Going Nowhere Fast

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ow 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 GDP—two 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 system—not 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 production—and more jobs. Wal-Mart, for example, wiped out the American equivalent of the Nakamura store—to nationwide hand wringing—throughout 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 household—making 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 engine—its high-profile export industries—is 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 workers—rendering 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.