Six Strategies for Greater Competitiveness

The Path Towards Reviving Japan's Competitiveness and Moving into an Industrial Structure which Fosters World Class Companies

Takeo HIRANUMA,
Minister for Economy, Trade and Industry
at the 41st OECD Council at Ministerial Level
15 May 2002
JAPAN

Interim Summary: Industrial Competitiveness Strategy Council*

Contents

I. The State of Competitiveness in Japan, and Reasons for Decline
II. Basic Concepts for Raising Competitiveness
III. Prospects and Challenges towards a New and Competitive Industrial Structure
IV. Corporate Reform as a Step Towards World-Class Management
V. Six Strategies for reviving Japan's Competitiveness and Moving into an Industrial Structure which Fosters World-Class Companies

*Industrial Competitiveness Strategy Council is an advisory committee for Minister Takeo Hiranuma of Ministry of Economy, Trade and Industry

I. The State of Competitiveness in Japan, and Reasons for Decline
1. Why has Japanese Industrial Competitiveness Declined?
1. State of Industrial Competitiveness
Some Japanese industries have remained very competitive internationally, such as automobiles, machine tools, and some parts and materials industries. On the whole, however, competitiveness deteriorated significantly during the 1990s.
2. Reasons for Declining Competitiveness
Changes in "the rules of the game" during the 1990s
Against a backdrop of rapid globalization and development of information technologies, the rules of the game for business activity changed drastically.
> Shift towards an era of equity finance emphasizing returns to investors.
> As the world marketplace became increasingly integrated, industries being restructured on a global scale.
> The source of competitiveness shifted from production efficiency to uniqueness and differentiation.

Japanese industry was slow to respond
Despite this changing environment, Japanese companies stuck to their general approach of growth in size, ultimately dragged down by "the three excesses"(Debt, Employment and Capacity) and their existing organizational and business practices. Most companies lacked the strong leadership to attempt "strategic managerial reform."
> Today, regardless of size, companies need to pursue internal reforms to become "world-class companies" with a high global "profit share" in the business or product area that constitutes to their core strength.

The Japanese government was slow to respond
Likewise, over the past several years, in spite of the fact the Japanese government has pursued policies all stressing the primary importance of "structural economic reform," compared to the U.S. EU and East Asia, Japan has failed to prioritize policies properly or execute them quickly enough.
> While maintaining an awareness of the need to be competitive in the global market, Japan needs to strengthen reforms aimed at moving towards an industrial structure where world-class corporations are developed.

2. The significance of industrial competitiveness to Japan's overall economy
Industry provides the societal foundation for achieving the long-term economic goal of continually preserving and improving the country's standard of living. It is essential that industry continues to add value by generating wealth through the provision of goods and services, while maintaining high productivity.

II. Basic Concepts for Raising Competitiveness
1. The relationship between macroeconomic policy, economic restructuring, and increased industrial competitiveness
In the current era of global capital mobility, companies are reducing their capital investments and personnel overhead costs in order to improve their return on assets (ROA). While logical when considered in isolation, this strategy can have unexpected adverse consequences, leading to overall declines in investment and consumption, when pursued en masse.
To avoid this problem, public policy needs to simultaneously bolster 1) technological and managerial reforms to maximize private-sector capital investment; and 2) the expansion of household demand (personal consumption and investment in housing).

2. Strategies to increase the overall competitiveness of the Japanese economy
The following steps need to be taken in order to increase the overall competitiveness of the Japanese economy.
1) A prospect for the desirable industrial structure in the future needs to be provided and the challenges to achieve it need to be identified.
2) Companies are expected to pursue decisive managerial reforms.
3) The government must deploy policy package with speed and priority, keeping the following three points in mind:
- In order to cultivate competitive companies, the government must do its part to promote business restructuring and corporate reform.
- Policies should create a better business environment with the aim of developing an industrial structure where world-class corporations are fostered.
- Policies must stimulate demand by expanding personal consumption at the macroeconomic level and encouraging the development of new markets in the 21st century.

III. Prospects and Challenges towards a New and Competitive Industrial Structure
1. Prospects for an industrial structure that will create world-class corporations and improve industrial competitiveness
Japan's manufacturing industry, with its export capability, high rates of productivity growth, and scientific and technological leadership, should continue to be the pillar of the country's economy. Therefore, we need to strive to move toward a new industrial structure that will foster world-class companies with high profitability, as well as service industries that are organically linked to the development of the manufacturing sector, creating employment opportunities and raising productivity.

2. Promising fields which lead a new industrial structure
There are three promising manufacturing fields that will lead Japan's future industrial structure (a structure that develops leading global corporations) and propel the growth of the overall economy: integrated finished goods, high-performance parts and materials, and unified product/service offers.
Moreover, three promising services can be identified: business support services, lifestyle support services, and privately run public services. These are the areas where we can expect increased productivity and expanded employment.

Promising Manufacturing Sectors
Integrated finished goods: Finished goods that are tightly linked to their components, with a high level of overall optimization required for assembly. Examples: automobiles, machine tools, next-generation flat-panel televisions, etc.
High-performance parts and materials: Employing advanced technology at their core that other companies will not be able to mimic easily. Examples: advanced semiconductors, new types of video displays, performance chemicals, new glass, etc.
Unified product/service offers: Will combine products with related services, such as maintenance and repair, packaged for maximum customer convenience. Examples: consumables for copiers, content creation for console game boxes, etc.

Promising Services Sectors
Business support services: Services that are cultivated as manufacturing industries increasingly outsource their support departments as cost centers in the hope of increasing productivity as they pursue a strategy of emphasizing core competency. Examples: information systems, distribution, personnel and pension/insurance services, etc.
Lifestyle support services: As society undergoes structural changes relating to trends such as the aging of the population and environmental constraints, we can expect the needs for individual services to both expand and become more apparent. Examples: health and welfare, daycare, leisure, etc.
Privately run public services: Services that are now government monopolies are in the process of being deregulated, privatized, or shifted to private companies under government contract. Examples: medicine, nursing, education, etc.

3. East Asia and the new industrial structure
Over the past few years, against the backdrop of a cheap, competent labor force, the accumulation of component manufacturers, and the rapid growth of the Asian market, the pace of investment by Japanese industry in the markets of China and East Asia has been accelerating. There is concern, however, that this trend could ultimately lead to a hollowing-out of the Japanese industry.
Nevertheless, Japan has a market with a high level of demand, a high concentration of research and development facilities, and a manufacturing base for integrated finished goods, all of which give the country a general strength that should preserve its competitiveness in many sectors.
If Japan is slow to reform its industry and stagnates, East Asia can pose a threat. On the other hand, if Japan accelerates the pace of its reforms, in promoting an evolution toward a higher value added Japanese industrial base,East Asia can be turned into an opportunity for Japan. An important precondition here is for the infringement of intellectual-property rights Government and private sector to deal aggressively with in accordance with international rules, such as those set by the WTO.

4. Problems in shifting towards a new industrial structure
Smooth restructuring of operations and the development of an environment that encourages technological innovation and investments in operations presupposes an effort to preserve and carefully manage the results of technological innovation and a shift to a dynamic style of management in the manufacturing sector, and efforts to lower costs such as those of energy and transportation to a comparable level. But these efforts alone may not be sufficient.

Business Restructuring
Compared to the restructuring efforts of U.S. and European companies, the pace and scope of Japanese corporate efforts toward selection and concentration are disappointing, and they have not gone far enough in paring their operations down to their core competencies. In addition, Japan still lacks a fluid labor market, and this poses an obstacle to corporate efforts towards selection and concentration. Japanese companies also lag their U.S. counterparts in embracing IT to revolutionize business processes, company organizations, and inter-corporate links.

Research and development
While R&D expenses have ballooned, the risks of commercializing the results have increased, forcing any company making investments to pass through "the valley of death," an obvious obstacle to adding more value. Furthermore, the universities and public research institutions doing basic research are being underutilized, leading to indications of a general decline in the quality of researchers.

Dealing with intellectual-property rights
Most Japanese companies do not necessarily have a strategic approach to acquiring and managing intellectual-property rights. Compared to U.S. companies, there seem to be a large number of cases of "unintended" technology transfer. Furthermore, it is not sufficient for companies to deal on the own with counterfeits from Asian economies including China. The patent protection system needs to be expanded.

Streamlining the environment that companies operate in
With high taxes, intricate regulations, and expensive infrastructure, Japan's business environment is increasingly unattractive, raising the concern that manufacturing will be transferred abroad even more quickly, with extremely little inward direct investment. Furthermore, the supply of risk equity capital is inadequate, labor mobility is low, making this a difficult environment for dynamic entrepreneurs to found new companies.

Ties with the rest of Asia
While the lack of mobility of people, products, capital and information remains a problem in Japan, Japanese corporate revenues from their overseas business are also insufficient. Especially in China, where the systems of law and government, and environment for intellectual property and investment all lack in transparency, the problems are significant. In addition, achieving a balanced development throughout East Asia and ASEAN remains an important concern.

IV .Corporate Reform as a Step Towards World-Class Management

There is a pressing need for individual enterprises to establish world class corporate management, based on management leadership with the clear allocation of responsibility, a focus on profitability and distinctive strategies, etc.. It is essential that the Government too should, as a priority, lend support to "management reform" by individual enterprises.

5 Responses aimed at management reform.

Strength in developing technology / active use of intellectual property rights
Maintaining competitiveness based on distinctiveness, through strength in technological development, strength in planning in high-end fashion and design and establishing brand power.

The creative use of IT to realize new business models
Realizing new business models through the use of IT - aiming at substantial cuts in administration costs, substantial cuts in delivery times, reductions in inventory through forecasting demand for products; speeding up management decision making.

Developing the fusion of products and services
Developing new business lines which are distinctive, hard to imitate and at the same time able to secure higher levels of customer satisfaction - by bringing together distinctive and high value added products with the service standards customers require. Establishing a "virtuous circle" in which addressing the service-related issues results in strengthening the competitiveness of the product itself.

Asian connections
Setting up the most appropriate cross-border structures for production, with clear-cut strategies regarding the place of Japan and other Asian countries. Repatriation where appropriate to Japan of profits earned elsewhere in Asia, for use in bringing on new added value through R&D etc.

Strengthening the development of the human resources which underpin high value added; having the right person in the right place
Actively take steps such as raising the level of specialist skills in staff, maintaining identity, clearly stating recruitment conditions to enable appropriate matching, and trial employment . Deploying the "right person in the right place" in the widest meaning of the expression - e.g. in some cases, through strategic outsourcing, involving postings outside the parent company and corporate division - thereby further strengthening staff training and retention.

V. Six Strategies toward Reviving Japan's Competitiveness and Moving into an Industrial Structure which Fosters World-Class Companies

[Strategy #1 Promotion of technological innovation]

1. Establish 3-5 year action plan in the following four areas to boost emerging markets and industries:

(1) environment and energy
(2) broadband communications and IT
(3) medical, healthcare and biotechnology
(4) nano-technology and material technology to support the above three areas

2. Start a new R&D funding program which focuses on bridging the research stage and the product development stage

3. Drastically improve R&D tax incentives

- Partial direct tax deduction of total R&D spending
- instant write-off of R&D related investment
- tax incentive for joint R&D with universities etc.

- set reference guidelines for better protection of trade secrets [FY 2002]
- legislation to strengthen measures to combat trade secrets infringement
- shorten processing time for patent approval
- set up a joint government-business body to deal with counterfeit goods produced overseas

- greater flexibility in the structure of academic organizations to overcome departmental boundaries
- greater flexibility in fund allocation (more funding provided on a competition basis etc)

[Strategy #2: Promotion of corporate restructuring with "selection and concentration"]

1. Promote restructuring at both enterprise and industry levels

*Extend and reinforce the extraordinary law for revival of industrial vitality in order to promote scrapping of overcapacity, corporate reorganization such as divestiture and IPO, and spin-out ventures
(FY 2002).

- provision of tax incentives and financing measures
- exceptions to Commercial law
- employment adjustment measures

* Stricter delisting rules in securities market (improvement of capital markets to promote fundamental management reform)

* Increased disclosure of the results and reasoning of Japan Fair Trade Commission decisions on corporate mergers

4. Rectify the high cost structure of Japan's domestic infrastructure in areas such as energy, distribution and communications

[Strategy #3: Enhance labor mobility and create more employment in the services sector]

1. Improve the quality of human resources and optimize its allocation through greater labor mobility

* Promoting greater labor mobility

- Strengthen re-employment infrastructure through such measures as trial employment
- establish clearer standards for evaluating white collar workers
- increase matching through revitalization of job placement industry especially through the expansion of private sector activities.
- increase flexibility in labor contracts allowing for different worker needs
- streamline employment insurance systems to emphasize job creation and labor mobility rather than job preservation
- reform tax structure for retirement benefits to take into account changes in increased labor mobility etc
- improvement of defined contribution pension system
- set up rules for dismissal

* Strengthen re-education infrastructure

- Expand scholarship programs for students and workers
- establish practical training institutions at an early date

3. Establish rules to promote greater productivity and growth in the services sector (care of elderly; nurseries and child care, franchising, content production, tourism, etc.)

4. Promote e-government initiatives on the national and local level; open up local government services to privatization

- Start on-line procedure at the latest by FY2003 and device action plans to reduce administrative procedures and administrative costs
- Establish and set specific goals for outsourcing of regional government services to the private sector

[Strategy #4: Attract foreign direct investment and talent from overseas]

1. Introduce tax reforms consistent with global standards

- Institute a consolidated tax payment system that is comparable to prevailing international standards
- Lower overall corporate tax rates, including local taxes

2. Introduce new methods of regulatory reform focused on specific zones (At latest FY 2003)

3. Promote inbound direct investment as a catalyst for structural reform

- Facilitate cross border M&A by allowing for holding of parent company stocks by subsidiary etc
- Provision of one stop shopping, inbound investment promotion system including the appointment of a senior official responsible for FDI promotion (FY 2002)

- Relaxing the issuance of working visas
- Expansion of a scholarship program for talented foreign students
- Improving housing and educational environment for foreign workers and families
- concluding bilateral agreements on double payment of pensions

[Strategy #5: Establish the "East Asia Free Business Area" ]

1. Establish an "East Asia Free Business Area" at an early date

*Ensure free movement of goods, services and people

- eliminate customs duties within the area
- simplify customs clearance and trade procedures and introduce electronic processing
- liberalize services trade
- expand personnel exchanges

*Facilitate economic activities within the area

- Establish investment rules and make the rules common in the area
- harmonize regimes and increase transparency

*Ensure stability and sustainable development

- Stability of the financial system and exchange market
- Liberalize capital transactions
- Energy security
- Protect the environment

[Strategy #6: "Create New Markets for the 21st Century"]

1. Reform the tax and social welfare systems to stimulate medium-term demand

* Consolidation of inheritance and gift tax regulations
* Achieve financial stability of basic pension and other public pensions, and strengthen the corporate pension system (abolish the special corporate tax, review the limits on defined contribution pensions, etc.)
* Enhance the tax provisions for housing investment
* Establish tax incentives for investment involving the creation of new markets for IT and other industries

* Establish a national strategy in the following four areas

1) environment and energy
2) digital consumer electronics, broadband communications and IT (making Japan, a Digital Consumer Electronics Island, a new global center for IT innovation)
3) medical, healthcare and biotechnology
4) nanotechnology and materials needed to support the above three areas.

,which covers the following points

- a market-oriented strategy covering technology development
- intellectual property protection
- standardization
- redesign of the regulatory framework
- government procurement