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Going Nowhere Fast

18 minute read
Jim Frederick/Tokyo

If you want a look at what’s really ailing the Japanese economy, just drive over on any given weekend to the Ito-Yokado shopping center parking lot in Shinyurigaoka, a large suburb half an hour west of Tokyo. Actually, it doesn’t matter where you go, since the same scene is played out at parking garages, train stations and construction sites all over the country. But on a typical weekend here in Shinyurigaoka, there are four guards at the intersection directing traffic. Another man is on hand to make sure you don’t miss the turn that leads to the garage. Five meters down the path, an attendant removes the ticket that the machine just generated and hands it to you. Head up the slope to the first floor and a woman will wave you on, just in case you missed the brightly lit No Vacancy sign over her head. (Every floor, whether full or not, gets its own guard.) When you exit, you get the same treatment in reverse: more floor guards waving you through, a white-gloved attendant to feed the ticket back into the machine, and a new crew of traffic smoothers to make sure you are safely on your way. By the end of your visit, at least 20 employees have provided you with a service of nearly zero value that could easily have beenand was clearly designed to becompletely automated.

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Forget (for now) the banking system crippled by mountains of bad loans, a government debt equal to 130% of the nation’s GDP, deflation that sucks the life from corporate profits and a stock market hovering near its lowest point since 1983. There is a more fundamental ailment undermining the world’s second-largest economy: Japan’s labor force is one of the most unproductive in the industrialized world. And not by a little. According to the Japan Productivity Center for Socio-Economic Development, a government-affiliated research center, Japanese laborers are 40% less efficient than Americans, 20% less efficient than the French and 11% less efficient than the Germans. The Japanese lag behind not just Britons and Swedes as well butwhere will the humiliations end?the Italians and Spanish, too.

Although the country’s showcase export industries such as automobiles and electronics have redefined competitiveness and economic advantage worldwide, the country’s far-larger domestic sectorsconstruction, retailing, agriculture, health care and financial services, among othershave languished. Shielded from competition by a tangle of government subsidies, tariffs and protectionist policies, the nation’s domestic manufacturers and services have hardly changedlet alone improvedfor decades. What may have once been an enlightened government plank to promote universal employment back when Japan really was a developing country is now backfiring massively. The high prices and poor consumer satisfaction that Japanese citizens encounter every day has spurred a never-ending cycle of depressed demand and low growth. “The quality of life in Japan is eroding and low domestic productivity is a primary reason why,” says Haruo Shimada, a professor of economics at Tokyo’s Keio University and a special advisor to the Cabinet Office. Japan’s domestic economy has become the millstone around the nation’s neck, slowly pulling it to the bottom of the pool.

Right now, Japan’s gargantuan banking crisis has taken center stage. Prime Minister Junichiro Koizumi and the rest of the Diet squabble endlessly over the various iterations of bank proposals recommended by Financial Services Minister Heizo Takenaka, while the national media reports with increasing confidence that one or more of the the nation’s four megabanks are in danger of imminent collapse. Last week, Takenaka gave the banks a deadline: they have four months to take convincing action aimed at solving their financial crisis or risk being nationalized.

Within this climate, a small but increasingly vocal group of observers insists that the real solution to the nation’s ills is not bad debt disposal or any of the other macho macroeconomic fixes currently capturing all the attention, but structural reform designed to remove governmental barriers to free-market competition at the domestic corporate level. “You can clean up the banks’ balance sheets all you want,” says James Kondo, a consultant at McKinsey & Co. who helped produce a recent study that remains one of the most comprehensive looks yet at Japan’s productivity gap. “But until you change the environments companies operate in, the same problems are going to keep returning. Right now, people are just treating the symptoms.” Because Japan’s productivity woes are largely the result of misguided or obsolete policy decisions, he argues, a committed reform movement could bring a quick recovery.

The word committed, of course, is the catch. When it comes to reform, the government suffers from what can be called a productivity problem of its own. On the one hand, industrial lobbies dedicated to preserving the status quo have tremendous sway over politicians. And on the other, there is no doubt that increasing competition in the domestic economy will draw what are now very abstract concepts into harsh focus at the local level, bringing high unemployment (at least in the short term) and the chance of social unrest. That is a reality that Japanese society has routinely proven willing to put off at all costs. But Japan might be running out of extensions. As its population begins aging dramatically in the decades ahead, the nation’s productivity crisis will become even starker, as far fewer workers will have to perform even more work even more efficiently to maintain the same standard of living.

Tell anyone who doesn’t live in Japan that the country has productivity problems and you’re likely to be met with disbelief, if not laughter. Japan Inc., inefficient? Companies like Sony, Toshiba and Toyota have made the country famous as the place where they always make things better, cheaper, smarter. Production techniques invented hereJust In Time Manufacturing, Total Quality Management, Continuous Improvementhave been imitated from Seoul to So Paulo. Certainly, Japan’s leading export manufacturers deserve this reputation. According to that report by McKinsey, Japanese export industries like automobiles, electronics and computer hardware are, indeed, 20% more productive than the worldwide benchmark. But here’s the problem: these industries, once you stop to count them, are quite few in number. Together, they make up only 10% of Japan’s workforce and 10% of its GDP.

Of the remaining 90%, retailing just might be the sickest of the bunch. Large-scale stores are rare in Japan, so if you go shopping, chances are good that you’ll find yourself in a joint like Yoko Nakamura’s general store in Kamimoku, a hot springs resort hamlet of about 800 people, an hour and a half north of Tokyo by bullet train. Nakamura, the 73-year-old granddaughter-in-law of the store’s founder, runs the place with two of her sons and their wives, selling beer and liquor, cigarettes, canned goods, toiletries and candy. Her store couldn’t be more picturesque, with worn wood floors, shelves of sake that reach to the ceiling, 10-kilo bags of rice stacked waist high and holiday decorations that say “Merry Christmas 1996.” She wears three sweaters and a flowered apron and sports a couple of gold teeth. Stay long enough and Nakamura will seat you by the space heater, serve you tea and apple slices and regale you with tales of the old days, both good and bad. In all, it seems like a quaint, harmless slice of Hometown Japan.

The problem is that in purely economic terms, this style of selling is a nightmare for consumers and the economy. The shelves at Nakamura’s shop are dusty and sprinkled with the odd dead moth, selection is poor (no dairy, baked goods or produce, not even those apples Nakamura serves her guests), and prices are high. “Sometimes, when people come in,” says Nakamura, “I hear them say, ‘Oh, it is so expensive!’ But I can’t cut my prices; that would be suicide. I am barely breaking even.” And fair enough, the high prices are not really her fault. They are built into the way small, independent retailing works. She can’t match the buying power, selection, service, price and merchandizing savvy of large-format and convenience-store chains.

In any other industrialized nation, to offer up Nakamura as a typical retailer, as a representative of anything other than a holdover from a bygone era, would be unfair. In other advanced countries, mom-and-pop shops are niche operators, accounting, for example, for only 19% of retail employment in the U.S. (measured by hours worked) and 26% in France. But in Japan, mom-and-pops are the rule not the exception, making up 55% of the retail labor force. They are, in other words, still the way the nation sells things. And they are woefully unproductive, generating only 19% of the output of the average U.S. store. That pathetic performance, combined with the mom-and-pops’ large share of the labor force, pulls Japan’s total retailing-sector productivity down to just half that of the U.S.

The result of all that inefficiency? Layers of increased costs are passed on to Japanese consumers, who face one of the world’s highest costs of living, which in turn depresses demand. Contrary to the shopaholic stereotypes, Japanese buy less stuff than their counterparts in other nations. Americans, for example, consume 63% more clothes, spend more than twice as much at restaurants and hotels, and about 2.5 to 3 times as much on books and cars. Larger stores would help increase efficiency and bring down costs, but government regulations designed to keep people like Nakamura in business prevent that from happening. The Large Scale Retail Location Law, for example, gives small-business owners a significant say in the approval process for new stores larger than 1,000 sq. meters opening in the area. Likewise, a combination of low property taxes and high capital-gains taxes encourages struggling sole proprietorships to bumble along for years rather than just sell out and leave the market.

Unfortunately, retailing is far from Japan’s only stunted sector, and rampant overemploymentas in that parking garage outside of Tokyois only the beginning of the problem. Hobbled by the government policies designed to help them, most domestic industries are basket cases. Often prevented from consolidating and insulated from competition, most businesses are too small to achieve economies of scale, are poorly managed, and use antiquated equipment and business modelsall of which hurt productivity and increase prices. Take food processing: Without state-of-the-art market research and sales-tracking capabilities, food companies churn out endless variations of new products that no one winds up buying. McKinsey cites an example of one Japanese chocolate maker whose 101 products generated sales of $556 million in 1998. Compare that to U.S.-based Hershey, which generated $4.4 billion in sales with just 78 products. Or take health care: The Japanese government’s generous hospital reimbursement criteria practically encourage health-care providers to prolong illness rather than attack it, dragging the average acute care hospital stay in Japan to 24 days, compared with 11 days in Germany and six in America. Financial services are also rife with inefficiencies: Life insurance is largely sold not by financial professionals but by brigades of old ladies, often part-timers working door to doora model that has not changed since the aftermath of World War II. Indeed, the sectors that account for 90% of Japan’s economic output achieve labor productivity rates just 63% of those in the U.S. As the McKinsey report bluntly puts it, these sectors are “the source of Japan’s ills and the Japanese economy will not rebound until the performance of these companies begins to turn around.” How did Japan become host to a handful of world-leading exporters offset by thousands of value destroyers at home? The simple truth: Japan’s economy was born this way. Not long after the end of World War II, the government reasoned that due to the country’s lack of natural resources and small population, its only hope for recovery was to produce high-value finished goods that the rest of the world wanted, at consistently improving quality and prices. And then, as only the Japanese can, the entire country single-mindedly set out to achieve that goal. Government bureaucracies picked favored industries, giving companies in those fields the incentives and market protection they needed to improve quality until they were ready to compete with the world’s best. And thus Japan’s textile, steel, automobile and finally, semiconductor and computer industries were born.

While international competition was the watchword for exporters, the government sought universal employment and stability at home. With coffers flush from the nation’s high personal-savings rate, the government launched massive public-works projects designed to rebuild a smashed infrastructure, provide jobs and spur internal demand. For the domestic industries, Japan pursued consistently protectionist, anti-competitive policies, with the intention of keeping as many companies afloat as possible. “Ten percent of the country was allowed to be capitalist, and the other 90% was socialist,” says Eisuke Sakakibara, director of the Global Security Research Center at Keio University and a former vice minister of finance. He’s not really joking. Antitrust laws were virtually nonexistent, cartels flourished and high tariffs pushed away foreign entrants.

“For a long time,” Sakakibara continues, “the dual economy worked.” Throughout the 1960s, 1970s and most of the 1980s, Japan’s unique form of bureaucratic capitalism was spectacularly successful. Beginning in the late 1980s, however, the world began to change. International competition has intensified dramatically, trade barriers elsewhere have fallen, China snapped out of its slumber, and Southeast Asia and South Korea have proven that they can match Japan as high-tech manufacturers and exporters. But rather than confront a new competitive landscape head on, Japan still acts as if it is a developing country that needs to be protected.

Instead of deregulating or evolving into a postindustrial economy more focused on services than manufacturing, or encouraging exports in anything other than cars, electronics and similar goods, Japan has been returning (with increasing desperation) to what always worked so well in the past: emphasis on high-glamour manufacturing, new public-spending projects and continued domestic protection. Japan already has more infrastructure than it needs (its “bridges to nowhere” have been made famous by frequent ridicule in the local press) and government debt handily exceeds GDPtwo good indicators that the returns on those Keynesian stimuli are diminishing. But like the laboratory pigeon that keeps hitting the lever even though the reward is no longer coming, Japan’s government can’t stop banging away with its favorite but increasingly useless palliatives: public spending and fiscal stimulus.

That’s why a growing number of economists are declaring that it’s time for a little creative destruction. “Stirring competition is the single-most-important strategy for driving productivity higher,” says economics professor Shimada. “That means getting rid of government subsidies and tariffs for protected industries and dismantling quasi-governmental monopolies.” But that is a lot easier said than done. For one thing, those protected industries have had plenty of time to develop powerful lobbying groups, which are now among the ruling Liberal Democratic Party’s biggest contributors. Many Diet members, in fact, are known by which zoku (tribe) they are members of: construction, agriculture or health care. Change is coming in dribs and drabs, but usually only after a prolonged fight. Liquor licenses will be fully deregulated next September, and telecommunications opened up a few years ago to a fair degree of success. “There is movement,” says Masaaki Kanno, chief economist for JP Morgan in Tokyo, “but it is too little, too slow.”

Another factor holding back structural reform is the acknowledgement from all parties that it would almost certainly bring about lots of short-term pain, including numerous bankruptcies and high unemployment. “There’s no doubt that the structure needs to be changed,” says former Finance Vice Minister Sakakibara, “but people are afraid of the costs.” Many Japanese wince just discussing joblessness; they speak about acquaintances who have been fired as if they’d been afflicted with a horrible disease. Many Japanese commentators claim that high unemployment is unacceptable because the nation does not have a well-developed social-welfare systemnot seeming to realize that allowing an estimated 17 million surplus workers to remain on the nation’s payrolls is a much more expensive version of the same thing.

Furthermore, it is also widely believed that increased productivity will lead to permanently high unemployment. Economic theory (and a preponderance of historical evidence) suggests that unemployment is only a temporary consequence of reform. Higher productivity leads to lower prices, which spurs increased consumption, which requires increased productionand more jobs. Wal-Mart, for example, wiped out the American equivalent of the Nakamura storeto nationwide hand wringingthroughout the 1980s and 1990s; unemployment is lower in the U.S. today than it was then, and at 5.7% is lower than Japan’s unemployment rate is now. Since 1990, according to the Japan Productivity Center for Socio-Economic Development, labor productivity has improved 49% in the U.S., 26% in France, and 18% in Germany. Japan’s productivity, meanwhile, has increased only 13%.

But why absorb pain today when you can put it off until tomorrow? Walk the streets of Tokyo and there is no sense of urgency, no indication that the country has a credit rating equal to Botswana’s. Part of Japan’s quiet confidence comes, no doubt, from the $6 trillion in personal savings its citizens have amassed, thanks to its exceptionally high 13% household-savings rate. That totes out to $150,000 per capita, or nearly two and a half years’ worth of the average worker’s income per householdmaking it a massive, self-funded social safety net, insulating the country’s citizens, at least to a degree, from the economic turmoil around them. And because many accounts are still government guaranteed, the Japanese just keep socking it away, no matter how bad the economic news gets. The government, meanwhile, directly controls 20% of that money through its postal savings system, which it has treated as an always-replenishing piggy bank to fund its huge public-spending projects. And thus the giant, unproductive cycle of money and labor churns on. “After all this time, Japan still has the resources to muddle through,” says Kiichi Murashima of Nikko Salomon Smith Barney. “And as long as Japan can muddle through, it will.”

Still, it might get harder to muddle through in the future, since there are indications that the most reliable part of Japan’s economic engineits high-profile export industriesis under unprecedented attack. “Japan’s competitive positioning is declining internationally,” says Ken Courtis, vice chairman of Goldman Sachs Asia in Tokyo. “There have been huge productivity gains in the U.S., while China has lower labor costs. Japan is getting it from every side. There is no place for them to hide.”

The country may also be staring at an internal demographic time bomb that will make efficiency and productivity all the more pressing in just a few years. Japan’s working population peaked in 1997 at 67.9 million people and is predicted to decline to 60 million by 2025. Kiyohiko Fukushima, chief economist of the Nomura Research Institute in Tokyo, reads the demographic tea leaves and deduces that Japan’s working population will dwindle so dramatically in the years ahead that the country will face an unprecedented shortage of workersrendering much of society’s current fears about unemployment moot. Japan will have no choice but to move every able body it can to the most competitive and productive industries possible. Furthermore, Japan may have to relax immigration restrictions, extend the retirement age beyond 60 and bring women into the workforce more aggressively, just to meet its labor needs.

With such changes, says Fukushima, Japan may manage to settle into a kind of affluent stasis, but the country is still probably finished as an economic overachiever. “The high-growth story in Japan is over,” he says, predicting that a long-run GDP growth rate of 1% per year is probably the best the country can hope for. With far fewer people working, output may stagnate no matter how productive Japan’s workforce becomes. All of which means that someday soon in the suburbs of Tokyo, and across the nation, you may have to start parking your car all by yourself.

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