Obstacles in the Path to Japan's Becoming an Entrepreneurial Society

YASUDA Takehiko
Visiting Fellow, RIETI

On 26 April, Japan's SME Agency issued its White Paper on Small and Medium Enterprises in Japan 2002. Reading through this document, it becomes painfully clear that there are several obstacles in the way of Japan's transition to an "entrepreneurial society."

What is meant by "entrepreneurial society"?

Having yet to take root in Japan, "entrepreneurial society" is a term with which the Japanese are relatively unfamiliar. Overseas, it is often used to mean "a society in which entrepreneurs emerge one after another to commercialize a new idea." I use the term here in a similar vein. The question arises as to whether it is necessary to differentiate between "entrepreneurial society" and "non-entrepreneurial society."

In all societies, there are people who possess novel ideas, upon which they devise business plans. Most of these plans are, however, inept. Though, among them there exist some that are truly epochal. This said, the two cannot be differentiated until they are implemented and the market has a chance to judge. The chances of an innovative idea being accepted by the market are greatly enhanced by the ease with which it can be commercialized. This is because existing businesses are sustained by existing products and few will risk challenging a novel concept at the expense of jeopardizing existing sources of income.

Accordingly, an entrepreneurial society is one that facilitates business start-ups and, as a result, gives rise to the debut of a succession of entrepreneurs. More energetic innovation and a more vital economy are thus hallmarks that distinguish an entrepreneurial society from a non-entrepreneurial one. Such has been demonstrated by empirical analyses conducted in the US and Europe.

What the White Paper indicates it will take to restore Japan to an entrepreneurial society

According to the The European Observatory for SMEs, the start-up rate for new businesses in Japan is 4%, when calculated based on the establishment of new offices. This the report points out to be the lowest level of start-ups among the advanced industrialized nations. There have been many attempts to seek the cause for this in either Japanese ethnicity or culture. Such inquiry is, however, misdirected.

During Japan's period of high growth, the rate of new business start-ups was at a level of near 10%. Looking back over the span from the Taisho Period (starting in 1912) till very recently (excluding World War II and the turbulent period following it), there has been a constantly rising trend in the number of businesses in Japan. Underscoring this has been a greater percentage of business openings than closings. The past decade of low business start-ups has been an anomaly when viewed from the perspective of the past century.

Therefore, the relatively low entrepreneurial activity in Japan over recent years should not be viewed in culture terms; its cause lies rather in other factors. The White Paper on Small and Medium Enterprises in Japan 2002 points these out to be the transition to a lower rate of economic growth and a decline in the income ratio between entrepreneurs and salaried workers (i.e., operating income of a proprietorship versus wage income).

While the stagnating business environment has narrowed the window of opportunity for new business start-ups, this income disparity offers little incentive for a person to become an entrepreneur, instead of remaining a salaried worker. Thinking back, when I was a boy I had a fat cat image of the presidents I knew of entrepreneurships. This is no longer the case, though. To begin with, the income that an entrepreneur can expect to receive these days is not worth a risk-fraught attempt to start up a new enterprise.

Why Japan ceased to be an entrepreneurial society

The question must be asked as to why there has been a decline in the income ratio between entrepreneurs and salaried workers.

A hint to explaining this may be found in the work (1978) of Robert Lucas, a 1995 recipient of the Nobel Prize in Economic Sciences. In short, he hypothesized that to the extent it does not completely replace labor, automation increases the demand for it and raises wages. While, as a result, not elevating productivity, automation has the effect of raising the income of labor vis-a-vis that of management. This, in turn, is considered to result in a decline in both the numbers of business start-ups and of entrepreneurs. Lucas demonstrated this phenomenon by developing detailed mathematical models. However, it is difficult to use them to explain the reverse in course over the past decade of the long-term trend of an increasing number of business start-ups in Japan.

My own hypothesis takes into account the effect of an aging workforce. In Japan's seniority-based employment-cum-wage system, an aging of the workforce equates to a increase in average salary. This acts to widen the income gap between entrepreneurs, whose wages increase little with age, and salaried workers. At the same time, it gives middle and older aged workers with special occupational skills little incentive to make the transition to entrepreneurs. While creating a decline in the income ratio between entrepreneurs and salaried workers, the aging workforce under Japan's seniority-based wage system is considered to hold a possible explanation for the decline in the rate of new business start-ups.

Moreover, under the seniority-based wage system, in which the salaries of middle and older aged workers (who comprise the core of Japan's current workforce) are predicated upon the accrual of in-house training, it is difficult for such a worker who has failed in an attempt to start a business to try again, particularly given the period needed for him to regain wage parity with co-workers and to recharge his battery so to speak. Consequently, having failed once as an entrepreneur can have the effect of greatly narrow one's remaining vocational choices. Given Japan's labor system, tied together as it is by combination of factors (e.g., in-house training, special occupational skills, and seniority-based wages) amidst an aging workforce, it becomes more difficult than would normally be anticipated to create a truly entrepreneurial society--that is, one steeped in a fluidity of individual employment choices and behaviors.

Tasks at hand in moving Japan back toward an entrepreneurial society

These labor system factors create a problem, which is all the more tenacious when factoring in retirement compensation. The difference in the amount of severance pay between company-induced retirement and individually requested retirement widens dramatically with length of service, posing an additional obstacle to middle and older aged workers in large companies leaving their organizations to establish new enterprises.

From the beginning of the 20th century, Japan led the class in carrying out industrialization, having best captured the flow of the secondary industry revolution. However, the Japanese employment system developed through that process contains many elements that are not compatible to the new paradigm required in the 21st century.

The lesson learned to date by the US and Europe holds true: That there is no other model for achieving economic revitalization than one based on an entrepreneurial society. Japan, therefore, has no option but to move in that direction. The question is how much Japan's labor system can be transformed through policy instruments. Empirical research and dialogue are needed to shed light on the answer.

May 14, 2002

May 14, 2002