Vaclav Smil discusses Japan’s economic challenges with particular reference to the rise and fall of many of its famous manufacturing companies.

Domestic debt ownership has obvious advantages. Above all it allows the country’s government finance to be isolated from the outside world and to keep bond yields very low. But there is also an obvious downside as the aging population with rising share of retired people cannot be expected to keep financing this burden for decades to come.

Japan’s average household saving rate has fallen sharply over four decades: using Cabinet Office data (expressed as shares of disposable household income), it fell from the peak of 18.6% in 1976 to less than 10% by 1994, less than 5% by 2001 and just 1.1% in 2006 (Campbell and Watanabe 2009). A different approach used by OECD (2012c) has the rate falling from nearly 15% in the early 1990s to 10% by 1999 and then to just 2.2% by 2008; before rebounding to about 6% by 2010 compared to more than 11% in Germany, nearly 11% in Sweden and more than 5% in the USA.

Clearly, Japan has lost its exceptionally high standing in this category and in the future the government will not be able to continue as it has for decades to recycle consumer savings to finance its rising deficits.

Reversing these unsustainable trends should include both considerable spending cuts and substantial tax increases, but there is no agreement about how to proceed; even within the ruling party. Indeed, a major cause of the continuing inability to strengthen the country’s finances has been its increasingly dysfunctional governance.

Prime Ministers tend to have short terms in offices. In 2005, the decades-long control exercised by the Liberal Democratic Party began to unravel and Japanese governments began to resemble those of post-World War II Italy. Apart from Junichiro Koizumi, who served from 2001 to 2005, none of the most recent Prime Ministers have remained in office for longer than fifteen months.

Reduced rates of growth, rising indebtedness, higher income inequality and increasingly dysfunctional governance are hardly limited to Japan. Their combination now amounts to a syndrome; the effects of which can be seen in virtually all other major high-income economies. National specifics differ but the US, Germany, France and the UK face very similar challenges. What makes the Japanese situation particularly worrisome is an unprecedented weakening of the country’s previously much admired manufacturing. Continuation of this trend would make it much harder to overcome those just outlined long-term negative trends.

There has been much discussion of the US’s manufacturing retreat, offshoring of factory jobs, and the loss of entire industries, but much less about the analogical shifts sapping Japan’s capacity to produce and to export. The country is facing relentless loss of market share to fiercely competitive South Korean companies and to state-subsidized Chinese manufacturers, massive offshoring of production to other parts of Asia, (most Japanese cars are already made overseas) and shortages of highly skilled labor in a country with virtually no population growth and a rising number of young “NEETs”, people not in employment, education or training (Genda 2007).

Perhaps most importantly, since 1990 Japan’s share of global value-added by manufacturing has been sliding at a faster rate than that of the US. While the US share dropped from about 23% to 19% by 2010, Japan’s share slipped from nearly 18% to just 11% (World Bank 2012).

Along the way, the former certainties of Japan’s labor market began to unravel: as Kambayashi and Kato (2011) showed, 10-year job retention rates for 1992-2002 were substantially lower for both sexes, for all ages above 19 and for educated employees and people without degrees. Moreover, many more workers had to be satisfied with part-time work without job security or benefits (Slater 2009).

Over the past few years, this weakening of Japan’s once-formidable manufacturing base has affected even some of the country’s iconic companies. First came the retreat of Sony, the company whose name was synonymous with creating the modern world of small electronic gadgets (Nathan 1999). One might say it was the original Apple – starting with its miniature transistor radio in 1955 to the planet-sweeping Walkman in 1979 and the PlayStation launched in 1994 – whose sleek designs were envied but, for a long time, rarely successfully copied or surpassed.

But in 2009 the company lost more than $2bn, in 2010 more than $3bn, and in the fiscal year ending March 31, 2012 more than $2.5bn. Sony’s TV division has been a large money-loser for eight straight years, and while gaming addicts keep the PlayStation enterprise going, cellphone addicts could not care less about Walkman, while Ginza’s Apple store is full of eager customers. After cutting its global workforce by 16,000 people in 2008, Sony announced 10,000 more layoffs in April 2012.

Panasonic, another paragon of Japan’s former electronic prowess, is in even worse shape, with a net operating loss of nearly $10bn in fiscal year 2011 and with announced layoffs of up to 40,000 workers. The latest record-beating claim for computer innovator NEC Corporation (NEC) came in October 2007 when it revealed the fastest-ever supercomputer, SX-9, the first machine capable of more than 100 Gflops (100bn floating operations per second). But in January 2012 NEC, with its market value down nearly 96% from its peak in 2000, announced that its losses for the fiscal 2011 will be well above US$1bn (Reuters 2012a). Analogical declines in market value by April 2012 are almost 92% for Sony and about 79% for Panasonic.

Besides consumer electronics, automobiles have been the most visible mainstay of Japanese exports. As quality has been their main selling feature, the 2010 public relations fiasco of mass vehicle recalls by Toyota, known as the relentless pioneer and practitioner of kaizen, constant product improvement and fierce quality control (Fujimoto 1999), has been particularly damaging.

In their obsession to surpass General Motors (GM) as the world’s largest automaker, Toyota’s top managers let the quality of new cars slip, and once the faults were revealed they failed to act resolutely to resolve the complaints and fears. After months of procrastination, the company finally began to fix its problems. However, in 2011 GM – risen from bankruptcy – was once again the world’s largest automaker.

Even Honda has admitted to losing its way. The company – much smaller than Toyota but always an aggressive competitor in foreign markets – has been praised for decades for its design, value, excellent engines and overall car durability. But in 2011 its new Civicwas called a cheapened redesign and the company’s car lost market share both in the US and Canada. InterestinglyAsahi Yoshinori, one of the company’s creative directors, recognized that ”we have a lot of designers here, and when we ask ourselves, ‘Which Honda car would we want to buy?’ sometimes some of us draw a blank” (Reuters 2012b).

Nevertheless, given the breadth of Japan’s manufacturing there are still many strengths, particularly among companies whose names are hardly known internationally but whose high-quality products and components claim large shares of their respective global markets (Schaede 2008).

These include Kyocera, primarily the maker of advanced ceramic components, but also diversified into connectors, cutting tools, computers, solar power and semiconductors (Kyocera 2012), and Fanuc, the world’s leading designer and manufacturer of industrial robots (Fanuc 2012). Unlike NEC or Sony these companies are thriving: in April 2012 Kyocera stock was only about 10% below its highs, and Fanuc stock reached a record level, nearly 85% higher than a decade ago.

Another positive factor is the increasing value of Japan’s corporate holdings abroad, from Ireland to Thailand and from Alabama to Liaoning. The critical question is whether these continuing strengths, combined with much-needed reforms, will be enough to counterbalance the negative trends and to support a new economic equilibrium.

That is why the recent news concerning the country’s trade balance has been such a cause for concern: in January 2012 Japan posted its first annual trade deficit in three decades, $32.3bn in 2011 compared to a surplus of 7.6bn in 2010 (JETRO 2012).

This, of course, is a fundamental shift as few countries in history have been such prodigious exporting machines as post-1960 Japan. In 1964, a decade after the country’s GDP matched its pre-war record, Japan began to run substantial trade surpluses whose growth was barely affected by the collapse of fixed (Bretton Woods) exchange rates in 1971 and the yen’s revaluation (from 360 yen to the USD to 308).

With Japan importing virtually all of its oil it was hardly a surprise that the Organization of the Petroleum Exporting Countries’ (OPEC) first (1973-74) round of oil price increases reversed the trend, but already in 1976 Japan’s efficient exporters had erased those losses. Coincidentally, 1976 was also the year when Honda began making the Accord: five years later Car & Drivercalled it the best vehicle in its category, and the design made history as of one of the most consistent best-sellers in North America.

OPEC’s second (1979-1980) round of oil price increases dented the trade balance again in 1980 but the surplus was back the very next year. Although Japan’s trade surplus with the US declined after the 1985 Plaza Agreement and eventually led to another large yen revaluation (from 250 to 160 to the $) and the country’s global trade surplus continued – after a short pause -to grow.

Read the last part on 11 January.

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.