If you were a spy…

If you were a spy charged with the mission of penetrating the very nucleus of shadowy political power in Japan and unavailing their thoughts and plans for the future, so as to have a view on what kind of projects and initiatives are coming your way, what would you do?

In my opinion, the most effective way of approaching such a task would be to take a deep breath, down a shot of Polish vodka (frozen), and immediately head over to their website to read the latest presentation.

Yes, the Ministry of Economy, Trade and Industry has a website, folks, and it is not full of empty platitudes (not any more, at least).

Recently, they have put up a presentation (http://www.meti.go.jp/press/2012/06/20120615005/20120615005-2.pdf, in Japanese) of the “New Industrial Structure Committee of the Industrial Structure Council”.*

In it, they present a surprisingly levelheaded (if flawed) analysis of the problems facing Japan, and an action plan on how to deal with it. The analysis is worth reading on its own merits, as well as an insight into what the bureaucracy (not the here-today-gone-tomorrow elected government) is thinking. The action plan, however, is an illustration of how a (somewhat) good analysis can result in poor decision-making.

 

*After I started writing this I discovered they have an English translated version, but it is missing important parts.

In my opinion, the best way to look at these kinds of white papers in Japan is as shopping lists, or wish lists, for the government. The more specific and realistic they are, the more likely they will be implemented. As I shall explain below, except for the reform of Haneda airport (specific and realistic), the 2009 wish list was just pie in the sky thinking. However, this has markedly improved of late, probably due to the multiple catastrophes over the last year and a half.

Note, if you still doubt that Japan is, at core, a fundamentally socialist state, you can read a (bad) translation of related documents with multiple references to the government and bureaucracy intervening heavily in industry on the MITI website. Interestingly, it appears that the bureaucracy is getting round to openly accepting the issues facing the country, and the “industrial structure engineering” (aka communist economics) of the country may be a benefit in mobilizing restructuring. That does not excuse socialism for getting us into this mess in the first place (no space to get into this, just consider one word: over-production). It is just a feature of the current system that the only way for inertia to be cured is either for a fantastic crash to occur, which was hardly likely while exports were strong (and while the government is paying every 50-year old unemployed guy to stand in a carpark waving a glow-stick), or for the bureaucracy to start pushing people around.

Firstly, the analysis:

1. The presentation has a neat little pentagonal cycle going like this:

 

Japan MITI deflation cycle

 

1. The savings rate is related to ageing
2. The price of Japanese exports has not been rising, while imports have become more expensive
3. Margins are low in Japan, and the gap with Europe in particular has widened (graph: op mgns; Red = US, Green = Europe, Blue = Japan)

Japan, EU, US margins

4. Insufficient savings to support government spending and a negative balance of payments will lead to rapidly rising interest rates, which will result in deteriorating finances, high inflation, and extreme yen weakness, followed by high unemployment and really bad economic conditions

5. The balance of payments might turn negative in the second half of this decade, particularly if there is no nuclear restarts and if industry hollows out. This can be delayed somewhat by restarting nuclear power plants and if the yen becomes cheap.

Relative to the usual governmental assault on logic, this is remarkable progress. It almost looks like it was written by McKinsey.

Compare the above with the kind of well-meant bland nonsense the same people were generating in 2009:

“Creation of a seamless Asian market” => Are you nuts?

“Japan as a ‘bridge nation to Asia’” => What are you smoking?

‘Making Japan a model country that leads the world in solving problems will be directly tied to strengthening the nation’s research and development capabilities and the foundations of its enterprises…. In addition to supporting human-resource development and technology development for “green innovation,” “life innovation,” and other areas as strategic innovation fields, government must generate demand while simultaneously moving to change the social rules from the standpoint of the users.’  => If you still feel that this makes sense, consider that just a few paragraphs above they bash the government deficit spending model, and here say that it needs to generate demand.

The rest of the paper is full of similar dross, but I just want to add one more (I couldn’t help myself): “We will work to spread technologies and systems that lead to social reform throughout the Asian region and the rest of the world. This can be called the creation of demand in Asia through the export of problem-solving prescriptions” => Who wrote this? Are you not ashamed? I can honestly say that the official website of North Korea has much better English and sense, and this text is bordering on second-tier North Korean English:

North Korean English

Secondly, what they plan to do about it:

1. Change companies’ strategies (from price competition to creating value)

Not many governments other than China’s would come up with a plan to directly influence industrial structure like this.

Japanese companies win in technology but lose in business. They plan to change this (no details given).

2. Do more global business

This will involve selling more stuff to middle-class people in Asia.

3. Create new industries and change the industrial structure

This means getting involved in growth industries such as healthcare, childcare, and green energy

4. Get women, old people, and the disabled participating in value creation (diversity)

Extraordinarily, the bureaucracy here lashes out at the “rigid and uniform salaryman model”

5. Develop people who can lead value creation

This means developing people who can sell things in Asia. [My comment: This will be a tough call, since Japan has been gradually becoming ever more isolated and inward looking over the last two decades. Graduates no longer want to work overseas.]

6. Move people from manufacturing to specialist/technology jobs

Social engineering in a PowerPoint presentation:

Japan social engineering

Red box is “Specialist” and “Admin,” and to the right is “Manufacturing”, followed by “Sales”, and “Services”

“Using women, old people, and young people and re-educating others is unavoidable”.

7. Expand internal demand

This basically means improving the competitiveness of cars and electronics. They then give three private sector examples (such as an IT system developed by Komatsu)

8. Taking “defensive” measures against the strong yen (any WTO lawyers in the house?)

This refers to subsidies to business, especially to car companies.

9. Attracting foreign capital

This means reducing the corporate tax rate (they already did this about a year and a half ago, but if they did it again it would be nice for stockholders), making it easier for foreigners to live in Japan (my heart jumped at this, but my head tells me to stay calm), and attracting businesses to set up shop (such as by setting up tax-free zones)

Difference from 2009

The difference from 2009 is striking. At that time, the focus was completely on low-carbon, environment, and energy (basically because the oil spike happened just before). Also, the prospect of losing the holy chalice (aka positive balance of payments) was not as apparently pressing then, so “low-carbon” seemed like a realistic thing to do. They have kept the low carbon thing in there, but there is now much more focus on things that may actually make money at market rates with known technology. There was in 2009 also some more discussion about how to use the medical industry as a source of competitive advantage, although overlooked was the fact that Japan is at a distinct competitive disadvantage here due to a. its insistence to have a separate clinical trial system from other major markets, b. taking too long to approve products, and c. the huge and growing cost burden of health care, which forces the government to mandate price reductions, which in turn discourages real R&D and encourages reformulation and repackaging.

Fourthly, what is right and wrong with the analysis

Where are the errors and glaring inconsistencies can you see with the analysis by the bureaucracy?

The data (input) is good, but the way it is processed is simpleminded.

The government’s thinking is like this:

Balance of trade and services goes negative, causing a balance of payments crisis.

So, it wants us to believe that the negative balance of trade in goods and services, which was -3.4 T yen in 2011, will become so negative that it will overcome factor income which has been consistently growing and currently stands at 14 T yen. Moreover, on the same slide, it shows a diagram of how LNG imports have contributed -4 T yen to the trade balance.

Expensive LNG imports are temporary factor.

The government also says that the hollowing out of industry will result in business is not returning to Japan after the yen weakens. This is ridiculous. You cannot have it both ways – either the yen will fall until investment in Japan is stimulated, or it will not fall. Perhaps they are thinking of cases such as the UK, which has a large nonmanufacturing sector which prices out manufacturing. The chances of this happening in Japan in the next half-century are low. At any rate, the current industrial structure with overcapacity and competing on cost against China and Korea has still managed to produce a trading surplus (excluding post-earthquake LNG pricing), and now there is widespread reform going on.

This “hollowing out” is a source of panic in the newspapers daily. Sure, manufacturing is moving overseas because of the high yen, forcing manufacturers to become more efficient and will eventually make them focus on high-value industries. Is this a bad thing? Will this cause Japan to have a balance of payments crisis? Not when they are earning 14 T yen (and growing) in factor income! Japan could allow this hollowing out to continue for a long time before it starts needing to borrow money overseas.

Another temporary factor is the net inflow of capital into Japan in 2011. Businesses will export capital when they feel happy. Not many businesses felt happy and 2011 in Japan. When the cycle turns, the movement of yen for investment outside of Japan will increase, pushing down the yen, and stimulating the local economy as well.

If the market was so worried about a possible yen implosion, why has the yen been so strong? There is no need to worry about the financial strength of net creditors who have their own currencies.

Even assuming that Japan cannot earn its way in international markets and has to go cap in hand to borrow money so that it can finance its lavish spending, what would happen? Obviously, interest rates would rise, which would limit government spending and give consumers and companies a return on their savings. There would be a hit to personal wealth as bonds decline, but the positive aspect of this would be that bonds would no longer be seen as a safe haven, and other assets would appear relatively less risky. Businesses will also need to focus on investing in things that actually produce a reasonable return. As the government’s balance sheet would start to shrink, it would enable more borrowing by other borrowers, reversing the trend that has been in place since the early 1990s.

However, due to the large factor income, the possibility of stimulus from yen weakening due to the business cycle turning, and continual improvements in efficiency, the above scenario is not imminent.

Finally, why the government’s plans are not as good as its analysis

Although their plan seems to make sense, the majority of their budget allocation is to projects such as research into solar power and energy efficiency. This is just a subsidy to big business, which will get to sell the products that come out of such research. The next biggest allocations are for direct subsidies.

Only a tiny amount is allocated to setting up tax-free zones (I do not know much about this, but hopefully it does not require a lot of money to designate an area as tax-free), attracting foreign companies to the country, or for making any serious reform. Piecemeal steps have characterized their approach so far, and it appears that they will do so going forwards.

It appears that the people in power have finally recognised that growth through public projects will not work.

The difference between now and three years ago is that it appears that the right questions are being raised, and the direction is improving, although the rate of change is still painfully slow.