Nurturing Entrepreneurship: What policymakers can do

Rethinking Japan’s large corporation-centered reform approach

The current government approach to business reform in Japan faces a fundamental limitation by primarily focusing on corporate governance reforms for large, listed corporations. Since these companies employ only approximately 10% of the labor force, this approach alone is inadequate for driving nationwide economic transformation. Additionally, successful, established companies often resist change, as seen by the Japanese automobile industry’s reluctance to embrace electric vehicle technology despite global market’s shift in that direction.

Though the government rhetoric of the Kishida administration had promoted startup support, including the ambitious targets of creating 100,000 new startups and increasing venture capital funding tenfold, concrete implementation of these goals has been limited. However, there appear to be specific measures the government could implement with minimal budgetary or political costs that remain unexplored or unutilized.

For large established corporations, market competition represents a significantly more effective catalyst for meaningful reform than corporate governance regulations alone. A more balanced approach addressing both established corporations and entrepreneurial ventures would likely produce even better economic outcomes.

The role of startups for future innovation and productivity

A significant portion of productivity growth in most economies comes from the exit of underperforming firms and entrance of new ones. Research shows this accounts for 1 percentage point of the 2.6% annual productivity growth in Europe, i.e. 40% of the total, while in Japan this mechanism contributes merely 0.2 points out of the total 1% productivity growth. It’s effectively negligible. The remaining productivity growth typically comes from existing firms becoming more efficient under competitive pressure.

Because established firms naturally become less productive and more rigid over time, economies require continuous infusion of new enterprises bringing fresh ideas. This is particularly crucial in Japan’s lifetime employment system, which inherently resists organizational change. By comparison, in the United States during the 1980s-1990s, firms less than five years old generated 60% of manufacturing sector productivity growth.

Japan’s adaptation to digital technology demonstrates this challenge. Despite significant investments, in a recent ranking by IMD, Japan ranked last among 64 countries in “digital agility” - the productivity, sales and profit benefits derived per dollar invested in digital technology. This failure to effectively implement digital transformation appears across sectors, including electronics and automotive industries.

Despite corporate governance reforms, Japan’s return on assets remains no higher than in the 1990s and below 1970s-1980s levels. This translates to a productivity decline relative to benchmark economies - after reaching 71% of U.S. productivity levels in the mid-1990s, Japan has fallen to 58%, a pattern not mirrored in European economies.

Japan consistently demonstrates the lowest entrepreneurship rate among OECD countries, with only about 2.5% of working-age men starting non-family businesses, compared to a typical 6% in other OECD countries. Moreover, new Japanese companies face significant growth barriers, particularly in accessing external finance. While initial company sizes in Japan’s service sector, for example, are comparable to international counterparts, their growth after ten years ranks lowest among developed economies.

Japan’s untapped entrepreneurial potential

The focus on Silicon Valley-style startups represents a misunderstanding of Japan’s entrepreneurial needs. While Silicon Valley has approximately 2,000 high-tech firms, the broader U.S. economy contains 50,000 high-growth SMEs, with comparable numbers in other developed economies: 20,000 in Italy, 15,000 in Korea, and around 10,000 each in the UK, Canada, and France. Japan’s count remains unknown as authorities do not measure this metric, revealing a significant policy blind spot, so measuring this high-growth SME metric is highly recommended for Japan.

Japan’s challenge is not cultural, as evidenced by its historical creativity and innovation in products like lithium-ion batteries, solar panels, and early electric vehicle technology. Rather, the issue lies in structural economic incentives: rewards for entrepreneurial success remain too low while penalties for failure are high, creating excessive risk for potential founders.

Despite apparent economic stasis at government levels, significant grassroots changes are emerging across Japan. A new generation of ambitious, self-confident young professionals is increasingly willing to pursue entrepreneurial ventures or work for them. These startup environments often provide better opportunities for women and reward innovative thinking. While perhaps 20% or so of the younger generates demonstrates willingness to switch jobs for higher wages or something more interesting, even mid-career professionals in their 40s have been leaving established companies to join startups.

Technology has altered the social balance of economic power by enabling direct customer access through e-commerce, bypassing traditional distribution systems controlled by incumbents. On Rakuten alone, nearly 60,000 SMEs have established significant customer bases. Meanwhile, established companies like Toyota increasingly depend on partnerships with independent software vendors that resist traditional keiretsu integration.

Globalization has further catalyzed entrepreneurship, with successful Japanese entrepreneurs invariably possessing some international experience through education, work, or living abroad during their childhood. While concepts from other countries are not necessarily always better than the Japanese status quo, the exposure to different ways of doing things provides greater idea fluidity and problem-solving versatility essential for competitive innovation.

Systematic hurdles faced by entrepreneurs in Japan

The innovation landscape has undergone a fundamental transformation from the analog era dominated by large, capital-rich, vertically integrated companies to today’s digital environment where smaller, more agile firms with fewer than 1,000 employees increasingly drive innovation through open collaboration and partnership networks. This shift is evident across multiple sectors, such as pharmaceuticals, household goods, electronics, and automotive industries. A striking example is the development of the Pfizer COVID-19 vaccine, which was actually created by a German startup founded by Turkish immigrants rather than by Pfizer itself. Despite this clear global pattern, approximately 90% of government R&D subsidies in Japan continue to flow to cash-rich large corporations that already maintain substantial reserves, rather than to innovative startups that genuinely need financial support for development and growth.

Access to capital undoubtedly represents the most significant and persistent barrier for Japanese entrepreneurs attempting to establish and grow businesses. The data clearly demonstrates that companies starting too small without adequate capitalization are substantially more likely to fail or experience stunted growth trajectories. Without reliable access to external funding, entrepreneurship becomes restricted to those with personal or family wealth. This creates a fundamentally inequitable system where potentially brilliant entrepreneurs who lack financial resources cannot participate in the innovation economy. The venture capital network in Japan remains significantly underdeveloped compared to other advanced economies, and business angel investment is minimal in both scope and scale.

Furthermore, the Kishida administration’s Angel Tax Credit program will be ineffective as it ignores the main drivers of innovation. Successful models implemented in France, the United Kingdom, and various U.S. states are all effective. These international models enable investment in certified angel funds rather than requiring direct investment in individual startups, recognizing that most individual startups fail while portfolio returns from the successful minority can generate substantial overall returns. The French implementation of this approach has been particularly remarkable, transforming a country once considered non-entrepreneurial into one with approximately 40,000 new companies valued at over $300 billion collectively, including several dozen unicorns and about 3,500 deep tech startups.

The banking sector presents additional substantial obstacles, as Japanese banks consistently favor established companies with mediocre credit ratings over promising younger firms with potentially stronger business models and growth trajectories. Furthermore, financial institutions still focus excessively on traditional collateral and personal guarantees rather than evaluating cash flow potential and business fundamentals. This creates a significant financing gap for knowledge-based businesses whose primary assets are intellectual property and human capital rather than physical collateral. The interest rate differentials between established and new companies further exacerbate this disadvantage, with older firms receiving substantially more favorable lending terms.

This financing landscape creates a vicious cycle throughout the economy: with approximately 12% of Japanese GDP allocated to government loans or credit guarantees for existing businesses, fewer inferior firms exit the market, leaving fewer resources available for new entrants to access capital, talent, and physical space. The result is a stagnant business ecosystem that struggles to renew itself through creative destruction.

Government procurement could serve as a powerful catalyst for startup growth, but implementation has been lacking. Despite establishing a modest 1% procurement set-aside for innovative companies that are less than ten years old in 2015, the government consistently failed to meet even this minimal target for many years. The government raised the goal to 3% recently in order to spur action, but the new goal only allowed the new companies to achieve 1.1% procurement, significantly short of the revised 3% goal. Effective procurement policies would not only provide direct revenue to innovative startups but would also enhance their credibility with banks and other financial institutions through the improved cash flow and implicit government endorsement. To encourage private investment, governments in the US and France monitor and certify Angel investor funds, which provides confidence to investors. Despite most startups sponsored by the fund failing, the success of a small percentage has allowed the investors to profit handsomely.

The tax system similarly disadvantages startups through several mechanisms. R&D tax credits primarily benefit established profitable companies, leaving startups without support during their critical pre-profit years when investment needs are highest. Unlike all other developed economies that allow “tax loss carry-forward” provisions ranging from 20 years (United States) to unlimited periods (United Kingdom), Japan allowed only one year for a provision that would have allowed startups to utilize accumulated R&D investment losses as tax credits once they become profitable, and then eliminated even that duing the Abe administration.

Digital transformation presents another challenge where support is insufficient. Many small businesses lack understanding of how digital technologies could benefit their operations, yet only limited consulting programs are offered compared to the comprehensive support available in European countries. This digital capability gap further disadvantages smaller enterprises in an increasingly technology-driven global economy.

The limited liability corporation framework which is meant to alleviate small firms from double taxation suffers from problematic implementation due to Ministry of Finance tax policies. Despite legal reforms intended to create business entities with corporate liability protection but single taxation (avoiding the double taxation of corporate profits and then dividends), the Tax Bureau maintained double taxation requirements, undermining the intended benefits of this business structure for entrepreneurial ventures.

Banking practices regarding personal guarantees continue to create excessive risk for entrepreneurs despite some progress. While the percentage of new loans requiring personal guarantees has decreased from 85% to approximately 50% following joint initiatives of METI and the FSA, this statistic lacks details. The FSA does not specifically track data on personal guarantee requirements for loans to newer companies versus loan renewals or extensions to established clients, making it impossible to determine whether meaningful progress has occurred in terms of benefiting actual startups.

More politically challenging but potentially transformative reforms would include actual enforcement of equal pay laws between regular and non-regular workers (which are established in Japan, but not enforced), which would significantly reduce the career risk of leaving established companies for startups. Currently, individuals who leave secure employment for entrepreneurial ventures face severe economic penalties if they need to return to traditional employment as non-regular workers following an unsuccessful startup attempt. Enforcing existing equal pay legislation, as is done in France with similar legal frameworks, would create a more flexible labor market conducive to entrepreneurial risk-taking.

Finally, rolling back corporate tax cuts that have demonstrably failed to deliver on promised investment increases and wage growth would provide resources for more effective entrepreneurial support programs. Despite corporate commitments that tax reductions would generate increased domestic investment, employment, and compensation, these outcomes have not materialized, while corporate cash reserves continue to accumulate. A more balanced tax policy could generate resources for targeted entrepreneurial support while encouraging more productive use of corporate capital.

From stasis to momentum: Practical policy recommendations

Overall, policy in Japan is characterized by a persistent bias toward large corporations at the expense of startup development. When faced with competing priorities during the Kishida administration’s fiscal planning which included potential corporate tax increases to fund defense spending, preventing corporate tax hikes was prioritized over developing tax advantages for SMEs and startups. However, this policy orientation has failed to deliver both the promised economic benefits and the action demanded of large corporations.

The current environment presents unprecedented opportunities for startup growth that did not exist even five years ago. Societal shifts have created favorable conditions for entrepreneurial development, but these positive trends require government amplification to achieve sufficient scale for meaningful economic impact. Without targeted policy support, these emerging trends will remain insufficient to transform Japan’s broader economic landscape.

Specific policy recommendations, starting with those less politically challenging and financially costly to implement, could begin catalyzing change in Japan’s entrepreneurial ecosystem. A strategic, incremental approach, starting with achievable policy adjustments, could gradually build momentum toward more comprehensive entrepreneurial support systems, including better pathways for both intrapreneurship within existing companies and external entrepreneurship with appropriate support mechanisms. That would give new companies greater weight in the economy and improve their lobbying leverage.

Comment

Tatsuya TERAZAWA:
Several important aspects of Japanese entrepreneurship deserve further consideration. The Japanese government has implemented numerous policy reforms over the past 25–30 years to promote entrepreneurship: stock options were enabled in 1995, Angel Tax Credits were introduced in 1997 (with subsequent improvements including eligibility for fund investments), the Tokyo Stock Exchange Mothers Market was established in 1999, Limited Liability Partnership (LLP) structures were created in 2005, and personal guarantee requirements for SME owners were simplified around 2005. Though some gaps remain, such as those involving LLC structures, many items have been addressed through policies.

Just focusing on the missing elements in government policies may be missing the core impediments for entrepreneurship in Japan. Looking beyond government policies may provide deeper insights into persistent entrepreneurship challenges that Japan seems to face. According to experienced venture capitalists, the lack of acceptance of failure represents a significant cultural impediment that transcends policy frameworks. Even with a fully implemented policy wish list, fundamental attitudes toward entrepreneurial risk may continue to limit progress in this area.

Despite pessimistic stereotypes about Japanese entrepreneurship, notable positive changes are occurring. Events like the G1 Global conference showcase promising Japanese entrepreneurs with global mindsets alongside non-Japanese entrepreneurs establishing businesses in Japan. Changing career patterns among younger generations indicate shifting attitudes, with top university graduates increasingly choosing startups over traditional employers or “stable” government posts. The pace of job changes among younger workers suggests lifetime employment norms are fading faster than older generations might recognize.

Additionally, one aspect that is often overlooked is the role of existing companies in fostering entrepreneurship. Historically, major Japanese firms have spawned successful spinoffs. There are many resources within existing companies which can be unleashed to create startups from within the existing companies. Furthermore, established companies are increasingly supporting the startup ecosystem through corporate venture capital, suggesting potential complementarity rather than opposition between established firms and entrepreneurial ventures.

Regarding entrepreneurial outcomes, Japan performs reasonably well in absolute number of IPOs but faces three significant challenges compared to the United States: Japanese startups have substantially smaller market capitalizations, demonstrate limited growth after IPOs, and remain predominantly domestic rather than accomplishing some form of global expansion. Addressing these scale, growth, and globalization limitations represents a critical next step for strengthening Japan’s entrepreneurial ecosystem.

Richard KATZ:
While numerous policy measures have indeed been implemented by the Japanese government, their effectiveness should be the primary concern. So, if all of these measures have not changed the big picture, the actions taken to this point should be highly reexamined to determine why they failed. For example, despite regulatory changes regarding personal guarantees in 2005, practical obstacles persist, as demonstrated by cases where managers still face untenable risk levels when taking over companies. Especially regarding the handover of businesses to a successor, there are cases where business owners are unable to transfer leadership due to personal guarantee requirements from banks. Some measures, though well-intentioned, remain inadequately designed or implemented.

Regarding emerging entrepreneurial activity among younger generations, these developments were indeed addressed in recent research. However, while graduates from elite Japanese universities are increasingly founding companies, the critical limiting factor remains access to external capital for growth. Policy measures should focus on improving capital access conditions, with careful evaluation of whether personal guarantee reductions extend to new firms or primarily benefit established businesses.

Corporate venture capital in Japan has largely functioned as a technology monitoring and attainment system rather than a startup development mechanism. Japanese corporate venture capital is typically invested to identify emerging technologies for parent company implementation without providing viable exit strategies for the new firms and does not lead to the development of new, viable companies. This approach fundamentally differs from effective venture capitalism because corporate venture capital teams in Japan generally consist of career employees with traditional corporate or banking mindsets, rather than professional venture capitalists with entrepreneurial instincts developed through experience. Meanwhile, the Tokyo Stock Exchange Mothers Market, despite initial expectations as “Japan’s NASDAQ,” has produced remarkably few companies with large-scale success, with fewer than a handful achieving billion-dollar revenues.

Additionally, regarding corporate spinoffs, important distinctions exist between genuine and nominal separations. True spinoffs occur when business units establish complete independence from parent companies. Intrapreneurship, where employees take a significant percentage of their time to work on independent ideas with the goal of creating other businesses and even other companies, is potentially one promising strategy which could be fostered to a greater extent, as Japan still has a very low percentage of intrapreneurs.

As for the fear factor, perhaps the problem is not that Japanese are too fearful, but there is too much to fear. The consequences of failure are too harsh, e.g., forced to take a non-regular job a low wages.

Q&A

Q:
Japan is changing its startup policy and placing more emphasis on entrepreneur education. These days, new technology such as AI solutions is changing startups’ business styles. How can this drastic change be addressed?

Richard KATZ:
Some people view AI as a magic tool, like superconductivity in the past. The example of quantum computing is similar to the situation surrounding AI to a certain extent. Japan’s physicists are among the top pioneers in quantum computing, but they do not create economic value. They create scientific ideas, and companies are the ones who must convert those ideas into economic value. However, Japanese companies do not hire PhDs. They hire employees as “blank slates” and. as a result, the technologists at these firms do not understand the science well enough to know how to generate economic value from it. Therefore, the overarching problem is companies’ ability to absorb new knowledge. It is a human capital issue, and also a management issue, because the companies need to hire more qualified people.

Q:
What about foreign companies interested in investing in Japan? Is Japanese policy attractive for them?

Richard KATZ:
Foreign companies would love to invest in Japan. Japan is a very attractive, large market, often described as a desirable destination in surveys and offering great potential. However, robust companies that are part of vertical keiretsu structures are not for sale. Regarding the issue of the succession crisis and possible solutions, there was a report discussing the roles of the government and JETRO. One short passage suggested that JETRO could recruit foreign firms to conduct M&A with healthy companies facing failure solely due to the lack of a successor. While this was a great idea, it was removed from the final report because the prospect of foreign companies entering the market was perceived as more threatening than allowing these firms to fail. This is old-style thinking, and it is time to move beyond it—especially considering the constant changes in Japan and pressing issues such as demographic decline and an aging society.

Q:
What are some suggestions for innovating the triangle of government, academia, and industry in Japan?

Richard KATZ:
Often, newer and smaller companies are not included in large consortia, which results in a lack of fresh ideas. Even though many universities nowadays have so-called entrepreneurship courses, it turns out that they do not monitor the career paths of participants who took those courses to determine if they actually provide value. For example, do participants create their own firms or join larger companies and introduce a more entrepreneurial way of thinking? Measurement would be one way to assess the effectiveness and future potential of existing programs. Stanford and MIT are examples showing that collaboration between top universities and potential startups can create significant impact. If all the companies created by MIT students were a country, its GDP would be the 10th largest in the world. Since Japan has often taken the successful approach of learning from what other countries have implemented, adapting it to Japanese conditions, and developing businesses based on that, collaboration between Japanese universities and successful institutions overseas has the potential to be very helpful in this regard.