronics and semiconductors, and companies still have tacit knowledge about the manufacturing products. Unlike most other countries, Japan also has the core input materials, such as the films mentioned above. The only thing that Japan does not have is rare earth materials, which China holds. While that is a complication, there are other places where some of that can be sourced. But overall, Japanese companies might be the best positioned, even better than the United States, to make some of these things. In contrast, South Korea would be in a real bind if there were a decoupling from Japan. For example, Samsung Electronics cannot develop 5G semiconductors without Japanese inputs. If you talk to the trade negotiators on both sides, there is really no economic interest in decoupling. If you could take the history and politics out, somehow, and have only businesspeople talk to each other, there would be little friction because a lot of money is to be made in the Asian supply chains. One hopes that this aspect can become a stabilizing factor in the region.
Based on press reports, Japan seems to be left behind in the race for clean energy, in particular, the transition to EVs. Can you explain the reasons why Japan is not as competitive in this space as we would expect?
Yes, if you believe the news, Japan and German car companies are both not as strong as people expected. You would think that Toyota, the largest car company in the world that brought us the hybrid car should be a leader in electric vehicles. And now they seem to be slow, making a lot of people think that Toyota has lost in the EV battle. But, I wouldn’t write Toyota off, ever. Perhaps they made a wrong strategic bet, with their focus on hydrogen. But that's okay because we don't know what the future brings, and they may still win. Their initial insight, which I believe is true, is that the electric vehicle is not a solution to the car challenge. This is because it still relies on power from the grid, which is dirty. Batteries also have a huge eco footprint in terms of the battery. Therefore, Toyota has invested heavily in next-gen, hydrogen-powered cars, and they may still win. If their bet pans out, Toyota would be far ahead of anybody else.
Japan has displayed many similarities to China, such as the decreasing working age population and sluggish growth. What broad lessons do you think China can learn from Japan's lost decades and the recent economic revival?
It is interesting that you say Japan is similar to China. Isn’t it the reverse? China is similar to Japan, only 50 years later. There are some parallels, such as the trade war with the U.S. which Japan experienced in the 1980s and 1990s. If you take some of the early U.S.-China trade war documents and you replace the word “China” with “Japan,” there are some commonalities – especially now with the financial bubble and the real estate collapse. Although, interestingly, the U.S-Japan trade disputes in the 1980s and early 1990s were never called a “war,” but rather a “dispute.” This points to a huge difference in the relations between these countries.
It is not clear that there is a lot to learn from the way Japan responded to the collapse of the bubble economy in the early 1990s. Such crises are quite idiosyncratic. When Japan’s real estate bubble burst, followed by a huge banking crisis, the Japanese government decided that social stability and ensuring that people were okay were the most important values. That is a choice that Japan made. The price that Japan paid for that choice was that it took a long time to clean it all up. The United States tends to make the opposite choice. After the 2008 financial crisis, the United States went right to cleaning it up and three years later the banking system was reformed. One could argue, of course, that the United States has still not fully recovered from the 2008 financial crisis, and that it failed to address the social issues that the crisis caused. Japan’s choice was to make sure that it did not encounter huge social issues from the fallout, such as income inequality, populism, or social distress.
As for China, the country will have to make its own choice on how to address the slowdown. I do not know what kind of choice China is going to make. Will it lean toward fast economic rebound or social stability? Or is China going to find another tradeoff, or will it find a balance between those two? We do not know, and it will be very interesting to observe going forward.
Benh LIEU SONG (Flickr), CC BY-SA 2.0 <https://creativecommons.org/licenses/by-sa/2.0>, via Wikimedia Commons