THE ORIENTAL ECONOMIST HE RIENTAL CONOMIST

R E P O R T
VOLUME 79, NO.8 PUBLISHED BY JAPAN WATCHERS LLC AUGUST 2011

Hollowing out fears return

Fear of Fleeing

he deathly hollows is what one of our readers called it: the fear that many of Japans leading firms will flee, leaving Japan with a hollowed out manufacturing sector and bankrupt small and medium suppliers. Virtually every day, some firm announces that it will shift more of its production facilities overseas. Among manufacturers with at least some overseas production, the ratio of overseas production to domestic production increased from 18% in 1990 to 31% by 1997. Since then, it has plateaued at around 30-33%. Now, it looks like the ratio will take another ratchet upwards (see top figure on pg. 2). Over the past two decades, overseas investment by manufacturing multinationals has risen from a level equal to 15% of domestic investment to nearly 60%. Over the next few years, this figure is also likely to ratchet upwards quite a bit. Among 660 listed companies surveyed by Nikkei, 245 firms booked overseas operating profits or losses in 2009 larger than their domestic levels. Thats three times as many as five years earlier. A recent survey of 140 firms by Nikkei reported that, 40% of the country's major corporations believe they will be forced to shift some operations overseas within three years if the current situation does not improve. Toyota, for example, sells 80% of its vehicles overseas through both exports and overseas transplants. Now, President Akio Toyoda says that the yen, is at a level where it no longer makes sense to keep producing in Japan. He said that Toyota would try to keep producing at least 3 million vehicles in Japan, down from 4 million in 2008. In the coming years, more and more of the overseas market will be met via overseas production rather than exports (see bottom figure on pg. 2). Nissan meanwhile announced that it will double its output in China to 2 million vehicles by 2015. That compares to only 1 million in Japan itself. China became Nissans biggest market in 2010 with sales of more than 1 million units. Hollowing versus globalization In Japan, an increase in outward Foreign Direct Investment (FDI) is often equated with hollowing out. But it need not be the case. It could instead mean a globalization with positive synergy between a firms growth overseas and its growth at home. In the US, in fact, there is some evidence (admittedly controversial) that FDI has had a positive impact on domestic investment, R&D and jobs. Thats because FDI allowed firmsand their suppliersgreater global sales than would have been the case without

FDI; it also lowered costs and therefore the firms competitive power. A 2005 study published by the National Bureau of Economic Research reported that, among hundreds of US manufacturing firms over the 1980s-90s: 10% greater foreign capital investment is associated with 2.2% greater domestic investment, and that 10% greater foreign employee compensation is associated with 4.0% greater domestic employee compensation. the evidence also indicates that greater foreign investment is associated with additional domestic exports and R&D spending. So, even as US outward FDI soared, Americas price-adjusted share of the global exports among all high-income OECD countries rose from 17% in 1970 to 20% in 2009. So far, that has not been the case in Japan. The reason is that, so far, manufacturing FDI has been very narrowly focused either on Japans top exporters in just a few industries, like autos, machinery and electronics, or sunset industries like textiles and apparel. According to calculations by HSBC, as of 2009, Japans cumulative outward FDI was equivalent to 15% of Japans nominal GDP. This is far lower than the ratios for the US, the UK, and Germany, which were 29%, 78%, and 40%, respectively. So, in Japans case, FDI replaced exports rather than reinforcing them. Japans share of rich countries price-adjusted exports peaked at 11% and has since fallen to 6.8%. The good news is that there are some trends that suggest this round of increased FDI could involve more than simple hollowing out. We discuss two of them below. Reducing insularity Traditionally, when Japanese firms went overseas, they often took some of their prime suppliers with them. That is changing. TV producers are outsourcing much of their production to unaffiliated Electronic Manufacturing Service (EMS) companies. These are independent firmsmany headquartered in the US, Korea or Taiwanthat produce for others in plants throughout the world. Sony, which already does 70% of its production overseas, says it will raise its reliance on EMS firms to 40% of its global production in 2010 to about 50% in fiscal 2011. Panasonic wants to hire EMS firms in Asia to make TVs with screens that are 20 inches or smaller for sale in overseas markets. This will give firms greater flexibility while cutting costs. It will also put greater competitive pressure on Japanese suppliers to become more efficient. Meanwhile, in order to cut costs, some leading exporters are increasing their imports of parts into Japan from non-Japanese firms.

2
Up until now, a very high share of Japans manufactured imports from Asia was from Japans own affiliates located there. That insulated the parents from global competition in their home market. Nissan, for example, intends to spin off its plant in Fukuoka Prefecture, and turn it into a production base capable of competing with firms from emerging countries by increasing parts procurement from South Korea and China. Domestic firms join the trend The FDI trend is now affecting even firms that have long relied primarily on the domestic market. Shiseidos overseas sales zoomed from 10% a decade ago to 40% today and the firm has a target of 50% by 2013. To realize this target, it has bought an important cosmetics firm in the US (Bare Escentuals) and built a research center in China, where it relies heavily on Chinese personnel. It has introduced a non-Japanese person onto its Board of Directors and three women (out of a total of 13 members). An international presence provides not just sales, but ideas. Procter & Gamble reports that more than 50% of its innovations involve collaboration with outsiders. Shiseido is just one of many traditionally domestic firms being compelled to internationalize (see figure on pg. 7). Facing low growth at home Perhaps the biggest reason for hollowing out is Japans anemic growth. The Japan Center of Economic Research (JCER) expects Japan to achieve an average of only 0.8% growth in private domestic demand during 2011-2020. In the past, many Japanese firms responded to low growth in Japan via exports. But now executives say that there are several reasons why FDI is becoming more advantageous than exports. The rebounding yen Many firms feel that the yen is far too high for them to use Japan as an export base. This is particularly true vis--vis new competitors like Korea in industries ranging from autos to electronics. As business pressed Tokyo to stop the yens risewhich it tried with a currency intervention on August 4executives raised the spectre of hollowing out. We should note however, that Korea has been increasing its global market share not just in times when the won has been weak, but also when it has been strong. Just in Case Following the March 11 disaster, many customers reliant on Japanese firms asked that they diversify geographically to reduce risk. In the business world, people these days are talking, not about just in time, but just in case. In METIs latest annual White Paper, 69% of 216 firms said that transferring part or all of their supply chain operations was a possibility. Consider Mitsui Mining & Smelting Co., which controls about 90 percent of the global market for ultra-thin copper foils used in smart phones. It decided to open a new production plant in Malaysia after its main plant in Saitama Prefecture was closed for a month due to rolling electricity blackouts. (Please turn to page 7)

Overseas production set for another ratchet upward

36% 33% 30% 27% 24% 21% 18% 15% 12% 9% 6% 3% 0% 1990
Source: METI

Overseas sales ratio

THE ORIENTAL ECONOMIST

R E P O R T
Editor Chief Correspondent Washington Contributing Editor Design
Richard Katz Takao Toshikawa Chris Nelson Yoshisuke Iinuma December Design, Inc.

Mfg. with overseas affiliates All mfg.

1992 1994 1996 1998 2000 2002 2004 2006 2008

Note: Equals ratio of overseas production to domestic production

Toyota to switch more of its exports to transplants

100%

The Oriental Economist Report is published monthly by Japan Watchers LLC 450 Seventh Ave., Suite 2107 New York, NY 10123 Chairman: Takao Toshikawa

Toyota production and sales, 2008

90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Production
Overseas production

Sales by transplants

Editorial information:

Te l : (212) 868-4380 Fax: (212) 868-4392 e-mail: rbkatz@orientaleconomist.com

Annual subscription price is $100 in all countries for e-mail delivery in PDF format

Export Japanese production Domestic sales

Subscription information: (US) 212-868-4380 (Japan) (03) 3263-0419 e-mail: sales@orientaleconomist.com http://www.orientaleconomist.com
Copyright Japan Watchers LLC. All rights reserved. Reproduction by any means without permission is strictly prohibited.

Sales

Source: Toyota

THE ORIENTAL ECONOMIST

AUGUST 2011

TOKYO INSIDELINE

by Takao Toshikawa

Let us go, why dont you, babe?

Still keeps on hanging on

uring the last two or three months, it seems like I have been making similar reports in each edition of this newsletter: Prime Minister Naoto Kan stubbornly remains in office despite the chorus of voices calling for his early resignation. Even though this repetition may be inescapable because Japanese politics has been stuck in this situation for so long, as a reporter I find it somewhat embarrassing. I hate to have to make such a prediction, but the situation may remain unchanged next month as well. Even Kan's political foe, former Democratic Party of Japan (DPJ) President Ichiro Ozawa, offered a political forecast saying, Kan will probably stay on whether he achieves the three conditions (that he set for his resignation) or not. Kans latest gambit was to say that he would not resign until the Diet passed the bill authorizing the deficit bonds needed to finance more than 40% of the budget. Otherwise, he would stay on through at least through September to push it through. He argued that, if he left the bill to the next Prime Minister, the opposition parties could use the same tactic against him. In response, one Liberal Democratic Party (LDP) executive told the Asahi that, if it allowed the deficit bonds bill to pass, then it would lack the leverage to force an early election. A Komeito leader said he didnt think Kan would resign even if the deficit bonds bill were passed. The media are overflowing with the Kan image, which implies that the slow recovery from the earthquake, political strife, the slowing economy, and the high yen are all because of Kan's presence. The Kan-hating political journalist Takao Iwami constantly says, I don't put the emotions of liking or disliking someone first when critiquing a Prime Minister, but he writes, I feel resentment beyond simple dislike (for Kan). Its his attitude of one minute talking about taking responsibility, and then in the next minute trying to evade it. I am not trying to find fault with this, but in all my

years of reporting I have yet to see a politician who never tries to evade responsibility. The Kan Cabinet's support rate has fallen into the teens. According to a July 9-10 Asahi Shimbun poll, his support rate is 15%, and the do not support rate is 71%. 70% want Kan to resign August, of which 31% say Immediately, and 39% say, At the end of the Diet session. Two different worlds It is all quite strange. Despite this public feeling, there have been no demonstrations calling for Kan's resignation. Other than those affected by the disaster, people's lives are going on as always. Nor is the national government paralyzed. It may be an ominous connection to draw, but in prewar Japan, such an incompetent Prime Minister might have led some factions to turn to terrorism. Another way of looking at it is that the current lack of excellent political leaders in Japan does not seem to prevent the government from functioning properly. Things are much the same no matter who the Prime Minister is, and the public expects nothing from politics. Is this a mark of a mature society? Is it the low standard of a society that cannot produce better politicians? In any event, political vagaries and people's everyday lives today seem to take place in two different worlds that never meet. Nevertheless, Kan's tenacity in clinging to power is astonishing. The way he cries that he is surrounded by enemies on all sides in the DPJ is already beyond normal. All one can do is to sarcastically say, Bravo! In Japan, there have been many Prime Ministers who simply gave up when they fell into difficult circumstances. Like him or not, Kan provides a model of a Prime Minister who will fight to the very end. Even Ozawa lately has begun to offer backhanded praise, saying, His tenacity is amazing. Even though it has been two months since he made an expression of his intention to resign, Kan shows no sign of quitting. Indeed, he is full of fight.

Kan says: prepare next budget At a social gathering with his Cabinet following a Cabinet meeting on July 12, Kan instructed the relevant Cabinet Members to begin working on compiling a third supplemental budget for earthquake recovery. It had been the implicit understanding of both the ruling and opposition parties that the third supplemental budget would be handled by the next Prime Minister. Some Cabinet Members were therefore disgusted to realize that Kan still intends to hang on. The basic direction of a supplemental budget bill is to be worked out in the various agencies starting in mid-August and then debated in the extraordinary Diet session expected to be convened in late September. Work on the third supplemental budget is to start at the same time that government agencies begin to make their budget requests for the coming fiscal year. Some suspect that Kan, who is calling for an end to nuclear power, intends to include enormous sums for the installation of solar panels in the budget process for the coming fiscal year. It all depends on how far the tracks for the Kan locomotive go, as it speeds through every red light. Administrative Vice-Minister Eijiro Katsu of the Ministry of Finance has recently stopped saying anything about Kan. Some people say that this is because secretly he expects to be the one to handle the third supplemental budget under Kan. People who know Kan well state flatly that he will never quit on his own. Most think that even if, for example, Secretary General Katsuya Okada, Deputy Chief Cabinet Secretary Yoshito Sengoku, and Chief Cabinet Secretary Yukio Edano were to submit their resignations together and ask him to join them, Kan would stubbornly refuse them. No exit? Is there no way to induce Kan to resign? For example, what would happen if, say, five members of the Kan Cabinet and all of the party executives were to submit their resignations while calling for Kan to step down? He would probably just replace the party leaders and shuffle his Cabinet before the end of the Diet session on August 31. Kan would probably expel from their cabinet and party posts the whole crew of Okada, Sengoku, Finance Minister Yoshihiko Noda, METI Minister Banri Kaieda, and Diet Affairs Committee Chair Jun Azumi, who form the net surrounding him. He would
THE ORIENTAL ECONOMIST

AUGUST 2011

4
then install the Kan-sympathizer Minister of Defense Toshimi Kitazawa as Chief Cabinet Secretary. He would elevate his favorite, Minister for Nuclear Power Goshi Hosono, all the way to Secretary General. He could cope with the emergency by bringing in veterans such as People's New Party President Shizuka Kamei and DPJ Vice President Hajime Ishii who long for Cabinet posts, SoftBank President Masayoshi Son, younger and mid-level supporters, and a few people from the LDP. There is only one method that Kan would not be able to resist: if the LDP and New Komeito were to submit a motion of no-confidence in the Cabinet, and if a majority of the DPJ were to vote in favor of it. If that motion were to pass, Kan would have no choice but to dissolve the Lower House and call a general election after his Cabinet resigns. If such a scenario began to transpire, however, Kan would most likely move first and dissolve the Lower House before a motion of no-confidence could be passed. Sengoku on Kan Until six months ago, Sengoku was working overtime to support Kan. What does he think of him now? Right up to Obon (August 15) is the limit (for Kan to resign). I won't accept him continuing after that. I've known Kan for a long time, but I never thought he'd hold that tightly to power. It will probably be after the memorial services for the victims of the Hiroshima and Nagasaki bombings, which Kan is determined to attend. No matter what, I can't tell him not to stay on until the memorial services. Okada, (DPJ Upper House Caucus Chair Azuma) Koshiishi, (Policy Research Committee Chair Koichiro) Gemba, and Azumi are all unified on this point. So says Sengoku, but this is not a certain outlook. It is no more than wishful thinking. Incidentally, Sengoku's assessment of Kan's leadership is harsh: He says whatever he wants and leaves everything up to other people. I have no idea where he's trying to go. My memories of Kan If the reader will excuse me for speaking of personal matters, I have known Kan for more than 30 years now. I knew him before he was elected to the Lower House for the first time in 1980. The late Jinbe Ando introduced Kan to me. Ando left the Japan Communist Party following the 1960 Japan-US security treaty.
THE ORIENTAL ECONOMIST

As the theoretical leader of a group of the structure faction of the socialist youth league during the student movements of the late 1960s, he founded the organ Gendai no Riron (Contemporary Theory). Ando subsequently changed direction, and in 1978 he contributed to the establishment of the Social Democratic Federation (SDF), of which Kan was also a member. I became closer to him and worked with him into the 1980s, for almost ten years, as an editorial staff member of Gendai no Riron thanks to Ando's kindness. Among the magazine's staff at the time was Banri Kaieda (now Minister of Economy, Trade and Industry). Every Saturday, Ando held a study group at a small bar in Ginza run by Mrs. Ando. The late Tetsuya Chikushi, who was an Asahi Shimbun political reporter at the time, and Mainichi Shimbun political reporter Iwami were among the regular members. That is also where my relationship with Kan, a member of my own generation, deepened. I first met Sengoku there as well, in 1990, after he had been elected to the Lower House for the first time. Despite our long friendship, I never expected Kan to cling so tightly to power. I share Sengoku's surprise on that point. Here I would like to point out something interesting. Ando's human network included the university intellectual Hajime Shinohara, a Professor Emeritus at the University of Tokyo. I have found something that Shinohara said that throws light on the reason Kan is able to be so tenacious. Shinohara is a mentor of Kan's political thought. It was something Shinohara said in an interview printed in the Asahi Shimbun on August 10 last year. It was right after the DPJ's big loss in the Upper House election. Shinohara offered Kan some wisdom. How can Kan rebuild the administration after his party suffered such a crushing defeat in the July Upper House election? More than anything else, his administration needs to make a fresh start and reset itself by going back to square one. Specifically, the administration needs to re-confirm the DPJ's basic policieshaving politicians, not bureaucrats, make policy, reducing the economy's dependence on public works projects, and creating an equal partnership with the United States, while championing the role of society in supporting child-rearing and coming up with initiatives to combat global warming. As a realist, Kan needs to go allout to achieve these goals. Transition can

be likened to climbing a mountain, in that the climber needs to securely fasten pitons into the rock surface to advance. What is important is to never give up and persistently make an effort to move forward. Even if one falls, one should hammer in pitons once again to move ahead. The goal cannot be reached unless one is prepared to go back a step and take two steps forward. I strongly urge him not to lose sight of his principles by getting caught up in realism or rushing headlong into achieving results. By square one, Shinohara seems to mean Kan returning to the activist roots of his days in the SDF. In that sense, Kan today is more than meeting Shinohara's desire. The way that Kan is ignoring the voices within his party calling to dump him while pushing forward on abandoning nuclear power if he has a chance, even to the point of planning to dissolve the Lower House and call a general election, is exactly what Shinohara said: after falling, hammering in pitons once again to move ahead. No doubt Kan will hammer in another piton by saying he wants to personally handle the compilation of a bill for the third supplemental budget. Shinohara advised against rushing head-long into achieving results. What Kan is doing now is different from what Shinohara meant. Kan is rushing headlong to extend his own political life, without regard for policy or principle. The outcry by old colleagues and friends cannot stop Kan's self-centered sprint. Kans proponents There are those who paradoxically admire Kan's tenacity. Journalist Toru Takeda suggests that Kan is hanging on and playing the clown in order to give the public time. Regarding the national policy of Japan, which formerly promoted nuclear power, Prime Minister Naoto Kan serves the function of a clown who gives the public time to pause, to stop and consciously make a choice. This is because their ultimate decision is, I want to get rid of nuclear power, but I don't want Mr. Kan. In light of the fact that it is now possible that a hasty decision will be avoided, paradoxically I think highly of him. (Mainichi, July 21). Takeda shows that, no matter the person, no matter the action, the way one shines a light on it will change one's assessment. Whether Kan will resign by the end of the Diet session on August 31 should become clear by the Obon holiday in mid-August.
AUGUST 2011

5
disaster are expected to run into the trillions of yen.) It hardly needs to be said that the discussion of denuclearization is grounded in profound distrust of the nuclear village (the government, the electric power plants and others), as discussed in previous issues of TOE. Can Japan dispense with nukes? As Japan learns coping mechanisms for dealing with power conservation and summer heat, there are tenuous hopes that, in time, Japan will somehow manage without nuclear-generated electric power. Chairman Hiroshi Komiyama of the Mitsubishi Research Institute reports that this summers daily peak electricity demand is 22% lower than last summer, when measured against days with comparable heat. This has been accomplished with some difficulty, as factories shift to weekend schedules and other changes are made. Still, the public is pleased: the quality of life has not suffered much from an approximately 10% cut back on highly wasteful electric consumption, and they can get by. If the entire nation changed over to LED lighting, the power conservation would be equivalent to the electricity generated from 13 reactors. And, it is estimated that the equivalent of electricity from 4 reactors would be saved just by switching away from incandescent bulbs. LED bulbs are flying out of the stores. But what is tolerable during a shortterm emergency may not be tolerable as a semi-permanent way of life. The Japan Institute of Energy Economics, which is affiliated with the Ministry of Economy, Trade and Industry (METI), reports that by June, 2012 no nuclear-generated electrical power will be available if nuclear power plants cannot resume operations after shutting down for routine checks. The summer of 2012 would have a 7.8% electrical shortage during peak demand. In order to have the 5% standby capacity needed for a stable power supply, the Institute predicts that the entire nation would have to reduce its power consumption by 13%. Thermal power plants, which include superannuated facilities, would have to operate at full capacity to take up the slack. Their use of fossil-fuels such as coal and liquefied natural gas would raise fuel costs by 3.5 trillion ($45.36 billion) compared to 2010. If this were applied uniformly to electrical costs for households and industry, it is estimated that prices would rise 18% for houseTHE ORIENTAL ECONOMIST

POLITICS
by Yoshisuke Iinuma

Passions and interests rule debate over nukes

Dialogue of the deaf

he idea of reducing dependence upon nuclear power, or ending it out, is rapidly gaining strength among the public. In an NHK poll taken one month after the March 11 accident 42% of the public wanted to continue the existing system of nuclear power generation, 32% wanted to reduce Japans dependence on nuclear power, and 12% wanted to abolish it. Thus, when decrease and abolish responses are combined, the two major viewpoints are almost evenly matched: 42% of the public responding with continue, and 44% of the public wanting to reduce or abolish. In July, however, there was a dramatic change, with only 25% wanting to continue the existing system of nuclear power generation, and 63% wanting to reduce or abolish dependence on it (reduce = 42%; abolish = 21%). In mid-July, another volley came from the Asahi Shimbun, Japans second largest newspaper. Its editorial stated, In the next twenty to thirty years, we must close all of Japans nuclear power plants and switch to natural gas and renewable energy as our power source. Two widely-circulated newspapers, the Mainichi Shimbun and the Tokyo Shimbun, are also tilting towards a long-term phase out of nuclear power. The sentiment is even spreading among business executives. According to a recent Nikkei survey of leading company executives, an astonishingly low 10% supported, "the continued operation of nuclear power plants" in the longer term. On the other hand, for the next two-three years, 75% supported the continued operation of nuclear power plants under clearly defined and explained safety criteria. The biggest U-turn came from Prime Minister Naoto Kan. During the G8 Deauville Summit at the end of May, Kan had stated, We will add a new pillarnatural energyto the two existing pillars of nuclear power and fossil fuel. But in midJuly, Kan declared: Our goal is the systematic and incremental elimination of dependence on nuclear power, as we become a soci-

ety that can navigate the future without nuclear reactors. Even members of Kans own Democratic Party of Japan (DPJ) opposed his statement, and forced him to back down (This is the Prime Ministers personal opinion), but the debate about zero nuclear power gained momentum. Fear of the invisible enemy More than anything, the cause of the swiftlychanging controversy has been fear. First, there was an uproar because of the discovery of radiation in vegetables and green tea, and then, in July, the discovery of radioactive beef. Rice straw grown 150 kilometers (93 miles) away from the Fukushima Daiichi power plant was fed to cattle and then found to have radioactive levels that greatly exceed safety standards. The straw had been sold to areas as far away as western Japan. Since then, the government has banned shipments of cattle from four prefectures: Tochigi, Miyagi, Iwate and Fukushima itself. Now, tests are beginning on rice paddies all across Japan. If it turns out that some of these far away from Fukushima are contaminated as well, the anti-nuclear fears will explode. Day after day, there are media reports about Tokyo Electric Power Companys (TEPCO) desperate fight to deal with the aftermath of the Fukushima accident, and about the problems involved in decommissioning a nuclear power plant. Further, the realization is spreading rapidly that nuclear power is not the cheap source of energy advertised by electric power companies and the government. Indeed, the cost is very high, if one adds in the expenditures not previously counted: government subsidies to the localities that have consented to host a nuclear power plant; the enormous cost of developing a system for processing spent fuel; additional investments needed for increasingly strict safety standards; and the huge compensation and reconstruction funds caused by a big accident. (Compensation costs for the Fukushima Daiichi power plant

AUGUST 2011

6
holds and 36% for industry. Energy-sourced CO2 discharges would increase by 11.8%. The economic impact There are numerous calculations about how electrical shortages and higher prices would affect the overall Japanese economy. The Japan Institute of Energy Economics estimates that real GDP will shrink by 5.6% during July-September of 2012 if no nuclear power plants are online. If the situation continues, real GDP for fiscal 2012 would decrease by 3.6% in comparison to previous years when Japan that used nuclear-generated electricity. Employment would drop by 200,000 workers. Chief economist Toshihiro Nagahama of Dai-Ichi Life Research Institute estimates that if the nuclear power plants do not function for 3 years, then GDP will drop 1.3% in the third year, and employment will decrease by 220,000 workers. The current account surplus would shrink by 35%, and the interest rate, the exchange rate and other current rates that are premised on high level current account surpluses would be thrown into confusion. Surely there will be damage, but not everyone will trust the Institutes forecast. They will fear that the METI-affiliated Institute could have an incentive exaggerate the negative impact. To minimize the blow to production, factories are shifting operations to weekends and night shifts, and scheduling holidays to fit periods of peak demand. But emergency measures cannot continue forever. Keidanren (Japan Federation of Economic Organizations) and others warn that electricity shortages and rate increases will drive factories overseas, one by one. The scale of the exodus is unclear, but the shift to overseas production has already started (see pg. 1). No consensus The media do not speak with a single voice. Newspapers such as the moderately conservative Yomiuri Shimbun, which has the largest circulation, and the Nihon Keizai Shimbun, which reflects business interests, take the position that a certain number of nuclear plants should remain in use once safety concerns have been addressed. Most politicians remain indecisive. In the DPJ, Kan abruptly dashed to the forefront with his zero nuclear-power policy, but most of the DPJ leaders have not committed themselves to full elimination, though many favor reducing it over an extended period of
THE ORIENTAL ECONOMIST

time. Immediately after the nuclear accident, pro-nuclear members of the Liberal Democratic Party (LDP) were fearful of an abrupt halt to nuclear power and started to initiate a campaign touting its advantages. Now, however, they have caught wind of the intensity of public opinion and pulled back. Currently, LDP Upper House member Ichita Yamamoto who until now has had absolutely no connection to electricity issuesis chair of a panel that is reexamining energy policy. The panel will start with a review of the LDP-led nuclear promotion policies, and apologize for the mistakes made, but seems unlikely to break completely with nuclear power. The LDP member who is most clearly critical of past nuclear promotion is Taro Kono, a member of the Lower House. Kono advocates a complete halt to nuclear power via a scheduled shutting down of plants over thirty years or so, and he calls for an immediate termination of development of both spent fuel reprocessing facilities and the fast breeder reactor. This is the man whom Chairman Yamamoto wanted to add as a key member of his committee, but was unable to do so because of adverse reactions. Meanwhile, the New Komeito has just begun to study a gradual reduction of nuclear powered electricity and suspension of plans for a fast breeder reactor. Japans electric companies would have found little allure in the high-cost, high-risk enterprise of nuclear power generation were it not for government policy, including substantial financial support for construction of a nuclear fuel cycle. Remedies are not yet apparent, but in the natural course of events it is likely that the electric companies would pull back of their own accord. Dialogue of the deaf Both sides of the nuclear debate have become (became) rigid and unable to engage in productive debate for many years. Instead, barren polemics have led to negative outcomes. The pro-nuclear faction was overly assertive about the safety of Japanese nuclear plants, and reluctant about safety reforms and plant replacement. They were even more negative about the introduction of further safety regulations because they feared that the public would react: If plants can be made safer than they are now, doesnt that mean there were flaws in the first place; how many more flaws remain? The antinuclear faction was excluded from regular news of actual plant operations, so more

often than not they engaged in criticism and an excessive fixation on the details of malfunctions. In refuting the charges, the pronuclear forces relied increasingly on a position of the facilities are absolutely safe and lost any chance of flexibility. The monthly magazine, the Wedge, reports that policy making was restricted by this position, Reactors are safe and accidents wont happen, and found that this line was present from the start of Japanese nuclear-power development. Because of the Fukushima accident, attention is now focused on the Atomic Energy Damage Compensation Law, which does not limit an electric companys responsibility for compensation. The original proposal was crafted by Japanese legal specialists, who specified limited liability in accordance with US law and provided for supplemental government compensation. The fact that this was changed was not just because the government feared the financial burden. Instead, it was feared that opponents would charge, The fact of limited liability is actually because they expect accidents, dont you think? Unlimited liability was written in because of desire for strong reinforcement of the official position, Accidents wont happen. Loss of trust Lost in the polemics about the safety of Japanese power plants is the exorbitant price now being paid for the loss of public faith after the government failed to create fully reliable regulation of nuclear power. This is clearly demonstrated by the difficulty in restarting reactors that have been closed for periodic checks. The Nuclear and Industrial Safety Agency (NISA) hastily cleared the way for resumed operations (Safety is assured), but merely required back-up power supply vehicles and fire engines with water pumps. Prime Minister Kan abruptly called for stress tests because of his great distrust of the NISA and the electric power companies, but standards and administrators for these are still to be resolved. Kan was heavily criticized as an amateur for not letting the experts in NISA and other agencies do their work. However, it turns out that Kan was right to have such distrust. It has now been revealed that NISA which is supposed to be the safety watchdog over the nuclear industrysecretly encouraged the utilities to bring their employees to public meetings in order to ask pro-nuclear
AUGUST 2011

7
questions. One problem is that NISA is part of the Ministry of Economy, Trade and Industry (METI), which is in charge of promoting nuclear power. The promoter and the watchdog should be separate. One wonders, however, why it took Kan so many months to order the stress tests. Niigata Governor Hirohiko Izumida, whose prefecture hosts the KashiwazakiKariwa nuclear power plant, does not take the stress test as the ultimate assurance of safety. Izumida said, I wont allow the plant to resume operations even after we know the results of the stress test. We cant do anything until we have an analysis of the Fukushima accident. The Nuclear Safety Commission has begun to reconsider its safety standards and will complete its examination of the overall power outage in a few months. But it will take two or three years to study the total impact of the earthquake and tsunami. During this interval, the nuclear debate will continue because Japan is drifting in the absence of reliable standards. With this issue, Japan is rapidly awakening to the enormous difficulties that a democratic society faces when it lacks the authority of independent institutions with expertise. That problem applies to more than just nuclear policy. It is at the root of so many of Japans policy quagmires. Amazingly, the debate has so far not included any analysis of the Fukushima Daini power plant, or of the Tohoku Electric Power Companys Onagawa power plant, both of which withstood the earthquake and tsunami. There is practically no discussion of the differing earthquake resistance of the outmoded plant that was destroyed and the more recent examples that have been updated. Nor has any precise data yet been provided on the costincluding government expendituresof atomic power generation. Without such basic information and coolheaded analysis, distrust and the need to defend vested interests will become entangled, which is to say that the current situation is one where emotion will override logic. Somehow, this calls to mind the ideological state of postwar Japan, when Japan did an about-face from militarism only to leap into an idealistic pacifism.

(Continued from page 2) Electricity volume and price In the wake of Fukushima, nuclear power is becoming increasingly unpopular (see pg. 5), making the electricity picture (both availability and cost) more uncertain for the coming decade. Back in May, when METI asked firms why the March 11 catastrophe would cause them to shift some production out of Japan, 70% said the reason was concern over shortages of electricity and 60% said due to an increase in its cost. Stringent carbon emissions standards Prior to March 11, the Kan administration had a target of lowering Japans carbon emissions by 30% from 1990 levels, a goal that firms considered impractical. The Fukushima nuclear disaster has thrown that out the window. Still, the new goal remains unclear. Some firms would like to move to countries more tolerant of carbon emissions. High corporate taxes In Japan, the top marginal tax rate on profits for big corporations is around 39.5%, the highest in the OECD. In the US, it is 39.2%, in Germany, 30%, and Korea, 24%. On small and medium firms, the top tax rate is 24.8% in Japan, compared to 20.1% in the US and 11% in Korea. In fact, many small and medium firms do not pay any taxes at all and the aggregate ratio of tax payments to company profits in Japan is 26%. However, many of Japans big
AUGUST 2011

multinational firms do pay taxes as high as 40% of total profits earned in Japan. Japan missing at FTA feast Japanese exporters are worried because Korea has secured a Free Trade Agreement (FTA) with the European Union. Since it went into force this year, Japanese firms say that Koreans have been able take away some of their market share in Europe. If the KoreaUS FTA (KORUS) is ratified, this could be repeated. As a result, some Japanese exporters think it may be to their advantage to locate production in countries that, unlike Japan, have FTAs with the US, Europe and China. According to a survey by JETRO (Japan

External Trade Organization), 40% of the Japanese firms exporting from the ASEAN (Association of Southeast Asian Nations) members like Thailand say that they do so to take advantage of FTAs. Government paralysis Another factor in the rush to the exits is the increasing governmental paralysis. Business feels it has less leverage to get what it wants from Tokyo across a host of policy issues. In response to all this, the Kan administrations growth strategy committee is preparing a report on measures to prevent the hollowing of industry. Its supposed to be ready by years end. If past is prologue, then dont expect much. (RK)

Domestic Firms Flocking to Growth Markets

50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Unicharm
Source: Mitsui & Co.

5 years ago

Now

% of sales overseas

Shiseido

Ajinomoto

Kikkoman

Kirin

THE ORIENTAL ECONOMIST

8
tended to oppose all sorts of reforms that would help revitalize Japan, from trade liberalization to taxpayer IDs that would drastically reduce tax evasion. Unfortunately, the very features that make the proposal so enticing also threaten to make it yet another one of the good ideas that arise in Japan only to be crushed by the vested interests. Traditionally, keeping farms small and inefficient means more farmers and therefore more rural votes. Of course, with 60% of people directly engaged in farming being over 65 as of 2005and a reluctance of younger people to stay on the farmthere is a limit to this course. The Mainichi recently profiled Atsuo Aoki, a 52-year-old man who works in the banking division of the powerful Japan Agriculture Cooperative (JA), but who has spent the past 30 years working two weekends per month on his 1.2 hectare rice farm. Aoki is one of a mere 40,000 rice farmers who grow nearly all of the nations rice while working at other jobs and getting lots of income subsidies from the taxpayers. Nonetheless, as of now, far too many politicians in both the Liberal Democratic Party and the ruling Democratic Party of Japan are dependent on the rural districts, whose weight in elections far outweighs their tiny share of the population. So, were not holding our breath waiting for this to be approved. Still, it shows that many of Japans problems are caused, not by a paucity of ideas, but by the political power of even dwindling vested interests at a time when all the major parties are weak and divided.

Economy Watch
Most quake-hit plants OK
About 80% of the corporate production bases damaged in the March 11 disaster have revived their output back to pre-quake levels as of June, according to a survey by the Ministry of Economy, Trade and Industry (METI). METI polled 123 major manufacturers, retailers and service companies. And 93% of the 91 facilities whose production was interrupted are back in operation, although not yet at pre-quake levels. At the sites not back to pre-quake output levels, at least 70% of respondents said they would be "before the end of this year." 70 per pack, leading to a 40% hike in prices. At present, only 24% of Japanese adults smoke, down from 29% in 2004 and 47% way back in 1970. So, Japan Tobacco is hoping to make up for this by buying operations in other countries where smoking remains more popular. Through a purchase in Russia, it has secured a 37% market share in a country where 40% of adults still smoke.

Rice would be nice

Were always on the lookout for signs of reform in Japan. And one of the latest is a proposal by a government panel to expand the average area of rice paddies in Japan ten fold: from 2 hectares (about 5 acres) at present to 20-to-30 hectares. Bigger farms would be able to produce much more cheaply by taking greater advantage of machinery like combines that shoot harvested grain directly into a truck, rather forcing farmers to handload trucks. Todays tiny, inefficient farms means that Japan has to slap a 700% tariff on rice imports to keep rice competitive. Given the fact that Japans farming population is aging very rapidly, the panel proposed that inheritances be used to consolidate farm tracts. It also called for financial support for agricultural corporations planning to engage in processing and marketing of farm products. The panel proposed that these reforms be implemented over the next five years in order to fortify the farming industry as Japan joins more Free Trade Agreements (FTAs). If Japan allowed free trade in rice, it would likely import the Japonica rice that is most popular in Japan from the US, where the average farm is 100 times larger than in Japan. Perhaps more importantly, if this approach were applied to all agriculture, not just rice, it would also enable fewer farmers to produce more food, thereby reducing the political influence of the farm sector on national politics. The rural districts have

Electricity use down 20%

Electricity demand in the eastern part of Japan (the part served by Tokyo Electric and Tohoku Electric) dropped in July to a level 20% below the same month of last year. Peak demand in TEPCO's service area came on July 15, and it reached 46.3 million kilowatts compared to 60 million kilowatts during the same hour on July 23 last year. It was also 12% short of TEPCOs estimate of its maximum capacity. This cutback was largely due to powersaving efforts by corporations and ordinary households. Big corporations have been under legal orders to reduce electricity use by 15%. But households have also reduced their use. This actually led to a binge in purchases of power-saving devices, such as LED light bulbs to replace incandescent bulbs, or disposable mops to reduce the use of vacuum cleaners, or detergents said to reduce the rinsing time in clothes washers.

India-Japan EPA
At first blush, it would seem like a good step forward. On August 1, Japan and India began implementing their Economic Partnership Agreement (EPA)a form of Free Trade Agreement (FTA). This is Japans 12th EPA. Given Indias rapid growth and huge population, demand will rapidly rise for Japan exports, from capital goods for Indian industry to consumer goods for Indias emerging middle class. At the same time, given Indias technical expertise, it would seem there are all sorts of areas where Japanese and Indian firms can cooperate in technical fields to the advantage of each, and where Indian firms could provide low-cost components for Japanese manufacturers. And finally, given that current Japan-India
AUGUST 2011

Tax hike cuts smoking

The hefty tax hike imposed on cigarettes last October has gone a long way toward achieving its objective: the period from October to May saw a 30% decline in the number of cigarettes bought from the year before. In October, Tokyo raised the cigarette tax by
THE ORIENTAL ECONOMIST

9
trade is so lowIndia accounts for a mere 1% of Japanese tradeit would seem that the only direction is up. However, for Japans business community, this is yet another EPA where there is less than meets the eye. The main focus of the EPA is tariff reduction on merchandise trade. The EPA has little to say about services, investment, regulatory barriers, and so forth. On the tariff side, it will end all tariffs within ten years on goods that now comprise about 94% of India-Japan trade. For example, Indian tariffs on Japanese auto parts and steel will be completely eliminated. Japan, in turn, will eliminate nearly all tariffs on Indian manufactures, while keeping tariffs on wheat, beef and pork will stay in place. However, a Nikkei editorial headline complained that the EPA lacks punch. The pact's biggest drawback, says the editorial, is that it puts Japan at a disadvantage in various fields compared with its rival, South Korea, whose EPA with India took effect in January 2010. India is set to reduce tariffs at a faster pace in trade with South Korea than with Japan. In particular, tariffs on South Korean engines and other automotive parts will be lowered noticeably faster than those on Japanese products, meaning it will cost less to export auto parts to India from South Korea than from JapanJapan should also pay keen attention to the ongoing negotiations for an EPA between the European Union and India. While India refused to cut tariffs on finished motor vehicles from Japan and South Korea for the sake of protecting its domestic auto industry, it is discussing the issue with the EU on a broad frontAs it stands, the EPA is unfinished. The obstacles include the difficulty of the ten ASEAN members to reach a common position and the difficulty of overcoming Japanese rules that hinder ASEAN access to Japans service sector. In 2010, two-way trade between Japan and ASEAN amounted to 203.9 billion. Foreign direct investment from Japan to the region reached $8.4 billion in 2010. vey by the Ministry of Internal Affairs and Communications showed that 47.1% of men in their early 30s were unmarried, up from 14% in 1975. Among women in their early 30s, 32% were unmarried, up from 8% in 1975. Economics is a big part of the reason for the wedding dearth. According to the Cabinet Office, 30-40% of men in their 20s and 30s with annual incomes of 3 million ($38,500) or more are married, while only about 10% of those with incomes below 3 million are married. Looking at men aged 30-34, 59.6% of those who had permanent employment were marriedtwice as high as the 30% figure for those with nonpermanent jobs. If present social and income trends continue, by 2030, says the Health Ministry, 30% of men and 23% of women will remain unmarried by the age of 50.

No partner at the altar

Japan now has the fewest children it has had since 1950. In fiscal 2010, the number children under 15 fell another 90,000 to 16.93 million. This is the 30th consecutive drop. Children now account for just 13.2% of the population, the lowest share among 26 countries with at least 40 million people. Germany came in second lowest at 13.5%. In fact, Kathy Matsui of Goldman Sachs was cited in the press as saying that in Tokyo there are more pets than children under the age of 14. Meanwhile, those over age 65 hit a record-high 23.2%, according to the Internal Affairs and Communications Ministry. One side effect of aging and delayed marriages is that the share of single-member households topped 30% for the first time. It came to 31.2% as of last October, higher than the number of couple-and-child households, which fell slightly to 28.7%. Perhaps this is one reason that the child allowance and free high school programs sponsored by the DPJ remain unpopular. In fact, PM Kan just made an agreement to scrap the child allowancewhich provides money to families regardless of income as long as they have children junior high school age or younger. The Liberal Democratic Party (LDP) had demanded this as one of its conditions for approving the deficit bonds needed to finance more than 40% of the budget (and will undoubtedly add more demands). Among younger people, many live in single households not by choice, but because they cannot find marriage partners. And, in Japan, it is rare for unmarried women to bear children. In a June Cabinet Office survey of single people in their 20s and 30s, 83% of the men and 90% of the women said that they wanted to get married in the future. That is one reason that matchmaking services are getting more business. But people are not getting the lives that they want. A 2005 sur-

Recovery tax stymied

One of the signs of Tokyos gridlock is the impasse over imposing a temporary (fiveyear) tax of around 10 trillion ($128 bil.), which would cover about half of the estimated expenses of reconstruction in the wake of the March 11 disaster. After getting shellacked in the 2010 Upper House election when Prime Minister Naoto Kan campaigned on a hike in the consumption tax, members of the Democratic Party of Japan (DPJ) are very reluctant to impose any tax hike at a time when they fear a new snap election for the Lower House. As a result, the reconstruction guidelines issued by the government simply omitted any discussion of taxes.

ASEAN-Japan EPA
Speaking of unfinished EPAs, there is also the pact with the ten-country ASEAN (Association of Southeast Asian Nations), one of Japans biggest trading partners. Although the EPA was signed way back in 2008, it left out key elements including: trade in services, investment, movement of business persons, government procurement and intellectual property. Japan and ASEAN now say that they hope to conclude negotiations on these issues by 2012 as an aspirational goal. Last year, they said that they wanted to conclude it this year. So, it remains very unclear whether the 2012 target can be reached.
AUGUST 2011

Credit ratings down

Moody's Investors Service says that the negative rating trend evident for Japanese corporations seen in the first half of 2011 will continue for the rest of the year. This is due not only to the impact of March 11 but also the flagging global recovery. "The continued negative rating trend for the rest of the year is evident by the fact that the share of the portfolio with negative rating implications surged to a high of 36% from 19% at end-2010," Clara Lau, a Moody's Group Credit Officer, told the press. The power and utility sectors led in the share of negative rating implications, followed by manufacturers.
THE ORIENTAL ECONOMIST