The Bear’s Lair: Trump will Make Japan Great Again

Japan has had a rough 30 years of no growth with soaring public debt and zero interest rates. In the same period, China’s economy has taken off at record-breaking speed – as we now learn, with considerable cheating on intellectual property protections and the like. On closer examination, the two phenomena are closely connected, with China’s rise being a major cause of Japan’s economic lassitude. Thus, if President Trump makes China play by the rules, he could Make Japan as well as America Great Again.

There is obvious overlap between Japan’s and China’s economic capabilities, but the overlap between the two economies is much deeper and more durable than at first appears. Both countries derive from ancient very impressive civilizations that lasted more than two millennia. The similarities between those civilizations were far more important than their differences, and the countries’ trajectories were distinctively different from those of the nations of Western Europe and the United States.

China, from the reign of Qin Shi Huang, which began in 221BC and Japan from 660BC were centralized empires with almost complete civilizational continuity over more than 2,000 years. In Western Europe, on the other hand, the only long-lasting centralized Empire, ancient Rome, collapsed and was replaced by a multitude of petty warring states.

The centralized empires of China and Japan shared one distinctive feature: they had a very high regard for learning. The Chinese mandarin system selected senior bureaucrats based on their intellectual capability, with the mandarinate being famously chosen through highly competitive examinations. The mandarinate system became fully established in the mid-Tang dynasty, around AD 700 and was only abolished in 1905. Ambitious boys from low-status families would hope to achieve material and social success through excelling in those examinations. In Japan, this system was also fully used in a locally adapted form during the Heian period (794-1185) although less so in the Shogunate that followed.

In both societies, commerce was regarded as a low-status activity and scientific discovery was not given priority, while in periods of peace even military prowess was subordinated to the mandarinate system – there was, after all, no existential threat to either Chinese or Japanese civilization for most of their histories. The result, especially in Song dynasty China, was societies with relatively high living standards and extremely high cultural levels.

Contrast this with the West. From the fall of Rome until the Renaissance, only military prowess was of any value; the incessant wars between petty states made it essential to collect, train and deploy warriors effectively. After 1500, commerce and eventually scientific achievement, of a practical kind, were also valued. Achievement for the young took the form not of success in examinations, but of military prowess, commercial success or eventually “handyman” technological advances. Examinations only began to play any kind of role in the late nineteenth century, with the British civil service being the first Western institution to adopt a form of the Chinese mandarinate examinations in 1855.

As a result of these millennia of cultural development, Chinese and Japanese societies share considerable similarities and have capabilities significantly different from those of the West. For example, both cultures are very receptive to the many years of hard study and rigorous training necessary to master the major STEM disciplines at internationally competitive levels. However, the two countries, partly through happenstance, pursued divergent paths towards the challenge of industrialization and Western competition.

After the Meiji Restoration of 1868, Japan copied Western technologies and much of the Western approach to technology. In particular, especially after World War II, Japanese policymakers internalized the importance of intellectual property and scientific advance in general. The MITI approach to economic advance, followed by Japan from the 1950s through the 1990s, took intellectual property seriously. Thus, as Japan attained Western living standards, building an expertise in modern electronics, among other sectors, Western intellectual property was respected and Japanese innovations were similarly protected.

By 1990, Japan had built itself an enviable position with a very high living standard, based to a large extent on excellence in technological and engineering fields, both of which required a great deal of rigorous study to master. The United States and to a lesser extent Western Europe remained competitive, because their history of fierce commercial competition and “handyman” technological advances continued to make them better innovators. However, Japanese engineering and production optimization capabilities made the competition an even one, even once Japan had Western-level wage rates.

At that point, China which had been liberated from full Communism by Deng Xiaoping a decade before, began to become seriously competitive. Once the Chinese education system had been restored, the society’s traditions of success through diligent study and hard work allowed China to produce many highly competitive scientists and engineers, the best of whom were able to perfect their skills in Western universities.

Once China began to catch up, Japan was at a severe disadvantage. Its wage rates were much higher than China’s. Although its science graduates were as capable and diligent as Chinese science graduates, they were hobbled competitively by Japan’s respect for Western intellectual property. China, whose national strategy involved developing in competition with the West rather than in synthesis with it, ignored Western intellectual property restrictions and allowed its companies to steal Western intellectual property whenever they needed to.

Japan was more seriously affected by China’s success than Western countries. It did not have a base of natural resources industries, inaccessible to Chinese competition, on which it could fall back. It was not as entrepreneurial as Western countries (at least the Anglosphere bloc) because like China it had less tradition of fierce commercial competition and bootstrap start-up activity than in the West. (Japanese commerce had been more developed than in China, but on an oligopolistic basis through the zaibatsu and their successors.) Hence, compared to Western countries, Japan had both fewer sectors and fewer capabilities that were protected from ferocious state-driven Chinese competition. Only the superb quality of Japanese manufacturing production, developed over more than a century, has turned out to be a skill that Chinese competitors cannot easily match.

Japan has therefore been the principal sufferer from Chinese competition, which has been artificially boosted by two factors: Chinese theft of Western intellectual property and the ultra-low interest rates in the Western and Japanese economies. (Ultra-low interest rates and “easy money” policies narrow the natural differential between capital costs in rich and poor countries, allowing poorer countries such as China to construct infrastructure and capital-intensive production facilities at artificially low cost.) Japanese productivity however continued to improve, until the last decade of foolish monetary policies produced a productivity malaise, as in the West.

Japan’s share of the world economy and of the sectors in which it specializes has tended downwards, eroded by new Chinese competitors. Lacking entrepreneurship, it has also lacked the wholly new equivalents of Google, Facebook, Uber and Palantir, which at least initially can establish new sectors outside the Chinese capabilities. As with Western intellectual property, Japanese intellectual property has been stolen by Chinese competitors, which can then undercut Japanese companies on cost. The whole Japanese consumer electronics sector, for example, dominant in the 1980s, has been eroded. Japanese banks’ tradition of preservation of “zombie” companies has also been unhelpful; most of the Japanese zombies will never be re-animated however much bank money is pumped into them.

President Trump is now confronting China and may be able to force it to stop cheating on intellectual property. To the extent he can achieve success in this negotiation, the principal beneficiary may well be Japan. If China is now forced to obey intellectual property restrictions and is prevented from stealing others’ innovations in the tech sector, it will become less competitive in precisely those areas in which its capabilities are matched by those of Japanese companies.

As a result, Japanese companies may find themselves better able to compete in world markets. Their innovations will no longer be pirated by cheap-labor Chinese competitors, and they will again be able to leverage their comparative advantages of an exceptionally diligent workforce and supreme manufacturing quality. Japan’s global market share will stop retreating and begin to expand once again.

There will still be difficulties. The Bank of Japan needs to abandon its idiotic zero-interest-rate policies and the government needs to stop running perpetual budget deficits and sucking the capital market dry through its debt issuance. Those changes will finally enable Japan’s smaller companies to compete with its big ones, and produce new competitors with young, more entrepreneurial management that can produce the innovation that Japanese industry needs.

No doubt some of the current behemoths will find themselves unable to compete and will go bankrupt. One suspects that Nissan, for example, whose principal strategy appears to be to jail its ex-chairman for disturbing Japanese management practices, will find the new world very difficult. But that is all to the good; as Schumpeter tells us, resources of equipment and above all people that are liberated from old moribund companies can form new ones. In a newly competitive Japan where the big companies no longer dominate, they will have plenty of opportunities.

Trump’s negotiations with China may help Make Japan Great Again, by allowing it to compete without being undercut by unfair competition. But Japan must make some urgent changes also, to allow this highly desirable outcome to be achieved.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)