A "Win-Win" Economic Policy toward Japan

By Lewis, William W. | The McKinsey Quarterly, Autumn 1992 | Go to article overview

A "Win-Win" Economic Policy toward Japan


Lewis, William W., The McKinsey Quarterly


Open competition in services would raise Japanese productivity, help Japanese consumers, and benefit Western companies

THE ECONOMIC POLICY of the other G7 nations toward Japan should focus on helping Japan globalize its entire economy. The benefits would be substantial for their own workers and corporations, especially those in the United States, and even larger for Japanese consumers. Such a policy, however, would require firm recognition on all sides that international economics is not a zero-sum game among closed national economies.

Globalization -- the current stage of international economic development -- is, rather, a process in which superior innovations are rapidly transferred back and forth across borders to the benefit of all countries.(*) These innovations may be imbedded in products, such as the Sony Walkman, or in processes, such as McDonald's. In either case, these transfers improve both worker and consumer well-being through productivity increases.

Countries with lower productivity benefit more from these transfers: it is easier to adopt innovations from elsewhere than to push out the frontier. For this reason, economic convergence is taking place among the developed countries. But the convergence is less complete than many people assume, and overall productivity levels in Japan are still about two-thirds of those, for example, in the United States.

Opening up the entire Japanese economy to the transfer of innovations, especially from the service sector and especially from the United States, would help to improve productivity in Japan. Japan needs to achieve productivity improvements to get its economy going again. Indeed, Japan is the most dramatic example of the need for such a policy. All the same, the policy is right for trading partners in Europe too.

Japan is now in economic recession, even by the strictest of definitions. Its economy did not grow at all in the second quarter of 1992 and declined by 1.6 percent on an annualized basis in the third quarter. Japan has responded to previous shocks through export-led growth from its pre-eminent heavy manufacturing and consumer electronics sectors. That path is not available this time. Japan will have to improve labor productivity throughout the rest of its economy. Such a change will require fundamental economic, political, and social reform, and may take a long time.

The causes of Japan's current economic recession are widely understood. Speculative bubbles in real estate and stock prices led to cheap capital and overinvestment. In the latter part of the 1980s, Japan's economy grew at rates of 5 to 6 percent per year, with slightly over half the growth coming from increased rates of investment. Fully one-third of this unusually high level of investment went for new capacity additions. Today, with simultaneous recessions in the United States, Europe, and Japan, Japan's industry has massive overcapacity. Utilization of capacity in the automotive sector is about 81 percent; in the electronic machinery sector about 77 percent; and in the industrial machinery sector about 70 percent. Such overcapacity has resulted in a sharp fall in profitability in these sectors since 1990.

The Japanese economy has responded successfully to similar challenges in the past. In 1979, when the world price of oil doubled overnight from $18 a barrel to $36, the Japanese automotive industry increased its share of the world market from 23 to 29 percent in 12 months. In 1985, when the Plaza Accord led to strong appreciation of the yen, the Japanese automotive industry reacted by increasing the unit sales price of its car exports by 40 percent in three years. It built larger cars with luxury features.

But this time is different. The economies of Europe, the United States, and Japan are all either in recession or growing very slowly, the worldwide automotive industry has significant overcapacity, and the consumer electronics market has matured. …

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