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Policies of Scale: Efficient Global Policy

Sounding the Alarm on Japan

I just returned from ten days in Japan and boy, I’m worried. The country is facing major challenges on at least four critical fronts: the economy, demographics, energy, and national security. This “quad-fecta” is truly a crossroads for a country ill prepared to address any one of them, let alone all of them. I had meetings with a number of senior officials across several government ministries, several think tankers, a retired diplomat, and a high profile television political commentator. I left feeling overwhelmed, quite frankly, as my cautiously optimistic nature was stretched very thin by the enormity of Japan’s challenges.

I am going to run briefly through these four fronts; this is meant more as an overview than a deep dive. Each front is worthy of its own piece, but due to limited time I’m providing a survey. I will however be writing about the national security front in greater depth in a forthcoming World Affairs Journal article, which I hope to cross-publish here on Economonitor. Keep an eye out for that later this summer.

First on the economy. Japan’s experience with the Great Recession was relatively minor as its exposure to the most toxic aspects of the American and European economies was fairly limited. However, the economy has stagnated in the years following the recession as its export-driven economy was ground nearly to a halt on decreasing demand from traditional export markets. Further, the 2011 Fukushima disaster that shut down all of the country’s nuclear power plants has forced Japan to import the most liquefied natural gas (LNG) of any country in the world, almost single-handedly turning the country’s trade balance negative (more on the energy dynamic later). And let’s not forget Japan’s public debt, which is over twice its gross domestic product (though to be fair a debt crisis is not imminent).

The yen has experienced roughly two decades of persistent depreciation, which has not made addressing the economy any easier. The Bank of Japan under Haruhiko Kuroda (Prime Minister Shinzo Abe’s “man”) has pursued aggressive quantitative easing, going so far as to enter the long-term interest rate arena as well. The BOJ set an inflation target of 2% and engaged a 1.4 trillion USD program to double the money supply. The stock market has responded, but the monetary supply has not come anywhere close to the vicinity of the monetary base. Nevertheless, there is cautious hope that the BOJ policies, known as the second arrow of “Abenomics,” have put the country on a better path.

Underlying the diverging paths of the monetary base and supply are a number of structural issues, many of which relate directly to Japan’s culture. I am one to dismiss the culture hypothesis first put forward by Max Weber, who postulated that the Protestant Reformation and ethic played a pivotal role in driving the rise of modern industrial Western Europe. Others since Weber have extrapolated from his logic to explain why, for example, Africa is poor and Latin America will never be rich. It’s bunk.

To keep this short, I’ll refer interested leaders to chapter 2 of Why Nations Fail by Daron Acemoglu and James Robinson who do an exemplary job of demonstrating that this theory fails to explain why some societies prosper and others do not. They admit, rightfully, that the culture hypothesis can be helpful is as much as social norms, which are tied to culture, “matter and can be hard to change, and they also sometimes support institutional differences.” However, the hypothesis ultimately fails to explain why some societies prosper while others do not “because those aspects of culture often emphasized – religion, national ethics, African or Latin values – are just not important for understanding how we got here and why the inequalities in the world persist.” The authors run though a number of examples that are worth reading.

That said, Japanese culture is one force for the exacerbation of its economic issues and the country’s inability to agree on prescriptions and implement them. Perhaps the most powerful cultural issue is the Japanese outright fear of failure. It is to be avoided at all costs. This means that the formerly powerful private sector has failed to progress into a real incubator of innovation. Men enter the workforce and with few exceptions remain at the same company for their entire career. These companies’ share of the economy has grown ever larger, but they achieve “innovation” not by creating new products, services, and technologies, but by expanding into additional and existing products and sectors; the toothpaste in my hotel room was made by Sanyo, which also makes electronics, for example.

These firms are selling to a domestic market that is plagued by an ever-depreciating currency while simultaneously selling to export markets where they are being out-competed by countries with lower overhead. In order to bring the monetary supply up towards the base, the economy needs to generate new activity, and it is just not happening. A traditional driver of activity in free market economies are small and medium sized enterprises (SMEs), but Japan has effectively none of them. The venture capital market, a traditional funder of SMEs, is essentially non-existent in Japan. And even more traditional financing are very hesitant to loan to SMEs. The reason for this is the fear of failure, which means that failing once is devastating to one’s career. Therefore, few find any interest in taking risks. In this kind of environment, the dominance of large companies who fail to innovate and the absence of SMEs and sources of funding and financing are naturally occurring phenomena, and hard to reverse. In order for the Japanese economy to really take off, the fear of failure must end.

The second challenge facing Japan is its demographics. If historic birthrates continue, Japan will decline from 120 million people today to 30 million in the year 2100. That’s absurd. And it’s not like the Japanese don’t know this; they do. The birthrate dropped below the 2.1 births per woman required to maintain population in 1975, and it continued to decline until 2005 when it bottomed out at 1.26. It has “recovered” since to 1.4, but Japan’s population has already begun declining: the country is going to have fewer people in 2015 than in 2013.

The country’s age dependency ratio continues to climb above unsustainable levels as those above 65 years of age will constitute 38% of the population in 2055 (to put that into perspective, the over-65 population of the US in 2050 is projected to be about 25%, and we’re just above the 2.1 birthrate threshold). With Japan destined to have fewer and fewer working-age people, the impacts of a severely declining population on a consumption-based economy are multifold, and Japan is struggling to conceptualize how it will achieve economic growth, let alone maintain current living standards. The strain this will put on social security and medical services has yet to be addressed.

One solution is to boost immigration. However, this is an extremely unpopular idea. The Japanese culture is thousands of years old and is the definition of homogeneous. A few of us on the trip were talking one night about “natural” allies, as in America’s natural alliance with Anglo countries due to shared histories, language, cultural norms, and religion. We came up with three countries whom we believe have no natural allies: Japan, Ethiopia, and Haiti. The idea of integrating or even assimilating new cultures into Japan is indeed a foreign one. The political realities of Japan, in which the over-50 crowd dominate the electorate, mean that immigration reform is dead on arrival.

Another solution is to reform the role of women in Japanese society. Women are, and this is no exaggeration, forced to choose between having a family and having a career. The curve of women in the workforce based on their age is “M” shaped, with a rise into the mid-20s, a dip during child rearing years, a slight rise into the 40s, and then a decline. The distance between peaks, however, is long, and the women who do return to work after raising a family face an extremely hostile labor market that pushes most of them into underemployment, which acts as a deterrent for some to re-enter the labor market at all. As the birthrate demonstrates, more and more women are choosing career over family even if it means getting paid less (wage inequality is a very real issue). Yet the cultural mindset in Japan is one of the woman as the homemaker, which makes it difficult for the men who run the government and corporations to get behind the kind of reforms that can allow a woman to be both a mother and have a professional a career. Child care, for instance, is lacking in a big way in Japan.

The third challenge is energy. As mentioned above the 2011 Fukushima disaster dramatically changed the country’s energy economy and security. Because Japan has no natural energy resources of its own, it developed one of the most advanced networks of nuclear power in the world that was producing 30% of the country’s electricity prior to the earthquake and ensuing tsunami that hit on April 7, 2011. The particularly disastrous events at the Fukushima plant have turned the Japanese public vehemently against nuclear power, and none of the plants have been re-started. According to people I spoke with on my trip, the chances of re-starting even a few are quite small in the foreseeable future.

For a country that had plans prior to the earthquake to increase nuclear’s contribution to 40% of its electricity supply, this has had devastating ramifications. Japan has become the world’s largest LNG importer in the world as a result, at a cost multiple times that of domestically produced nuclear energy. This has drug the country’s trade balance into the negative, and increased overhead for businesses and households. Prime Minister Shinzo Abe has met with Vladmir Putin five times, visited Turkey twice, and hosted Turkey’s Tayyip Erdogan, all in the name of improving relations and securing additional energy resources. There is also a big hope that Japan can line up some contracts for American LNG. For the future, though, no matter how diverse Japan’s energy imports, they will be more expensive than domestic nuclear production.

The forth challenge is its national security. I will be going into length about Japan’s new foreign policy  under Abe in a forthcoming World Affairs Journal article. I can’t spill all the beans here, but let me whet the appetite: Japan, reliant on historical agreements that put the onus for its national security on America, is facing an increasingly hostile neighborhood at a time its people believe its protector, the US, is losing power and influence while demonstrating dubious commitment to its allies around the world.

China’s “creeping expansion” in Asia and its outright confrontation with the Philippians and Vietnam have Japan scared as China continues to invade Japanese territory on a daily basis. North Korea is as unpredictable as ever, and with its relationship with China weakening and the US unwilling to engage, Japan worries not enough eyes are on the situation. And despite reassurances from President Obama and Secretary of Defense Chuck Hagel, every Japanese policy pro I talked to, when asked if they thought Japan could count on the US if it meant putting the US military between Japan and China, pointed to Syria and said, emphatically, “no.”

All of this is giving momentum to Abe’s push to reinterpret the country’s constitution in a way that would allow Japan to perform “collective self defense,” which basically means joining war time international coalitions. He started the country’s first National Security Council last December, and is revising rules to allow the country to participate in international defense research and development. And he has proposed substantial capability upgrades for the Japanese Self-Defense Forces. These are existential changes to Japan’s post-World War Two defense policies, and they scare many Japanese.

Critics, including an outspoken former diplomat I spoke to, point to this as proof that the reliance on America is both stupid and counterproductive. The relationship is proving too weak for Japan while also driving Japan towards greater militarization when the country’s soul prefers non-violent approaches to international relations as the World War Two guilt is still thick.

This is a lot for any country to deal with. I enjoyed my trip to Japan, and found the people, culture, and country beautiful. It is a country as proud as it is internally tormented. At a meeting with a number of think tankers, I explained that I felt Japan is playing catch up on these four fronts, how they are all products of the very headstrong Japanese culture, and require monumental changes in mindset and policy to overcome. I told them that despite my appreciation for the country and its people I would be returning to the United States pessimistic about Japan’s future. And then I asked if they thought the Japanese public was as down on the country’s outlook as I am.

Only one person answered to the group, and it was a long-winded response of “give us time, we realize our problems, we need time to address them and we will.” As an example he pointed out that despite being the world’s second largest economy in the 1990s, the country’s first think tank was not established until 1997. But since then, the policy community has professionalized rapidly. This was meant to be a reassuring antidote, but I found it to be the opposite: the second largest economy should have had a lot more than one think tank in the 90s.

Afterwards, one of the think tankers came up to me privately and said he agreed with my analysis, and told me that he feels most Japanese people are likewise pessimistic about their future, and went on to articulate a cogent view of his own. It was nice to get some honesty, but again I found it discouraging that this very intelligent and thoughtful individual was unable to express failure in public. A venture capital friend of mine who was on the trip spoke a few times about his concern that there was no VC culture in Japan, and recommended to several Japanese that they start “failing forward.” Japan faces many challenges, but if it is unable to fail I have my doubts that it can move forward.

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