One reason why the effects of quantitative and qualitative monetary easing under Abenomics, the economic policy package of the government of Prime Minister Shinzo Abe, have been unable to reach the real economy is a lack of robust response from exports despite a significant depreciation of the yen.
Initially, it was thought that Japan's export volume failed to increase because of the J-curve effect, i.e., an inevitable time lag between currency devaluation and the substantiation of its effects on exports resulting from the time required for repricing products in response to large and rapid exchange rate changes. As it turned out, however, no significant ripple effects were observed on exports even after a due course of time. Furthermore, this year has seen a reversal in the trend of the yen from depreciation to appreciation. Against this backdrop, many people are now focusing on structural problems as background factors for what they see as a decline in the international competitiveness of Japanese companies.
However, changes in Japanese companies' export behavior did not start with the launch of Abenomics. Indeed, signs of the changes were emerging as early as the turn of the century.
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How to cope with fluctuations in the yen has always been a headache for Japanese companies ever since Japan shifted to a floating exchange rate regime. Many companies had prioritized domestic production volume over profits, whereby they avoided raising export prices to maintain the volume of exports even when the yen appreciated. However, as Japan's financial crisis began to unfold in 1997, they were no longer able to count on support from their banks, and it was becoming increasingly difficult to respond to the yen's rise in the same manner. A new model of corporate strategies that emerged in response to those changes in the business environment is "choose and focus."
The term contains many interpretations. One of them is to focus resources on producing high value added or highly productive products and thereby build a solid revenue base that can remain unaffected by fluctuations in product prices and foreign exchange rates.
The effects of a shift to such strategies, which was not obvious during the early to mid-2000s when the yen was relatively weak, became pronounced with the strengthening of the yen following the global financial crisis in 2008. Furthermore, it became a standard practice for Japanese companies to fulfill the demand from overseas by producing locally. The prevalence of such strategies among Japanese companies is believed to be the reason behind the lack of a robust increase in the volume of Japanese exports despite the yen's depreciation following the launch of Abenomics. Indeed, Japan's real exports, which represent the "quantity" of exports calculated by dividing the nominal value of exports by the corresponding price index value, have remained relatively stable despite the yen's substantial appreciation since the beginning of 2016 (see Figure).
After Harvard University Professor Marc Melitz published a paper showing that highly competitive (productive) firms and products are less sensitive to foreign exchange rate fluctuations, a number of empirical studies have been conducted using data from various countries. In a joint paper with Princeton University Professor Nobuhiro Kiyotaki, University of Southern California Professor Robert Dekle, and Teikyo University Associate Professor Atsushi Kawakami, we confirmed his hypothesis in our empirical findings using Japanese firm level data.
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This approach requires companies to focus on highly productive products, abandoning the traditional approach of seeking to maintain the international competitiveness of domestic production capabilities in their entirety. In order to avoid falling into a downward spiral of dwindling demand and falling production, major players need to employ two strategies, under which the utilization of intangible assets—accumulated knowledge and technology within respective organizations, human capital, etc.—hold the key to success.
One strategy is to make foreign direct investment (FDI), a practice pursued since the 1980s. Having gone through multiple episodes of sustained yen appreciation, Japanese companies have established a system for meeting local demand with local production. As University of Tokyo Professor Emeritus Ryutaro Komiya points out, FDI can be defined as a transfer of an intangible asset called production know-hows, not just as a physical transfer of production bases.
The other is to develop new products by partnering with foreign companies through equity participation, mergers and acquisitions (M&As), and so forth. Such equity participation and M&As can be defined as an attempt to maintain competitiveness by utilizing a broad range of intangible assets accumulated over time, not by utilizing the existing domestic facilities and human resources.
One classic example of intangible assets is brands such as Walt Disney characters in the United States and the Beatles and Harry Potter in the United Kingdom.
The popular smartphone game Pokémon Go is a product that combined Pokémon, a Japanese video game character developed in the 1990s, and the latest technology developed by a U.S.-based company. The joint development of new drugs by a Japanese pharmaceutical company and a foreign research laboratory, with the former providing human and other necessary resources, is considered a similar pattern.
In particular, cross-border M&As by Japanese companies have been on the rise in recent years, as they are under pressure from their shareholders to deliver a return on equity comparable to those of their overseas counterparts over a short-term horizon. According to RECOF, an M&A consultation services provider, overseas M&As by Japanese companies topped 10 trillion yen in 2015, more than doubling the amount for the preceding year.
Meanwhile, the Ministry of Finance's Financial Statements Statistics of Corporations by Industry show that an increase in retained earnings has led to an increase in cash and deposits on a short-term basis. However, a closer look at historical data over the period from the 2000s onward reveals that the amount of securities for long-term investment, which reflects purchases of stocks in other companies and M&As, has increased almost in tandem with that of retained earnings.
Such behavior of Japanese companies is quite rational, given the changes in the business environment over the years. However, even if they manage to attain international competitiveness by making full use of their intangible assets, will it be sustainable long into the future?
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It is known that, with just a handful of exceptions, intangible assets such as knowledge and brands are quicker to decrease in value than tangible assets. In making or expanding FDI, global players need to establish a new, integrated production system that employs leading-edge information technologies and covers both domestic and overseas operations.
According to the Japan Bank for International Cooperation (JBIC)'s survey of Japanese manufacturers' overseas business operations, Japanese companies operating in overseas markets lag behind their foreign counterparts in taking advantage of information technologies. Thus, their responses to the changing business environment, which are considered rational at the moment, do not necessarily guarantee their long-term success.
It is no longer practical for Japanese companies to domestically produce all sorts of products that are internationally competitive in their respective fields. However, in order to improve productivity and sustain international competitiveness over a long period of time, they need to maintain organizational capacity for developing new products and services by continuing to accumulate both tangible and intangible assets.
One big concern in this regard is a lack of human resources, which has been pointed out in various fields. Our research project team at RIETI, which is working on the measurement of intangible assets, is particularly concerned about the fact that firm-level investment in human resources has decreased significantly following the collapse of the bubble economy.
In the past, when lifetime employment was the norm, Japanese companies could reasonably expect that investment in the human resource development of their employees would contribute to an increase in corporate earnings. When labor mobility is high, companies have little incentive to invest in the internal education and training of employees.
At the same time, however, there have been cases in which skilled talent—those who received in-house education and training as company employees—give back to society by starting up their own businesses and creating jobs. In other words, there emerged a typical divergence between private returns and public returns on the development of human resources. It remains a challenge for the government to develop policy responses to this new reality.
Some people are pessimistic about the development of skilled human resources because of a decreasing youth population in Japan. However, the fact that Japanese athletes won a record number of medals at the just concluded Summer Olympics in Rio de Janeiro stands as evidence to the contrary. Many of the Olympic athletes are in their 20s and the population of this age group has been continuing to decline in Japan. According to calculations, the number of medals won by Japanese athletes was supposed to have decreased and continue to do so each time.
Innovative training methods, effective ways of finding promising athletes, improved trainer training, and appropriate government support are considered to be factors behind the remarkable accomplishment of Japanese young athletes despite a decrease in their number. The world of business differs from that of athletes in many aspects. However, when it comes to the development of human resources for the purpose of improving international competitiveness, we should be fully aware of the fact that there exists a specific case example that precludes putting any blame on a dwindling population.
* Translated by RIETI.
September 21, 2016 Nihon Keizai Shimbun
