Everybody is asking whether Japan will be able to keep its current business recovery on track. Various statistics have been pointing in a positive direction. Real gross domestic product has now expanded on a quarter-to-quarter basis for seven quarters in a row. And in its December tankan survey of short-term business sentiment, the Bank of Japan found major manufacturers to be more upbeat than at any time since June 1997.
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The diffusion index for these firms, calculated by subtracting the percentage of them with negative business outlooks from the percentage with positive outlooks, recorded a 10-point gain at major manufacturers over the previous survey in September, rising to a positive figure of 11. Behind the new mood lie export growth, improved profitability, and expanded capital investment.
Clearly the performance of the manufacturing sector has bottomed out, since even small and midsize firms are on the mend, but the nonmanufacturing sector may be set for a further fall before reaching its trough. The recovery is being fueled to a large extent by exports, and this calls its sustainability into question. There are reasons for both pessimism and optimism on this score. While a stronger yen or a slump in the US economy would darken the export picture, sales to China, which is now absorbing some 12% of Japan’s exports, are going strong.
In the area of domestic demand, all eyes are on capital investment. The BOJ December tankan found that big manufacturers expect their outlays for plants and equipment to grow by 11% in fiscal 2003 (April 2003 to March 2004). This suggests that even now, following the unprecedented slump of the 1990s, an upturn in business performance and an attendant improvement in companies’ cash flow can still work to produce an increase in capital investment. But the same mechanism is not at work in nonmanufacturing firms, nor is it likely to kick in soon.
These firms are dependent on the domestic market for all their sales, and because prices have been deflating, sales receipts and profits are being held down. To make matters worse, many of these firms must devote money that might have gone into capital investment to paying off debts instead. The overall trends in capital investment hinge on the trends in these nonmanufacturing firms, since they account for some 70% of the Japanese economy’s total output, while manufacturers account for only 25%. A recovery dependent on exports will thus not be self-sustaining.
Monetary policy has been left unchanged. The BOJ’s Policy Board takes the view that the existing policy of quantitative relaxation should be left in place while the foundation for a gradual recovery takes shape. After Fukui Toshihiko became governor of the BOJ last March, the central bank saw a toning down of the earlier debate over the advisability of a shift to inflation targeting. This appears to have been because Fukui was more explicit than his predecessor in committing the central bank to the fight against deflation, pledging that the BOJ would not alter course until the year-to-year changes in the consumer price index turn positive. Recently, though, the price index has edged up slightly from year-earlier levels, and this has prompted some board members to renew the call for the policy of quantitative relaxation to be linked to a specific inflation rate target. That, they argue, would help to eradicate deflationary psychology.
Within the toolbox of macroeconomic measures the government has at its disposal, fiscal policy is the other key instrument. In the budget for fiscal 2004, the government is planning to cut appropriations in categories including public works. Thus we should expect a macroeconomic policy mix of quantitative relaxation on the monetary front and reduced expenditures on the fiscal front. In this context, companies and industries will be under pressure to pursue microeconomic restructuring in order to stay alive and prosper. Those companies that can come up with fresh business models should be able to secure a stronger competitive position whatever quarter of industry they are operating in, whether the materials sector or the high-tech frontier.
The article by Fujimoto Takahiro below seeks to dispel the mood of gloom and doom that has been spreading widely in manufacturing circles. The key to competitiveness, Fujimoto asserts, lies in what he calls “organizational capabilities for manufacturing.” That is, true competitive power depends on the strength of companies’ production and development operations as measured by such indicators as productivity, yield, production lead times, and product development lead times. The Japanese corporations that have good organizational skills in these areas, such as Toyota, Honda, Sony, and Canon, all excel in “capability-building competition,” Fujimoto says. Responding to the worries about a mass exodus of manufacturing to China, Fujimoto points out that what competitive firms like these have been doing is creating manufacturing systems that make effective use of Chinese production bases as a part of their overall setups.
With regard to the differences between Japan and China in production, people have recently been talking about a “smile curve” (see the figure). This is a graph with value added plotted from low to high on the vertical axis and production processes plotted from upstream to downstream on the horizontal axis. The point the graph makes is that assembly work adds only a small part of the value of products. Larger value-added components are provided by parts production and research and development in the upstream direction and by marketing and after-sales services in the downstream direction. If a line is drawn to connect these components, it forms a curve shaped rather like a smile. As far as Japan’s manufacturers are concerned, this is indeed a smile-inducing set of data, since their rivals in China, the emerging “factory of the world,” are engaged mainly in assembly and other processes in the middle, where value added is the lowest.
Furthermore, in the period to come the slope of this curve is expected to become steeper on both sides. In other words, product assembly is likely to account for an increasingly smaller portion of total value. The very growth of China’s labor-intensive industries will work to drive down the value-added margins of their operations. This means that if Japanese firms specialize in processes producing more value, especially R&D and after-sales services, they will not be hurt by competition from Chinese firms; rather, they will be in a position to benefit by farming out their relatively low-value assembly operations to China. It should be possible for Japan’s manufacturers to sharpen their competitive edge by concentrating on high-value-added production.
Iwai Katsuhito, a professor of economics at the University of Tokyo, has produced a bestseller with his Kaisha wa kore kara dô naru no ka (What Will Become of the Company?). In its December 20 issue, the business weekly Shûkan Daiyamondo listed it as the best economics book of 2003 in a ranking determined by economists and other academics. The magazine Daikôkai recently carried a lengthy dialogue between Iwai and the magazine’s editor in chief, Miura Masashi. We have broken this piece into two parts for inclusion in this and the next issue of Japan Echo.
Iwai’s book is part of a recent reassessment of Japanese corporate management among economists. In the 1990s the Anglo-Saxon style of management grounded in shareholder capitalism was hailed as the new business model for Japan to emulate, but more recently this style of management has revealed its fallibility. Simply stated, shareholder capitalism encourages a company to place profits above all. But as scandals like the Enron Corp. debacle have demonstrated, this approach is liable to cause the morals of corporate executives to break down. Colluding with their accountants, executives sometimes engage in frenzied efforts to jack up share prices over the short term. The American approach to corporate governance has failed to correct this situation.
Another aspect of the reassessment is the idea that we are entering a new age of “postindustrial capitalism.” The Japanese economy, in Iwai’s view, has already entered the postindustrial age. Unlike in the preceding age of industrial capitalism, being in possession of money and plants is no guarantee of success. The new formula for winning relies on skillful exploitation of the differences that set companies apart from each other. A firm’s personnel create these differences through the application of their ingenuity and skills. To get the most out of the talents of its personnel, a firm must have an organization capable of long-term development of human assets. And firms with Japanese-style management seem better suited to this task than ones with management based on the Anglo-Saxon approach.
Iwai and Miura delve deeply into a variety of subjects in their dialogue, tracing the essence of capitalism back to its roots. The first half of the dialogue presented here touches on a number of philosophical and ideological issues in the course of a discussion on the nature of the agents of capitalism and the proper ways to perceive capitalism’s formation and development. This sets the stage for locating postindustrial capitalism within the capitalist framework. The dialogue is, we believe, a valuable resource for inquiries into what a company essentially is and how it can best be managed. (Nariai Osamu, Professor, Reitaku University)
