Why the sun is rising over Britain, not Japan

By Anatole Kaletsky (THE TIMES, 09/11/06):

THIS WEEK I had a strange and enlightening experience. At a conference in Tokyo organised by The Times and Japan’s biggest paper, the Yomiuri Shimbun, I was asked how Japan could improve its economic performance. What was strange, at least for someone born in the 1950s, was that the country running the world’s most successful economy for most of my lifetime was now seeking advice from the country that had done worst.

What was enlightening was the theme that united the replies of the three British panellists. Richard Lambert, of the CBI, and Ed Balls, of the Treasury, focused mostly on Britain’s experience, while I spoke about global conditions, but our comments had an important theme in common: the world has changed so much since the postwar heyday of Japan’s successes — or indeed of the economic miracles in Germany, France and other European countries — that the ideas of that period are worse than useless as a guide to economic policy today.

This may seem so obvious that it’s hardly worth stating, but consider the following questions: is a country with a trade surplus healthier than one with a deficit? Is high investment or low investment more likely to make a country rich? Does high consumer borrowing create unsustainable bubbles that threaten stable growth? If you answered “yes” to these questions, then you should think again — and visit Japan.

Japan pulled out of a decade-long stagnation two years ago and, assuming its policymakers can avoid some obvious errors, such as raising interest rates too quickly, it will not relapse into recession any time soon. But looking further ahead, things are still seriously amiss. Nobody in Japan believes the economy can ever again match the growth rates of 2 to 3 per cent that are taken for granted in America and Britain. As a result, Japan’s living standards are expected to fall steadily in relation to other countries and everyone takes for granted that the country’s economic heyday is behind.

This pessimism can partly be explained by the shrinking population and workforce, since the postwar baby boom and subsequent collapse in birth rates was more extreme in Japan than anywhere else in the world. But demography is only one cause of the national malaise and can, in principle, be addressed through later retirement, more immigration and work-life balance for women. A much greater problem, in my view, is a reluctance, which one also finds in Germany, the other miracle economy of the postwar era, to admit that conditions for success in today’s world economy are almost the opposite of the ones that prevailed in the miracle years.

Everybody now knows about the great historic trends driving economic globalisation: the end of communism, which has united the world for the first time in history under one economic system; the emergence of China, India and other developing countries that has brought three billion new workers and consumers into this global trade for the first time; and the virtual elimination of transport and communications costs, which has made it possible for the whole world economy to function as one. But many of the consequences that follow logically from this process are still not understood.

Particularly relevant to the contrast between Japan and Britain are two. First, manufactured goods, whose production is readily transferable to low-cost economies such as China, are falling relentlessly in price. Secondly, this process of outsourcing has created a new type of business, called “the platform company” by Charles Gave, the French economist (and my partner in an economic consulting business).

Platform companies sell everywhere but produce nowhere — businesses such as Dell, Nokia, Ikea, Glaxo, Apple or L’Oréal. Where, for example, are the factories owned by Ikea or Dell? They do not exist, because these companies subcontract almost all their manufacturing to other businesses, mostly in developing countries. Any business process can be divided into three stages — design, production and marketing — and platform companies have perceived that the relative value of these stages has fundamentally changed. In the 20th century, control over production was the key to business success. Today the other two stages add most value, because production can be shifted to subcontractors in developing countries that compete intensely to reduce costs.

This outsourcing is familiar enough, but its macroeconomic implications are less well understood. Because the manufacture of physical goods is the most volatile and capital-intensive part of the business process, outsourcing does not just transfer jobs and factories — platform companies also outsource to China and other developing countries much of the economic volatility that goes with capital investment, inventory cycles and the unionised factory employment.

At the macroeconomic level, therefore, the platform company model has produced several unexpected results. Large trade surpluses and high levels of investment, which used to be indicators of economic dynamism, may now be symptomatic of a country’s reluctance to integrate fully with the world economy and capitalise on the opportunities presented by free trade.

Globalisation has also affected the growth of borrowing in ways that are not yet fully understood. For example, outsourcing has made Western economies far more stable, as demonstrated by the marked decline in all measures of economic volatility since the early 1990s, especially in Britain and the US. This new-found stability has, in turn, made high levels of borrowing both safer and more attractive for businesses and consumers in the advanced economies. At the same time, the integration of global capital markets has allowed countries that embrace high levels of borrowing and financial sophistication, such as America, Britain and Spain, to take advantage of excess savings in more conservative countries such as Japan and Germany.

These processes of global specialisation, outsourcing and financial deregulation have all been beneficial to Britain, which has a clear comparative advantage in finance and other business services that oil the wheels of global commerce. Japan’s comparative advantage, by contrast, has been in precisely those manufacturing industries where Chinese competition is at its most intense. Even the legendary Japanese ability to cut costs through skilful production management is of less value in a world where factory labour is so cheap.

The upshot is that Japan and Britain have reversed the relative positions they occupied in the postwar decades. Britain’s service industries are now carried along by some of the strongest currents of the world economy; Japan’s manufacturing economy, by contrast, must sail against the headwinds of global change.