This is a continuation from Part 1 of the proposal I sent to the national strategy commission of the government of Japan.

The Symptomatic Issues

Japan’s problems cannot be solved separately from one another. The causes and consequent problems must be approached in their entirety as closely interlinked issues that have been developing prior to 3.11.

With a fertility rate at just 1.35 per person, 40% of the population will be over 65 years old by 2060 and the total population reduced by 30% to 86.75 million people. The difficulties that stem from these demographic issues will only continue to increase for following generations under the present circumstances. As a result, Japan must devise methods that will enable its population to be more efficient with fewer resources. Japan must be willing to venture into new sectors that are knowledge based and that will build on the tools that Japan has available as a first world country. Currently, however, the burdens simply continue to grow.

While foreign investment returns have managed to offset the trade deficit and the current account still supports a surplus, the latter narrowed to a record low by 43.9% to 9.629 trillion yen in 2011. The Japanese deficit has now reached a record 958 trillion yen. This amounts to 7.6 million yen for every man, woman and child, compared to the U.S. 3.8 million yen per capita. In the U.S., this large number fuels heated debates and disruption, but in Japan the issue has barely been raised and the populace seems to be accepting it quite complacently. With projections of the deficit increasing by another 13%over the next year to 1,085 trillion yen – the equivalent to the GDP of Switzerland – the country will soon not be able to maintain the deficit at “local” rates and will have to seek foreign investors at significantly higher global rates.

The Japanese government also announced its first annual merchandise trade deficit, since 1980, of 2.49 trillion yen this year. Exports have decreased by 2.7% and imports have increased by 12%, particularly of oil and liquefied natural gas, due to the nuclear disaster and the subsequent energy shortage. While this was partially caused by the Great East Earthquake, tsunami, nuclear accident, the floods in Thailand, and Euro crisis, the long term trend has already been showing evident signs of decreasing exports due to the lack of innovation, expansion, and product development.

Nothing is being done to change this. Japan is increasingly becoming a low margin “parts” supplier in juxtaposition to China and Korea. Many also in fact prefer to discourage businesses from moving or expanding overseas in their efforts to prevent the “hollowing out” of corporate Japan. However, when both the supply and demand side of an industry is overseas, it is logical for the more mature industries to locate closer to their suppliers and customers. “Hollowing out” would also cease to be an issue if new industries were created to fill the vacuum. For this to occur, globally relevant innovation, that is not purely domestic and incremental, is paramount.

Many do recognize the importance of innovation. However, the methods to initiate it within Japan are poor. The government here always favors the distribution of subsidies, which in fact foster moral hazards and additional obstacles to the form of innovation that needs to be accomplished. Due to the presence of too many subsidies, growth beyond research is stifled and actual product development never takes place.

Furthermore, while a strong yen may have negative effects on exports, it is also a powerful opportunity that Japan fails to utilize. This is very discouraging, considering the fact that Japanese corporations ought to be utilizing the yen’s purchasing power in global markets. Instead, they continue to behave very timidly and have amassed a cash hoard of approximately 200 trillion yen. While foreign acquisitions have increased, the reality is that in 2011 only 6.3 trillion yen was spent on acquiring foreign businesses. Additionally, due to the lack of real integration, profits and dividend income from these overseas sources that are purchased are relatively low, especially compared to those of the US and UK. The profit margin for US acquisitions averaged 8.9%, 7.5% for the U.K, and a mere 4.6% in Japan.

The lack of corporate spending and integration overseas is a clear example of the Japanese aversion to risk, which is also emulated within Japanese governmental policy. For example, the majority of Japanese government deficit spending is funded by the issuance of Japanese government bonds (JGBs). This is the favored method over raising taxes, since it is generally cheaper, easier to implement, and politically safer. JGBs, in turn, are purchased by Japanese corporations who prefer risk free investments over other forms of value creation. A stable market for government debt issuance is created, and this internal rate of borrowing creates a “safe haven” compared to other currencies and continues to keep the yen artificially high.

The final part (3 of 3) is here. Your comments are always welcome.