Tourism, sustainable cities and circular economy: 3 sectors full of perspectives for Japan’s trade of international services

Essay submitted on September 6th, 2016 for the competition “Searching for a New Initiative in Global Trade and the Role of Japanese Companies” organized by the Japan Foreign Trade Council.

In its contemporary history, which can be considered having started in 1945, Japan has achieved the remarkable performance of having most of the time recorded trade surpluses. This result is all the more impressive that it has been mainly driven by exports of goods, almost constantly on the rise since the Japanese economic take-off in the 1950-1960s, despite limited local availability of raw materials and, after 1980, a stagnant population.

The extraordinary and lasting success of Japan in exporting goods can be attributed to at least three factors. First, Japanese public authorities, in particular the Ministry of Economy, Trade and Industry (METI), have paid a lot of attention to raw material issues and integrated them in foreign policy orientations.

For instance, following the first oil crisis in 1973, Japan, which at that time heavily relied on imports from the Middle East and was targeted by the embargo, changed its position in the Arab-Israeli conflict against the will of its American ally. Japanese development aid, one of the largest in the world, is also used to back a wider “resource diplomacy”¹ that includes both financial support for strategic projects and reputation building.

A second reason explaning the strength of the Japanese export-oriented manufacturing sector is a sound domestic raw material policy and large investments in technologies allowing an optimal use of resources. Japan being one of the world’s most energy-efficient countries and a leader in robotics, it can generate a high level of output with smaller quantities of raw material and labour.

Third, the specialization of Japanese industries in high-end products, also permitted by significant expenses in research and development (R&D), preserves them from price competition and makes them less vulnerable to price shocks resulting from raw material shortages or demands for pay rises, encouraged by a demographic situation favourable to workers.

Yet these advantages should not lead to overlook difficulties and challenges faced by the Japanese economy, either due to internal factors or global evolutions. In the first place, a shrinking and aging population represents, despite some substitution with machines, a major threat for Japan to maintain in the future a high level of production and export. This is especially visible in the agricultural sector², where full automation is difficult to achieve and labour shortage is aggravated by the general loss of interest for countryside life.

Another trend adversely impacting Japanese export performances – though the overall effect on the economy of Japan is not necessarily negative – is the increasing rapid expansion of Japanese companies overseas³. While this phenomenon is not new – the world’s largest automaker, Toyota, opened factories in Thailand already back in the 1960s –, during the past five years Japan’s outward foreign direct investment (FDI) has experienced record levels above 100 billion dollars per annum, with a peak of 155.6 billion dollars in 2013.

Offshoring some parts of the production chain, if not the totality, in countries where the workforce is cheaper and local demand more dynamic is rational, but it mechanically reduces the volume and value of Japanese exports. Even if the process generates in return money transfers back to Japan, e.g. dividends or payments for licenses and intellectual property rights, the impact on the trade balance is nonetheless negative.

Last but not least, global “slow trade”, which for the first time in over four decades has led trade to grow more slowly than GDP, seems to announce a structural change in the globalized economy, that is China moving from being the world’s factory to a more balanced model, with increased domestic consumption and progress of Chinese companies up the value chain instead of simply supplying foreign corporations with intermediate goods⁴.

That causes more acute competition for Japanese firms, particularly perceptible in the field of consumer electronics where Japan’s most famous brands like Sony, Sharp or Panasonic have been losing ground to American, South Korean or Taiwanese competitors such as Apple, Samsung or Asus. China is also becoming a serious player on overseas markets with enterprises like Lenovo, ZTE and Huawei while in the automotive sector, which stands for around 20% of Japanese total exports, Chinese carmakers such as Geely and BYD have been ramping up exports.

Developing trade in services

Having these elements in mind, the will of Japanese authorities to develop trade in services is fully understandable, especially as they can hardly count on domestic consumption and investment to pull up growth with current demographic perspectives. Maintaining a strong presence in international trade is therefore crucial for Japan to preserve its citizens’ high level of wealth, but also the country’s political significance in the world.

Trade in services already represents an important share of Japan’s GDP and has been regularly growing over the past years, reaching a record high of 7.13% in 2014. That is in the same range as the United States (6.72%), but for example much lower than for European countries with more integrated economies inside the European Union. If considering value added in Japanese exports, the weight of services is even bigger (18.3%)⁵, mostly thanks to the sectors of wholesale and retail trade, repairs, transport and storage.

Nevertheless, the overall balance is traditionally negative in Japan, the deficit being explained in a large extent by the propensity of Japanese tourists to travel and do shopping abroad. The problem has been identified by the country’s authorities, which have taken initiatives like the “Cool Japan” strategy, visa liberalization and the successful bid for Tokyo to host the 2020 Olympic Games in order to attract more visitors to Japan.

This policy has been very fruitful as being demonstrated by last year’s positive balance between the numbers of inbound and outbound tourists – a first time in 45 years⁶. The government’s goal is even more ambitious, consisting in doubling the number of foreign visitors to 40 million by 2020⁷.

Turning Japan into a lasting major touristic destination

While the achievement of this target might be facilitated by the organization of the Olympic Games, such one-time events are unlikely to be sufficient to turn Japan into a lasting major touristic destination. Though spectacular and real, the recent boom might indeed be short-living for at least three reasons.

First, current tourist flows, mostly originating from China (a quarter of the total) and the rest of the Asia-Pacific region (85%!), are often driven by motivations linked to shopping. Even if this type of behaviour generates by definition a lot of cash flows, it is relatively volatile, all the more that it is sensitive to the image of brands in consumer goods. In a scenario where Japanese companies would continue losing ground for example to South Korean competitors, it is not excluded that shopping-oriented tourist flows will follow this trend and go where the most trendy products are available.

Second, the lack of diversification in terms of tourists’ country of origin makes these flows more vulnerable to sudden economic or political shocks, for instance a strong degradation of Japanese-Chinese relations or a large devaluation that would affect tourists’ purchasing power and their ability to visit and spend money in Japan.

Third, on the Japanese side itself, the tourist boom has been supported by a weak yen policy – one of the arrows of “Abeconomics” – which is unsustainable in the long run. The United States has already started to show signs of discontent regarding this issue, and Japan’s high reliance on raw material imports means that in case a rebound of commodity prices occurs, consumer prices will also rocket and Japanese citizens’ purchasing power will be seriously eroded.

Services are labour-intensive

Consolidating and strengthening the position of Japan in the tourism business, and more generally speaking in international services, requires a deep transformation of the Japanese economy, but also of some other public policies like education and migration. Indeed, tourism, as other types of services, is more labour-intensive than the contemporary manufacturing sector, to a large extent automated. Also, for the time being, productivity gains and further mechanization or computerization seem difficult to achieve in services.

Since Japan has a stagnant, if not shrinking population, any plan to develop trade in international services needs to address the question of where to find the required workforce. Despite a certain opposition from Japanese citizens, the government seems to be aware of the problem and has recently announced new measures to increase the number of foreign workers, in particular skilled migrants⁸.

In addition to governmental initiatives, Japanese companies operating abroad – as written above, this presence is growing – could run their own internal promotion programmes in order to move to Japan the best local employees working in subsidiaries. Such people would be better prepared to live in Japan and would for example be able to attend language courses provided by their employers – possibly with a financial participation of the Japanese state – before settling in Japan.

Because in the case of the tourism sector, labour needs also concern low-skilled people, Japanese authorities should consider creating a special track for seasonal workers, for instance by extending working holiday programmes – which is also a good way to promote tourism – or by designing new schemes better tailored to certain countries or jobs.

Apart from the necessity to attract more foreign workers, either on a permanent or a temporary basis, the development of international services in Japan also requires from Japanese people to get more familiar with other languages and cultures. Feedbacks from tourists visiting Japan usually recognize that Japanese people demonstrate a high level of hospitality, respect and support, however it remains difficult for foreigners who do not speak Japanese and do not know Japanese culture to feel comfortable in Japan due to the complexity of local cultural conventions and hesitations of Japanese people to speak English.

One of the ways to address this issue would be to encourage Japanese students to participate in international exchanges. Currently the number of Japanese students overseas is around 70,000, that is twice less than Germany even if the total population of Japanese students is 1.5 times higher⁹. The government and universities could grant more scholarships, or even make international exchanges compulsory in curricula, like it is the case in some French grandes écoles.

Students would be offered the choice between a semester or a year in a foreign university or in a company where they could intern. Subsidiaries of Japanese companies abroad would put in place such internship programmes to help students getting familiar with the language and the business environment of the destination country, but in this manner they would also be able to identify promising employees and contribute to their training at an early stage.

Current workers should also have access to internal mobility programmes or, when it is not possible, to public-funded life-long learning opportunities to get a first-hand experience of studying or working abroad and improve their language skills as as well as their ability to deal with international consumers and business partners.

A large-scale Iwakura Mission

This new opening to the world, which is not without recalling the Iwakura Mission of the 1870s, would also benefit the manufacturing sector, as one of the cited reasons behind its relative decline is the lack of understanding of foreign consumers’ new tastes. The traditional Japanese industrial model, relying on high-quality products but generally very standardized, seems indeed less fit in the post-industrial economy, where consumers have more diverse preferences and marketing plays a bigger role. This increases at the same time the significance of psychology and highlights the need to perceive cultural differences and pecularities.

Nonetheless, far from being a burden, Japan’s strong industry can serve as a foundation to further promote e.g. tourism. Besides cultural tourism, there are also other types of tourism based on industry – which Japan has already started to develop – or medecine. Japan has a reputation of being a very modern country with an extremely high level of hygiene and cutting-edge technologies for medical diagnosis, treatment and, thanks to robots, for care. This reputation is backed by one of the world’s highest scores in terms of life expectancy and a great number of hospitals.

If investing in promotion abroad and in developing a work force fit for the task, both in terms of quantity and quality, Japan would be able to attract tens of thousands of “medical tourists” per year, in particular from neighbouring countries where the healthcare does not enjoy full trust from the population, for instance Russia or China.

Albo being known for its high quality of life, low risk of insecurity, good food and beautiful nature, Japan could also innovate by setting up a wider offer for old people looking for a place to spend their retirement period (and pensions). True enough, Japan is a relatively expensive country where not every retired person would be able to sustain themselves, however the number of very rich, and at the same time very mobile people is raising on Earth and could be the best target for Japanese promotion efforts.

Alike cultural tourism, building up a world-class position in industrial, medical or retirement tourism would require from Japan a new approach to migration in order to attract more foreign workers as well as changes in education curricula to better prepare young Japanese people to understand alien cultures and communicate in different languages.

A Japanese model of sustainable cities

Another field where Japan could have a distinctive competitive advantage thanks to its technological advance in the manufacturing sector, its early bet on an resource-efficient economy and its geographical specificities is engineering consultancy. Global trends such as urbanization, reduction of greenhouse gas emissions (on the mitigation side) and adaptation to climate change create massive demand for high-tech environmental and urban services that can be financed, in developing countries, by development aid and new programmes such as the Green Climate Fund.

Many Japanese sogo shosha are already involved in projects like the design and/or construction of power plants and water treatment facilities. However, Japan could reap more fruits from these business opportunities by proposing to foreign potential customers – many of them being local authorities – comprehensive packages that also include consultancy services on architecture and urbanism.

A public agency could ensure coordination between private companies, but would also make sure that other public bodies – the Ministry of Foreign Affairs and its embassies, the Japan International Cooperation Agency (JICA), overseas offices of the Japan External Trade Organization (JETRO) as well as local authorities – are involved in order to promote a common Japanese vision for cities of tomorrow and provide adequate tools to implement it, for example administrative models or financial support.

Japan could build up on existing initiatives such as the Eco-Model City programme and the Cities Solution Research Alliance to use provable and replicable examples successfully realized at home and promote them abroad. Some other practical steps have been proposed by the Japan Business Federation Keidanren in 2015¹⁰. The Olympic Games of 2020 will provide a perfect window of opportunity to present to a foreign audience Japanese achievements in developing sustainable cities.

Towards a post-industrial, services-based economy

The next sector where Japan could strengthen its position as a supplier of international services is maintenance and repair. Instead of exporting know-how and building infrastructure abroad, Japan could indeed generate more value and keep a certain level of industrial employment at home, not so much to produce new goods and equipment as to maintain existing ones.

Increasing extraction costs of natural resources – not to speak about the possibility of their physical rarefaction – and new chances offered by recycling and computer technologies are slowly but surely pulling economies from an industrial productivist model towards a post-industrial, intensive and services-based economy.

Whether called the sharing economy or the functional economy, its first advantage is that it resolves the classical opposition of interests between producers, who want to manufacture and sell as much as possible, and consumers who are willing to spend as less money as possible for a particular item in order to buy some others. The most extreme illustration of this contradiction is planned obsolescence, whereby producers voluntarily release on the market goods with built-in defects, so that after a certain period of time consumers will buy newer versions.

Being already one of the most resource-efficient economies in the world, Japan could become the leader of the so-called circular economy at different phases of products’ lifecycle: a design which will lower production, use, maintenance and disposal costs; an economical production process; smart ways to use the item; appropriate schemes to collect it and give it a second life as such or by dismantling and recycling raw material or parts.

A second advantage of the functional economy is that it is much more labour-intensive than the industrial productivist model, as efforts to diminish the raw material footprint of a given product lead to an increase in demand for engineering services, maintenance or recycling. Items which are expected to live long instead of being abandoned in a landfill require indeed more attention and labour.

That would be a good news for employment, but also for the balance of payments. Machines running abroad, yet transported in a given country for maintenance before being shipped back account for international services, and for a lot of high-end professional equipment like medical scanners, it is not always possible to fix them in the country of operation.

Japanese companies have already been following such practices, but their success is highly dependent on the penetration level of their sales. A way to make this problem less salient would be to encourage contacts with foreign competitors and mutualize, as far as it is possible and desirable, maintenance and repair services in order to optimize running costs for such centres spread in all major markets.

However, demand for such services would be even higher if certain public policies were in place, ideally on the global level. They could for instance consist in taxes on natural resource extraction or greenhouse gas emissions, extended compulsory warranty periods or technical norms for energy efficiency or eco-design. If no consensus could be reached to introduce such measures for the whole planet, Japanese authorities could at least try to integrate them into bilateral trade agreements.

Already having domestically a Law for the Promotion of Efficient Utilization of Resources, Japan has the know-how and experience to take the lead on the transition to a circular economy in the world and to push for the adoption of a favourable legal and fiscal framework, either on a global level, within regional organizations or in partnership with them as well as through bilateral trade agreements. The Japanese diplomacy should be more active in these issues and in a similar fashion as regarding sustainable cities, uses its political and administrative resources to promote models and norms that will be favourable to Japanese companies.

At the end of this essay, it is also worth writing a few words about sectors of international services that have not been mentioned above, in particular telecommunications, computer, and information services as well financial and insurance services. It is indeed assumed here that e.g. for historical reasons, these types of international services are not going to become very significant in the composition of Japan’s trade with the rest of the world.

Based on an analysis of Japanese competitive advantages, it is recommended that Japan focuses on three fields: tourism (in a wide meaning), sustainable cities and the circular economy. It should also be added that whatever choice(s) it makes in terms of sectors, the ability to strengthen the pillar of services, in particular international services in the economy, will most of all depend on the capacity – and the willingness – of the Japanese society and its authorities to be more open to the world and to have enough work force, even if it has to be “imported”.