Japanese Manufacturing in Search of Salvation

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Japanese Manufacturing in Search of Salvation
Concern grows as sector behind postwar miracle shifts overseas

Last June, Akio Toyoda, president of Japan’s Toyota Motor, delivered a blunt appraisal of his country’s most cherished economic asset: its competitiveness as a manufacturing power. “If you look at it logically,” he said as he announced a reorganisation of the carmaker’s domestic operations, which were haemorrhaging money as a result of a soaring yen, “it doesn’t make sense to manufacture in Japan.”

Alarm bells are ringing in the offices and factories of Japan Incorporated. The currency, electricity shortages caused by last year’s tsunami, unfavourable tax and trade policies and the relentless rise of China and South Korea are heaping pressure on the country’s once unchallenged makers of cars and electronics to decamp for lower-cost locations. Politicians, business leaders and the media warn that, if nothing is done, the industries responsible for much of Japan’s postwar growth could fall into irreversible decline – and drag the country’s chances of pulling itself out of a 20-year economic malaise with them. “We are in unprecedented danger of hollowing out,” Yoshihiko Noda, prime minister, said in September.

Handwringing over the decline of manufacturing is not entirely new, nor is it unique to Japan. The share of the workforce involved making physical objects, as in other wealthy countries, has been shrinking for years: from 27 per cent in 1970 to 17 per cent today. That has left it somewhere between the UK and the US, where only one in 10 workers is in manufacturing; and Germany and Italy, where the figure is about 20 per cent, according to statistics collected by the Paris-based Organisation for Economic Co-operation and Development.

Yet for Japan, the prospect of industrial irrelevance is especially worrying. Since the country’s economic bubble burst in the 1990s, real income per worker has fallen by 10 per cent and the loss of more well paid manufacturing jobs would accelerate the downward trend. Although official unemployment remains low, at a little more than 4 per cent, the government calculates that the rate would increase more than threefold if companies cut their workforces to match the actual level of demand. So far, that outcome has been deferred by worker-friendly labour laws, government job subsidies, sometimes called a dole for the idle employed, and the legacy of postwar “lifetime employment” schemes but it is unlikely to be avoidable for ever.

More broadly, Japan’s industrial problems have coincided with the country’s shrinking role on the world stage. Two decades ago, its economic output accounted for 14 per cent of global gross domestic product; today, it is less than 9 per cent. Even in Asia, it has been eclipsed by China as an economic and a diplomatic power.

Perhaps most worryingly, many in Japan appear to believe the country has nothing to fall back on if manufacturing fails; that its workers are uniquely suited to monozukuri, the almost mystical concept of “making things”. They point to a scarcity of national champions in industries such as software and finance and to the inefficient services sector, where output per worker is less than half the US level. When manufacturing companies stumble – as in Toyota’s recalls in 2009 or the ongoing accounting scandal at Olympus – the sense of national embarrassment is keen.

“Japan’s whole identity is tied to manufacturing,” says Yoshikazu Tanaka, founder of Gree, a social gaming company. “If you’re not producing actual material objects, people treat you as though you’re doing something dodgy.”

There is indeed evidence that manufacturing’s shift abroad has accelerated. Since the yen began its 40 per cent climb against the dollar in mid-2007, net outbound foreign direct investment has jumped from an average of $30bn-$50bn in the first half of the 2000s to $130bn in 2008. It remains above its long-term trend. Domestically, corporate capital investment has been falling.

The performance gap between companies that have moved overseas aggressively and those that have not is stark. Toyota makes about 50 per cent of its cars in Japan, where it sells fewer units than it exports, and expects net profit to halve in the fiscal year to March. In contrast, Nissan, which makes only one-quarter of its vehicles domestically, forecasts a profit decline of 9 per cent.

“If Japan wants employment, you’re going to have to do something about establishing a normal exchange rate,” Carlos Ghosn, Nissan’s chief executive, warned recently. He wants Tokyo to ditch the sporadic and mostly ineffective market interventions it has tried since late 2010 in favour of a Swiss-style currency ceiling that it would defend at all costs.

The country’s problems have been compounded by last year’s natural disasters. The March earthquake and tsunami, and more recent floods in Thailand, damaged Japanese factories and threw supply chains into disarray. Although many companies recovered faster than expected – national industrial output was back to near normal levels by August, after plunging 15 per cent in April – its effect on business in the country will linger.

One problem is the cost of energy. The destruction of Fukushima Daiichi nuclear power station by the tsunami has led to electricity shortages elsewhere, as other plants have been forced offline pending safety reviews. That has raised the prospect of long-term rationing and rising prices in a country where companies already pay 40 per cent more for electricity than do their peers in the US and 2.5 times more than South Korean groups, a consequence, in part, of the power sector’s monopolistic structure. Tokyo Electric Power, owner of the Fukushima plant, wants to raise tariffs in Tokyo and the surrounding area by 15 per cent to cover its compensation and clean-up costs – a proposal strongly opposed by business. “The electricity issue is as big a headwind as the strong yen,” says Minoru Usui, president of Seiko Epson, the maker of printers and video projectors.

Tsunamis and currency markets may be outside Japan’s control but industry and government leaders have also inflicted wounds on themselves. Many companies, for instance, have backed so-called Galapagos technologies – Japanese gadgets that travel poorly because they are tailored too narrowly to local requirements. A classic case is the mobile phone. Japan had internet-surfing handsets nearly a decade before the iPhone, yet local producers never tapped overseas markets and failed to update their designs. Today, they are surrendering share even at home, where Apple’s globally popular device is the best-selling model.

Meanwhile, businesspeople say government policy discourages investment and hiring at home. They cite burdensome labour rules, a high corporate tax rate (41 per cent against an OECD average of 26 per cent) and the fact exporters pay higher duties than competitors in South Korea and elsewhere. The huge cost of repairing the Tohoku coast following the tsunami will add to Japan’s already unparalleled public debt of 200 per cent of GDP, making the case for cutting business taxes harder to win.
"If you’re not producing actual material objects, people treat you as though you’re doing something dodgy"

Not all the country’s industry is doomed, of course. Paradoxically, the disasters of 2011 served as a reminder that the country retains competitive advantages in important but often overlooked areas, such as precision components and materials. Many people were surprised to learn, for instance, that a single Japanese semiconductor maker, Renesas, supplies nearly half the microcontrollers used in automobiles worldwide. When the factory that produces the devices, which move seats, lock doors and wind down power windows, was knocked out of commission by the quake, assembly plants from the Japanese carmaking hub of Nagoya to Alabama ground to a standstill.

The strength of Japanese component-makers was also highlighted by the debut passenger flight of Boeing’s 787 Dreamliner in October, a third of whose high-tech parts were made in Japan. Toray, the materials group that supplies the lightweight carbon- fibre elements that make the model more fuel efficient than older aircraft, may not be a household name such as Sony but it represents what is arguably the most competitive corner of Japanese manufacturing.

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So far, most companies have chosen to keep making their most cutting-edge, high-value products in Japan, while shifting production of low-margin goods to cheaper sites abroad. The strategy has worked to a greater or lesser degree for individual groups but experts doubt it will preserve large-scale employment, especially as big emerging economies such as China move up the industrial value chain to produce increasingly sophisticated goods.

Waichi Sekiguchi, a writer at Japan’s Nikkei business daily and member of the Beyond Galapagos Study Group of industry experts, argues that cost competitiveness and the yen are side issues, as changes in technology itself have made Japanese manufacturers’ engineering-focused business model obsolete. “That model worked wondrously well when global competition revolved around individual products and the winners were the companies that made the best products at the cheapest price,” he says. “But it makes much less sense in the world of digital electronics where the network is king.”

Mr Sekiguchi makes his case in Reimagining Japan, a collection of analysis and policy recommendations published last year by McKinsey, the consultancy. Other contributors to the book say an excessive focus on saving manufacturing may even be harmful if it draws resources from more promising exits from the economic cul-de-sac. “Nuts and bolts are Japan’s past, not its future,” argues Masayoshi Son, founder of Japanese telecoms group Softbank. “No labour-intensive industry can revive Japan … for Japan, knowledge-intensive industries are the only way forward. And yet our government policies are not focused on such industries.” Official policy is focused mostly on preserving what is left of monozukuri. In the fragmented electronics sector, the government is trying to speed up consolidation and create national champions: it recently backed a merger of the small liquid crystal display businesses of Sony, Toshiba and Hitachi. It hopes the new entity will be better able to compete with Korean and Taiwanese groups.

Yet policymakers have also recognised the need to diversify and are targeting non-metal-bashing industries as potential growth areas, including tourism, manga comics and fashion. Japanese styles are popular elsewhere, yet its cultural industries export only about 2 per cent of output.

Yoshihiko Miyauchi, chief executive of Japanese financial services company Orix and an advocate of liberalising the highly protected services sector, lists other areas where the country is strong but under-represented in global markets – from delivery services to convenience stores and medical care. “Japan could have the Mayo Clinic of Asia,” he says, referring to the renowned private hospital in Minnesota that attracts wealthy patients from around the world.

As for manufacturing, he would rather see companies shift production abroad and thrive than stay and wither. “When Japanese companies go out into the world, they get stronger. It’s the companies that try to fight it out at home that are struggling.”

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Korean competition: Seoul’s titans triumph but little lies below

It is little wonder that fuming Japanese officials criticise Seoul for what they see as unfair currency interventions to keep the won weak for South Korea’s big exporters, writes Christian Oliver.

At first glance, many of the largest Korean companies are pulverising their Japanese competitors. Samsung Electronics posted four times as much net profits in the third quarter as Japan’s 19 main listed technology and consumer electronics companies combined. South Korea’s shipyards overhauled Japan’s in recent times to become the world’s biggest, though they in turn are now being eclipsed by China. Hyundai Motor is proving a potent rival to Toyota, particularly with its Sonata challenging Toyota’s Camry in the US.

But the success of South Korea’s chaebol, or big conglomerates, disguises a more complex picture. Those same chaebol are dependent on parts from Japan’s specialist engineering companies. In 2010, South Korea ran a titanic $36bn trade deficit with its old colonial overlord. This is a big strategic worry for Korea, which, facing the rise of China, dearly wishes it had the high-quality small and medium-sized manufacturers that serve both Japan and Germany so well.

For now, South Korea has production advantages over China’s manufacturers through both quality and speedy project management but this will not last indefinitely. South Korean policymakers are vowing Seoul will not get stuck in a limbo between China and Japan and are promising to help build SMEs. But there has been little in terms of practical policy to break the reliance on chaebol that are vulnerable to China’s rise.

Small businesses complain that they will never gain the strength of their peers in Japan and Germany because the chaebol buy them out to strip their staff and assets once they become successful. Robust financing is also difficult to secure, they add. Compounding the problem, the education system is not receiving the overhaul it needs to foster imagination and innovation.

Until South Korea builds better SMEs, the chaebol need to innovate quickly to stay one step ahead of China. Hyundai Heavy Industries, the world’s biggest shipbuilder, is transforming itself into a general engineering company that produces wind turbines and electric generators as well as freighters. It is also focusing on higher-value vessels for offshore drilling and carrying liquefied natural gas.

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January 23, 2012 at 9:36 AM