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The Future of Structural Reforms in Japan and Germany

Martin Schulz
Senior Research Fellow

Wednesday, March 23, 2016

Japan and Germany are each challenged by structural changes in their rapidly ageing societies. Potential growth is slowing, increasing globalization is squeezing profit margins, and the need to increase productivity requires broad digitalization and often new business models. Since the 1990s, each country has reacted to these challenges with significant structural reform initiatives that were supposed to stimulate growth, but their differing approaches have shown widely different results.

Germany largely focused on globalization and expanding its home market through EU integration, which boosted its exports to almost 50% of GDP. Japan, meanwhile, focused on domestic restructuring with an ever increasing market share of service sectors. So far, Germany’s globalization strategy seems to have been more successful; its growth has been stronger and it has been widely applauded for its recovery—from the “sick man of Europe” to a key-player in international business and politics. Japan, on the other hand, seems to have resigned itself to experimenting with open-ended monetary policies and trade-related (TPP) reforms that might have a limited impact in the very long run at best.

To analyze the strengths and weaknesses of the reform processes in these two quintessential aging societies, Fujitsu Research Institute joined forces with the Japanese German Center in Berlin and the Cologne Institute of Economic Research (German industry’s think tank) for a research project, which culminated in an international conference titled “Future of Structural Reforms”, held in Tokyo on September 8, 2015. Below, we summarize some significant findings which may help to draft and implement more effective reform processes in the future.

Different attitudes toward reform

Not only do globalization strategies seem to be significantly different in Japan and Germany, but public attitudes and perceptions towards economic reforms—in particular large “structural” reforms—differ as well. In Japan, economic reform plans regularly reach the top spot for political campaign issues and election promises. Every five years or so, major elections are won on the basis of widely applauded structural reform platforms that promise to change Japan fundamentally. In 1997, the “Hashimoto Reforms” aimed to make fundamental changes in the governance system, including ministry restructuring and tax reform. In 2003, the “Koizumi Reforms” undertook supply-side and financial reforms to improve Japan’s competitiveness. In 2009, the Democratic Party promised to change the entire process of policymaking and the role of bureaucracy. Most recently, “Abenomics” has tried to kick-start the economy with unprecedented macro-economic policies and a wide range of business reforms.

After starting out with big political fanfare, however, the implementation of reforms in Japan has mostly fallen short. Since structural reform programs essentially target the shortcomings of earlier reform initiatives and repackage them, their overall stance has remained rather backward–looking. Furthermore, implementation has suffered from resistance that had built up long before a given initiative even started, while few new opportunities seem to have been seeded.

Fig. 1: Structural reform initiatives in Japan and Germany

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In Germany, on the other hand, reforms rarely gain as much popularity as in Japan. During elections, politicians promise “stability” rather than “change.” Reforms that are seen as necessary are usually pushed into the initial period after an election, when they can do the least political harm, while justification for government action usually revolves around the need to adjust to external pressures or even “shocks” (such as the euro crisis or the nuclear disaster in Fukushima). Similarly, media coverage of reform projects mostly increases “after the fact,” when implementation runs into difficulties and opposition, in particular for such major structural changes as energy reform, the euro crisis, or the handling of the refugee crisis. Indeed, major reform packages, such as the introduction of the Euro under chancellor Kohl in 1998 or the “Schroeder reforms” (Agenda 2010), ended in crushing election defeats in 1998 and 2005.

Ironically, as Professor Korte from the NRW School of Governance has pointed out, while these reforms are highly applauded internationally for their positive impact on Germany’s employment situation and their role in boosting Germany’s economy to the strongest in Europe, at home they would never be replicated because they resulted in damaging election defeats. Furthermore, as Dr. Puls from the Cologne Institute of Economics showed with an analysis of the impact of regulatory changes on the economy, subsequent governments (i.e., Chancellor Merkel) have been dialing back most of the effective but unpopular reforms, such as social security and pension cuts. Today, the German government seems to target structural reforms mostly for the wider EU market but not for the domestic economy anymore, as Dr. Bardt (Cologne Institute of Economics) has pointed out.

Structural reforms and the role of globalization

In sum, Japan’s reform initiatives seem to get stuck despite broad popular support, because repackaging reform backlogs as “structural” reforms did not do the trick to overcome ingrained resistance. Germany, on the other hand, despite low popularity of reform agendas, has been more successful in implementing reforms by using external stimuli for reform (“gaiatsu”) and by pushing for sweeping change initially before settling for gradual implementation. It remains up for debate, however, whether implementation speed and strategy could be changed in Japan by pushing for more front-loaded strategies.

As already pointed out above, the role of globalization can hardly be overstated when analyzing the effectiveness of reform strategies. Germany, being located in the middle of Europe with a very open economy, was able to focus on regional economic and political integration to break up internal policy deadlocks and reform its institutions. Japan, on the other hand, facing relative isolation with only a 17% export share of GDP and comparatively little overseas investment integration (in/out FDI), lacked the urgency of exogenous shocks. Related reform pushes were often weak as a result and faded into a slow adjustment phase within existing institutions, with few tangible results.

Furthermore, globalization supports reform processes in at least two additional ways. Foreign trade and investment expands markets for existing products and technologies while bringing in new ideas and initiatives, which supports continuous adjustments of actors and institutions and reduces the risk of reform backlogs.

Fig. 2: Continuous reform: Main initiatives in Japan and Germany

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To boost structural reforms, “Abenomics” has positioned globalization at the center of its initiatives and focused on external TPP negotiations from the start. It supports international investment and service trade by promoting Asian integration and opening Japan’s doors to tourism through changes in visa regulations. Globalization can play only a supportive role for most domestic initiatives that target changes in governance, labor markets, energy, and innovation, however. Most of these domestic reforms need to be implemented against strong domestic resistance well beyond the persuasive powers even of convincing “gaiatsu”. Therefore, Abenomics also uses the power of institutional change by changing the rules of the game in such a key institution as the central bank: The BOJ has shifted from protecting the assets of (ageing) savers towards boosting credit supply for investment and lowering the yen exchange rate as well as the government’s credit costs.

Furthermore, resistance against globalization policies seems to be growing internationally, probably not least because of its important role in reform policies. In Europe in particular, the costs of extreme globalization (such as the Euro crisis or opening borders for fast-track immigration) seem to have become evident and have resulted in broad political backlash. The list of reform initiatives in the chart above already seems to indicate a major shift from reforms relating to the external environment (forex, trade, etc.) towards more internal governance reforms, and recently even to outright innovation policies (“Industry 4.0”).

In ageing societies, such a shift of reform policies towards efficiency and innovation should prove to be particularly important because the old engines of growth, investment, population growth and urbanization have run out of steam. In such an environment, globalization provides a useful tool to buffer the effects of slowing demand by expanding the market for existing products and technologies beyond old borders. Ultimately, however, increasing productivity and innovation will have to drive long-term growth again.

For companies, as much as for governments, a revival of innovation in ageing market structures is becoming the most important target. In healthcare, productivity needs to grow significantly to avoid an explosion of costs, while demand for a wider range of services needs to drive innovation. Ageing urban infrastructures require new concepts of sustainable mobility and a broader range of infrastructure services, as a “second wave” of urbanization drives young and old households closer to the city. Digitalization allows for new concepts of retail, mobility, and efficiency with tremendous potential for productivity and innovation gains, which will turn out to be particularly important in a stagnating or even shrinking market.

Reform strategy, objectives, and players

The key messages for future structural reforms can be summarized as follows:

  • Big (comprehensive) structural reform packages should be avoided for three reasons: they produce too much resistance; they are the result of earlier implementation neglect; and they run into the next election before showing positive results. Ideally, a key reform (e.g., “equal pay for equal work”, which aims to eliminate discrimination against women and temporary workers in labor markets) would be triggered and supported by a subsequent reform by implementing institutions, with a strong focus on implementation efficiency.
  • Reform initiatives need institutional change to support the reform agenda and its implementation in the long run. From central banks to labor market institutions, new mandates, instruments and personnel are needed to push towards new targets against incumbents and prevailing political (business) currents. “Change” needs to be anchored not just in the reform agenda but also in the foundation of its institutions, in order to give necessarily gradual implementation a chance to prevail. In practical terms, institutional reform could borrow pages from corporate governance reform, since efficiency-oriented change and innovation have become almost as important in policy processes today as they have always been in corporate processes.
  • Ideally, reform initiatives should be started immediately after elections and implemented as quickly as possible to allow enough time to show positive policy results before the next election. In contrast, searching for renewed public support through a fresh round of elections after reform processes run into trouble (as frequently occurs in Japan) does not seem to revive the reform process.

Reform processes in ageing societies do not, however, need adjustments only on the government’s side of policy. Companies need to realize that they have started to play an important new role in society beyond their traditional, rather narrow focus on business. In a young, dynamic economy, the “invisible hand” of dynamic competition (Adam Smith) was thought to take care of adjustments and market changes, while those who “lose out” to change could recover in a process of overall growth. Policy changes occurred as companies pushed the boundaries of regulation and minded their own business while governments took care of gradual adjustments of the market framework through continuous regulatory reform.

In an ageing society, on the other hand, with growth close to stagnation, change almost always results in hard-to-recover losses and redistribution with little hope for future gains; this serves to increase the resistance to change. To push for reforms, even strong companies need to band together as weaker companies look for shelter, and the government finds a role in protecting potential “losers.” Within government, policies get stuck in blocking minorities while the electorate asks for the protection of the status quo.

In order to drive growth, companies therefore cannot rely on gains within the given market frame and slow moving regulatory reform processes anymore, but they also should give up hope for major reforms that could change the overall (underperforming) fabric of the economy, unless a major crisis strikes. Instead, companies need to develop smaller, effective initiatives that look at both sides of a market (supply and demand, as well as winners and losers) and develop business models along with the necessary policy processes to deliver the potential for gains along with necessary change.

For example, a disruptive innovation, such as Uber’s challenge to the taxi industry and transport regulations, cannot (only) focus on high consumer gains in a market with a large group of stagnating incumbents. Uber’s business plan needs to evolve into a reform initiative that shows the potential for growth (through increasing efficiency and consumer gains) while bringing along a sufficiently large group of incumbent taxi companies by offering franchises. The government would cooperate—even with complex regulatory changes—in such cases, potentially opening the door for more new initiatives.

Developing business plans beyond the range of single-company business ideas would certainly be difficult for companies, and could further restrain competition and innovation. In particular, startups with few resources would have a hard time of following through on their potential. But the alternative would be to wait for the government to clear the way for corporate business dynamics, which seems less realistic. In an ageing society, the realities of the market require companies to deal with the complexities of delivering on business ideas along with reform ideas. Ultimately, in an environment where initiative and change become possible again, even the disruptive innovation of startups and outsiders might have a better chance of implementation.

An excellent example of such a “new” structural reform initiative which promotes long-term growth is Germany’s “Industry 4.0”. The initiative started in the IT industry, spurred by concerns that Germany was falling further behind in the digital economy and the Internet of Things. Instead of simply asking the government for a “digital agenda,” however, the initiative was coordinated among various industries (machinery, cars, automation) and their associations, as well as think tanks. Based on the development of convincing (whole economy) scenarios, industry organizations proposed strategy recommendations, which won the support of the government and became rolled into a national strategy. Long-stagnant government initiatives, such as country-wide broadband internet rollout, vocational training reforms (“Education 4.0”), cooperation between universities and companies, and even labor market reform (“Work 4.0”) were triggered and implemented much faster and with less opposition than before.

In Japan, with its great tradition of reform committees, round tables and industry-government cooperation, an industry-led dynamization of the structural reform element of Abenomics should be possible if the focus is shifted further towards future-oriented reforms with significant corporate support. Fortunately, there are already an increasing number of initiatives that point in this direction. One initiative related to Industry 4.0, the Industrial Value Chain Initiative (IVI), is preparing new ground for industry cooperation on digital platforms. In R&D, the Strategic Innovation Promotion Program (SIP) is breaking up outdated ministry and research structures. Finally, in contentious labor market reforms, proposals are gaining traction to provide better opportunities for contract workers while also giving compensation to permanent employees during difficult corporate restructuring periods.


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