Sometimes Japan seems to be on the wrong continent. Everywhere else in Asia, from Shanghai to Mumbai to Jakarta, there is an aura of perpetual motion, a sense that tomorrow will be better than today. The region is on a frenetic 365-day-a-year hurtle into a brighter future. Japan once shared Asia's dynamism and mission. But not anymore. Today, Japan is an island of inertia in an Asia in constant flux. Japan's political leadership is paralyzed, its corporate elite befuddled, its people agonized about the future. While Asia lurches forward, Japan inches backward.
And yet no one in Japan is doing very much about it. For 20 long years, ever since the spectacular collapse of a stock-and-property price bubble in the early 1990s, the economy has existed in a near cryogenic state. The postbubble period of malaise called the "lost decade" has stretched into the lost decades. Growth has been practically nonexistent, the welfare of the Japanese people has suffered and the old industrial titans of Japan Inc. are retreating on the world stage. Japan will likely lose its cherished status as the world's No.2 economy this year, to a more energetic China. Though that was inevitable, the fact that China is so quickly closing the gap in economic power doesn't bode well for Japan's standing in the world. (See pictures of stagnant Japanese economy.)
Every few months, Tokyo's political revolving door spits out a new Prime Minister (Japan's had six PMs in the past four years) who inevitably vows that the time has come, finally, truly, to reform. But the proposals announced with expectant fanfare usually get swallowed up in Japan's dysfunctional political system. Even Prime Minister Naoto Kan has acknowledged the atmosphere of suffocating hopelessness. "There is a growing feeling of being fenced in," he told the nation upon taking office in June, "a vague sense that the whole country is being stifled."
Kan is the latest political leader to promise a breakthrough. The former Finance Minister has proffered a growth strategy he calls the "Third Approach" — an agenda mixing European welfare-state policies with government-supported efforts to create jobs in promising sectors like green energy and health care. But Japan's political process instantaneously became his ball and chain. In July elections, frustrated voters stripped Kan's Democratic Party of Japan (DPJ) of its majority in the upper house of the Diet, the country's parliament, less than a year after sweeping the longtime opposition party into office in a landslide triumph. The continual disarray in Japanese politics threatens to make Kan's attempts to reform the economy even more difficult. (Read "Can Japan Put Its Economy Back on Track?")
Time may finally be running out for Japan. In the wake of Greece's sovereign-debt crisis, investors have begun focusing on the sick state of national finances in the industrialized world, and Japan's are among the sickest. Decades of fiscal mismanagement have saddled the government with debt equivalent to nearly 200% of the country's entire economic output — the biggest burden among developed nations — and pressure is building on Kan to introduce painful austerity measures. "There is an awareness that things can't stay the same," says Jeffrey Kingston, director of Asian studies at Temple University's Japan campus. "The problem is, people really don't know what is next. Japan's huge problems are just festering and Japan remains rudderless."
From Dynamo to Dinosaur
In many ways, Japan is a glimpse into a possible future for the U.S. and Western Europe. The Japanese have been struggling with major issues — an aging society, a fiscal disaster, weakening competitiveness — that the West is beginning to contend with as well. Japan's struggle today starkly shows the perils of inaction, of allowing domestic political calculations and ideological inflexibility to take precedence over the pragmatism necessary to thrive in a changing world.
What makes Japan's story so much more frustrating is that not so long ago, the nation was at the forefront of change. Japan's bureaucracy-led economic system was heralded as a growth machine superior to the more laissez-faire approaches of the West. The management practices of Japan's biggest corporations — from ultra-efficient "just-in-time" manufacturing processes to consensus-based decisionmaking — were the envy of the world. Long before Apple's iPad, it was Japan's Sony that invented the must-have gadgets that changed global lifestyles (remember the Walkman?). Japan didn't need answers; Japan was the answer.
Yet those same policies and practices that sparked Japan's miracle have come to strangle it. Japan has remained wedded to the same basic growth model it used in its miracle years — bureaucracy-led policymaking and a die-hard devotion to exports and manufacturing — even though it no longer fits Japan's modern, high-cost economy or keeps the country competitive. Though Japan's financial sector generally avoided the subprime-induced meltdown that hit the U.S., it got smacked much harder by the global downturn. In 2009 the economy sank 5.2% compared to 2.4% in the U.S.
The Japanese people are paying the price. Though Japan is still the richest in Asia, on a per capita basis, it is not getting any wealthier. A distorted, overprotected labor market, much like those in Western Europe, forces 1 in 3 workers into temporary or contract jobs, denying them proper security, wages, benefits or training, and dampening the consumer spending the country needs to restart growth. The average wage, at $3,400 a month, was roughly the same last year as it was in the mid-1990s, while the household income of a worker's family, at $5,300 a month, fell 4.6% in 2009 from the year before.
Stumbling in Sendai
Sendai is a microcosm of what ails Japan. The modest town of 1 million people is the capital of the prefecture of Miyagi, where unemployment, at 6.4% in 2009, was well above the national rate of 5.1%. Sendai's young graduates are forced to relocate to bigger cities like Tokyo or Osaka since they are unable to find good jobs at home. Yet local government officials and business leaders display a distinct lack of creativity in addressing the region's economic woes. (Read "Japan's Government: Five Ways to Fix the Economy.")
Take the local economic development plan. The government intends to create jobs by attracting factories to Miyagi in three industries — automobiles, food processing and electronics — with special tax breaks and other financial incentives. Yoshinobu Ikuta, an assistant manager at the prefecture's New Industry Promotion Division, explains that the goal is to turn Miyagi into a major industrial hub, on par with the area around Nagoya. As a sign of the potential promise, he points to the construction of a car-assembly plant in Miyagi by Toyota subsidiary Central Motor, due to open in 2011. "We want autos to create more jobs so young people stay in the area instead of getting jobs outside," says Ikuta.
Such a plan might have worked — if the date were 1975. Back then, Japan was a rapid-growth economy with high rates of industrial investment. But the Japan of today is a high-cost economy suffering from excess capacity, in which companies have less incentive to invest heavily. Investment as a percentage of GDP was 20% in 2009, down steeply from 33% in 1990. Many manufacturers in industries like carmaking prefer to build plants overseas, where costs are lower or markets are expanding. The Central Motor plant is the first new assembly factory Toyota or one of its subsidiaries has opened in Japan since 1993. As a result, the essence of Miyagi's development plan is effectively to steal jobs from other parts of Japan, not create entirely new industries that could increase overall employment. (See pictures of Japan in the 1980s and today.)
Ikuta is aware of such facts, but dismisses them. He and his colleagues — and their overlords in Tokyo, who still call most of the shots — are stuck on the decades-old idea to equate economic progress with physical factories. He defends the Miyagi plan, saying that technological changes in the auto industry, such as a potential shift to electric cars, will provide opportunities for Miyagi. "We hope that the whole industry will change and merge with other industries," Ikuta says. But what about targeting more cutting-edge sectors? Maybe IT services or R&D centers? Sendai, after all, is home to Tohoku University, one of the nation's top science and technology schools. Ikuta and his colleague Hiroo Sato, who oversees efforts to woo electronics makers to Miyagi, say any investment is welcome, but the government's focus is still on factories. Nor do they seem interested in having foreigners create jobs for Miyagi's unemployed. Ikuta and Sato both say Miyagi is open to foreign investors, but, unlike competing cities and provinces in China, Taiwan and elsewhere in Asia, the local government is doing little to attract them.
Sendai's business leaders don't seem to have any better ideas. At the city's Chamber of Commerce, Morio Sato, the secretary general, simply repeats the exact same government development plan. Autos. Electronics. Factories. When pressed for their own ideas for creating jobs in the region, Sato and his colleagues go mum. What can the government do to help businessmen in Sendai? More squirming and nervous giggles, but no clear answers. Perhaps Sato and the other chamber members have bold ideas for fixing the economy, but were uncomfortable speaking out due to their sense of politeness, a common trait among Japan's older generation. But that, too, is telling — it shows the lack of public debate on economic reform. Eventually Sato works up the nerve to express an opinion, muttering that more state subsidies for small businessmen would help.
The desire for government handouts is a constant theme in Sendai. Kazunori Chiba, director of the Miyagi branch of the National Federation of Agricultural Cooperative Associations, says that the region's tillers have come under strain from past liberalization policies and require continued government support to survive. He not only wants continued subsidies for farmers, but also state efforts to control food supply to support prices. Farmers had traditionally been loyal supporters of Kan's political rivals in the Liberal Democratic Party, he not very delicately points out, but many switched to the DPJ. Now, Chiba suggests, it's time for the payoff, whatever fiscal problems Tokyo might be facing. "We are all aware of the government budget situation, and we are not demanding a great amount," says Chiba.
The business-as-usual approach in Sendai shows how stale Japan's bureaucracy-led economic model has become. "Japan still craves the old structure, but that structure is preventing the emergence of new industries," says Kazunori Kawamura, a political scientist at Tohoku University. "The bureaucrats create a system that benefits themselves. They are reluctant to invest in something that has a chance of failure. They'd rather invest in something with a track record. We need to take the relationship between the bureaucrats and the economy apart."
A few bold politicians have tried. Junichiro Koizumi, Prime Minister from 2001 to 2006, believed Japanese required more freedom to take risks to get the economy moving again. He undertook a wide-ranging American-style liberalization program, loosening up inflexible labor markets and deregulating the corporate sector to encourage new investment and entrepreneurship. But in a society that prides itself on egalitarianism, the disparities in welfare brought about by the Koizumi reforms made many Japanese queasy. The public was shocked when unemployed workers set up tents in downtown Tokyo during the Great Recession. The idea of market reform has become so tainted in Japan that the DPJ actively campaigned against it during last year's general election. Yukio Hatoyama, the first DPJ Prime Minister, decried what he called "market fundamentalism" as inherently immoral. (See pictures of Yukio Hatoyama's political life.)
The DPJ is trying to fix Japan in a very different way. Kan, as Hatoyama also intended, wants to snatch policymaking power from the bureaucrats and put it into the hands of the Cabinet. The DPJ has also realized that selling reform to the average Japanese will be difficult without a major upgrade of the country's often weak social safety net. The party has already waived high school tuition fees and introduced a state subsidy for families with young children, and it has promised to strengthen medical and child-day-care services. In doing so, Kan hopes to restart growth by bolstering consumer confidence and convincing Japanese families to spend more and save less. Kan has also raised the idea of cutting the corporate tax rate, which is higher than those in most other industrialized countries, to spur investment and create jobs. "The economy has continued to be stagnant because of the pursuit of economic policies that did not match the changes in the structure of industry and of society," Kan said in a June policy speech.
Doubts about Kan's plans are already mounting. Decades of wasteful fiscal spending — which previous Prime Ministers had used to stimulate growth with "bridge to nowhere" construction projects while sidestepping reform — have restricted Kan's ability to create growth with government policy. Kan himself has called the country's financial position "dire" and has warned of "fiscal collapse" if action isn't taken. In June, Kan rolled out a fiscal austerity package that would balance the budget over the next decade. Kan also floated a controversial proposal to double the sales tax to 10% to help fill depleted coffers. He argues that his administration can simultaneously rein in fiscal deficits and fund his social-welfare expenses. (Read "New Scandal Hits Japan's Ruling Party.")
Yet his argument is unconvincing. Raising taxes would stifle the very consumer spending he wants to stimulate, while possibly only denting the country's fiscal problems. Carl Weinberg, an economist at research outfit High Frequency Economics, warns the Japanese government will have to take far more severe measures if it wishes to reduce its debt. "We presently have no plausible scenario in which the ratio of debt to GDP ever declines," Weinberg wrote in a recent study.
Japan's corporate sector hasn't been any more enlightened. The biggest names of Japan Inc. have been steadily losing ground in key industries and markets around the world, often to more nimble competitors from elsewhere in Asia. That is especially the case in the crucial emerging markets of the future — China and India — where Japanese managers have been slow to adapt product lines to the different needs of their up-and-coming, but still low-income, consumers. In India, for example, South Korea's Hyundai sold two-and-a-half times more cars in the rapidly growing market in 2009 than Toyota and Honda combined, according to J.D. Power & Associates. Japanese brands are also falling behind in hot, new consumer markets. South Korea's Samsung and LG Electronics are tops in the expanding LCD TV business, not Sony, Sharp or Panasonic, while Taiwan's Acer is winning in the mini-PC netbook market.
If Japanese companies continue to lose global market share, consulting firm Bain & Co. warns, they could shed half of their mid-2009 market capitalization by 2012. Their problem is outdated boardroom practices. Work-your-way-up-the-ladder promotion systems and consensus-based decisionmaking have made managers risk-averse and opposed to outside influences. As a result, says Jean-Philippe Biragnet, a partner at Bain in Tokyo, Japanese firms don't absorb talent from around the world or identify new growth businesses as well as their American, European or even other Asian competitors. "Japan's consensus-based management becomes counterproductive in certain situations, when they use it as an excuse to not make tough decisions," Biragnet says. "What needs to be done is not rocket science. You need leaders who will be bold enough to make certain decisions." (See pictures of Tokyo Auto Show.)
Of course, some sound decisions are getting made. Japanese companies still possess the smarts to churn out some of the world's most inventive and beloved products — from Toyota's hybrid Prius sedan to Nintendo's Wii video-game console — and top-notch technology in key industries for the future, such as nuclear power and solar panels. Corporate managers are also learning to adjust to the needs of emerging markets. Toyota will begin production of its first model designed specifically for the India market, called the Etios, in late 2010, while in mid-July the company announced it will build a $600 million plant in Brazil to manufacture small cars for local consumers. In another sign Japanese companies are thinking more globally, both Internet retailer Rakuten and the company that operates the Uniqlo clothing-store chain announced this year that English would become their official language. Young people also appear more inclined to start their own businesses instead of automatically signing up with big corporations or government ministries as they did in the past. "Younger Japanese are definitely not company men in the old salaryman sense," says Kenneth Grossberg, a marketing professor at Waseda Business School in Tokyo.
The question is, What will they do instead? The economy is still so wrapped up by the old-fashioned bureaucracy that starting new businesses is a tough task. In fact, Japan's entire economic model needs an overhaul in order to create new opportunities for the nation's youth. Policymakers must break once and for all from the export obsession held dear for decades and find new sources of growth at home. That means ending its traditional bias toward manufacturing and developing the inefficient services sector by slashing the red tape that stifles competition. Japan also requires major labor-market reform in order to boost wages, productivity and worker welfare, thus stimulating more consumer spending. Softening the protection of permanent employees to encourage more hiring would help, as would enhancing the benefits and training offered to part-timers. Japan could also do with a greater role for women in the workplace and wider acceptance of immigration to ease the burden of an aging society. More broadly, the Japanese should finally jump on the globalization bandwagon by opening more to foreign investment and talent while seeking greater international experience. In a disturbing trend, the number of Japanese students enrolled at American universities sank 38% to 29,264 over the past decade, while those from China increased 80%, according to the Institute of International Education. (See pictures of young Japanese women in despair.)
Such a sweeping vision for the nation's future and its role in the world is regrettably absent. Katsuji Konno, president of Igeta Tea Manufacturing, a Sendai-based chain of specialty tea shops, complains that the country's leaders are too focused on short-term fixes rather than long-term solutions. "You have to think of more drastic measures," he says. "You need to think 10, 30, 40 years ahead." Until Japan stops living in the past, it may not have a future.
— with reporting by Terrence Terashima / Sendai