Perspectives of Enhancing Industrial Competitiveness: Responsive and flexible strategies are the keys

Faculty Fellow, RIETI

Stuck with sluggish growth since the 1990s, the size of the Japanese economy measured in terms of nominal gross domestic product (GDP) remains the same today as it was two decades ago. The trade balance, which is an indicator of export competitiveness, suffered its worst deficit ever in 2012. Does this mean a decline in the competitiveness of the Japanese industry, which used to lead the world in automobiles and electronics until around the end of the 1980s? Or, is it just a temporary phenomenon caused by the effects of the stronger yen and the European crisis?

This article will clarify the current situation of Japan's industrial competitiveness and explore policy measures needed in order to sustain its economic vitality over the medium- to long-term.

♦  ♦  ♦

First, we take a look into the economic growth rate. Japan's real GDP growth declined from an average annual rate of 3.9% in the period 1975-1990 to 1.5% in the period 1990-2007. According to my estimates, the decline in the growth rate was caused by a decrease in production factor inputs such as capital and labor. Meanwhile, the growth of total factor productivity (TFP), a key indicator of international competitiveness, remained unchanged over the same period of time at an annual rate of approximately 0.7%. This is roughly comparable to TFP growth in the United States which has been steady at approximately 0.8% since the 1990s, according to estimates by Harvard University Professor Dale Jorgenson.

Second, the globalization of economic activities, such as the expansion of overseas production, works to reduce trade surplus. As direct investment increases, products that are manufactured domestically and exported to overseas markets will be replaced by those produced locally in the respective export markets, resulting in a decrease in exports. In the meantime, Japan's income surplus, which represents the net receipts of income earned abroad, has been consistently on the rise, exceeding the trade surplus since around 2005. Thus, the competitiveness of Japanese companies, including their overseas operations, has not diminished. Their innovation activities have not declined either as Japan maintains the top-level position in research and development (R&D) expenditure and the number of patents owned by residents.

However, with its TFP growth lower than that of China and South Korea, Japan's competitiveness has been declining in relative terms. A typical example would be the electronics industry. Semiconductors used to symbolize the strength of Japanese comprehensive manufacturers of electrical and electronics products, but most companies have been forced to consolidate or discontinue their semiconductor business. The home appliances business including television sets is also in a slump.

Another concern is that the traditional management system underpinned by stable labor-management relations and highly motivated employees, which has long been a strength of Japanese companies, is now coming to a turning point with an increase in the percentage of non-permanent employees. As the working population continues to shrink, the economic growth rate will inevitably decline further unless productivity grows faster than ever.

Harvard University Professor Michael Porter attributed Japanese companies' competitiveness before 1990 to their ability to provide products differentiated in terms of quality and function at lower prices through efficient production processes. However, the comparative advantage of their production technologies and product development capabilities, based on tacit knowledge held by individual companies, was lost in the 1990s with the advent of the information technology (IT) revolution.

For instance, production technology needed for manufacturing high quality products has now become attainable by introducing production facilities equipped with digital control technology. In addition, the advent of three-dimensional computer-aided design (3D CAD) technology has made it possible to design products by utilizing digital information. The externalization of know-how--i.e., the conversion of tacit knowledge retained within organizational boundaries into explicit knowledge accessible to outsiders--has made it easier for companies in emerging countries such as South Korea to catch up with their Japanese rivals. This tendency has been particularly conspicuous in the electronics industry, where the pace of technological advancement is fast and products are highly digitized. Japanese electronics companies have been suffering a significant decline in their competitiveness in the global market. The situation is in stark contrast, for instance, with that of the automobile industry where Japanese companies' products still maintain competitive advantage.

♦  ♦  ♦

The so-called "new technologies"--i.e., IT, biotechnology, nanotechnology, etc.--are general-purpose technologies applicable to various areas and have been flourishing since the 1990s. This gave rise to a new innovation model based on the horizontal division of labor where companies use such new technologies as a foundation to develop their products. The result is a decline in the comparative advantage of the vertically integrated innovation model where the entire process of innovation from research to development would be carried out within a company, one in which Japanese companies have their strength.

In order to conform to the new innovation model, it is important to develop and execute open and flexible technology and management strategies with a view to collaborate with other companies, rather than keeping the companies' area of specialty as closed innovation. Meanwhile, in terms of enhancing Japan's national innovation system, high-tech ventures engaging in the development of innovative fundamental technologies need to play a critical role. Japanese companies' approach to open innovation is slower, compared to their European and U.S. counterparts.

The World Competitiveness Yearbook, published by the International Institute for Management Development (IMD), shows that factors defining the competitive advantage of a nation have changed in recent years. The leading business school in Switzerland has been publishing the annual competitiveness ranking of countries based on economic data and questionnaire surveys of corporate managers.

After topping the list for the first five years of the survey, namely from 1989 through 1993, Japan slid down significantly in the late 1990s to rank 27th among 59 countries in 2012 (refer to the figure). The sharp drop is reflective of Japan's poor macroeconomic performance but also is attributable to changes in ranking criteria. Some of the ranking criteria that existed in the 1990s--"quality and reliability of products" and "robotization and automation of factories"--have been eliminated, and new criteria--"adaptability to changes" and "flexibility"--have recently been added. The focus in evaluating the international competitiveness of countries has been shifting from product quality and production efficiency to strategic flexibility and agility.

Figure. Changes in IMD RankingFigure. Changes in IMD Ranking

Japan is rated low in terms of openness to the world. Although many Japanese companies earn more than half of their sales income from overseas markets, their overseas subsidiaries are staffed mainly by Japanese employees, lagging behind their European and U.S. counterparts in localizing overseas operations. With the rise of emerging economies as a key battleground for global business competition, the localization of overseas operations is becoming all the more important.

In order to regain the competitive vigor that characterized the Japanese industry in the 1980s, Japan must accelerate its efforts to adapt to the new environments, namely, an open and globalized world. First, open innovation that conforms to the innovation model based on the horizontal division of labor should be promoted. What is important is to distinguish between the core and non-core areas of technologies based on companies' own business strategies. Japanese companies should adopt external innovations to a broad range of open non-core areas. At the same time, they pursue self-development and closed innovation in the core areas to bring out their respective competitive advantage.

Such "open and closed" strategy can also be applied to overseas operations including those in emerging countries. Japanese companies need to change their conventional policy of "doing everything in-house" under the command of the headquarters and adopt an open strategy to allow greater independence for overseas subsidiaries. At the same time, however, they must ensure that the headquarters set and take firm control of company-wide global strategies. In order to implement such open and closed strategies, it is essential to have a department that keeps track of a wide range of new technologies and market trends around the world and, where necessary, acquire external technologies and materialize them into development projects to be undertaken by relevant business departments.

A hearing survey jointly conducted by myself and the Ministry of Economy, Trade and Industry found that some Japanese companies have established such a specialized department to serve as a node linking the inside and outside of the company.

♦  ♦  ♦

Potential policies to promote open innovation include the revitalization of technology markets by means of facilitating academic-industrial collaboration and enhancing intellectual property rights protection as well as the nurturing of high-tech ventures. Clearly defining the risk allocation between the public and private sectors is the key to ensuring the efficacy of these policies. There are great risks involved when companies collaborate with external parties in R&D, global operations, or other core business activities that determine their competitiveness. This means that the government can give private-sector companies a supportive push by having relevant public sector agencies assume some of the risks.

A public fund designed to help companies translate basic research findings into practical applications and expand into overseas markets, a scheme included in the Emergency Economic Measures for the Revitalization of the Japanese Economy adopted by the Cabinet on January 11, 2013, is one way to achieve that end. However, excessive government support is prone to induce moral hazard among the companies.

While the public sector should assume risks arising from the uncertainty of basic technologies or associated with the political environment of host countries, business risks should be entirely the responsibility of individual companies. In reality, however, there are many projects where it is difficult to draw a clear dividing line between public- and private-sector responsibilities, as is the case in the construction of public service infrastructure. Therefore, in promoting open innovation projects under the public-private partnership initiative, it is critically important to build a trusting relationship between the two sides.

>> Original text in Japanese

* Translated by RIETI.

February 8, 2013 Nihon Keizai Shimbun

March 18, 2013