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 sectors—construction, retailing, agriculture, health care and financial services, among others—have languished. Shielded from competition by a tangle of government subsidies, tariffs and protectionist policies, the nation's domestic manufacturers and services have hardly changed—let alone improved—for 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 here—Just In Time Manufacturing, Total Quality Management, Continuous Improvement—have been imitated from Seoul to Săo 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 overemployment—as in that parking garage outside of Tokyo—is 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 models—all 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 door—a 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."