Columbia Professor Hugh Patrick: Japan’s Economic Success and Failure and lessons for China

Dec 12-2013   

Professor Hugh Patrick, Director of the Centre on Japanese Economy and Business, Columbia Business School was invited to speak on the Japanese economy and lessons for China.

Professor Patrick covered a number of areas including his observations on the Japanese labour market, deflation and company growth. In addition, he spoke about the internalisation of the Japanese Yen and Sino-Japanese political and economic ties.

Prof. Patrick’s association with Japan began quite by accident, but was immediately drawn in by its development and was drawn ever deeper the more he learned about the country. Through his research he began to gain a deeper understanding of Japan and later cemented his preeminent status as a leading expert in the area.

The Japanese Labour Market

Low unemployment rates hide a structural change in the labour market–part-time workers are increasingly replacing full-time workers. At the same time, younger people are replacing those retiring. These two factors put downward pressure on average wages. Whilst the Japanese government has actively pushed companies to improve wages but given no improvement in the economic situation, with labour supply larger than demand, it is difficult for much to change.

Meanwhile, Japanese demographics are putting pressure on the economy – the aging population will change the long-term structure of Japanese society. On the one hand, pregnancy rates are low – since 1974 the rate is under 0.8. On the other hand, life expectancy rates are the world’s longest. In 2010 life expectancy for women was 86.3 and 79.6 for men. As the baby boomers enter retirement age, they will face a very serious pension problem given the government’s budget deficit. However Prof. Patrick is optimistic on future pregnancy rates, as children are a ‘luxury product’, demand will grow as incomes grow. 

Deflation

Prof. Patrick believes the current Abe government’s resoluteness on deflation is greater than that of any previous government. Monetary expansion, fiscal stimulus and structural reform are at the heart of the Abe’s economic policy. Abe has firmly stated a target rate of 2% and, by passing a bill to raise consumption tax rate, is taking efforts to reduce the budget deficit. This series of measures is aimed to alter market expectations for future inflation and take the country out of the shadow of long-term deflation. Hugh Patrick stated his own concerns that the future of Japan’s reform process is likely to slow down due to political in-fighting both between the major parties and within the government itself.

As for future company growth, Prof. Patrick believes Japan’s competitive advantage lies in a number of specialised areas. For example in manufacturing, Japan has a lot of companies largely unknown to the outside world but whose specialised equipment which hold an astounding share of the world market. These companies, with their advanced technology, are the future drivers of Japanese company development.

Industrial ‘Hollowing Out’

Regarding the popular theory of Japanese industry’s ‘hollowing out’ (the practice of domestic industrial companies going overseas to manufacture, leaving a ‘hollow’industry base back home), Prof. Patrick is not worried – he sees this as a process of moving scarce resources to a more efficient area.

For any economy, the process of industrial grading involves moving from labour intense production to other areas. For example if there are many textiles companies in an economy, product prices will be pushed downwards, funds will flow to other industries and these textiles companies will need to look for new opportunities in the market. An example worth noting is the experience of the Sogo Sosha, Japanese general trading houses which deal in trading, industry and finance. These are companies such as Marubeni and Mitsubishi which re-emerged after WW2 as a prominent force. The Sogo Sosha’s success lay in their technical knowledge, understanding of the competition and that of the consumer’s needs. They actively changed their business models to suit changing client needs – this is something that Chinese companies can draw from. Industrial upgrading is a process that all economies go through – Japan’s move towards hi-tech industry is something that China will experience so Chinese firms must prepare accordingly.

Challenges for Japanese Companies

Prof. Patrick stated three problems facing Japanese companies:

First, is the system of ‘employment for life’ – after WW2, especially from 1950 to the early 1970s, national production value was growing on average at about 10%, labour shortages were rife so to attract talent companies enacted a policy of ‘lifetime employment’.

Today, the drawbacks of this system have become increasingly apparent. Firstly, it can block the flow of talent and decrease energy in a company. For a talented worker, opportunities can be limited to lack of seniority and therefore it is easy to become demotivated.

Moreover, given the aging population, lifetime employment presents a heavy labour cost. In today’s companies, retirement wages represent a large proportion of fixed costs. Even in a recession, companies find it difficult to adjust their structure via redundancies which seriously restricts market vitality. Chinese enterprises have greater autonomy than their Japanese companies in this respect.

Another problem for Japanese companies is the issue of ‘zombie companies’, those that can only survive with continual bank loans. The effect these companies have on the market is apparent: ‘good’ companies cannot get loans, ‘bad’ companies do. Concerns on rising unemployment mean banks keep giving out loans, making it an enduring issue. 

As for China, CCER professor Huang Yiping proposed a similar problem, ‘greenhouse firms’ that can only continue to survive given a GDP growth rate of 8%. According to local governments, the real problem is not whether these companies should shut down but rather who should shut them down and how should they be shut down. Prof. Huang suggested financial liberalisation can be a way to resolve it.

The third problem is the internationalisation of Japanese firms– this is largely due to a poor level of English, which the Japanese Treasurer himself has stated. English being the international business language should be an essential skill but those Japanese fluent in English are in the minority.

Lack of internationalisation is also reflected in the Japanese Yen. Figures show that 16% of international debt was denominated in Yen. By 2003 this figure was under 3%.  One reason was that the domestic financial market is underdeveloped and unable to transform itself into a global financial centre. More importantly, in global markets the US dollar still reigns supreme. Compared to the Euro, the Yen is at a disadvantage also. As for the renminbi, Prof. Patrick stated the currency still has a long way to go before becoming a world currency due to the country’s opacity, but given China’s speed of growth, it may happen sooner than many think.

Sino-Japanese Ties

Prof. Patrick ended the session with his views on future Sino-Japanese relations. Prof. Patrick admitted the current situation is somewhat tense but given common interests, future cooperation is most likely. Even if political conflicts remain in the short-term, the fact is China and Japan are two major economic players in Asia, the fact they are neighbours is not changeable. China is Japan’s largest investor and in terms of culture exchange and tourism exchanges are increasing by the day. In the long-term, China’s massive market is a major attraction for Japan. Likewise Japan’s advanced technology is a major attraction for China. Sino-Japanese cooperation is not only advantageous for the two countries but also for the world.