Bill Emmott - International Author & Adviser

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Don’t write Japan off. The giant is stirring
The Times - January 25th 2010

Its economy is set to lose its No 2 position to China, but after years of stagnation Japan seems ready to shake itself up

When a car full of boy-racers overtakes an older, sputtering jalopy, onlookers give the slower vehicle barely a glance, though the racers themselves might offer it a finger-related gesture. Given that today’s boy-racers happen to be China, and that their super-charged economy has defied the global recession and is about to surpass Japan as the world’s second-biggest, the focus on the overtakers may be understandable. But it is regrettable. Japan merits more than a glance, and certainly not a rude gesture.

Some of my regret may, admittedly, derive from personal sentiment. I was a correspondent (for The Economist) in Tokyo during part of the 1980s, a time when it was Japan, not China, that caused shock and awe around the world. As with China today, it was widely assumed that since Japan’s economy was speeding along it must be doing everything right. Since 1990, when the Tokyo stock market began its crash and the economy entered a long stagnation, the assumption has gone into reverse: Japan must be doing everything wrong.

That assumption has been particularly evident since the West started to turn Japanese as the credit crunch began in mid-2007. Japan became an object lesson in how not to handle the aftermath of a financial collapse. (Crib version of how to do better: reflate quickly, print money energetically, punish and clean up the banks promptly and thoroughly, but avoid raising taxes too soon lest it chokes off your recovery.) It is time to look at Japan with fresh eyes. Such eyes should light upon four main things: that the moment when China’s economy does overtake Japan’s will be utterly meaningless to anyone except statisticians; that China’s economic development is nevertheless good for Japan; that an obsession with manufacturing and the ignoring of services is a main cause of Japan’s weakness; and that, slow and sputtering though it seems, Japan has just begun a political revolution that has the potential to bring economic strength back too.

The statistical point can be dealt with simply. Does any German remember the moment in the 1970s when Japan overtook West Germany as the world’s second-biggest economy? With a much larger population (120 million now, against 82 million Germans) it was natural for Japan’s output to be bigger once it approached German productivity levels. So it is with China, only more so, since its population of 1.3 billion is ten times Japan’s. Thus, its economy will “surpass” Japan’s at a time when its income per head is less than one tenth as large. And, if China did not have an artificially cheap currency, it would have overtaken Japan already.

Those income-per-head comparisons help to show why to be overtaken is good for Japan. To find yourself plonked just off the coast from a huge population of eager new consumers is a wonderful opportunity. China is already Japan’s biggest trading partner, and Japan sells a lot more to China than it buys from it. If the Chinese currency is revalued this year — and especially if the market is eventually allowed to set its exchange rate — the terms of trade will move even more in Japan’s favour, both for goods and for services.

Japanese manufacturers remain among the world’s best, even if the likes of Panasonic, Sony and Toyota no longer cruise effortlessly past their rivals. Manufacturing output provides a fifth of Japan’s GDP, against about an eighth in Britain. Yet those who think Britain’s salvation lies in boosting factories should note that this manufacturing strength has done nothing to save Japan from nearly two decades of stagnation. If anything, Japan’s own manufacturing obsession has made things worse: to help to reduce labour costs and stay competitive, Japanese governments in 1997-2005 made repeated reforms to create a two-tier labour market. The second tier, of part-time and non-contract workers, get much lower wages, less employment protection and no benefits.

That group now makes up one third of the labour force. It is Japan’s “working poor”, and is the reason why the once famously egalitarian country now matches British levels of income inequality. Japan is the only OECD country to have seen its level of absolute poverty rise in the past two decades. Meanwhile, wages are declining, and not just those of the working poor: last Friday the Japanese Government forecast that nominal wages will decline in 2010 for the fourth consecutive year.

Why the mismatch between the lovely Chinese market and declining Japanese incomes? It is the difference between corporate interests and national ones. Individual companies do well from lower labour costs and a nice neighbouring market. The country, however, will benefit only if this brings about a broad rise in incomes, with the creation of more productive and well-paid jobs in the whole economy. Japan’s problem is that its healthy factory productivity has not been echoed by its much larger services sector which, including both public and private services, makes up 70 per cent of GDP. Governments have neglected the service-sector deregulation necessary to bring this about. Indeed, by creating the working poor they have made things worse, by offering services firms a pool of ultra-cheap labour.

The big question now, and the biggest new reason to watch Japan, is whether this could change. A country that invigorated its service sector, rescued its working poor and also had the booming China market nearby could do well. For Japan to do so, it needs quite a revolution, which in political terms it has just had: five months ago voters kicked out the party that had run the country for most of the past 60 years, and brought in the Centre-Left, led by Yukio Hatoyama, who promised big changes: a rebuilt welfare state, an end to the stifling power of the bureaucracy, and a more balanced relationship with America and China.

Can he do it? Last November I had an interview with the new Prime Minister, and came away impressed. Although criticised for his leadership skills, and often exhibiting a startled look like a rabbit caught in headlights, he is strikingly sincere, straightforward and even consistent in what he says. Like Barack Obama, however, what he mainly wants to do — expand pensions and welfare benefits — will cost public money, and in these straitened times voters will be hard to persuade to cough up. His party is also being beset by fundraising scandals at just the moment when it needs public trust.

A wise old Tokyo saying holds that in Japanese politics, an inch ahead is darkness. Even so, it will be worth peering into the murk. Something has begun to change in Japan, and it is not just the slipstream caused by the overtaking Chinese boy-racers.


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