Conventional wisdom on Japan is largely wrong

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Canada and Japan are presently discussing an economic framework agreement, with Prime Minister Harper expected to visit Japan in the near future. Yet a recent article in a leading Canadian newspaper reflects conventional wisdom on Japan as a failing economy. It refers to Japan's first trade deficit since 1980 as a sign of its continuing economic demise. It cites as examples of declining competitive position of Japanese firms Hitachi's decision to stop making flat-panel televisions in Japan, and Canon's decision to shift 60 per cent of its production offshore.

But conventional wisdom on Japan is largely wrong, the devastating impact of the recent earthquake and tsunami notwithstanding. A better understanding of Japan can provide important options for Canada, especially in Asia. Canadian firms could benefit from alliances with Japanese enterprises implementing sophisticated Asian regional strategies. And Canada could strengthen effectiveness of its development assistance programs in emerging Asia, with particular focus on the key role of the private sector, through partnerships with Japanese institutions in the region.

Seeing Japan's first trade deficit in more than 30 years as signaling the end of its sustained export success is misleading. Japan has had a current account surplus since 1985 – the widest measure of trade that includes financial inflows such as dividends, interest payments and royalties – standing in 2010 at $196-billion (U.S.), a more than threefold increase since 1989, during which Japanese exports to China grew more than 14-fold. This helped turn Japan into the world's largest creditor country, with net international investment position (total domestically owned assets minus its foreign owned assets) estimated in 2010 by the IMF at over $3-trillion. Japanese export performance thrived in spite of an appreciating yen that, paradoxically for a supposedly failing economy, strengthened during global (and domestic) economic crises from more than 120 to the US dollar in 2007 to around 80 today. Japanese households accumulated around ¥1.5-trillion in assets, which along with robust export earnings helped the government finance an extensive fiscal deficit, borrowing cheaply (less than 1 per cent for 10 years) from domestic investors, who hold around 95 per cent of public debt, suggesting that Japan does not have to worry about foreign investors losing confidence. The large public debt, in addition to contributing to oft-cited wastes in public investment, has also provided financing for restructuring Japanese enterprises.

The banking crisis and the rise of competitive Asian mass-manufacturers have led to big changes in Japan's business environment over the past 10 years. Banks are becoming more efficient, shifting to the direct disposal of bad loans through the sale of assets, and focusing on credit ratings and expected returns in financing corporate loans. New accounting rules have included consolidated balance sheets and new disclosure requirements. Japan's traditional business group (keiretsu) system is changing, including through the introduction of bankruptcy laws to replace informal bailouts, and greatly reduced roles of cross-shareholdings and of the "main bank" system. Corporate governance reform has included internal oversight committees; directors that are held liable; new rules on mergers and acquisitions; and stricter enforcement. The lifetime employment system is moving toward performance pay, flexible wages and increased labour mobility.

Meanwhile, Japanese firms have quietly achieved global market dominance by increasingly focusing on higher value added and higher technology materials and components, instead of more visible but lower value added consumer end products. For example in high technology materials Japanese firms control around 70 per cent of the market for fine chemicals for electronics; 75 per cent of the market for ceramic condensers; and 65 per cent of the market for carbon-fibers. In technology components, Murata makes around 40 per cent of the world's supply of capacitors (a cellphone has over 100; a computer over 1,000), Nidec supplies 75 per cent of the motors for hard-disk drives, and Mabuchi supplies around 90 per cent of micro-motors for car rear view mirrors; and in key low technology components, Shimano supplies 60-70 per cent of global bicycle breaks and gears, and YKK makes more than half of the world's zippers, by value.

All this means that Hitachi's decision to stop making flat-panel televisions in Japan reflects not declining but strengthening competitive position of Japanese firms. Korea's LG may dominate production of LCD panels, but Japanese firms make high value added and high technology layers, films and fine chemicals that are critical inputs in such panels. The iPhone may have counted (misleadingly) as adding $1.9-billion to the 2009 U.S. trade deficit with China, but 34 per cent of the value was added by Japanese firms, far larger than Germany, second at 17 per cent; and China, where most iPhones are assembled, but that added only 3.6 per cent of the final value.

In the face of an appreciating yen and declining labour force, Japanese firms such as Canon, have been shifting production offshore, a process on-going since the 1985 Plaza Accord revaluation of the yen. More than 20 per cent of Japan's production is now abroad, with emphasis on emerging Asia. At the end of 2010 Japan had ¥251.5-trillion in net assets overseas, almost the size of Germany's annual economic output in dollar terms. Japanese enterprises have implemented sophisticated regional (and global) strategies, sourcing components, for example for Hitachi's hard disks largely assembled in Thailand, from producers throughout the region, within the framework of extensive cross-border supply chains. In the process, Japanese development assistance is contributing to emerging Asian economies in key areas such as logistics, labour skills, and product standards; and facilitating economic integration that increasingly drives Asian regional development. For example, Minebea's recent investment in Cambodia for assembly of motors for office equipment and household appliances, using components from countries such as Thailand and Malaysia, will help diversify Cambodia's economy, creating much needed incomes and higher skill jobs; also enhancing production efficiency and integration in the region. This builds on Japanese development assistance both in Cambodia and regionally, in areas such as logistics and skills.

What does all this mean for Canada? Economic cooperation with Japan can stress trade and investment liberalization, as does the framework agreement under discussion; however, it can do more. It can also focus discussion on ways of expanding and strengthening alliances between Canadian and Japanese firms in Asia, where Canada has had limited presence to date, and where Japanese enterprises have long experience in developing competitive regional production networks for global markets. Furthermore, development cooperation with Japan can strengthen Canada's development assistance in emerging Asia, particularly as related to the role of the private sector, the key driver of development in the region.

George Abonyi, based in Ottawa, is Visiting Professor, Dept. of Public Administration and International Affairs, Maxwell School, Syracuse University, and Senior Advisor to the Fiscal Policy Research Institute (FPRI), Ministry of Finance, Thailand.