Why I'm Bullish on Japan

Posted March 26, 2009

The media loves to harp on Japan's "lost decade" and use the world's second-largest economy as a negative example. Yet while corporations in other countries are still gaming the government for handouts and freebees, corporate Japan has learned the hard way that government actions tend to merely delay the inevitable. This time Japan Inc. is restructuring for real and a leaner, meaner Japan is poised to rise back to the top.

As the global crisis deepens, it is back to basics. No more excuses, no more cushion from fancy financial products. The future winners will be those who focus on their core competence and redefine their competitive edge. Japan's core competence is clear: superb technology and a proven track record of applying technology to bring innovation and better products to global consumers and producers.

The facts speak for themselves: Japan's focus on investing in R&D has been relentless. Currently, almost 3.5% of GDP is invested on R&D, by far the highest in the OECD. The U.S. is about 2.6%, and China is barely 1%.

Most importantly, Japan's R&D investment has steadily increased over the past decade. Japan's competitive edge may be hidden by the current gloomy cyclical news. But structurally Japan is in pole position—whether it's in the field of energy efficiency, medical devices, construction machinery, cars or electronic components, the world cannot do without Japanese suppliers.

Global patent-applications data confirms Japan's undisputed lead in Asia. Her engineers filed 28,744 patents last year, which is about 18% of the global total, second only to the U.S. China is often touted as the next intellectual property superpower, but the facts suggest Japan has nothing to fear from the People's Republic. Last year, China filed 6,089 patents, not even one-fifth of Japan's total.

Moreover, over the past four years (2004-08), Japan added 8,480 patents to its annual total--more than twice as many as China did over the same period. Remember, Japan barely produces one-twelth of the engineers that China does, so clearly Japan's got a sizable productivity advantage.

Also, Panasonic and Toyota alone registered 3,093 patents in 2008—two companies alone doing more than half of what all of China achieved. Japan's top six companies exceed China's total. Also interesting, Huawei Technologies alone accounts for 29% of all of China's total patents. Japan's leader, Panasonic, is barely 6% of the country's total.

Sure, Japan is a developed, advanced industrial economy while China is still in the development stage. However, the diversity, depth and number of intellectual property patents produced by Japanese companies is still overwhelming. Make no mistake, the immediate future will be designed and invented in Japan, not China, nor elsewhere in Asia.

Technology is a powerful asset, but in the end the most important asset for any economy is its people. Here, it is fashionable to lament the decline of youthful vigor in Japan's younger generation, but this is more an indication of the older generation not willing to let go, rather than the lack of new, creative and forward-looking ideas from the younger generation.

In the corporate world, the current crisis is accelerating the generational change. Already, the leading car company, under new, younger leadership, is pushing through changes that the older generation would have thought impossible. For example, steel is now being sources from lower cost Korea and the entire supply chain and merchandizing chain is being radically restructured.

Rather than crying to the government, Japan's companies are making hard but forward-looking decisions to ensure future global leadership and competitiveness. The  government is seen as an obstacle, not a solution, to help corporate leaders size the opportunities created by the global crisis. This perhaps is the biggest contrast between Japan and America today: Japan is rediscovering its capitalist roots, while America is gaming the public sector for all it can get.

Japan's most powerful asset, however, is its people. Highly educated, diligent and hard working, Mr. and Mrs. Watanabe still possess a basic power and discipline that build a strong foundation for future recovery. Everywhere global consumers face harsh adjustment, with unemployment rising and debt repayments mounting. Japan is not spared the former, but has nothing to worry about from the latter.

Household balance sheets are very strong, since Japan's deleveraging already happened during the 1990s. Prudent borrowing and spend-thrift financial management is nothing new to the Japanese people, and the current crisis is not a financial and balance sheet crisis for Japan's consumers.

Indeed, if there is one household sector in the world that has the financial wherewithal to invest, it is the Japanese households with their huge liquidity base-almost two-thirds of Japanese household financial assets are in bank deposits/liquid assets. Just as in management, the generational change of these assets from old into the hands of the young, will unfreeze this capital. A young generation will take risks, in fact is eager to do so sooner rather than later.

Finally, Japanese politics is much better than its reputation. It's fair to criticize the lack of leadership in the current government. But let's not forget that Japan is a functioning democracy. The opposition Democratic Party of Japan (DPJ) has a real chance of winning control of the government, not just because the ruling Liberal Democratic Party (LDP) has made such a mess of things, but also because their ideas are actually forward looking, new and credible.

Heath-care reform, pension reform, tax reform, reform of the technocracy-all the hard-to-tackle policies at the core of Japan's problem are right at the top of the DPJ agenda. Where the old-generation LDP just waffles, the young DPJ wants to make real changes-just as the young corporate leaders are actively building a new, leaner and meaner corporate Japan.

Of course, there is much that needs to be done. Most daunting, perhaps, is the task to reform public finance.  It's well known that Japan's fiscal deficit is more than 180% of GDP. But its real problem is that the tax system is terribly  inefficient--the tax multiplier is barely 0.5, while in most OECD countries, including the U.S., it's about 1.

But every country faces harsh fiscal realities as the cost to combat the crisis mounts. In the end, public debt will have to be paid back by the people and by the returns generated on national assets. Japan's technology base and its powerful diligent workforce should bring high returns.

With the stock market,  land prices and the level of production all back to levels last seen in 1983, it's certainly been fashionable  to "short" Japan and treat it as a has-been. But Japan thrives in times of hardship and global turmoil. This time, in my view, will be no different. A new generation of Japanese leaders in business and politics is poised to emerge and, together with the strength and creativity of the Japanese people, will prove that it is by no means a  lost generation.

Jesper Koll, former chief economist for Merrill Lynch Japan, is the president of TRJ KK, a Tokyo-based investment-research firm.