Jun 6, 2017 | 01:36 GMT

13 mins read

Trade Profile: Japan Adapts to Its Aging Population

The Japanese flag flies in front of Mt. Fuji. In this installment of Stratfor's Trade Profiles series, we examine the Japanese economy.
(STEVEN DIAZ/Unsplash)
Editor's Note:
Global trade is changing. The kinds of multilateral agreements that characterized the post-war years have stalled out over the past two decades, prompting countries and economic blocs to try to negotiate smaller deals with fewer partners. Nations and blocs have more leeway under this new model to negotiate the trade agreements that best suit their interests and to avoid those that don't. Now more than ever, the future of international trade depends on a country or bloc's defensive interests, offensive interests and underlying factors of production. Our fortnightly Trade Profiles aim to break down these factors to facilitate an understanding of where global trade stands today and where it's headed.
In the second installment, we focus on Japan.

Economic background

Japan has maintained a defensive trade stance since the end of World War II. Though the country has benefited from global efforts at economic liberalization, it has never spearheaded them itself, unlike other developed powers such as the United States and European Union. It has, however, gradually liberalized its economy over the years under pressure from the United States, long its most important trade partner and a driving force behind its economic growth. And the Japanese government has started adapting its trade strategy recently to accommodate the country's aging population and the increasingly competitive environment that trade agreements have fostered in the modern economy. Today, Japan is taking a more proactive approach as it tries to catch up with its peers.
A dual economy emerged in Japan in the wake of World War II. On one side, the side most familiar to the rest of the world, a vibrant export economy took shape. Japan adjusted course to make the most of the growing workforce its post-war baby boom would impart. The government and its mighty bureaucracy favored developing sectors suited to Japan's strengths and gave them the regulatory and financial support necessary to help them compete abroad. From the 1950s through the 1980s Japan's manufacturing industry gradually moved up the value chain as it accrued capital and more skilled workers. From textiles, which relied on cheap labor, the country moved on to more capital-intensive sectors such as steel and automobiles, and from there, to highly skilled machinery and electronics manufacturing. All the while, Japan's currency was widely perceived as undervalued, at least until the 1985 Plaza Accord, a factor that made the country's exports even more competitive on the global stage. The sustained growth and influx of international capital that Japan's exports yielded enabled Japan to rise up through the world's gross domestic product rankings from seventh place in 1960 to second place in 1990.
But on the other side of Japan's booming export economy, a considerably less competitive domestic economy languished. As multinational giants like Toyota and Honda revolutionized the global automotive market with "just in time" supply chains, large swaths of the country's population continued to live much as their forefathers had lived. Small firms employed the majority of the workforce — 74 percent even in 2012 — though they achieved less than half the productivity that large international companies managed. Artisans and mom and pop stores, moreover, ruled on the Japanese archipelago even after supermarkets and shopping malls began cropping up across the world. And though the amount of capital coursing through Japan helped its banks grow — in 1989 the country was home to the world's 10 largest banks — they weren't allowed to compete with one another on interest rates. Instead, the so-called "convoy system" evolved to keep the banks growing at the same rate.
Japan's agricultural sector exemplifies the domestic economy's noncompetitiveness. The Japanese islands, though fertile, are mountainous. Just 12 percent of the country's land is arable. Yet maintaining the self-sufficiency required to see the island nation through disaster is a high priority for the Japanese people, many of whom remember the food shortages that occurred during and after World War II. The importance of agriculture in Japanese society has given the sector outsize political power even as its economic clout has dwindled. The Japan Agricultural Cooperatives embodies the industry's power. Now a formidable agricultural lobby, the institution, known as JA, began as a system of agricultural cooperatives that the government set up to prevent the black marketeers from cornering the rice market, which was strictly controlled at the time. The Liberal Democratic Party (LDP) — Japan's ruling party for all but four years since 1955 — subsidized and sheltered the agricultural sector with help from the civil service in the decades after the war. In return, JA used its sway with rural voters to keep the LDP in power year after year. The farming sector's inefficiencies facilitated this system: The large number of farmers working part-time on each tiny plot of farmland meant more votes for the ruling party and, in turn, more political influence for JA.
The country's unwieldy domestic economy prevailed in spite of itself. Non-tariff barriers — such as prohibitive regulations and cross-ownership of shares among Japanese companies, which made it hard for foreigners to acquire interest in Japanese firms — helped protect the domestic economy from outside competition. And Japanese consumers' patriotic willingness to pay high prices for goods and services at home helped sustain it. At the same time, the benefits of the economic model, including the consistently high employment rates that Japan's abundant small enterprises ensured, compensated for the system's inefficiencies, as did the country's thriving export sector.
Then, in the 1980s, things began to change. Japan's export economy became a victim of its own success. Competing firms in Europe and the United States started complaining to their governments, which pressured Tokyo to temper its bustling international trade by imposing voluntary export restraints. The Plaza Accord of 1985, meanwhile, caused the yen to appreciate quickly, making Japanese exports uncompetitive. Japan's wealthy companies opted to skirt these issues by moving production into their target markets. That way, they could sell their goods directly to foreign consumers without having to worry about import restrictions. Japanese cars continued to perform strongly in the U.S. automotive market as a result.
In the late 1980s, the global push toward liberalization, combined with the advent of the container ship, drove Japan's investments abroad even higher. Japanese companies found that they could drastically reduce their labor costs by basing production in less affluent countries in Southeast Asia. And so, the country began spinning the web of international supply chains that envelops the globe today. The yen's value, in turn, remained of key importance in the Japanese economy, since it directly affected the relative value of revenues from the country's foreign investments.
Japan moved from being an export powerhouse, like Germany, to an investment powerhouse. The new role suited it well, in part because it enabled the country to get better returns on its abundant capital than it could hope to get at home, helping Japan cope with its changing demographics. Japan, like many of Western countries, experienced a baby boom immediately after World War II. But compared with those of its peers, Japan's population surge started earlier and ended sooner. As a result, Japan leads the world in demographic aging. The country has had the world's oldest population since about 2005, and members of its workforce are retiring in droves. In today's market, an ageing and capital-heavy country like Japan must look abroad for growth opportunities.

Implications for Trade

Trade Strategy
For most of the post-war era, Japan has pursued a largely reactive trade strategy. International multilateral initiatives to remove tariffs and liberalize the global economy have helped the country turn the world into its factory. Though Japan has been willing to reduce tariffs on goods along with its peers, it has nevertheless resisted opening the more sensitive parts of its economy up to international competition. Japan kept up this strategy even after negotiations broke down during the World Trade Organization's Doha Round that began in 2001, signaling a global shift toward bilateral and regional trade agreements. Its early bilateral agreements include fewer liberalizations for Japan's economy than for that of its trade partner. In the deal it struck with Mexico in 2004, for example, Japan agreed to liberalize tariffs by 86.8 percent, compared with its partner's 98.4 percent liberalization. Tokyo preferred to draw on its abundant capital and intellectual resources to make up the difference, promising Mexico City investment and technical training. The approach yielded a suite of trade agreements that include liberalization levels lower than the global average and exclude the more sensitive sectors in the Japanese economy. After all, trading partners would likely have insisted on addressing areas such as agriculture in a comprehensive trade agreement.
Japan has started to rethink this strategy in recent years, however. Its aging population has made the sectors Tokyo has traditionally protected increasingly unsustainable. The average age of Japanese farmers, for example, is 66. As older workers retire, finding younger workers to replace them is getting harder. The services sector, where small and medium-sized enterprises dominate, faces a similar predicament. Between 1999 and 2014, the total number of small businesses dropped by 21 percent because of aging employees leaving the workforce. The old system that the government has long protected seems to be reaching its natural end.


Global trade, moreover, has evolved over the past two decades. As it became clear that the reforms of the 2001 Doha Round would not be resurrected, countries got more ambitious in their trade agreements. Nations such as South Korea, whose carmakers and electronics firms directly competed with Japanese companies, took a more proactive approach to negotiating trade deals, and Japan soon found itself outmaneuvered. Mega-regional trade pacts — for instance the Trans-Pacific Partnership (TPP), the Transatlantic Trade and Investment Partnership (TTIP) and the Regional Comprehensive Economic Partnership (RCEP) — also began to take shape. To join in on a regional deal of this scale, Japan would have to compromise more than it ever had before. If it refrained, on the other hand, it could find itself at an enormous disadvantage in key markets. The Japanese government, bearing these factors and the implications of its demographic decline in mind, chose to try a new strategy of proactive engagement. Prime Minister Shinzo Abe outlined extensive structural reforms in areas such as agriculture, corporate governance and labor through his Abenomics policies. Japan has forged on with its new liberalizing course even as the TPP and TTIP have foundered and the United States moved away from mega-regional arrangements under President Donald Trump's administration. Nevertheless, deep down Tokyo still yearns for the pre-1995 days of multilateral trade engagement, when it could protect its vulnerable domestic sectors secure in the knowledge that its competitors could not outmaneuver it, even if they were willing to make more sacrifices.
Defensive Interests
Agriculture is still the most sensitive area for Japanese trade negotiators. Food self-sufficiency has dropped to just 39 percent, down from 79 percent in 1960, but it is no less a concern for the Japanese public. In a 2009 poll, 89 percent of Japanese people surveyed cited national security as a reason they were willing to pay high prices for domestic produce. Japan's trade protectionism focuses on five key areas of agricultural production: rice, wheat and barley, sugar and starch, dairy products, and beef and pork. The tariff barriers around these categories are so high — well over 100 percent — that they skew the applied average for agriculture. While negotiating the TPP agreement, Japan tried to exclude these products as usual, but the United States resisted and in the end only rice, wheat and barley were exempt. The deal sparked controversy among the Japanese public; JA collected 11 million signatures protesting the TPP. Even so, Japan saw the negotiations to completion and even lobbied its fellow signatories in the region to ratify the deal without the United States' accession.
Going forward, signs suggest that Japan may continue its agricultural liberalization. For one thing, the Abe administration has introduced legislation to limit JA's power. For another, a few concurrent trends in Japanese agriculture stand to make the sector more competitive. As more farmers retire, and as legislators ease laws prohibiting corporate ownership of agricultural land, small plots could be consolidated into larger, more efficient farms. Japan, moreover, is on the cutting edge of automating and digitizing agricultural procedures, and it is an early proponent of vertical farms, multistory indoor compounds that could eventually produce high-quality agricultural goods in large quantities. These advances will play to Japan's strengths, requiring less land and more capital and highly skilled labor than traditional farms do. Depending on their progress, in fact, the developments could enable Japan to assume a more offensive stance on agricultural trade. The country has already made attempts to increase its agricultural exports with a view to becoming more competitive.
Japan is also sensitive about its currency. A weak yen, after all, helps maximize income from foreign investments, while a stronger currency has the opposite effect. Abe rolled out the first part, or arrow, of his Abenomics plan — a massive monetary policy intervention — as a measure to stimulate inflation in the Japanese economy after more than two decades of deflation. But the measure had the added benefit of keeping the yen's value in check. (Consequently, Tokyo will have to tread lightly in trade negotiations to avoid allegations of currency manipulation.)
Foreign investment is another of Japan's defensive interests, albeit perhaps a counterintuitive one. Japan has the world's largest net international investment surplus. Rather than pursuing investor-state dispute settlement (ISDS) clauses to protect its investments abroad, though, popular antipathy toward foreign interference has prompted Tokyo to avoid the provisions at every opportunity. Japan has omitted ISDS clauses from bilateral trade agreements with countries such as Australia, and its legislature, the Diet, debated the subject at length before it conceded to including one in the TPP. Furthermore, the country has filed just two ISDS cases in its history, compared with the United State's 148 total cases and 67 from the United Kingdom.
Finally, Japan staunchly defends its non-tariff barriers. Negotiating such measures with trade partners can be challenging, since they often include subjective issues such as standards, regulations and legal practices. Foreign automakers, for instance, may chafe at the size standards for cars in the Japanese market, while Japanese negotiators may insist that they are necessary to ensure vehicles will fit into the country's high-tech self-parking machines. Today, however, Japan is growing more flexible about non-tariff barriers. Before entering talks over a free trade agreement with Japan, the European Union compiled a list of the non-tariff barriers it wanted removed. The TPP contained similar stipulations, along with a mechanism to detect and remove new non-tariff barriers that might subsequently emerge. Future moves to reduce non-tariff barriers will probably hit sectors of the country's domestic economy, including retail, construction, food processing and financial services, the hardest. But over time, Abe's changes to corporate governance laws, as well as his prospective labor reforms, will likely make these industries more competitive. They could also expose Japan's automotive sector, which has been sheltered by non-tariff barriers, to increased foreign competition.
Offensive Interests
Automobiles are Japan's number one product. Toyota is the world's leading automaker, and Honda and Suzuki also rank in the top 10. Although much of Japan's automotive industry has moved abroad to be near its target markets, the country is always working to topple what lingering trade barriers stand in the way of its cars and trucks. During TPP negotiations, Japan was keen to remove the United States' 2.5 percent tariff on cars and 25 percent tariff on trucks. The country has likewise made getting rid of the European Union's 10 percent automobile tariff a key priority in its talks with the bloc. Japan pursues the same objective, though to a lesser extent, in its other competitive sectors such as machinery and electronics
Japan also strives to remove barriers to export its agricultural goods. Though they struggle to compete on price, commodities such as Japanese rice have found a niche on the high end of the market. And agriculture may prove to be an increasingly important export sector as it becomes more efficient. But exports aren't Japan's only concern. As an island nation with limited natural resources, Japan must also prioritize certain essential imports, a consideration that has led to bilateral agreements with metals and natural gas exporters such as Chile, Australia and Mongolia.


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