Challenges and Direction of Industrial Policy

Challenges and Direction of the Industrial Policy December , 2012 Tadao Yanase Ministry of Economy, Trade and Industry

Before the Great East Japan Earthquake The Industrial Structure Vision 2010 June 3 ,2010: released by METI Minister’s Task Force

Industrial Structure Vision 2010 For the reform, the first step must be to objectively observe and recognize severe current situation and challenges of Japanese industries.

We analyze the background of the current stalemate into three factors.

［1st factor］: Problem of the overall industrial structure ( i.e. “too dependent on automobile” and “too many companies in one sector”) ［2nd factor］: Obsolete business model (Why Japanese industries “win in technology but lose in business”) ［3rd factor］: Incompetitive business infrastructure (tax system, human resources, etc.)

2

Current Situation and challenges of Japanese Industry ２．Background to the Stalemate ① Problems in the Overall Industrial Structure ●

Extreme dependent on automotive industry

Not sustainable

Contribution of auto industry to GDP growth (2000 – 2007 )

¥ 13

trillion

Automotive contribution is about 50 % ¥6

Overall (GDP growth rate)

trillion

Auto industry share

3

Current Situation and challenges of Japanese Industry ２．Background to the Stalemate ① Problems in the Overall Industrial Structure ● Too many companies in one industry → low profitability.

Japan

North America

Europe

Asia & others Samsung (ROK), LGE (ROK), TCL (China)

LCD TVs

Sony; Sharp; Toshiba; Panasonic; Funai Electric

Vizio (U.S.)

Railways

Nippon Sharyo; Hitachi, Kawasaki Heavy Industries; Tokyu car corp.; Kinki Sharyo

Bombardier (Canada)

Toshiba (WH), Hitachi, Mitsubishi Heavy Industries

GE (U.S.)

AREVA (France)

Doosan Heavy Industries & Construction (ROK)

oray; Metawater; Ebara; Kubota, others *The number of leading companies is 16 in equipment, 9 in plant construction, and 3 in operation and maintenance management.

GE (U.S.), Nalco (U.S.)

Veolia (Europe); Siemens (Germany), Suez (France)

Thames Water (Australia)

Toshiba Medical systems, Hitachi Medical, Shimadzu; ALOKA

GE (U.S.)

Philips (France)

Nuclear

Power

Water business (Drinking water & sewerage)

Diagnostic imaging

equipment

Philips (Netherlands)

ALSTOM (France), Siemens (Germany)

Hyundai Rotem (ROK)

?

4

Current Situation and challenges of Japanese Industry

Japanese companies profitability is less than half that of overseas companies

Comparison of profitability (5 industries) (Profitability)

18% 16%

14% 12% 10%

Japanese

8% Foreign

6% 4% 2%

0%

Telecommunications equipment (2007)

Heavy electric Semiconductors Chemicals machinery (2007) (2006) (2007)

Cement (2007)

(source) Made by METI based on 2009 White Paper on Manufacturing.

5

Current Situation and challenges of Japanese Industry ●

The “key” to capture the global market has shifted to the “scale and speed of investment.”

Domestic market size per company in South Korea(Market size in Japan=1)

Investment in Semiconductor After the major reorganization After the major reorganization ofindustries industries inin South Korea of South Korea

(trillion yen) 8,000

Samsung

Passenger cars

Iron and steel

Cellular phones

Electricity

Oil distributor

1.5

1.5

2.2

3.9

1.1

7,000 6,000 5,000 4,000

Average of Average of 5 5Japanese Japanesecompanies companies

3,000 2,000

South Korea’s domestic market is smaller than Japan’s, but market size per company is bigger in South Korea.

1,000 0 199119921993199419951996199719981999200020012002200320042005200620072008

6

Sharp decrease of private sector’s investment  Basic trend: Among Japanese manufacturers, capital investment scale is limited to their depreciation value after 90’s.  Vintage of plant and equipment results in drop of their competitive position. （trillion yen）

70

＜capital investment＞

60

50

Capital investment

Negative trend after 90’s

（year）

＜vintages of fixed capital＞

14.0 13.4 13.0 manufacturer 12.0

40 11.0 30

Getting older after 90’s

10.0 20

depreciation value

9.0

10 8.0 0

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

1961年度 1966年度 1971年度 1976年度 1981年度 1986年度 1991年度 1996年度 2001年度 2006年度

left：Financial Statements Statistics of Corporations by Industry(MOF) right：Business and Investment Survey of Incorporated Enterprises:, National Wealth Survey(Cabinet)

7

Current Situation and Issues of Japanese Industry ２．Background to the Stalemate ② Problems Involved in Corporate Business Model

●Win by technology, but Lose in business

Shareshare in theinworld market (%)(%) Japan’s the world market

DVD player

Car navigation system

Liquid crystal panel

DRAM memory

Solar power generation panel

8

Closed / Open success strategy (Digital camera) Successful business model: Closed / Open strategy (Digital camera)

MCU

Fourier Transformation

A/D

CDS

CCD

Shutter Apertures

AF+ Lenses

DSP image processing

Applications M/W OS Drivers Image compression and expansion

LCD

Concentration and encapsulation of integration know-how

Video

Controllers AF and other lenses, shutters, sensors

Memory cards USB

Internal structure is a complete “black box�

Source: Materials from Univ. of Tokyo Professor Koichi Ogawa

Only external interface of digital camera adheres to global standard

Increase in mass production by other companies 9

Changes in Added-Value Strategy in the World 1970s

Late 1980s

Japan

Dominated the world through vertical Integral model and in-house development policy

1990s

Measures to boost domestic economy

Collapse of bubble economy (1991)

Digital technology

・Pro-patent ・Joint research

Loss of world share

Modularization, Move to open technology

・Drawing intellectual human resources ・International standardization

Europe

・Strengthening of location competitiveness (corporate tax reductions, etc.) ・Integration of intra-regional markets ・Government-led joint research

Asia

Asian currency crisis ⇒Large industrial reorganization (South Korea)

Restrictions on foreign investment

Delay of change

Reform of state-run enterprises, foreign capital inflow policy (China)

Bold tax reductions Concentrated investment in for investment

specific products

U.S. and European cooperation with labor production in Asia

U.S. Loss of world share due to vertical integration

Shift in strategy to open inovation

Present

Three excesses (debts, capacities, employment)

Yen’s appreciation Bubble

Competition

Around 2000s

Winning back world market share by promoting modularization models

Concentrated support for strategic fields (clean energy, next-generation automobiles)

10

Current Situation and Issues of Japanese Industry ２．Background to the Stalemate ③ Problems in Corporate Business Infrastructure

(1) Corporate tax rate 45

40

35

30

42%

Japan

41%

○Actual tax burden ratios of major corporations in Japan and South Korea (Average for fiscal 2006 through 2008, on a consolidated basis)

Japan

40%

40%

Advanced country average

34%

U.S. (New York State)

Sharp

Canon

Nominal tax rate

35.8%

38.0%

40.7%

28%

26% 25

25%

Asia (NIEs + ASEAN4 + China)

20 2000

2001

2002

2003

2004

2005

2006

2007

2008

South Korea

Samsung Electronics

LG Electronics

Nominal tax rate

15.7%

19.2%

27.5%

2009

(Source) KPMG Japan (Note) Figures for EU (15 countries as of 1998), OECD, and Asia are simple averages (but for Switzerland, the tax rate as of January 2008 was used).

11

(2) Competitiveness of Distribution Infrastructure ・ Japanese port and harbor infrastructure has become less competitive. ・ Narita losing ground in terms of air cargo handled.

Port

Airport

(Ranking of major ports in terms of containers handled)

(Ranking of major airports in terms of air cargo handled)

1994

2000

2008

Port name

Port name

2008

Airport name

Airport name

1

Hong Kong

1

Singapore

1

Memphis (U.S.)

1

Memphis (U.S.)

2

Singapore

2

Shanghai

2

2

3

Kaohsiung

3

Hong Kong

Hong Kong (China)

Hong Kong (China)

4

Rotterdam

4

Shenzhen

3

3

Shanghai (China)

5

Pusan

5

Pusan

Los Angeles (U.S.)

4

Incheon (ROK)

6

Kobe

6

Dubai

5

Anchorage (U.S.)

6

Paris (France)

7

Frankfurt (Germany)

8

Narita (Japan)

・・・

10

Yokohama

・・・

4

Narita (Japan)

5

Seoul (ROK)

6 New York (U.S.)

・・・

15

・・・

24

7

Tokyo 24

Tokyo ・・・

Nagoya

29

Yokohama

8

Anchorage (U.S.) Frankfurt (Germany)

12

(3) Competitiveness of Japanese Human Resources ăƒťThe inflow of highly intellectual foreign human resources into the Japanese labor market is very small compared with other advanced countries.

Ratio of foreigners who have finished higher education in the country (By far smaller compared with other advanced countries)

(2008)

Australia

Canada

U.K.

U.S.

France

Japan

29%

26%

16%

13%

12%

0.7%

Ratio of foreign students (Japan is lowest among major countries)

U.S. 5.8%

U.K. 25.7%

Germany 12.4%

France 11.7%

(2009)

Australia 28.6%

Japan 3.5%

ďźˆNumber of foreign students accepted á Number of students attending higher education institutions)

13

How to tackle the challenges

I

Shift in industrial structure - Building a new industrial structure that connects potential strengths to business Strengthen 5 strategic areas

Industrial structure

From a “Mono-pole structure” based on automobiles and electronics

To a “Stable multi-pole structure” based on the 5 strategic industrial fields

- Infrastructure related / system sales globally(nuclear, water, railroad, etc)

Sources of added value

To industries focused on system sales, business solutions and cultural value-added products

- Environment and energy problem solving industry(smart community, next generation automobiles)

From a efficient, oneitem selling industry

- Creative industries (fashion, content, etc.)

Impediments to growth Environment & energy, falling birthrate, aging population

Converting inhibitors into “Problem solving industry”

- Medical, nursing, health, and child care services - Frontier fields (robots, space, etc.)

14

How to tackle the challenges

II

Shift in business model - Win by technology and win in business -

Many firms in a war of attrition in Japan

Keys to global competition

High-level vertical integral model and in-house development policy

Modularization model (strategic combination of black box policy with open policy and international standards) in the private sector

International standardization in coordination with business strategy

Investment scale and speed

Industry reorganization and realignment to meet global markets

15

Aims of the Industrial Structure Vision Embarking on a nationwide effort to strengthen industrial competitiveness

III

Shift from the dichotomy between globalization and domestic employment - Job creation by aggressive globalization “and” building world-class business infrastructure - Make domestic operations more internationally competitive (corporate tax reform aiming at international standards, enhanced logistics infrastructure)

“Globalization = hollowing out” theory

Shift in growing markets from Japan and developed countries to emerging countries

- Attract High Added-value function of foreign enterprises abroad(Asia headquarter, R&D)

- Develop and invite high-level global human resources - Maintain key industrial capabilities within Japan (support investments in strategic areas, develop shop floor professionals) - Support SMEs’ entry into overseas markets 16

Development after Industrial Structure Vision

Major progress after the Industrial Structure Vision 2010 Cross-cutting policies

Corporate tax reform aiming at international standards ・FY2011 tax reform (reducing the effective corporate tax rate by five percentage points)

Reorganization of industries to enhance their competitiveness in the global market ・Amendments to the Law on Special Measures for Industrial Revitalization ・Establish the big fund for the open innovation (the Innovation Network Corporation of Japan (INCJ))

Attract and educate for higher-level global human resources ・Providing preferential treatment in terms of immigration control for foreign people by “point system.” ・Bill on Special Measures for the Promotion of Research and Development by Certified Multinational Enterprises (aimed at making Japan an Asian business center)

Promoting economic partnership for high-level liberalization ・Progress negotiations of Japan-EU, Japan-China-Korea FTA ,TPP, Japan-Canada EPA ・Support to industrialization of Agriculture

Enhancement and retention of key industrial capabilities ・Introduce a subsidy program for domestic site location ・An Act of Support for Strengthening the Management of Small and Medium Enterprises

18

Major progress after the Industrial Structure Vision 2010 Strategic areas

Overseas sales of all-inclusive infrastructure packages ・Support for the export of infrastructure and related operational management services ・Demonstrative experiments on smart community technologies

Environmental and energy solution business ・Enforcement of the Act on special Measures Concerning Renewable Energy ・Storage battery strategy ・Bill to amend the Act on the Rational Use of Energy

Creative industries (fashion, content, etc.) ・Introduction fund by strategic partnership between the government and private ・Adoption the projects to cultivate overseas

Medical, nursing, health, and child care services ・Bill to Promote Businesses to Address Economic and Social Issues ・Promotion of Japanese-style medical care with integrated devices and services overseas

Frontier fields (robots, space, etc.) ・Promotion of R&D in Frontier fields ・Identification of seven strategic fields of International standardization(next-generation automobiles, etc.)

19

Reducing the effective corporate tax rate by 5 percentage points

Effective corporate tax rate (including local taxes) (FY2011)

(FY2012-2014)

(FY2015~)

40.69%

38.01%

35.64%

Cut by 5%

20

New Economic challenges after the Great East Japan Earthquake

０．Repair of Fragility of supply chains against earthquake and flood →Relatively repaired ”reconfirming Japanese strong point”

１．Continuous deflation ２．Risk of hollowing-out by further appreciation of the yen exchange rate ３．Supply shortage and cost increase of electricity and energy (by the accident at the Fukushima Dai-ichi nuclear power station and unstable Middle-East politics)

４．Financial problem in Europe

22

Current status: Shrinking equilibrium and gradual decline 

Shrinking equilibrium and gradual decline of the private sector ・Households: With suppressed consumption, savings continue to increase. ・Corporations: Weak domestic investments lead to excess savings.



National wealth keeps shrinking

Nominal GDP has decreased by over 40 trillion yen in the last four years

Difficult to reallocate a shrinking pie

Nominal GDP (2007FY)

(2011FY)

513 trillion yen

470 trillion yen

▲ 43 trillion yen 23

Limitation of business management based on patience and cost cutting ①  During the recovery phase starting in 2002, domestic demand failed to provide a sufficient driving force for the Japanese economy as the benefits of increased exports did not trickle down in the form of higher wages U.S.A.

Japan

180

Export

170

160

160

150

150

140

140

130

130 Private-sector Investments

120

Export

Employees’ compensation

120

Private-sector Investments

110

110

Employees’ compensation

100 90 ⅠⅡⅢⅣⅠⅡⅢⅣⅠⅡⅢⅣⅠⅡⅢⅣⅠⅡⅢⅣⅠⅡⅢⅣ 2002 2003 2004 2005 2006 2007

100 90 ⅠⅡⅢⅣⅠⅡⅢⅣⅠⅡⅢⅣⅠⅡⅢⅣⅠⅡⅢⅣⅠⅡⅢⅣ 2002

2003

2004

2005

2006

2007

(Sources) “National Accounts,” OECD; net values

24

Limitation of business management based on patience and cost cutting②  Japan’s import price index has risen significantly while export price index has been on a downward trend (i.e., deterioration in the terms of trade).

(Year 2000=100)

(Year 2000=100)

Japan

U.S.A.

Import price index Import price index Export price index Export price index

(Year 2000=100)

(Year)

Euro Zone

(Year)

(Year 2000=100)

Asia Import price index

Export price index Import price index Export price index

(Year)

(Year)

【Note】 (Source) IMF International Financial Statistics Import prices are U.S.dollar-denominated. Asia includes India, Indonesia, Malaysia, Philippines, Thailand, etc.

The Japanese industry today may be poor in its ability to increase or create value added (i.e., ability to pass costs on to prices).

25

Limitation of business management based on patience and cost cutting③ ■Despite reduced compensation for employees, the labor’s share of national income remains high in Japan.

Labor’s share of national income (Labor share = Compensation of employees / national income: %) （労働分配率＝雇用者報酬/国民所得：％）

70

Japan 65

フランス

United States ドイツ

U.K.日本 イギリス France Germany アメリカ

60

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

55

（年） (Year)

(Source) OECD National Accounts

Unless Japanese companies build ability to create and increase value added, Japan will never be able to stave off shrinking equilibrium and gradual decline.

26

Consumers also exercise patience out of anxiety about their future 

With more people feeling anxious about post-retirement life, the savings rate of wage-earning households is on the rise.  People with post-retirement concerns tend to have additional savings of two million to three million yen. → Worries about post-retirement life cause consumers to suppress consumption (patience for restrained consumption)

Impact of anxiety about post-retirement life and pensions on saving behavior measured in the amount of additional savings

Relationship between the savings rate and post-retirement concerns

Thousands of yen

2,846

3,000

Savings rate (%) 29

2,500 28

2,000

27

25

1,000

24

500

23

0

22

1985 20 30 40 Ratio of people with post-retirement lconcerns

50

Sources: Ministry of Internal Affairs and Communications, “Survey of Household Economy”; Cabinet Office, “Survey on People’s Life.”

1,786

1,500

2008

26

1,982

60 (%)

Extremely worried about overall postretirement life

Worried about the sufficiency of pension and insurance benefits

Worried about possible cuts in pension benefits

Source: Cabinet Office, “Annual Report on the Japanese Economy and Public Finance 2009.”

27

Structural factors of the current scenario of shrinking equilibrium and gradual decline

Business management based on patience → Low value added

Continuing deflation → Decrease in the expected rate of growth

Worsening employment environment → Decline in labor income

Downward spiral of the shrinking equilibrium and gradual decline Weak domestic consumption

Increasing anxiety about the future →Increase in domestic savings

Efforts need to be focused on enhancing value added and increasing households’ labor income.

28

Strong yen poses the risk of driving entire industries out of Japan 【Conventional offshoring】 ◆ Serving the growing local markets of host countries ◆ Taking advantage of cheap labor

【Ongoing offshoring】 ◆Burdened with six handicaps, Japan has lost locational advantage ◆Foreign exchange risk is too big to be dealt with by a single company

①Processing and assembling factories established to produce for local markets ②Capital equipment-intensive industries and certain materials industries giving priority to the “black-boxing” of their technologies tend to stay in Japan.

①Processing and assembling factories producing for the Japanese market transferred overseas (e.g., Nissan’s production lines for the March transferred to Thailand) ②Materials industries are joining the offshoring bandwagon (e.g., Toray’s carbon fiber production in Korea; Downstream steel processing operations in Asia) ③Increasing dependence on overseas suppliers for parts procurement (e.g., Nissan Kyushu’s import dependency ratio for parts procurement: 10%→40%)

Offshored operations may not return to Japan even if the yen weakens in the future 29

Why Japanese manufacturers find themselves in a difficult situation ■ A Japan-Korea comparison of automobile manufacturers’ profit-making structures shows that while declining cost competitiveness and shrinking profit margins are factors behind why Japanese automakers are thrown into difficult situations, the yen’s appreciation is having the biggest impact at the moment. 【Comparison of Japanese and Korean automakers in profit-making structures】 Japan Sales

Korea 100.0

100.0

－67.8 －1.0 －3.2 －10.1 －4.8 －1.9

－64.4 －0.5 －3.2 －7.3 －5.5 0.0

(Total cost)

88.8

80.9

Operating profit

11.2

19.1

Interest paid

－0.1

－1.0

Profit before tax

11.1

18.0

－4.4

－4.0

6.6

14.1

－12.8

－0.4

－6.2

13.6

Raw materials Fuel Outsourcing etc.

Labor Depreciation Customs

Corporate tax※ Profit after tax Foreign exchange impact Profit net of forex impact

A. Cost competitiveness B. Profit margin

※Effective corporate tax rates: Japan 40%, Korea 22%

C. Appreciation of the yen

Source: Table was prepared by the Mizuho Corporate Bank’s Industry Research Division with some adjustments made by the presenter based on data from industrial and other statistics issued by the Ministry of Economy, Trade and Industry and other information.

30

Japan may fall into a current account deficit as early as the second half of the 2010s

(Trillion yen)

Japan’s current account balance (estimate)

If nuclear power plants resume operations and the yen depreciates

If nuclear power plants remain shut down and the hollowing out continues

Current account balance may turn negative in the second half of the 2010s.

31

How to tackle?

【Survival Plan①】 “Defensive” measures to cope with industrial hollowing out “Defensive” measures are needed in order to prevent the rapid hollowing out of industries. Ⅰ. Developing globally comparable investment and business environment  Coping with overshooting yen appreciation

 Establishing new economically viable energy policy and global warming policy  Promoting economic partnership for high-level liberalization  Reducing public service burden on companies e.g., the effective corporate tax rate, the equipment investment tax (depreciable property tax), the employers’ share of social security contributions  Ensuring sustainability in social security and public finance → Promoting integrated social security and tax reform Ⅱ．Measures to counter the strong yen  Assisting companies to keep investigation in Japan  Supporting small- and medium-sized enterprises in restoring operations, making capital investments  Addressing the mismatch between job openings and job seekers 33

【Survival Plan ②】 Package of “Proactive” measures (Creation of new industries) <Industries that cultivate potential domestic demand> New energy industry Healthcare Industry (Rechargeable batteries, (Medical and nursing care; electricity-saving health-related services) services etc.)

<Industries that capture global demands> Creative industry Infrastructure, (Agriculture, next-generation foods, content, automobiles “Cool Japan”)

Bill to Promote Businesses to Address Economic and Social Issues

Act of Support for Strengthening the Management of Small and Medium Enterprises

Aging society and fewer children ○Healthcare services ○Support services for working women ○Development of new medical care equipment, care robots, automatic cradles, etc.

Support SMEs to expand overseas operations Energy and environment ○Development and production of energy-saving and renewable energy technologies and products ○Commercialization of energy management services

Basic policy (collaboration with other ministries) →Plans approval and authorization

Financial support

Quality evaluation

Diversify and revitalize SME support service providers Exploring overseas markets ・Exporting infrastructure systems and reviewing the trade insurance ・TPP, Japan-China-Korea FTA, EU-Japan EIA, etc.

Social regulations reviewed for changes Bill to amend the Act on the Rational Use of Energy

34