Farewell the land of the rising yen
Sunday 03 September 1995
Japan has been portrayed as such an industrial success story and the strong yen such a symbol of that success that it is hard for outsiders to appreciate the sense of concern within the country about the next stage of its development.
It is easy to see the damage that the high yen has done, forcing more and more of Japanese production offshore. The figures show how Japan, alone of the large economies, has been unable to recover from recession. And anyone who goes further back into historical statistics can also see how Japan is the only developed country which is exporting a smaller proportion of GDP now than it was in 1960. But what does not emerge from this macro- economic view of Japan's economic situation is the need for supply-side measures to encourage entrepreneurship and boost job creation in the services sector.
The job situation is perhaps the best place to start. The official figures for unemployment in Japan show it to be something close to a heaven on earth: with published unemployment at 3 per cent, it is the only country in the world where unemployment seems to be at the levels which were commonplace elsewhere in the 1950s and 1960s. But these low levels of official unemployment mask considerable underemployment. If discouraged workers are added, plus workers whose hours have been shortened, the rate jumps, and is comparable to US unemployment measured on the same basis (see graph). We do not yet have figures for this year, but it is perfectly possible that Japanese unemployment on this wider but arguably more realistic measure has now passed the US level.
This sets a sombre backcloth against which Japanese industry has to shed jobs. Anyone who goes round a factory in Japan will note that while the actual production process is generally very lean, the office support is quite the reverse. Many people have jobs which are not really needed at all. On one calculation Japanese manufacturers should cut more than 3 million jobs if they are to reach US productivity levels. Add that in to the figures above and unemployment in Japan would be about 16 per cent.
Such a figure would, of course, be socially unacceptable. But that is the scale of the adjustment needed. Industry has no option: it has to cut its labour costs.
Not many people appreciate the extent to which the share of labour costs in relation to total value added has been climbing. As the other graph shows, this has risen from under 50 per cent in the 1960s to almost 70 per cent now. One of the reasons why Japanese companies have, by world standards, such low profits is because of the rising share taken by labour. So the only point at issue is the pace at which labour costs can be reduced. Given the overriding Japanese social objective to hold down unemployment, the pace of change in manufacturing will be largely determined by the ability of the rest of the economy to expand employment. In practice, additional employment can only come from the private sector service industries.
Surprisingly perhaps, given Japan's inventive and well-educated workforce, there is not a particularly strong culture of entrepreneurship in Japan. The famous names of Japanese business are either pre-war, or like Honda and Sony, creations of the immediate post-war generation. There are relatively few people in the mould of Bill Gates or Richard Branson.
There is no obvious single explanation of this. Part of the answer may lie in the education system, with its emphasis on order and attention to detail rather than creativity. Part may lie in the tax system, which encourages rewards by perks and status (which can easily be offered by large companies) rather than money (which is taxed away). And part is explained by regulatory blockages to the creation of new companies in many areas.
While the big companies prospered, it mattered little that small ones were not springing up. But if big employers have to downsize, you need smaller firms to take up the slack. There are lots of small firms in Japan, but they compete within much more delineated areas and have a much more subservient role than they do in Britain or North America.
Naturally not everyone in Japan wants to see this change, or even accepts the need for the economy to adapt. But there is, certainly among the business community, widespread acceptance of the need for tax changes to stimulate growth, and the British tax reforms of the 1980s are being studied with interest. One example is the reform of company taxation of Nigel Lawson, when headline corporation tax rates were cut, but investment subsidies cut, too. The effective corporation tax rate in Japan is 55 per cent, among the highest in the world. This has in the past encouraged investment - it seemed more sensible to spend profits on plant instead of retaining it and losing the tax - but the experience of the 1980s has been that much of the new investment is simply wasted.
Japanese companies funnelled funds into factories which then ran far below capacity, or office blocks which did nothing to improve productivity, inflated land values, and are now worth less than half what was paid for them. (Worse than wasting profits on useless investment was borrowing to pay for it: the legacy of bad debts still hangs over the banking system and, as we saw last week, is leading to banking collapses.)
Rationally then, one could envisage a set of measures which would couple tax reform with deregulation. Together these would not only stimulate the economy, but, more important, they would jump-start the structural changes which Japan will inevitably have to make. Politically there is no consensus to do this, but the whole problem becomes more manageable if companies are making good profits and the economy is growing. This is where the yen becomes very important, for the further that the yen falls the less the theoretical adjustment that Japanese prices need to make. At purchasing power parity the yen/ dollar rate should be between 150 and 170: ie, Japanese domestic prices were, when the dollar was below 80, roughly double those of the US. PPPs in individual industries where Japan has a competitive edge are different: a rate of 93 has been quoted for electrical machinery and 101 for the motor industry. But even those rates are a bit suspect, for Japanese company profits have been too low: those might be levels where survival is possible, but there is not much of a living to be had.
If one postulates a rate of 120, though, one would still have Japanese domestic prices above US ones, and so retain an incentive to increase manufacturing efficiency, but would create sufficient fat in export-oriented industries to help fund structural change. Profitable large companies could stand the pressures of domestic deregulation better than unprofitable ones - and, just as important, are less likely to resist the necessary deregulation.
Whether this experience of the over-valued yen has frightened the Japanese establishment enough to persuade it that it is not in its national self- interest to run a large current account surplus is a story for another day.
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