Kick-starting entrepreneurship in Japan

Economist Richard Katz

Can Japan kick-start its economy through entrepreneurship? Economist Richard Katz aims to find out. He’s on sabbatical from The Oriental Economist, his monthly Japan economic newsletter, researching how other countries have achieved growth through entrepreneurship. Katz promises to reveal in a new book on the subject a list of outside the box policy measures which government could take to solve Japan’s vexing slow growth problem “without having to rejigger all the institutions”.

Abenomics is over, says Katz: “The third arrow, if it really existed, would be about 1,000 feathers. So, I decided to take one of those feathers—entrepreneurship—because I think it is critical to growth,” for the book’s topic. Katz has authored two previous books about Japan’s economy.

Beacon Reports believes the topic is timely. Everyone agrees Japan needs more people willing to experiment with outside the box ideas—in full knowledge that most will fail—if the nation is going to compete in a world that is speedier, increasingly global and more innovative. Politicians, however, seem unwilling or unable to introduce disruptive change, perhaps because Japan is largely at peace with itself. The nation enjoys one of the lowest unemployment rates. The streets are safe and clean. Divisive populism, as found in the US, UK and Europe, does not exist. Japan may not be the most productive nation, but it is a most comfortable place to live.

The country enjoyed an earlier peaceful time between 1603 and 1867 under Tokugawa rule, when Japanese culture flourished. However, productivity gains—especially those related to industrialization—failed to materialize. For example, gun-making know-how, first introduced by the Portuguese in 1543, barely advanced in 270 years of isolation. As a result, Commodore Matthew Perry easily prized open Japan in 1853 when his sailors were confronted by Japanese warriors bearing 17th century flintlocks. In modern times, Steve Jobs also prized open Japan without struggle, when Apple captured Japan’s mobile telecom’s market armed with more innovative Smartphone technology.

The nation, now barely growing, produces enough tax revenues to cover only about half of government expenditures. Yearly deficits have caused national debt to soar to the heights of Mount Fuji. To reduce the mountain to manageable levels, the government aims to lift average real annual output growth from less than 1% to 2% by 2022. Government should welcome any policy measures Katz can suggest to lift global competitiveness without the need for spending much political capital.

Katz explains that economies can grow only two ways, either by increasing the number of workers or by lifting output per worker. “If the number of hours worked grow by 1% and output per worker is growing by 2%, then the country is going to grow 3%,” he calculates. Yet the total number of hours worked in Japan has steadily declined since the 1990s. That’s not because Japanese are working fewer hours. It is because of a decline in the population of the labor force. To grow the economy, each worker must produce more. That, says Katz, will take a productivity revolution involving creative destruction on a much greater scale.

Creative destruction occurs when existing firms get better at what they are doing. It involves superior firms taking market share away from lesser performing companies. More productive firms enter the market and then grow to replace older, inferior firms. “About 40% of the growth in productivity comes from inferior firms dying and being replaced by more productive ones,” says Katz.

Each new firm is like a Darwinian experiment. Most startups fail, but the few that succeed change the entire economic ecology. “In 1910, do you know how many car companies there were in America?” asks Katz. “People usually say 15 or 20. There were 200. Some cars burned gasoline. Some were steam driven. Some had batteries and others burned wood. Almost all of those car companies failed,” he notes. Yet Japan has the lowest rate of firm turnover within the OECD, because the nation does too few experiments.

New firms also fail to grow as fast or as large as elsewhere. In the US, for instance, “gazelles” (fast growing small firms) create not only many new jobs, but more productive jobs than the ones they replace. A few hundred thousand US companies, many little known, started off with 10 people. They have since grown to employ 200 or 300 people each, says Katz. These once fledgling companies today employ 30 or 40 million people, representing about 20% – 25% of the US workforce. Japanese firms, in comparison, grow much more slowly. When they do mature, they also employ fewer people, so productivity output per worker suffers.

One obstacle preventing a productivity revolution is Japan’s social policy, which props up ‘elephants’ (old, established inferior firms). A rigid labor system and the lack of a robust government social safety net pressures policy makers to keep inferior firms alive, lest workers lose their main source of protection—their current jobs. Government helps large inefficient firms to remain afloat by keeping interest rates artificially low. With loan rates close to zero percent, any firm can look as if they are solvent, says Katz. The result is that too many inefficient companies survive, making it difficult for new firms to gain a toehold. For example, the top Japanese consumer electronics firms haven’t changed in over 70 years, while 8 of the top 21 US electronic firms did not exist before 1970.

Which firms will provide the growth? Katz thinks that companies marketing exotic technologies (for instance, nano-tech firms) will not be the main drivers. Nor will much growth come from ‘hidden champions’, entrepreneurial firms which have a clear business focus and ‘go global’ early in their lives (see article). Both kinds of firms impact growth, but rarely disrupt entire industries. Rather, he believes growth will mostly arise from new and established firms which adopt new technologies. That is because Japan did not experience a productivity revolution from information and communication technology (ICT) as did the US. About two-thirds of US productivity growth, starting from the mid-1990s, came from firms adopting ICT.

Could policy measures encouraging entrepreneurship trigger a productivity revolution in Japan? Research conducted by Professor Kyoji Fukao, Director of the Institute of Economic Research at Hitotsubashi University, indicates that Japan’s missed productivity revolution results mainly from firms treating labor saving technology as threats to harmony in the workplace. By contrast, US firms treat new technologies as a means to innovate (see article). The key problem is that Japan’s seniority based labor system empowers middle-aged managers in their late 40s and 50s, instead of tech-savvy new graduates who champion technological revolution elsewhere. So the question of how to unleash the potential of Japan’s youth remains unanswered.

Why do Japanese value harmony so highly? That is best explained by Dr. Ryo Kubota who founded the $400m public listed biotech company, Acucela Inc. Kubota recounts his third grade Japanese elementary schoolteacher calling on his childhood friend and classmate to answer the simple question, “What color is the opposite of white?” His friend answered “red”, citing the colors of the Japanese flag, as well as the traditional colors used at ceremonial events. For answering wrongly (black is the right answer) his friend was severely scolded (and later dropped out of school). The following year Kubota’s family moved to the US for one year. There, his fourth grade US science teacher asked another short question, “Does the moon rotate?” Students this time were asked to consider the evidence, debate the issues, and draw their own conclusions. Kubota reasoned from these experiences that students in Japan are taught to preserve harmony by answering questions with memorized answers out of fear of being heavily criticized. In the US, by comparison, he felt free to think as he liked (see article).

Kubota thinks harmony is not always bad. “Much of society works well when people rely on others to think and act in coordinated ways,” he says. These attributes helped Japan become an industrial powerhouse after the war. However, they became an inherent weakness in a fast changing world, where firms compete globally on the basis of rapid innovation.

Ex-Line CEO Akira Morikawa, another leading entrepreneur, believes Japanese managers lack the ability to be creative or innovate because they are the product of postwar export-led manufacturers which grew by fine-tuning processes, operations and logistics. Within these behemoths, too much consensus and paperwork is needed to start new projects. Too many senior managers with vested interests block change. He compares traditional Japanese companies to zoos in which well-fed managers have become lazy. “Japanese people like to move in a straight path, but it’s a dream. Every day the global market changes quickly, like water,” says Morikawa (see article). He feels Japan needs more outside the box risk takers, if firms are going to survive on the savanna.

Katz argues Japan must find market friendly ways to increase potential rewards and reduce risks which encourage entrepreneurship. “Japan must create the conditions to make it possible for people to take those (risks) in recognition that most (innovative efforts) will fail,” he says.

Katz does not believe that Japanese are any more risk averse than Americans or other people. “The big difference between Japan and the US is that the risk to reward ratio is very different,” he says, adding, “It is not an issue of risk aversion. It is an accurate perception of what the real situation is on the ground.”

He does believe the Japanese educational system must change, but also thinks it is not the primary obstacle. “If you believe that, then the possibility of making changes in any kind of reasonable time frame would be very difficult indeed,” he says.

Katz points to Japan’s labor system as the biggest obstacle to productivity growth. “If you are working for a prestigious company and then leave for a startup which fails, you are going to find it very hard to get another good, high-paying job again. That reality has nothing to do with Japanese culture. It was a decision made after World War I and especially after World War II by Japanese corporations.” He believes those decisions are malleable.

Katz’s writing is always well argued, if not controversial. We look forward to reading his new book, tentatively titled, “Reigniting Japanese Growth: The Role of Startups,” when it is published in about 18 month’s time.

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