Looking Beyond Protectionism

The free fall of the Japanese economy has continued into a second quarter. Gross domestic product, after contracting at an annualized rate of 13.5% in October–December 2008, fell by an annualized 14.2% in January–March this year, the steepest quarter-to-quarter decline on record since the end of World War II. The consecutive contractions caused growth for all of fiscal 2008, which ended in March 2009, to come in at minus 3.3%. Fiscal 2009 is expected to be another year of a shrinking economy, with negative growth of about 4% projected. By comparison, the economic contraction in the United States, where the financial crisis started, was limited to a 6.3% decrease in the fourth quarter of 2008 and another 5.7% decline in the first quarter of 2009, measured from quarter to quarter at annualized rates.

WHY JAPAN TOOK A HEAVY HIT Why is the shrinkage of the Japanese economy on a larger scale than that of the US economy? The financial losses caused by the crash are thought to have been on the order of ¥150 trillion in both the United States and Europe, but the damage to Japan’s financial institutions is estimated at only ¥5 trillion–¥10 trillion. One of the factors that caused Japan to take a harder hit is the heavier weight of its manufacturing sector. While the share of manufacturing in GDP is about 12% in the United States, it was 21.6% in Japan as of 2007. The Japanese economic expansion that began in 2002 was helped along by overblown consumption in the United States, and when American consumers suddenly stopped spending, the upturn came to a halt. Japanese exports went into a steep decline, pushing manufacturing firms to cut back their capital investment. The sharp downturn in this investment in the first quarter of 2009 was a component of slumping domestic demand, but its cause should be seen as the sudden loss of export momentum. In March this year Japan’s exports were 46% below their level a year earlier measured in yen. Exports to the American market plunged by as much as 51%, while those to the Chinese market dropped 32%.

Germany is another country whose manufacturing sector figures prominently in its economy, but the blow it felt was less than Japan’s, causing declines of only about 20% in exports and production. What this tells us is that the free fall in Japan was caused not so much by heavy dependence on exports as by a global division of labor in which Japan serves the world as a high-tech supply base. Japanese firms have energetically deployed global operations in which they move labor- intensive assembly processes overseas and focus on research, development, and the manufacture of products embodying advanced technology at home. The specialization in Japan is moving forward in technologically sophisticated capital goods (production equipment) as well as high-tech materials, such as the HeatTech garments sold by the retail chain Uniqlo Co., which both insulate against the cold and convert moisture into heat. Under this division of labor, a demand downturn in the developed world translates into a drop in Japanese production larger than the decline in demand for end products.

Another factor is the weakness of Japanese consumer spending, which never gained much vigor during the 2002–7 expansion. Statistics on real GDP over this period reveal that there was only 5.8% growth in private consumption, compared with 12.7% growth for GDP overall. Exports performed far better, registering 58.5% growth.

The faster drop in production than in demand is a sign that inventory adjustment was proceeding apace. As a result, most forecasts take January–March 2009 as the bottom of the trough. The chances are good that both production and GDP will return to positive quarterly growth in April–June. The monthly production forecast survey of the Ministry of Economy, Trade, and Industry reveals that manufacturers planned to increase production by 4.3% in April and 6.1% in May. The power of the recovery is weak, however. We need to appreciate that the world’s structures of production and demand are in the midst of major changes. The traditional cyclical pattern of a rebound in production once inventories have been trimmed cannot be counted upon at present.

Observers have pointed out two reasons for fearing a renewed downturn. First, financial institutions have not made much progress in writing off bad debts. In particular, American and British banks are short of capital and are liable to go slow on lending, which could invite a decline in asset prices. Japan’s experience in the 1990s teaches us that when banks postpone moves to clean up their balance sheets, they open the door to further erosion of asset values, which prolongs the process of getting the books back in order. If similar problems are encountered on the other side of the Pacific, the American economy’s recovery may bog down. Second, a slide into deflation in Japan would put pressure on corporate profits and darken the employment picture. It is now predicted that Japanese unemployment will climb to the 6%–7% range, becoming the highest on record. This could cause capital investment to weaken further and consumption to taper off.

PROTECTIONISM TAKES ROOT We should expect the world to look quite different after it pulls out of the recession. The decline in status of the United States and the dramatic increase of Asia’s weight in the world cannot be turned back. In this section’s dialogue between Iwai Katsuhito and Itoh Motoshige, Iwai makes a number of comments reflecting his long-held view that corporate managers play a valuable role not so much by increasing the value of the company’s shares as by effectively employing the corporate resources put in their care by shareholders. Because of the crisis, he points out, people have ceased to believe the assertion by neoclassical economists that the stock market efficiently assigns prices to companies, and the notion of shareholder primacy can be expected to fall out of favor. Iwai describes the company as a two-tiered structure that is an object owned by shareholders on the top tier and a "person" possessing assets and human resources on the bottom. While both tiers need to work smoothly together, it must not be forgotten that the core activity on the bottom tier is manufacturing. Iwai also emphasizes that the key to corporate success lies in the differences that distinguish firms and their products.

As Hama Noriko remarks in another of this section’s articles, the global financial crisis is popularizing a new term: deglobalization. Major countries are moving in the protectionist direction, reminding people of the dark years of the 1930s. Today’s protectionism is by no means limited to the sphere of trade. Moves by governments to prop up key companies, especially financial institutions, through infusions of public funds also have protectionist implications. And there have even been popular protests seeking to shut out foreign labor.

In April the Group of Twenty agreed on a fiscal expansion with a value of some $5 trillion. Critics have pointed out, however, that a response centered on stimulating domestic demand has both limits and unreasonable aspects. Moreover, moves to expand domestic demand may become linked to protectionist policies. As Kashiwagi Shigeo discusses in his article below, the international community needs to rebuild the Bretton Woods system, originally established in 1944, in order to prevent globalization from going into reverse. With the leadership strength of the United States in decline, the time has come for Japan to step forward. Developing cooperative relations with other Asian countries and working hand in hand with Washington, Tokyo should take a positive approach to economic diplomacy.

A TWENTY-FIRST-CENTURY INDUSTRIAL REVOLUTION Batteries will be one of the fronts of the industrial revolution of the twenty-first century. Among carmakers, the race is on to produce electric vehicles powered by lithium-ion batteries. In another dialogue below, President Masuko Osamu of Mitsubishi Motors discusses the prospects for the "i-MiEV," an all-electric car with a large-capacity lithium-ion battery. To be launched in July, it represents the next step beyond hybrids, which are partly powered by gasoline. Mitsubishi plans to roll out about 2,000 i-MiEVs in fiscal 2009 and hopes to reach annual production exceeding 15,000 vehicles within three years. Elsewhere in the industry, Fuji Heavy Industries and Nissan Motor have also decided to market all-electric vehicles. Hybrids, meanwhile, are enjoying strong growth. New car sales of Toyota’s Prius reached 10,915 vehicles in May, 2.1 times the level a year earlier, while sales of Honda’s Insight reached 8,183 vehicles.

Eco cars are now benefiting from a strong tailwind, and demand for electric vehicles can be expected to grow. There are, however, some tall hurdles still to be cleared. One is developing and manufacturing lithium-ion batteries. Here constraints on the supply of lithium, which needs to be procured from the salt lakes in China and other countries, will have to be dealt with. Another is that Japan’s automakers may find it hard to maintain a technological edge in production. They excel at the production of engines for gasoline- powered vehicles partly because these are highly complex devices. Building gasoline cars requires the smooth meshing of from 30,000 to 50,000 parts. By comparison, electric cars have only several thousand parts, and their production might become a mere assembly industry.

Solar power will be another front of this century’s industrial revolution, but currently Japan’s firms have lost their place among the world’s leaders in the field. Germany’s firms are now running out in front, and the reason for that turns out to be simple. The installation of solar panels in Germany got a major boost when the government sharply hiked the price at which the country’s utilities buy electricity from solar power producers. For new industries to prosper and grow, careful attention must also be given to the policies and institutions supporting them. (Nariai Osamu, Professor, Reitaku University)

© 2009 Japan Echo Inc.