No country is an island
Nov 29th 2007
From The Economist print edition
Japan is reluctantly embracing globalisation
THROUGHOUT its history Japan has oscillated between openness to foreign ideas and fierce isolationism. This ambivalence is still reflected in its attitude to globalisation. Despite the worldwide presence of companies such as Toyota, Honda, Canon and Sony, Japan's integration into the world economy is surprisingly weak.
Japan has the lowest levels of import penetration, inward foreign direct investment (FDI) and foreign workers in the OECD (see chart 8). Foreign affiliates' share of turnover in manufacturing and services, at 3% and 1% respectively, is the lowest in the OECD. Nor has Japan participated in the global wave of cross-border mergers and acquisitions (M&A). In 2004 the sale of companies in the European Union to foreign firms accounted for 47% of global M&A by value, and that of American firms for a further 22%. The Japanese share, by contrast, was just 2.3%. In an era of unprecedented mobility of people, as well as goods and services, Japan's net migration since the second world war has been approximately zero. And so on.
Why is Japan such an outlier? Part of the reason is regulatory hangover from the post-war period. Rules restricting inward flows of goods and investment, put in place to protect growing domestic industries after the second world war, have hindered economic integration. So too have complicated regulations governing particular markets, which deterred foreign firms from entering the Japanese market. (In one infamous example, Japan restricted imports of foreign skis, arguing that Japanese snow was different.) The use of cross-holdings made it very difficult for foreigners to take over Japanese firms.
For their part, many Japanese firms have been too preoccupied in the past 15 years to expand abroad, says Heang Chhor, the head of the Tokyo office of McKinsey, a consultancy: “They have been so busy with the domestic crisis that they have forgotten to remain connected with the rest of the world.” Having been enthusiastic about overseas expansion in the 1980s, many Japanese companies retrenched at home during the dark days of the 1990s. Now that the domestic market has matured and the population has started to shrink, Japanese firms must look abroad for growth opportunities.
That is the main reason for Japan to globalise more vigorously, but not the only one. As well as seeking new markets, Japanese firms will be able to benefit from foreign ideas, which could help to boost innovation. “There should have been a Japanese Silicon Valley,” says Mr Chhor. But during the 1990s, he explains, Japan's connection to the outside world actually weakened, “so the engine for innovation became much less powerful.”
Globalisation should also speed internal reform as more efficient foreign firms, particularly in services, shake up the domestic market. The government has duly set about dismantling regulations that hindered tighter integration with the rest of the world, and in 2006 the Council on Economic and Fiscal Policy even produced a “globalisation strategy” for Japan to enhance the country's international competitiveness by making better use of goods, services and expertise from abroad.
Better late than never—but it will not be easy. For while corporate Japan spent the past few years restructuring, a global M&A binge created multinational giants in many industries, often leaving Japanese firms looking puny by comparison. Japanese firms also face a shortage of managers with international experience and the mindset and skills needed to operate globally. In addition to competitors in America and Europe, they now also have to contend with new rivals from China, India and South Korea in many markets. But “Japan cannot continue to live as an isolated island,” says Keizai Doyukai's Mr Hasegawa. “Japan must strengthen its relationship with other countries.”
Some Japanese firms, of course, embraced globalisation years ago and have prospered as a result—notably Toyota, which is now nearly the world's biggest carmaker. For the past two decades, says Fujio Cho, the company's chairman, “we have been changing our business and management style to respond to the race of globalisation.” Today the company has factories in 27 countries around the world. Other Japanese multinationals include Sony, which makes 74% of its sales outside Japan, and Nintendo and Canon, Japan's second- and third-largest companies by market capitalisation after Toyota.
How to go global
But what of the Japanese companies that have come late to the globalisation party? They have several options, says Mr Marra of A.T. Kearney. The boldest is to try to achieve global scale through domestic and foreign acquisitions. This was the route taken by Nippon Sheet Glass, Toshiba and Japan Tobacco—as well as by Takeda, Japan's largest pharmaceuticals company, of which Mr Hasegawa is president. After spinning off non-core businesses in chemicals, agriculture and food, Takeda went on an acquisition spree, buying domestic and foreign pharmaceutical and biotech firms. A decade ago 50% of Takeda's revenue came from Japan; now the figure is below one-third, and falling.
Mr Hasegawa notes that Europe accounts for 30% of the world market for pharmaceuticals but only 14% of Takeda's sales, so future acquisitions in Europe are on the cards. And further consolidation is looming in Japan, he says, where there are still dozens of drugs companies that will be vulnerable once protectionist measures are unwound. Rather than grumble about this, says Mr Hasegawa, it is best to accept what is coming and plan accordingly.
Other options for Japanese firms, notes Mr Marra, are to move into high-value specialist products, as many Japanese steel and chemicals firms have done; adopt a regional strategy, focusing on Asian markets; or form a global alliance with a foreign firm, as Renault-Nissan has done in cars and Sony Ericsson in mobile phones. Alliances have the advantage of allowing Japanese firms to avoid the indignity (in their eyes) of a takeover. They also provide them with quick access to foreign markets and management expertise, says McKinsey's Mr Chhor: “Allying with international players will be the name of the game for the next five years.”
Even as they globalise, Japanese firms continue to do some things in distinctly Japanese ways, points out Steven Vogel of the University of California, Berkeley. Toyota, for example, has to some extent replicated its domestic supplier networks in other countries. “It doesn't act exactly like it does at home, but it doesn't act like an American company either,” he says. Japanese electronics firms have also taken a cautious approach to outsourcing. Sony, for example, outsources the manufacturing of standardised items such as mobile phones and PCs to India, China and Taiwan, but for digital cameras and video camcorders, where it has specialist manufacturing technology, it prefers to keep production in Japan, says Katsumi Ihara, head of the firm's electronics division.
Japan's relative lack of enthusiasm for outsourcing to China is due partly to the deep-rooted enmity between China and Japan, but also to Japanese firms' desire to protect their intellectual property and to a belief that manufacturing remains a core Japanese competency. The two countries have strikingly complementary economies and look like natural partners: Japan makes high-tech, high-margin goods whereas China tends to concentrate on high-volume, low-tech products. But China represents both an opportunity and a threat: it is a big market on Japan's doorstep, but it seems set in due course to displace Japan as Asia's biggest economic and political power.
China recently surpassed America as Japan's main trading partner, but new investment by Japanese firms in China actually fell by 30% in 2006, to $4.5 billion. In a survey asking Japanese firms to rate the best countries to invest in over the next three years, the proportion picking China fell from 91% in 2004 to 77% in 2006. That is still an impressive number, but the decline reflects both the expense of making things in China (compared with India and Vietnam) and growing concern over anti-Japanese sentiment.
Come in, gaijin
Globalisation is a two-way street, and Japan has as much to gain from letting in foreign firms as it does from sending its own firms out into the world. So in 2003 JETRO, a government agency that used to be in charge solely of promoting exports, was given a new mission: to encourage more FDI in Japan. This is not because Japan is short of capital; it has an excess of the stuff. It is because the government recognises that inviting in foreign firms is an indirect means of promoting reform, by exposing sleepy Japanese firms, particularly in the service sector, to a dose of competition.
“It is important to have new players in the Japanese economy with new ideas and new business models,” says JETRO's Nobuyuki Nagashima. In 2003 the then prime minister, Mr Koizumi, set a target of doubling FDI between 2001 and 2006, which was only just missed. Now JETRO has a new target: for FDI to reach 5% of GDP by 2010, more than twice the 2005 figure. But even if that target is reached, Japan's figure will still be far lower than other rich countries' (around 15% in America and 30-40% in Britain, France and Germany).
There is clear evidence that foreign investment has a galvanising effect. In 2002 labour productivity in foreign affiliates in Japan was 60% higher than the national average in manufacturing and 80% higher in services. Foreign companies operating in Japan also outperform domestic firms in profitability, capital investment and R&D spending. This is partly because they are not bound by existing business relationships, but also because only the most globally competitive and efficient firms enter the Japanese market. “We are benefiting a lot from the stimulus that foreign capital is bringing,” says Kuniko Inoguchi, a member of parliament and a former minister in the Koizumi government.
Deregulation has encouraged foreign firms to enter fields such as telecoms, retailing and financial services. The arrival of Starbucks forced outmoded and overpriced kissaten coffeeshops to do better. Foreign insurers offered new products that had previously been unavailable in Japan, prompting local rivals to follow suit. When an old rule banning roadside advertising hoardings was abolished, JCDecaux of France introduced bus-stop advertising. It now operates in 13 Japanese cities. And the simplification of complicated rules relating to large shops prompted IKEA, a Swedish furniture retailer, to open superstores in Japan, offering a wider range and lower prices than local firms, along with an unusual shopping experience. All this shows that Japan is not closed to foreigners, says Mr Nagashima, “but when things are very different, it just looks closed.”
Foreign firms going into Japan need to understand the local market but must also offer something distinctive, says Gerhard Fasol of Eurotechnology, a consultancy based in Tokyo that advises foreign companies about doing business in Japan. Starbucks, he notes, carefully crafted a strategy for the Japanese market; but Vodafone, a big European mobile operator, provides a cautionary tale. When it took control of Japan's third-largest mobile operator in 2001, it made the mistake of trying to introduce European-style handsets into Japan, causing customers to defect in droves. (Vodafone sold its Japanese arm to SoftBank in 2006.) “When you want to sell to Japanese consumers you have to give them what they want, not what you think they should buy,” says Mr Fasol. Another foreign giant that has failed to gain traction in Japan is Wal-Mart, which in 2002 bought a controlling stake in Seiyu, a Japanese retailer, and has yet to turn it around.
The introduction of the new triangular-merger law, which enables foreign firms to use their own shares to buy Japanese firms via local affiliates, should encourage more foreigners to enter the Japanese market. The first example—Citigroup's takeover of Nikko Cordial—will set a precedent for Citigroup's customers, says Mr Fasol. More deregulation is still needed, says Mr Nagashima, “but we are changing.”
Illustration by JacUnder new management
That foreigners might have useful expertise was strikingly demonstrated by Carlos Ghosn's turnaround at Nissan; another instructive case was the rescue by Ripplewood, a private-equity firm, of Long-Term Credit Bank of Japan in 2000. The bank was relaunched as Shinsei (which literally means “newborn”) with new management, including many foreigners who had previously worked for financial institutions in Japan. Shinsei went public in 2004, netting Ripplewood and its partners over ¥100 billion in profit. Goldman Sachs recently fixed and resold Universal Studios Japan, an ailing theme park, and is part of a consortium trying to sort out Sanyo, an electronics conglomerate.
In theory, Japan ought to offer rich pickings for foreign private-equity firms. There are lots of troubled companies that would benefit from an injection of management expertise, and Japan itself has few turnaround specialists. But suspicion of private-equity firms is even greater than elsewhere, so investors must tread carefully. “It's a market with a lot of potential, but requires an enormous amount of patience and determination,” says Thierry Porté, who became boss of Shinsei Bank in 2005. But, he points out, foreigners have often been catalysts of change in Japanese history: “They can be used in Japan to bring in new ideas, which are then adopted and get adapted to the Japanese system.”
Tuesday, October 20, 2009
Business in Japan: Not Invented Here
Not invented here
Nov 29th 2007
From The Economist print edition
Entrepreneurs have had a hard time, but things are slowly improving
TAKASHI MASUDA wiggles his finger next to an apparently random collage of tinsel, cuddly toys and cutlery, illuminated by a spotlight. A small black chip, glued to a plastic ruler, is propped up nearby, with wires running to a circuit board festooned with blinking red lights. From this another cable runs to a large high-definition TV where every ridge of the skin on Mr Masuda's finger, every twinkly highlight on the tinsel and every hair on the cuddly toys can be clearly seen.
Mr Masuda's company, Acutelogic, makes specialist image-processing chips and software for digital cameras. Its newest product, which picked up every nuance of Mr Masuda's wiggling finger, is a tiny high-definition video sensor that can fit into a mobile phone. The idea is to make camcorders obsolete, says Mr Masuda.
He founded Acutelogic after leaving Sony, where he worked on the team that created the Cyber-shot digital camera. He felt that the electronics giant's management had lost its way and wanted to start his own company. So he set up Acutelogic, with venture-capital funding, some investment from Fujitsu, a computer giant, and money raised from friends and family.
All this sounds very similar to the way things are done in America's Silicon Valley, where large firms such as IBM, Oracle, Sun and Hewlett-Packard often act as unofficial “incubators” for engineers who spend a few years learning the ropes and then leave to set up on their own. But Mr Masuda's story differs in one crucial respect: he was 50 when he left Sony, and was able to make the leap because he was offered an early-retirement package. “It would have been better to do it at 40,” he says. But had he done so, he would have lost his company pension. His story illustrates not how easy it is to start a company in Japan, but how difficult.
Japan scores poorly on almost every measure of entrepreneurship. It has the second-lowest level in the OECD of venture-capital investment as a share of GDP, and what little venture capital is available goes disproportionately into existing firms rather than start-ups. Venture-capital investment in Japan amounts to some $2 billion a year, around a tenth of the figure in America. Start-ups account for 4% of all firms, compared with 10% in Europe and 14% in America. Japan also came last in the International Institute for Management Development's rankings on entrepreneurship and second-last in the Global Entrepreneurship Monitor's ranking of early-stage entrepreneurial activity (defined as the proportion of people of working age who are involved in such activity). Why?
Cultural factors are a big part of the explanation. As a hoary old Japanese saying has it, “the nail that sticks out is hammered down.” Conformity is valued over individualism. “Students work hard at school, but they learn how to take tests, not how to think,” laments Sakie Fukushima of Korn/Ferry. And unlike American culture, which venerates the maverick self-made millionaire and is tolerant of failure, Japan frowns upon public displays of wealth and stigmatises business failure.
On the outer edge
Take Takafumi Horie, an example of the sort of entrepreneur who remains extremely rare in Japan. With his characteristic jeans, sneakers and spiky hair, this self-styled rebel against Japan's corporate establishment transformed his internet start-up, aptly named Livin' On The Edge, into a vast conglomerate, which he renamed livedoor in 2004. At its peak, livedoor was worth some ¥930 billion ($8 billion) and owned an accounting-software firm, an internet travel agency, a securities house and a second-hand car business.
In 2005 Mr Horie mounted a takeover bid for Nippon Broadcasting System, a radio station, which would have given him control of Fuji Television, Japan's biggest commercial television station. The battle ended in a truce between Fuji and livedoor, but Mr Horie had infuriated the business establishment. In January 2006 raids on his home and office were broadcast live on television, and in March this year he was convicted of fraud and sentenced to two-and-a-half years in jail.
Mr Horie's critics regarded his use of elaborate financial engineering as evidence that pro-market reforms had gone too far; his supporters claimed that the attack on his empire had been orchestrated by Japan's corporate old guard. But his fate sent a clear signal to anyone who regarded Mr Horie as a new role model for Japanese entrepreneurs, says Hirotaka Takeuchi, dean of the school of corporate strategy at Hitotsubashi University. “He showed you can be an entrepreneur and be successful, but you shouldn't take it to excess. You've got to abide by the rules.”
In truth, Mr Horie was not the American-style capitalist people imagined him to be; indeed, the way he concealed the precarious financial state of his sprawling empire reeked of old-style Japanese book-cooking. But his behaviour served to reinforce the traditional Japanese scepticism towards showy entrepreneurs.
“If you stand out too much you become a target,” says Yoshito Hori, a venture capitalist and the founder of Globis Management School, a business school. That alone persuades many entrepreneurs to keep a low profile. But they face more than just cultural obstacles: the rigidity of the Japanese labour market makes life that much harder for them. Anyone who leaves a regular job for a start-up will find it difficult to get another job if the venture fails. And pensions are a particular problem: as Mr Masuda's example shows, people working for large companies are reluctant to leave their jobs in their 30s and 40s because they will lose their retirement benefits.
Other difficulties facing entrepreneurs include the lack of venture-capital funding, a dearth of knowledgeable angel investors, difficulty in hiring experienced managers and a lack of support networks, says Joichi Ito, an internet investor with experience both in Japan and in Silicon Valley. This forces some entrepreneurs to rely on foreign funding. “VCs and entrepreneurs are not as professional as they are in Silicon Valley,” says Sachio Semmoto, the entrepreneur behind a series of successful Japanese telecoms firms. Goldman Sachs, an American investment bank, put $25m into his most recent venture, whereas local Japanese venture funds contributed just a few hundred thousand dollars.
Given the innovative prowess of Japan's industrial giants, does it matter if start-ups have a hard time? The Economist Intelligence Unit, a sister company of this newspaper, ranked Japan first in a recent study of innovation, based on the number of patents awarded per million people. Japan generates 51% more patents than America in absolute terms, which works out at around 3.5 times as many patents per person. It also has more scientific researchers per million people (5,900 compared with 4,200 for America) and a higher research-and-development (R&D) intensity, at 3.4% of GDP compared with 2.8% for America.
But things may not be as rosy as these numbers suggest. Patents are an imperfect proxy for innovation; Japan's armies of researchers spend more time than their foreign counterparts on non-research activities such as administration, which reduces their effectiveness; and a report by the Cabinet Office found that the effectiveness of Japan's private-sector R&D—the ratio of operating profits to R&D expenditure—declined throughout the 1990s (see chart 7).
All this has fuelled concerns that Japan might now be on the wrong side of several trends. Japan's most famous innovations, such as the Sony Walkman and the Toyota Prius, originated in big companies. But the internet boom highlighted the vibrancy of the American way of innovating, in which a host of entrepreneurial start-ups try out risky new ideas and the most successful of them either become, or are acquired by, larger firms. The American approach supports radical technological breakthroughs but depends on plenty of risk capital.
Akira Takeishi of the Institute of Innovation Research at Hitotsubashi University has investigated why Japanese firms are highly competitive in some industries (carmaking, electronics, imaging products, video games) and less so in others (personal computers, software). He concluded that Japanese firms did best in manufacturing industries with closed product designs that do not require collaboration with the rest of the industry, and worst in fields based on open standards and modular architectures. So if the nature of innovation has changed, and it now depends on collaboration with other firms around the world, Japan could be in trouble. Japanese patents with foreign co-inventors accounted for less than 3% of the total, compared with 12% in America.
Another worry is that Japanese companies concentrate too much on incremental innovations rather than radical breakthroughs. This served them well in the second half of the 20th century. But given the disruptive impact of the internet and the need for entirely new energy technologies to mitigate climate change, it may no longer be the right thing to do.
The government has formulated a series of plans and targets, including measures to boost international co-operation and increased funding for researchers in fields such as nanotechnology and clean energy, where breakthroughs could open up big new markets. It has also set about improving the climate for entrepreneurs and start-ups, for example by offering more favourable tax treatment for venture-capital investments, reducing the minimum capital requirement for new businesses to ¥1 and making it easier for start-ups to issue share options to staff.
Land of opportunity?
One sign of progress is the higher turnover of new firms. Between 1997 and 2004 an average of 99 new companies a year were listed in Japan, up from 26 a year in 1981-89 and 36 a year in 1990-96. The number of delistings also rose, from four or five a year in the 1980s and early 1990s to an average of 41 a year in 1997-2004. This is due in part to the rise of second-tier stockmarkets such as Mothers in Tokyo and Hercules in Osaka, and the loosening of listing requirements on JASDAQ, which has made it easier for start-ups to go public. Mr Hori notes that there were 747 IPOs in Japan between 2001 and 2005, compared with 617 in America.
The slightly more flexible labour market has made it easier for start-ups to attract skilled workers. “Things are changing—people are coming out of big firms to join us,” says Mr Masuda, whose firm has hired engineers from JVC, Canon and other electronics giants. He says start-ups also offer more opportunities and better prospects to Chinese and South Korean engineering students in Japan: “We evaluate people for their skills, not their skins and eyes.”
Mr Hori goes so far as to suggest that start-ups have played an unacknowledged role in helping to turn around Japan's economy in recent years. He says the rebound was partly driven by the emergence of new companies in knowledge-based industries, led by entrepreneurs in their 20s and 30s. He points to Rakuten, an internet-shopping firm that now has a market capitalisation of nearly $6 billion, making it one of the largest internet-commerce firms in the world. Other Japanese success stories include DeNA, an internet-auction and shopping site, and Mixi, a social-networking site. Mr Ito is heartened by Japan's latest crop of internet entrepreneurs, such as Mixi's Kenji Kasahara. “The new generation of internet CEOs are very humble. They don't spend all their money in Ginza buying cars,” he says.
It seems that entrepreneurs can do well in Japan as long as they do not draw too much attention to themselves. Mr Hori thinks they have excellent prospects. There are still relatively few of them, and productivity in Japan's service sector is notoriously low, offering plenty of opportunities for start-ups. He says 70% of his venture-capital investments are in services companies, from nursing homes to wedding planning. Apart from services, says Mr Hori, “we are betting in areas where Japan has an edge,” such as mobile technology, optics, robotics, digital animation and video games.
Despite these hopeful signs, however, some worries remain. One concern is that if economic growth strengthens and more full-time jobs are created, would-be entrepreneurs may be tempted to take the safer option of a job instead. Japan's recent wave of entrepreneurship, suggests Randall Jones at the OECD, was caused in part by the lack of job opportunities for talented graduates during the hiring freeze of the 1990s. But Mr Hori insists that times have changed, and “the best and brightest are now going into the entrepreneurial field, which has never happened before.”
Another concern is that too much government effort to encourage start-ups and promote innovation is concentrated on manufacturing and technology rather than services, which is arguably where change is most needed. To keep the momentum going, the OECD recommends reductions in capital-gains tax to encourage venture capital; more portable pensions and performance-based pay for researchers to encourage mobility between academia and industry; a broader educational curriculum; and the promotion of cross-border trade and investment, since good ideas often come from abroad. Changing Japanese attitudes to entrepreneurship will take time and further reforms, but at least the wheels have started turning.
Nov 29th 2007
From The Economist print edition
Entrepreneurs have had a hard time, but things are slowly improving
TAKASHI MASUDA wiggles his finger next to an apparently random collage of tinsel, cuddly toys and cutlery, illuminated by a spotlight. A small black chip, glued to a plastic ruler, is propped up nearby, with wires running to a circuit board festooned with blinking red lights. From this another cable runs to a large high-definition TV where every ridge of the skin on Mr Masuda's finger, every twinkly highlight on the tinsel and every hair on the cuddly toys can be clearly seen.
Mr Masuda's company, Acutelogic, makes specialist image-processing chips and software for digital cameras. Its newest product, which picked up every nuance of Mr Masuda's wiggling finger, is a tiny high-definition video sensor that can fit into a mobile phone. The idea is to make camcorders obsolete, says Mr Masuda.
He founded Acutelogic after leaving Sony, where he worked on the team that created the Cyber-shot digital camera. He felt that the electronics giant's management had lost its way and wanted to start his own company. So he set up Acutelogic, with venture-capital funding, some investment from Fujitsu, a computer giant, and money raised from friends and family.
All this sounds very similar to the way things are done in America's Silicon Valley, where large firms such as IBM, Oracle, Sun and Hewlett-Packard often act as unofficial “incubators” for engineers who spend a few years learning the ropes and then leave to set up on their own. But Mr Masuda's story differs in one crucial respect: he was 50 when he left Sony, and was able to make the leap because he was offered an early-retirement package. “It would have been better to do it at 40,” he says. But had he done so, he would have lost his company pension. His story illustrates not how easy it is to start a company in Japan, but how difficult.
Japan scores poorly on almost every measure of entrepreneurship. It has the second-lowest level in the OECD of venture-capital investment as a share of GDP, and what little venture capital is available goes disproportionately into existing firms rather than start-ups. Venture-capital investment in Japan amounts to some $2 billion a year, around a tenth of the figure in America. Start-ups account for 4% of all firms, compared with 10% in Europe and 14% in America. Japan also came last in the International Institute for Management Development's rankings on entrepreneurship and second-last in the Global Entrepreneurship Monitor's ranking of early-stage entrepreneurial activity (defined as the proportion of people of working age who are involved in such activity). Why?
Cultural factors are a big part of the explanation. As a hoary old Japanese saying has it, “the nail that sticks out is hammered down.” Conformity is valued over individualism. “Students work hard at school, but they learn how to take tests, not how to think,” laments Sakie Fukushima of Korn/Ferry. And unlike American culture, which venerates the maverick self-made millionaire and is tolerant of failure, Japan frowns upon public displays of wealth and stigmatises business failure.
On the outer edge
Take Takafumi Horie, an example of the sort of entrepreneur who remains extremely rare in Japan. With his characteristic jeans, sneakers and spiky hair, this self-styled rebel against Japan's corporate establishment transformed his internet start-up, aptly named Livin' On The Edge, into a vast conglomerate, which he renamed livedoor in 2004. At its peak, livedoor was worth some ¥930 billion ($8 billion) and owned an accounting-software firm, an internet travel agency, a securities house and a second-hand car business.
In 2005 Mr Horie mounted a takeover bid for Nippon Broadcasting System, a radio station, which would have given him control of Fuji Television, Japan's biggest commercial television station. The battle ended in a truce between Fuji and livedoor, but Mr Horie had infuriated the business establishment. In January 2006 raids on his home and office were broadcast live on television, and in March this year he was convicted of fraud and sentenced to two-and-a-half years in jail.
Mr Horie's critics regarded his use of elaborate financial engineering as evidence that pro-market reforms had gone too far; his supporters claimed that the attack on his empire had been orchestrated by Japan's corporate old guard. But his fate sent a clear signal to anyone who regarded Mr Horie as a new role model for Japanese entrepreneurs, says Hirotaka Takeuchi, dean of the school of corporate strategy at Hitotsubashi University. “He showed you can be an entrepreneur and be successful, but you shouldn't take it to excess. You've got to abide by the rules.”
In truth, Mr Horie was not the American-style capitalist people imagined him to be; indeed, the way he concealed the precarious financial state of his sprawling empire reeked of old-style Japanese book-cooking. But his behaviour served to reinforce the traditional Japanese scepticism towards showy entrepreneurs.
“If you stand out too much you become a target,” says Yoshito Hori, a venture capitalist and the founder of Globis Management School, a business school. That alone persuades many entrepreneurs to keep a low profile. But they face more than just cultural obstacles: the rigidity of the Japanese labour market makes life that much harder for them. Anyone who leaves a regular job for a start-up will find it difficult to get another job if the venture fails. And pensions are a particular problem: as Mr Masuda's example shows, people working for large companies are reluctant to leave their jobs in their 30s and 40s because they will lose their retirement benefits.
Other difficulties facing entrepreneurs include the lack of venture-capital funding, a dearth of knowledgeable angel investors, difficulty in hiring experienced managers and a lack of support networks, says Joichi Ito, an internet investor with experience both in Japan and in Silicon Valley. This forces some entrepreneurs to rely on foreign funding. “VCs and entrepreneurs are not as professional as they are in Silicon Valley,” says Sachio Semmoto, the entrepreneur behind a series of successful Japanese telecoms firms. Goldman Sachs, an American investment bank, put $25m into his most recent venture, whereas local Japanese venture funds contributed just a few hundred thousand dollars.
Given the innovative prowess of Japan's industrial giants, does it matter if start-ups have a hard time? The Economist Intelligence Unit, a sister company of this newspaper, ranked Japan first in a recent study of innovation, based on the number of patents awarded per million people. Japan generates 51% more patents than America in absolute terms, which works out at around 3.5 times as many patents per person. It also has more scientific researchers per million people (5,900 compared with 4,200 for America) and a higher research-and-development (R&D) intensity, at 3.4% of GDP compared with 2.8% for America.
But things may not be as rosy as these numbers suggest. Patents are an imperfect proxy for innovation; Japan's armies of researchers spend more time than their foreign counterparts on non-research activities such as administration, which reduces their effectiveness; and a report by the Cabinet Office found that the effectiveness of Japan's private-sector R&D—the ratio of operating profits to R&D expenditure—declined throughout the 1990s (see chart 7).
All this has fuelled concerns that Japan might now be on the wrong side of several trends. Japan's most famous innovations, such as the Sony Walkman and the Toyota Prius, originated in big companies. But the internet boom highlighted the vibrancy of the American way of innovating, in which a host of entrepreneurial start-ups try out risky new ideas and the most successful of them either become, or are acquired by, larger firms. The American approach supports radical technological breakthroughs but depends on plenty of risk capital.
Akira Takeishi of the Institute of Innovation Research at Hitotsubashi University has investigated why Japanese firms are highly competitive in some industries (carmaking, electronics, imaging products, video games) and less so in others (personal computers, software). He concluded that Japanese firms did best in manufacturing industries with closed product designs that do not require collaboration with the rest of the industry, and worst in fields based on open standards and modular architectures. So if the nature of innovation has changed, and it now depends on collaboration with other firms around the world, Japan could be in trouble. Japanese patents with foreign co-inventors accounted for less than 3% of the total, compared with 12% in America.
Another worry is that Japanese companies concentrate too much on incremental innovations rather than radical breakthroughs. This served them well in the second half of the 20th century. But given the disruptive impact of the internet and the need for entirely new energy technologies to mitigate climate change, it may no longer be the right thing to do.
The government has formulated a series of plans and targets, including measures to boost international co-operation and increased funding for researchers in fields such as nanotechnology and clean energy, where breakthroughs could open up big new markets. It has also set about improving the climate for entrepreneurs and start-ups, for example by offering more favourable tax treatment for venture-capital investments, reducing the minimum capital requirement for new businesses to ¥1 and making it easier for start-ups to issue share options to staff.
Land of opportunity?
One sign of progress is the higher turnover of new firms. Between 1997 and 2004 an average of 99 new companies a year were listed in Japan, up from 26 a year in 1981-89 and 36 a year in 1990-96. The number of delistings also rose, from four or five a year in the 1980s and early 1990s to an average of 41 a year in 1997-2004. This is due in part to the rise of second-tier stockmarkets such as Mothers in Tokyo and Hercules in Osaka, and the loosening of listing requirements on JASDAQ, which has made it easier for start-ups to go public. Mr Hori notes that there were 747 IPOs in Japan between 2001 and 2005, compared with 617 in America.
The slightly more flexible labour market has made it easier for start-ups to attract skilled workers. “Things are changing—people are coming out of big firms to join us,” says Mr Masuda, whose firm has hired engineers from JVC, Canon and other electronics giants. He says start-ups also offer more opportunities and better prospects to Chinese and South Korean engineering students in Japan: “We evaluate people for their skills, not their skins and eyes.”
Mr Hori goes so far as to suggest that start-ups have played an unacknowledged role in helping to turn around Japan's economy in recent years. He says the rebound was partly driven by the emergence of new companies in knowledge-based industries, led by entrepreneurs in their 20s and 30s. He points to Rakuten, an internet-shopping firm that now has a market capitalisation of nearly $6 billion, making it one of the largest internet-commerce firms in the world. Other Japanese success stories include DeNA, an internet-auction and shopping site, and Mixi, a social-networking site. Mr Ito is heartened by Japan's latest crop of internet entrepreneurs, such as Mixi's Kenji Kasahara. “The new generation of internet CEOs are very humble. They don't spend all their money in Ginza buying cars,” he says.
It seems that entrepreneurs can do well in Japan as long as they do not draw too much attention to themselves. Mr Hori thinks they have excellent prospects. There are still relatively few of them, and productivity in Japan's service sector is notoriously low, offering plenty of opportunities for start-ups. He says 70% of his venture-capital investments are in services companies, from nursing homes to wedding planning. Apart from services, says Mr Hori, “we are betting in areas where Japan has an edge,” such as mobile technology, optics, robotics, digital animation and video games.
Despite these hopeful signs, however, some worries remain. One concern is that if economic growth strengthens and more full-time jobs are created, would-be entrepreneurs may be tempted to take the safer option of a job instead. Japan's recent wave of entrepreneurship, suggests Randall Jones at the OECD, was caused in part by the lack of job opportunities for talented graduates during the hiring freeze of the 1990s. But Mr Hori insists that times have changed, and “the best and brightest are now going into the entrepreneurial field, which has never happened before.”
Another concern is that too much government effort to encourage start-ups and promote innovation is concentrated on manufacturing and technology rather than services, which is arguably where change is most needed. To keep the momentum going, the OECD recommends reductions in capital-gains tax to encourage venture capital; more portable pensions and performance-based pay for researchers to encourage mobility between academia and industry; a broader educational curriculum; and the promotion of cross-border trade and investment, since good ideas often come from abroad. Changing Japanese attitudes to entrepreneurship will take time and further reforms, but at least the wheels have started turning.
Business in Japan: Still Work to be Done
Still work to be done
Nov 29th 2007
From The Economist print edition
Japan's labour market is becoming more flexible, but also more unequal
IN THE summer of 2007 Toshifumi Mori moved back to Japan, having spent 14 years in America, Canada, Britain and Germany working for Mitsubishi, one of Japan's big industrial groups. He was struck by some of the advertisements he saw on the Tokyo subway. Such hoardings, he feels, “tell you what's in”. Alongside the posters promoting mobile phones and beer he was surprised to see advertisements for headhunters and recruitment firms. “There was nothing like that 15 years ago,” he says. He joined Heidrick & Struggles, one of several companies both promoting and profiting from a more flexible Japanese labour market.
Where he worked before, the traditional Japanese “lifetime employment” model was deeply entrenched. It is often said that this model is now collapsing and that the era of “jobs for life” has come to an end. But the reality is more complicated. For one thing, the traditional lifetime-employment system existed for only a few decades, and only at large Japanese firms; it was never universal. The system is now slowly crumbling, but only at the edges, notes Akira Kawamoto, the director of research at RIETI, a government think-tank. Most of the “salarymen” inside the traditional system will stay there until they retire. But the labour market is becoming more flexible in several ways.
Mid-career job changes, once unheard of, are no longer quite such a rarity. The strict seniority system is giving way to a greater emphasis on performance-based pay and promotion on merit. And the number of “non-regular workers” (a term that encompasses temporary, part-time and contract workers) is increasing. But much of this reflects efforts by Japanese companies to shore up the lifetime employment system for its “regular workers”, involving necessary concessions to keep the old system going. Useful though the reforms have been, they have also raised concerns about the growing inequality between regular and non-regular workers.
Under the traditional system, companies hired graduates and then invested heavily in their training and development. To keep workers loyal and protect their investment, they offered lifetime employment on steadily increasing pay, with generous fringe benefits and a lump sum on retirement. Employees worked their way up through the ranks, so age and seniority were tightly intertwined. This made it hard for people to switch companies in mid-career. Women who left to have children found they could return only to more junior, part-time positions. People competed fiercely for jobs at the best companies—but once they were in, their performance made no difference to their pay. “At Mitsubishi your salary went up by the same amount, no matter how hard you worked. My friends at foreign firms found this unbelievable,” recalls Mr Mori.
But this is now changing. Young people who start work at a big company no longer expect to stay there for their entire career. Some of them want more of a challenge, says Mr Mori; others “have seen what happens to people who move to another company and do well”. Foreign firms in Japan helped things along by poaching staff from Japanese firms, offering attractive benefits and better prospects for promotion on merit. “That creates more mobility,” says Mr Mori. “People hear success stories by word of mouth. If some people jump and become top managers, others want to do the same.” This is particularly noticeable in financial services, he says, but is spreading to other industries too. A common strategy is to start at a Japanese firm, move on to a foreign firm and then return to a Japanese firm in a more senior position.
Signs of movement
A greater willingness to switch jobs also reflects declining confidence in the guarantee of lifetime employment, says Sakie Fukushima of Korn/Ferry, an executive-search firm. When she moved to Korn/Ferry in 1991, she says, on average only one in ten of the candidates she called was prepared to meet her. “Others would say they were not interested in moving or were scared by the term ‘headhunting'—we were thought to be industrial spies.” But after the dramatic collapse in 1997 of Yamaichi Securities, a securities-trading firm, there was “a huge change in psychology” as people realised that companies could fail. Today, she says, seven or eight out of ten people she contacts are prepared to meet her. “Many do not move, but they are interested to see what their options are.”
For their part, Japanese firms have become more willing to hire outsiders. With the fall from grace of the Japanese model in the 1990s and the increasing competitiveness of foreign firms, Japanese companies started to realise that they might benefit from outside expertise. There was also a “Carlos Ghosn” effect. When he first arrived at Nissan, Mr Ghosn was held in contempt by the corporate establishment. But within two years he had turned the company around, prompting a rethink among Japanese bosses.
More portable pensions have further increased labour mobility. Under the traditional Japanese system, employees qualified for a lump sum at retirement (over and above the state pension scheme) after 30 years at the same firm, which strongly discouraged mid-career moves. But some firms, most famously Matsushita, a big electronics manufacturer, have introduced a new scheme in which employees waive the lump sum at retirement in return for a higher salary. They can then put some of their extra pay into a personal pension plan, akin to an American 401(k), which they can take with them if they switch employers. This is particularly popular with women, says Mr Kawamoto. Workers who opt for it do not seem to be seen as disloyal. The tax system could be changed to encourage more people to use the scheme, he suggests: as things stand, the tax on traditional retirement income is low, but the tax treatment of portable personal pensions is comparatively ungenerous.
Performance-related pay has been another example of Japanese firms' experimentation with American ways of doing things. In some cases it started off as a form of wage restraint in the dark days of the 1990s: companies cut basic wages and employees hoped that performance-related pay might make up the difference, which it did not always do.
The idea met with stiff resistance. When Fujitsu, a Japanese computer giant, introduced a performance-based pay scheme during the 1990s, it proved so unpopular that the company had to scale it back. Managers found that workers became demoralised if they were not given above-average grades for performance—which, by definition, most could not be. NEC, another Japanese computer giant, introduced a similar programme and also had to modify it. Many firms now offer performance-based pay and other incentives, such as stock options, only to certain categories of worker, and keep the performance-related component small.
Along with performance-related pay has come a greater emphasis on meritocratic rather than seniority-based promotion. In recent years some firms have appointed younger chief executives, in their 50s, but many salarymen are unwilling to work under managers who are younger than themselves or who used to be their subordinates. Even within Sony, one of the most Americanised companies, old habits die hard. “I offered someone a senior job and he said: ‘But I'm only 48!',” says Sir Howard Stringer, the company's chief executive. “People thought seniority and skill were totally intertwined.”
As the labour market has become more dynamic for regular workers, however, the gulf between regular and non-regular workers has widened. When the recession took hold in the early 1990s, the idea that Japanese firms would make workers redundant was unthinkable. Instead, to maintain lifetime employment, companies held down pay and benefits for existing employees and stopped hiring new graduates. Spurred by changes to employment law, they also began to take on more non-regular workers on lower pay and short-term contracts. Whereas in 1994 non-regular workers accounted for only 19% of the labour force, the figure has since risen to 33%. This created a “lost generation” of graduates who were unable to get full-time jobs during the 1990s, got stuck in low-paid, non-regular positions in which no training was provided and found it difficult to move into regular employment.
There are different grades of people without regular employment. First come the “freeters” (a combination of “free” and Arbeiter, the German word for worker), those in temporary or part-time employment, whether by choice or necessity. Some freeters enjoy flitting between jobs, but many would prefer regular employment. According to a survey carried out in 2003, 40% of temporary workers and 22% of part-time workers said they would rather have a regular job but could not find one. Next are the NEETs (those “not in education, employment or training”) and the hikikomori, the twenty-somethings who withdraw from social life.
Most notorious are the so-called “net-café refugees”, an underclass of non-regular workers who cannot afford accommodation in the cities where they work and instead sleep in rented cubicles in internet cafés. A recent government report put the number of such “refugees” at some 5,400 nationwide. That is not a lot, but it highlights an area of growing concern: inequality was one of the issues on which the Democratic Party of Japan fought its successful upper-house election campaign in July which led to the downfall of the prime minister, Shinzo Abe.
The protection of regular workers, in short, has come at the cost of a growing army of non-regular workers. The irony is that companies that claim to be committed to lifetime employment can meet this commitment only by cutting back on hiring regular workers and relying increasingly on non-regular workers. “Toyota and Canon say they are still keeping lifetime employment, but to do so they are introducing a large number of non-regular workers,” says Keio University's Mr Seike. Canon, for example, now employs 70% of its factory workers on non-regular terms, up from 50% in 2000 and 10% in 1995. Non-regular workers typically earn half as much as regular workers for comparable work. About half of them are not covered by company pension or health-care schemes. But although the use of low-paid, non-regular workers reduces firms' costs, says Randall Jones of the OECD, it has the broader effect of constraining consumption, “so the expansion is still not firing on all cylinders.”
That said, as the economic recovery causes the labour market to tighten—unemployment hit a nine-year low of 3.6% in July—companies are starting to move some non-regular workers into regular positions. UNIQLO, for example, a clothes retailer, said in March that it would turn 5,000 of its 6,000 non-regular workers into regular ones within two years, and Canon said it would do the same for 1,000 of its 13,000 factory workers. Companies are also readier to hire workers in their 30s, particularly those with specific skills, says Mr Mori. That is helping to mop up some of the lost-generation freeters.
The danger remains that Japan will find itself with a generation of middle-aged workers with inadequate levels of training, says Mr Seike. What is needed, he says, is a scheme to encourage companies to invest in training those in their 30s, with some of the training costs provided by the government. But the best way forward would be to close the gap between regular and non-regular workers by reducing the pay and benefits of the first group and creating better conditions for the second.
Tick, tick
The reform of Japan's labour market is being driven by the need to become more competitive and flexible in the face of global competition. But Japan also needs to tackle a longer-term threat: the ageing of its population. The share of its population aged 65 or over, currently 21%, will rise to 25% by 2014 and 36% by 2050. Japan's fertility rate has also been declining, hitting a low of 1.26 in 2005, though it has since risen slightly, to 1.32. But that is still far below the replacement rate of 2.1 children per woman. So as well as ageing, Japan's population is now shrinking. By 2030 Japan will have two workers for every pensioner; by 2050 there will be only 1.5. Large-scale immigration, the solution favoured in other rich countries, is not culturally acceptable in Japan. So it will have to put more women and old people to work in order to maintain its workforce.
To this end, the government has already passed a law requiring companies to raise their mandatory retirement age or provide retraining and re-employment for older workers. Most companies favour the second option: the seniority-based pay system makes the oldest workers the most expensive, so it is cheaper to offer them lower-paid work in semi-retirement than to keep them on as full-time employees.
Japan's elderly are still willing to work, unlike their counterparts in Europe, notes Mr Seike. In theory, older workers could be put to good use training their younger colleagues. Raising the retirement age to 70 would roughly halve the rate of decline of the workforce. Increasing the participation rate of women from its current level of 61% (versus 69% in America) would help even more. Japan's working-age population is expected to decline by nearly one-fifth by 2030, and boosting female participation would be the single most effective means of limiting the decline.
Many of the measures needed to do that, such as reducing the inequality between regular and non-regular workers and placing more emphasis on merit-based pay and promotion, would also improve flexibility more generally, notes Kuniko Inoguchi, who was minister for gender equality under the Koizumi government. But other measures that would specifically benefit women, such as better provision of child-care facilities, are also needed. Only 33% of children between the age of three and the mandatory school age (six in Japan) are in formal child care, compared with the OECD average of 73%. New rules for corporate child-care schemes and maternity leave for non-regular workers came into force in April. Big companies tend to offer child-care facilities already, but 90% of women in jobs work at small firms, which need to be persuaded to follow suit, says Ms Inoguchi.
Japan is doing its best to combine the stability and equality of its old labour-market system with the dynamism of the new. But as it becomes clearer that conditions for non-regular workers need to be improved and more women have to be encouraged to enter the workforce, the crumbling of the old system will accelerate.
Nov 29th 2007
From The Economist print edition
Japan's labour market is becoming more flexible, but also more unequal
IN THE summer of 2007 Toshifumi Mori moved back to Japan, having spent 14 years in America, Canada, Britain and Germany working for Mitsubishi, one of Japan's big industrial groups. He was struck by some of the advertisements he saw on the Tokyo subway. Such hoardings, he feels, “tell you what's in”. Alongside the posters promoting mobile phones and beer he was surprised to see advertisements for headhunters and recruitment firms. “There was nothing like that 15 years ago,” he says. He joined Heidrick & Struggles, one of several companies both promoting and profiting from a more flexible Japanese labour market.
Where he worked before, the traditional Japanese “lifetime employment” model was deeply entrenched. It is often said that this model is now collapsing and that the era of “jobs for life” has come to an end. But the reality is more complicated. For one thing, the traditional lifetime-employment system existed for only a few decades, and only at large Japanese firms; it was never universal. The system is now slowly crumbling, but only at the edges, notes Akira Kawamoto, the director of research at RIETI, a government think-tank. Most of the “salarymen” inside the traditional system will stay there until they retire. But the labour market is becoming more flexible in several ways.
Mid-career job changes, once unheard of, are no longer quite such a rarity. The strict seniority system is giving way to a greater emphasis on performance-based pay and promotion on merit. And the number of “non-regular workers” (a term that encompasses temporary, part-time and contract workers) is increasing. But much of this reflects efforts by Japanese companies to shore up the lifetime employment system for its “regular workers”, involving necessary concessions to keep the old system going. Useful though the reforms have been, they have also raised concerns about the growing inequality between regular and non-regular workers.
Under the traditional system, companies hired graduates and then invested heavily in their training and development. To keep workers loyal and protect their investment, they offered lifetime employment on steadily increasing pay, with generous fringe benefits and a lump sum on retirement. Employees worked their way up through the ranks, so age and seniority were tightly intertwined. This made it hard for people to switch companies in mid-career. Women who left to have children found they could return only to more junior, part-time positions. People competed fiercely for jobs at the best companies—but once they were in, their performance made no difference to their pay. “At Mitsubishi your salary went up by the same amount, no matter how hard you worked. My friends at foreign firms found this unbelievable,” recalls Mr Mori.
But this is now changing. Young people who start work at a big company no longer expect to stay there for their entire career. Some of them want more of a challenge, says Mr Mori; others “have seen what happens to people who move to another company and do well”. Foreign firms in Japan helped things along by poaching staff from Japanese firms, offering attractive benefits and better prospects for promotion on merit. “That creates more mobility,” says Mr Mori. “People hear success stories by word of mouth. If some people jump and become top managers, others want to do the same.” This is particularly noticeable in financial services, he says, but is spreading to other industries too. A common strategy is to start at a Japanese firm, move on to a foreign firm and then return to a Japanese firm in a more senior position.
Signs of movement
A greater willingness to switch jobs also reflects declining confidence in the guarantee of lifetime employment, says Sakie Fukushima of Korn/Ferry, an executive-search firm. When she moved to Korn/Ferry in 1991, she says, on average only one in ten of the candidates she called was prepared to meet her. “Others would say they were not interested in moving or were scared by the term ‘headhunting'—we were thought to be industrial spies.” But after the dramatic collapse in 1997 of Yamaichi Securities, a securities-trading firm, there was “a huge change in psychology” as people realised that companies could fail. Today, she says, seven or eight out of ten people she contacts are prepared to meet her. “Many do not move, but they are interested to see what their options are.”
For their part, Japanese firms have become more willing to hire outsiders. With the fall from grace of the Japanese model in the 1990s and the increasing competitiveness of foreign firms, Japanese companies started to realise that they might benefit from outside expertise. There was also a “Carlos Ghosn” effect. When he first arrived at Nissan, Mr Ghosn was held in contempt by the corporate establishment. But within two years he had turned the company around, prompting a rethink among Japanese bosses.
More portable pensions have further increased labour mobility. Under the traditional Japanese system, employees qualified for a lump sum at retirement (over and above the state pension scheme) after 30 years at the same firm, which strongly discouraged mid-career moves. But some firms, most famously Matsushita, a big electronics manufacturer, have introduced a new scheme in which employees waive the lump sum at retirement in return for a higher salary. They can then put some of their extra pay into a personal pension plan, akin to an American 401(k), which they can take with them if they switch employers. This is particularly popular with women, says Mr Kawamoto. Workers who opt for it do not seem to be seen as disloyal. The tax system could be changed to encourage more people to use the scheme, he suggests: as things stand, the tax on traditional retirement income is low, but the tax treatment of portable personal pensions is comparatively ungenerous.
Performance-related pay has been another example of Japanese firms' experimentation with American ways of doing things. In some cases it started off as a form of wage restraint in the dark days of the 1990s: companies cut basic wages and employees hoped that performance-related pay might make up the difference, which it did not always do.
The idea met with stiff resistance. When Fujitsu, a Japanese computer giant, introduced a performance-based pay scheme during the 1990s, it proved so unpopular that the company had to scale it back. Managers found that workers became demoralised if they were not given above-average grades for performance—which, by definition, most could not be. NEC, another Japanese computer giant, introduced a similar programme and also had to modify it. Many firms now offer performance-based pay and other incentives, such as stock options, only to certain categories of worker, and keep the performance-related component small.
Along with performance-related pay has come a greater emphasis on meritocratic rather than seniority-based promotion. In recent years some firms have appointed younger chief executives, in their 50s, but many salarymen are unwilling to work under managers who are younger than themselves or who used to be their subordinates. Even within Sony, one of the most Americanised companies, old habits die hard. “I offered someone a senior job and he said: ‘But I'm only 48!',” says Sir Howard Stringer, the company's chief executive. “People thought seniority and skill were totally intertwined.”
As the labour market has become more dynamic for regular workers, however, the gulf between regular and non-regular workers has widened. When the recession took hold in the early 1990s, the idea that Japanese firms would make workers redundant was unthinkable. Instead, to maintain lifetime employment, companies held down pay and benefits for existing employees and stopped hiring new graduates. Spurred by changes to employment law, they also began to take on more non-regular workers on lower pay and short-term contracts. Whereas in 1994 non-regular workers accounted for only 19% of the labour force, the figure has since risen to 33%. This created a “lost generation” of graduates who were unable to get full-time jobs during the 1990s, got stuck in low-paid, non-regular positions in which no training was provided and found it difficult to move into regular employment.
There are different grades of people without regular employment. First come the “freeters” (a combination of “free” and Arbeiter, the German word for worker), those in temporary or part-time employment, whether by choice or necessity. Some freeters enjoy flitting between jobs, but many would prefer regular employment. According to a survey carried out in 2003, 40% of temporary workers and 22% of part-time workers said they would rather have a regular job but could not find one. Next are the NEETs (those “not in education, employment or training”) and the hikikomori, the twenty-somethings who withdraw from social life.
Most notorious are the so-called “net-café refugees”, an underclass of non-regular workers who cannot afford accommodation in the cities where they work and instead sleep in rented cubicles in internet cafés. A recent government report put the number of such “refugees” at some 5,400 nationwide. That is not a lot, but it highlights an area of growing concern: inequality was one of the issues on which the Democratic Party of Japan fought its successful upper-house election campaign in July which led to the downfall of the prime minister, Shinzo Abe.
The protection of regular workers, in short, has come at the cost of a growing army of non-regular workers. The irony is that companies that claim to be committed to lifetime employment can meet this commitment only by cutting back on hiring regular workers and relying increasingly on non-regular workers. “Toyota and Canon say they are still keeping lifetime employment, but to do so they are introducing a large number of non-regular workers,” says Keio University's Mr Seike. Canon, for example, now employs 70% of its factory workers on non-regular terms, up from 50% in 2000 and 10% in 1995. Non-regular workers typically earn half as much as regular workers for comparable work. About half of them are not covered by company pension or health-care schemes. But although the use of low-paid, non-regular workers reduces firms' costs, says Randall Jones of the OECD, it has the broader effect of constraining consumption, “so the expansion is still not firing on all cylinders.”
That said, as the economic recovery causes the labour market to tighten—unemployment hit a nine-year low of 3.6% in July—companies are starting to move some non-regular workers into regular positions. UNIQLO, for example, a clothes retailer, said in March that it would turn 5,000 of its 6,000 non-regular workers into regular ones within two years, and Canon said it would do the same for 1,000 of its 13,000 factory workers. Companies are also readier to hire workers in their 30s, particularly those with specific skills, says Mr Mori. That is helping to mop up some of the lost-generation freeters.
The danger remains that Japan will find itself with a generation of middle-aged workers with inadequate levels of training, says Mr Seike. What is needed, he says, is a scheme to encourage companies to invest in training those in their 30s, with some of the training costs provided by the government. But the best way forward would be to close the gap between regular and non-regular workers by reducing the pay and benefits of the first group and creating better conditions for the second.
Tick, tick
The reform of Japan's labour market is being driven by the need to become more competitive and flexible in the face of global competition. But Japan also needs to tackle a longer-term threat: the ageing of its population. The share of its population aged 65 or over, currently 21%, will rise to 25% by 2014 and 36% by 2050. Japan's fertility rate has also been declining, hitting a low of 1.26 in 2005, though it has since risen slightly, to 1.32. But that is still far below the replacement rate of 2.1 children per woman. So as well as ageing, Japan's population is now shrinking. By 2030 Japan will have two workers for every pensioner; by 2050 there will be only 1.5. Large-scale immigration, the solution favoured in other rich countries, is not culturally acceptable in Japan. So it will have to put more women and old people to work in order to maintain its workforce.
To this end, the government has already passed a law requiring companies to raise their mandatory retirement age or provide retraining and re-employment for older workers. Most companies favour the second option: the seniority-based pay system makes the oldest workers the most expensive, so it is cheaper to offer them lower-paid work in semi-retirement than to keep them on as full-time employees.
Japan's elderly are still willing to work, unlike their counterparts in Europe, notes Mr Seike. In theory, older workers could be put to good use training their younger colleagues. Raising the retirement age to 70 would roughly halve the rate of decline of the workforce. Increasing the participation rate of women from its current level of 61% (versus 69% in America) would help even more. Japan's working-age population is expected to decline by nearly one-fifth by 2030, and boosting female participation would be the single most effective means of limiting the decline.
Many of the measures needed to do that, such as reducing the inequality between regular and non-regular workers and placing more emphasis on merit-based pay and promotion, would also improve flexibility more generally, notes Kuniko Inoguchi, who was minister for gender equality under the Koizumi government. But other measures that would specifically benefit women, such as better provision of child-care facilities, are also needed. Only 33% of children between the age of three and the mandatory school age (six in Japan) are in formal child care, compared with the OECD average of 73%. New rules for corporate child-care schemes and maternity leave for non-regular workers came into force in April. Big companies tend to offer child-care facilities already, but 90% of women in jobs work at small firms, which need to be persuaded to follow suit, says Ms Inoguchi.
Japan is doing its best to combine the stability and equality of its old labour-market system with the dynamism of the new. But as it becomes clearer that conditions for non-regular workers need to be improved and more women have to be encouraged to enter the workforce, the crumbling of the old system will accelerate.
Business in Japan: Message in a Bottle of Sauce
BUSINESS IN JAPAN
Message in a bottle of sauce
Nov 29th 2007
From The Economist print edition
IT WAS not a storm in a teacup but a battle over a bottle of sauce. The fight during 2007 for Bull-Dog Sauce, a Japanese condiment-maker with 27% of the sauce market, cast into sharp relief the conflict between no-holds-barred Anglo-Saxon capitalism and the traditional Japanese approach to corporate governance.
The supposed villain of the piece was Steel Partners, an American investment fund that since 2000 has invested more than $3 billion in some 30 Japanese companies. Having built up a 10% stake in Bull-Dog, Steel launched a takeover bid in May, offering to buy all outstanding shares in the company for around $260m, a 20% premium over the share price at the time. Bull-Dog's management opposed the bid. “Why us?” lamented the firm's managing director, Masaomi Tamiya. Steel was accused of being a “greenmailer”—a predator that buys a large share in a company, threatens to take it over and then agrees to drop its bid and sell its stake back to the company at a hefty premium. Warren Lichtenstein, Steel's boss, insisted that Steel had a long-term commitment to Bull-Dog. But on a visit to Tokyo to meet Bull-Dog's management, he made matters worse by saying he planned to “educate” and “enlighten” Japanese managers about American-style capitalism.
At its shareholder meeting in June, Bull-Dog proposed to enact a “poison pill” defence that involved issuing three new shares for every existing share to all shareholders—except Steel, which would instead receive cash, diluting its original stake. Mr Lichtenstein gave warning that the poison pill could set a dangerous precedent and deter investment in other Japanese companies. But that, of course, was the whole idea. The poison-pill motion was passed, and although Steel mounted a legal challenge, Bull-Dog's right to use the device was upheld by the courts. So the foreign investors were thwarted, but at great cost to Bull-Dog, which said it expected to make a loss of ¥980m ($8.3m) for the year to March 2008, rather than the previously forecast profit of ¥500m.
The Bull-Dog saga was a litmus test for attitudes to shareholder capitalism. Those who believe that companies should be run to maximise the returns to shareholders thought that shareholders should have accepted Steel's generous offer; but those who hold the traditional Japanese view that companies are social communities, not baubles to be bought and sold, disapproved of Steel's treatment of a venerated 105-year-old company.
Both sides have a point. Japanese companies have neglected their shareholders for too long. But, says Gerald Curtis, a Japan-watcher at New York's Columbia University, Steel's “heavy-handed, flat-footed approach” has made it more difficult for others to argue that companies should pay more attention to their shareholders. “A lot of Japanese in the business and financial community are mainly mad at Steel because they make it more difficult for Japan to do what it has to do,” says Mr Curtis.
For one thing, Japanese firms tend to sit on piles of money: the cash and securities they hold amount to 16% of gross domestic product, compared with a long-term average in America of around 5%. And Japanese companies' average return on equity is only around 9%, compared with 14-17% in America and Europe. Under a previous set of rules, dividend payments were taxed whereas capital gains were not, so Japanese investors were more interested in share-price gains than in dividends; but those rules no longer apply. And the proportion of Japanese shares held by foreign investors has increased hugely, from 5% in 1990 to 28% now. Both these changes have increased the pressure on companies to use any excess cash to increase dividends, or to buy back shares to boost prices.
Foreign investors have been demanding this for years, but domestic investors are now following suit. A pioneer in this field was Japan's most famous activist investor, Yoshiaki Murakami, a colourful and controversial figure who in July was found guilty of insider trading and sentenced to two years in prison. Although Mr Murakami plainly went too far, he helped make the case for a greater emphasis on shareholder returns. Japan's Pension Fund Association, a quasi-governmental body that oversees investments worth more than $100 billion, said this year that it would press firms to pay higher dividends and would vote against directors of companies making inadequate returns.
Another example of an investor exerting pressure involves Sparx Group, a Japanese investment fund that was the largest shareholder in Pentax, a camera-maker. In April Pentax changed its mind over an agreed takeover offer from another Japanese firm, Hoya, the world's biggest producer of optical glass, and ousted the company's president who had devised the deal. But Sparx, along with other investors, felt that being bought by Hoya would be the best option for Pentax as well as for its shareholders, so it got the ousted president reinstated, prompting the Pentax board to resign. The deal went ahead on improved terms. Sparx prevailed by handling the situation delicately. “That's their style—not to put up a loudspeaker,” says David Marra of A.T. Kearney.
Similarly, in February another Japanese investment fund, Ichigo Asset Management, successfully persuaded shareholders in Tokyo Kohtetsu, a steel company, to reject a merger with Osaka Steel. This was the first time that shareholders in a Japanese company had ever rejected a merger plan already approved by the two companies' boards. Ichigo, which held a 13% stake in Tokyo Kohtetsu, approved of the logic of the deal but felt that the proposed share-swap short-changed Tokyo Kohtetsu's shareholders.
Some foreign activist investors are also taking a more subtle approach. The Children's Investment fund (TCI), for instance, which has a 10% stake in J-Power, an electrical utility, earlier this year pressed the company to triple its year-end dividend. TCI's boss, Christopher Hohn, began his letter to shareholders by apologising for writing to them out of the blue, then carefully explained why he thought that J-Power needed to do better. The company responded with a letter of its own, and in June TCI's resolution was defeated. “TCI trod carefully and decided to lose round one gracefully,” says Mr Marra approvingly. Investors who recognise that Japan is still getting used to a more activist approach (rather than treating Japanese firms in the same way they would treat American ones) will reap benefits in the long term, he says.
Japanese managers may not find it easy to switch their attention to shareholder value, but the trend towards greater shareholder activism is clear. This year around 30 companies have faced shareholder resolutions, double the 2006 figure. Many of them demanded higher dividend payouts. All such resolutions were defeated, notes Steven Thomas of UBS, an investment bank, but in many cases companies subsequently introduced their own resolutions to increase dividends by a smaller amount, in effect meeting the activists halfway. Japan is gradually coming to appreciate the benefits that activist investors can provide, says Shoichi Niwa of RECOF, a specialist mergers-and-acquisitions consultancy.
Learning to love M&A
Japanese firms are also changing their attitudes towards M&A. The pace is picking up (see chart 3) and the nature of the deals is changing. For most of the past decade, says Mr Niwa, M&A deals involved mainly domestic firms as they restructured and spun off non-core subsidiaries. But then the merger activity spread to the core businesses themselves, with consolidation in a number of industries including oil, steel, banking, insurance, pharmaceuticals and retailing. In the past two years Japanese firms have also made more acquisitions abroad. These are not the trophy assets of the late 1980s, but strategic purchases by Japanese firms to make themselves more globally competitive: Nippon Sheet Glass bought Pilkington, Japan Tobacco bought Gallaher and Toshiba bought Westinghouse, for example.
Changes in Japan's corporate law acted as catalysts. In 1999 it became possible to buy other firms using shares; in 2000 it became easier for companies to spin off non-core divisions. Accounting rules were also changed, forcing companies to produce consolidated statements and disclose cashflow figures and making it harder to hide poorly performing subsidiaries. Another rule change requires companies to list assets at market value, which makes it easier to work out whether a company's market capitalisation is lower than the value of its assets (not uncommon in Japan). “There have been very drastic changes in this area in the past ten years—more drastic than anything seen before,” says Mr Niwa.
With each change, the rate of deal-making picks up. The latest one, which took effect in May, covers “triangular mergers” in which a foreign firm uses its own shares, via a Japanese subsidiary, to buy a Japanese firm. The first triangular deal, the takeover of Nikko Cordial by Citigroup, was announced in October. “Things are getting bought and sold in a way we didn't see in the 1980s and 1990s,” says Mr Thomas. Managers used to regard M&A as a sign of weakness, unnecessary for “good” companies. “But now they understand that M&A can be a good thing, that this is a standard part of the corporate toolbox,” he explains. Admittedly, the average level of M&A as a proportion of GDP, at around 3%, is much lower than that in America or Britain, at about 10%, but it is a lot higher than Japan's figure in 1991, when it was just 0.4% of GDP.
A bigger concern is that M&A activity is not playing its proper part, which is to make companies more efficient. That is because acquired companies often continue to be run as distinct firms within a firm, and the usual cost savings from laying off staff do not materialise because Japanese firms rarely sack people. Similarly, the opportunity to save money by replacing two brands with a single one is not always taken. “Companies have a face problem,” explains Katsumi Ihara, the head of Sony's electronics division. Employees and customers have strong attachments to companies and brands and want them to live on, which hinders M&A, he says.
Mr Marra points out that the average takeover premium paid in America is 25%, which reflects the cost savings that the buyer hopes to achieve. In Japan, the average premium is zero. “You don't pay anything because you're not going to do anything,” says Mr Marra. Instead, staff numbers are reduced by natural attrition, and brands live on.
Mr Niwa is more optimistic. Japan is now at the beginning of a new era of “fully fledged M&A”, he says, which will go beyond mere asset-shuffling to more radical restructuring. Japanese managers have spent the past decade getting used to the idea of M&A. “Now, at last, M&A is not something odd but a normal part of business.” There have even been a few attempts at hostile takeovers, something that was previously unheard of in Japan's cosy corporate culture.
Hostile intent
When in August 2006 Oji Paper, Japan's biggest paper firm, tried to take over Hokuetsu Paper, a smaller rival, it was the first hostile bid by one blue-chip firm for another. Oji's bid made commercial sense: in an industry lumbered with overcapacity, it seemed a better idea to buy Hokuetsu, which had just invested huge sums in new equipment, than to splash out on updated equipment itself. But Oji's move was widely criticised, and the bid was blocked when Nippon Paper, the industry's number two, bought a stake in Hokuetsu, the value of which has since declined. Had Oji's bid succeeded, “it would have set a fantastic precedent,” says Mr Thomas. But hostile bids still seem to be regarded as taboo—though a recent survey by Japan's Cabinet Office found that 66% of companies said they were interested in pursuing M&A, and a further 6% said they would consider making a hostile bid if necessary.
A precedent would be a good thing, since it would help to convince Japanese firms of the merits of a more dynamic approach to M&A, says Marc Goldstein of Institutional Shareholder Services (ISS), a research firm. He cites Renault's alliance with Nissan, which convinced Japanese bosses that selling a big stake to a foreign firm could be a good idea, and also illustrated, in the person of Carlos Ghosn, that foreign managers could use their expertise to turn a Japanese company around. “There always needs to be a success story to convince corporate Japan of the merits of foreign practices,” says Mr Goldstein.
Similarly, he says, a successful triangular merger might change attitudes towards foreign takeovers. At the moment, many Japanese firms are worried that the new triangular-merger law will lead to an outbreak of hostile takeovers by foreign buyers. The law was delayed for a year after a campaign by Keidanren, Japan's conservative big-business association, which gave companies time to put in place defensive measures, such as poison pills and cross-shareholdings with other companies—a once common practice that had been in decline for many years (see chart 4). Yet the new rules make it almost impossible to pull off a triangular merger without the approval of the target firm's management. And the big foreign firms that are most likely to take advantage of the new law would prefer to do friendly deals anyway, says Mr Goldstein, otherwise the Japanese firms they acquire will be difficult to run.
But there is no question that attitudes on things like mergers and shareholder value are changing, even if they still stop far short of Anglo-Saxon enthusiasm. According to figures from the Cabinet Office, the proportion of Japanese companies that describe themselves as “shareholder-focused” increased to 40% this year from 33% in 2002, and the proportion describing themselves as “worker-focused” fell from 18% to 13%. In other areas of corporate governance, too, Japanese companies have shifted towards a more Anglo-Saxon approach, but in a way that respects traditional Japanese sensibilities.
In 2002 the commercial code was amended to give Japanese companies a choice of two models for corporate governance: the traditional Japanese system with statutory auditors and an alternative committee-based system, modelled on the American approach, which involves separate audit, remuneration and nomination committees with a majority of outside directors. This was the most explicit example of the government's efforts to encourage Japanese companies to adopt a more American style of corporate governance.
But although several large companies immediately adopted the new system—including Sony, Hitachi, Toshiba, Hoya, Nomura and Nikko Cordial—very few others followed suit. Of the 1,750 companies in the Tokyo Stock Exchange's first tier, only 100 or so have adopted it. Still, many have gone for something in-between, sticking with the Japanese system but appointing more outside directors to their boards. Around one-third of Japanese companies now have outside directors.
The Japanese definition of “outsider” is not necessarily one that foreigners would recognise. One survey found that 30% of outside directors came from partner companies, 18% from other companies in the same keiretsu, 16% from a parent company and 5% from the company's “main bank”. True, some Japanese companies—Sony is a notable example—have installed genuinely independent outside directors on their boards. But others, such as Toyota, still do not have any outside directors at all.
In this aspect of corporate governance, as in many others, Japan has shifted towards a more American approach, but has retained many elements of the traditional Japanese way of doing things. “Japan sees a new thing and says: ‘Hold on, we don't do that’,” says Mr Thomas. “Then it says: ‘Oh, it's not so bad—but let's do it in a Japanese way’.”
Message in a bottle of sauce
Nov 29th 2007
From The Economist print edition
IT WAS not a storm in a teacup but a battle over a bottle of sauce. The fight during 2007 for Bull-Dog Sauce, a Japanese condiment-maker with 27% of the sauce market, cast into sharp relief the conflict between no-holds-barred Anglo-Saxon capitalism and the traditional Japanese approach to corporate governance.
The supposed villain of the piece was Steel Partners, an American investment fund that since 2000 has invested more than $3 billion in some 30 Japanese companies. Having built up a 10% stake in Bull-Dog, Steel launched a takeover bid in May, offering to buy all outstanding shares in the company for around $260m, a 20% premium over the share price at the time. Bull-Dog's management opposed the bid. “Why us?” lamented the firm's managing director, Masaomi Tamiya. Steel was accused of being a “greenmailer”—a predator that buys a large share in a company, threatens to take it over and then agrees to drop its bid and sell its stake back to the company at a hefty premium. Warren Lichtenstein, Steel's boss, insisted that Steel had a long-term commitment to Bull-Dog. But on a visit to Tokyo to meet Bull-Dog's management, he made matters worse by saying he planned to “educate” and “enlighten” Japanese managers about American-style capitalism.
At its shareholder meeting in June, Bull-Dog proposed to enact a “poison pill” defence that involved issuing three new shares for every existing share to all shareholders—except Steel, which would instead receive cash, diluting its original stake. Mr Lichtenstein gave warning that the poison pill could set a dangerous precedent and deter investment in other Japanese companies. But that, of course, was the whole idea. The poison-pill motion was passed, and although Steel mounted a legal challenge, Bull-Dog's right to use the device was upheld by the courts. So the foreign investors were thwarted, but at great cost to Bull-Dog, which said it expected to make a loss of ¥980m ($8.3m) for the year to March 2008, rather than the previously forecast profit of ¥500m.
The Bull-Dog saga was a litmus test for attitudes to shareholder capitalism. Those who believe that companies should be run to maximise the returns to shareholders thought that shareholders should have accepted Steel's generous offer; but those who hold the traditional Japanese view that companies are social communities, not baubles to be bought and sold, disapproved of Steel's treatment of a venerated 105-year-old company.
Both sides have a point. Japanese companies have neglected their shareholders for too long. But, says Gerald Curtis, a Japan-watcher at New York's Columbia University, Steel's “heavy-handed, flat-footed approach” has made it more difficult for others to argue that companies should pay more attention to their shareholders. “A lot of Japanese in the business and financial community are mainly mad at Steel because they make it more difficult for Japan to do what it has to do,” says Mr Curtis.
For one thing, Japanese firms tend to sit on piles of money: the cash and securities they hold amount to 16% of gross domestic product, compared with a long-term average in America of around 5%. And Japanese companies' average return on equity is only around 9%, compared with 14-17% in America and Europe. Under a previous set of rules, dividend payments were taxed whereas capital gains were not, so Japanese investors were more interested in share-price gains than in dividends; but those rules no longer apply. And the proportion of Japanese shares held by foreign investors has increased hugely, from 5% in 1990 to 28% now. Both these changes have increased the pressure on companies to use any excess cash to increase dividends, or to buy back shares to boost prices.
Foreign investors have been demanding this for years, but domestic investors are now following suit. A pioneer in this field was Japan's most famous activist investor, Yoshiaki Murakami, a colourful and controversial figure who in July was found guilty of insider trading and sentenced to two years in prison. Although Mr Murakami plainly went too far, he helped make the case for a greater emphasis on shareholder returns. Japan's Pension Fund Association, a quasi-governmental body that oversees investments worth more than $100 billion, said this year that it would press firms to pay higher dividends and would vote against directors of companies making inadequate returns.
Another example of an investor exerting pressure involves Sparx Group, a Japanese investment fund that was the largest shareholder in Pentax, a camera-maker. In April Pentax changed its mind over an agreed takeover offer from another Japanese firm, Hoya, the world's biggest producer of optical glass, and ousted the company's president who had devised the deal. But Sparx, along with other investors, felt that being bought by Hoya would be the best option for Pentax as well as for its shareholders, so it got the ousted president reinstated, prompting the Pentax board to resign. The deal went ahead on improved terms. Sparx prevailed by handling the situation delicately. “That's their style—not to put up a loudspeaker,” says David Marra of A.T. Kearney.
Similarly, in February another Japanese investment fund, Ichigo Asset Management, successfully persuaded shareholders in Tokyo Kohtetsu, a steel company, to reject a merger with Osaka Steel. This was the first time that shareholders in a Japanese company had ever rejected a merger plan already approved by the two companies' boards. Ichigo, which held a 13% stake in Tokyo Kohtetsu, approved of the logic of the deal but felt that the proposed share-swap short-changed Tokyo Kohtetsu's shareholders.
Some foreign activist investors are also taking a more subtle approach. The Children's Investment fund (TCI), for instance, which has a 10% stake in J-Power, an electrical utility, earlier this year pressed the company to triple its year-end dividend. TCI's boss, Christopher Hohn, began his letter to shareholders by apologising for writing to them out of the blue, then carefully explained why he thought that J-Power needed to do better. The company responded with a letter of its own, and in June TCI's resolution was defeated. “TCI trod carefully and decided to lose round one gracefully,” says Mr Marra approvingly. Investors who recognise that Japan is still getting used to a more activist approach (rather than treating Japanese firms in the same way they would treat American ones) will reap benefits in the long term, he says.
Japanese managers may not find it easy to switch their attention to shareholder value, but the trend towards greater shareholder activism is clear. This year around 30 companies have faced shareholder resolutions, double the 2006 figure. Many of them demanded higher dividend payouts. All such resolutions were defeated, notes Steven Thomas of UBS, an investment bank, but in many cases companies subsequently introduced their own resolutions to increase dividends by a smaller amount, in effect meeting the activists halfway. Japan is gradually coming to appreciate the benefits that activist investors can provide, says Shoichi Niwa of RECOF, a specialist mergers-and-acquisitions consultancy.
Learning to love M&A
Japanese firms are also changing their attitudes towards M&A. The pace is picking up (see chart 3) and the nature of the deals is changing. For most of the past decade, says Mr Niwa, M&A deals involved mainly domestic firms as they restructured and spun off non-core subsidiaries. But then the merger activity spread to the core businesses themselves, with consolidation in a number of industries including oil, steel, banking, insurance, pharmaceuticals and retailing. In the past two years Japanese firms have also made more acquisitions abroad. These are not the trophy assets of the late 1980s, but strategic purchases by Japanese firms to make themselves more globally competitive: Nippon Sheet Glass bought Pilkington, Japan Tobacco bought Gallaher and Toshiba bought Westinghouse, for example.
Changes in Japan's corporate law acted as catalysts. In 1999 it became possible to buy other firms using shares; in 2000 it became easier for companies to spin off non-core divisions. Accounting rules were also changed, forcing companies to produce consolidated statements and disclose cashflow figures and making it harder to hide poorly performing subsidiaries. Another rule change requires companies to list assets at market value, which makes it easier to work out whether a company's market capitalisation is lower than the value of its assets (not uncommon in Japan). “There have been very drastic changes in this area in the past ten years—more drastic than anything seen before,” says Mr Niwa.
With each change, the rate of deal-making picks up. The latest one, which took effect in May, covers “triangular mergers” in which a foreign firm uses its own shares, via a Japanese subsidiary, to buy a Japanese firm. The first triangular deal, the takeover of Nikko Cordial by Citigroup, was announced in October. “Things are getting bought and sold in a way we didn't see in the 1980s and 1990s,” says Mr Thomas. Managers used to regard M&A as a sign of weakness, unnecessary for “good” companies. “But now they understand that M&A can be a good thing, that this is a standard part of the corporate toolbox,” he explains. Admittedly, the average level of M&A as a proportion of GDP, at around 3%, is much lower than that in America or Britain, at about 10%, but it is a lot higher than Japan's figure in 1991, when it was just 0.4% of GDP.
A bigger concern is that M&A activity is not playing its proper part, which is to make companies more efficient. That is because acquired companies often continue to be run as distinct firms within a firm, and the usual cost savings from laying off staff do not materialise because Japanese firms rarely sack people. Similarly, the opportunity to save money by replacing two brands with a single one is not always taken. “Companies have a face problem,” explains Katsumi Ihara, the head of Sony's electronics division. Employees and customers have strong attachments to companies and brands and want them to live on, which hinders M&A, he says.
Mr Marra points out that the average takeover premium paid in America is 25%, which reflects the cost savings that the buyer hopes to achieve. In Japan, the average premium is zero. “You don't pay anything because you're not going to do anything,” says Mr Marra. Instead, staff numbers are reduced by natural attrition, and brands live on.
Mr Niwa is more optimistic. Japan is now at the beginning of a new era of “fully fledged M&A”, he says, which will go beyond mere asset-shuffling to more radical restructuring. Japanese managers have spent the past decade getting used to the idea of M&A. “Now, at last, M&A is not something odd but a normal part of business.” There have even been a few attempts at hostile takeovers, something that was previously unheard of in Japan's cosy corporate culture.
Hostile intent
When in August 2006 Oji Paper, Japan's biggest paper firm, tried to take over Hokuetsu Paper, a smaller rival, it was the first hostile bid by one blue-chip firm for another. Oji's bid made commercial sense: in an industry lumbered with overcapacity, it seemed a better idea to buy Hokuetsu, which had just invested huge sums in new equipment, than to splash out on updated equipment itself. But Oji's move was widely criticised, and the bid was blocked when Nippon Paper, the industry's number two, bought a stake in Hokuetsu, the value of which has since declined. Had Oji's bid succeeded, “it would have set a fantastic precedent,” says Mr Thomas. But hostile bids still seem to be regarded as taboo—though a recent survey by Japan's Cabinet Office found that 66% of companies said they were interested in pursuing M&A, and a further 6% said they would consider making a hostile bid if necessary.
A precedent would be a good thing, since it would help to convince Japanese firms of the merits of a more dynamic approach to M&A, says Marc Goldstein of Institutional Shareholder Services (ISS), a research firm. He cites Renault's alliance with Nissan, which convinced Japanese bosses that selling a big stake to a foreign firm could be a good idea, and also illustrated, in the person of Carlos Ghosn, that foreign managers could use their expertise to turn a Japanese company around. “There always needs to be a success story to convince corporate Japan of the merits of foreign practices,” says Mr Goldstein.
Similarly, he says, a successful triangular merger might change attitudes towards foreign takeovers. At the moment, many Japanese firms are worried that the new triangular-merger law will lead to an outbreak of hostile takeovers by foreign buyers. The law was delayed for a year after a campaign by Keidanren, Japan's conservative big-business association, which gave companies time to put in place defensive measures, such as poison pills and cross-shareholdings with other companies—a once common practice that had been in decline for many years (see chart 4). Yet the new rules make it almost impossible to pull off a triangular merger without the approval of the target firm's management. And the big foreign firms that are most likely to take advantage of the new law would prefer to do friendly deals anyway, says Mr Goldstein, otherwise the Japanese firms they acquire will be difficult to run.
But there is no question that attitudes on things like mergers and shareholder value are changing, even if they still stop far short of Anglo-Saxon enthusiasm. According to figures from the Cabinet Office, the proportion of Japanese companies that describe themselves as “shareholder-focused” increased to 40% this year from 33% in 2002, and the proportion describing themselves as “worker-focused” fell from 18% to 13%. In other areas of corporate governance, too, Japanese companies have shifted towards a more Anglo-Saxon approach, but in a way that respects traditional Japanese sensibilities.
In 2002 the commercial code was amended to give Japanese companies a choice of two models for corporate governance: the traditional Japanese system with statutory auditors and an alternative committee-based system, modelled on the American approach, which involves separate audit, remuneration and nomination committees with a majority of outside directors. This was the most explicit example of the government's efforts to encourage Japanese companies to adopt a more American style of corporate governance.
But although several large companies immediately adopted the new system—including Sony, Hitachi, Toshiba, Hoya, Nomura and Nikko Cordial—very few others followed suit. Of the 1,750 companies in the Tokyo Stock Exchange's first tier, only 100 or so have adopted it. Still, many have gone for something in-between, sticking with the Japanese system but appointing more outside directors to their boards. Around one-third of Japanese companies now have outside directors.
The Japanese definition of “outsider” is not necessarily one that foreigners would recognise. One survey found that 30% of outside directors came from partner companies, 18% from other companies in the same keiretsu, 16% from a parent company and 5% from the company's “main bank”. True, some Japanese companies—Sony is a notable example—have installed genuinely independent outside directors on their boards. But others, such as Toyota, still do not have any outside directors at all.
In this aspect of corporate governance, as in many others, Japan has shifted towards a more American approach, but has retained many elements of the traditional Japanese way of doing things. “Japan sees a new thing and says: ‘Hold on, we don't do that’,” says Mr Thomas. “Then it says: ‘Oh, it's not so bad—but let's do it in a Japanese way’.”
Business in Japan: Going Hybrid
Going hybrid
Nov 29th 2007
From The Economist print edition
ONCE it was the Walkman. Then it was the PlayStation. Today it is the Toyota Prius that epitomises Japan's technological and industrial prowess. Built by Japan's largest company, which is now on the verge of becoming the world's largest carmaker, the Prius is a hybrid car propelled by the combination of a petrol engine (for range) and an electric motor (for energy-efficiency). The Prius was the first commercial hybrid car and has become by far the most successful, with sales of over 1m since its launch in 1997. Although that is a modest figure compared with Toyota's annual output of around 8m vehicles, it has transformed the company's image. Toyota is now known for greenery and innovation as well as manufacturing efficiency.
But the Prius also symbolises another transformation: that of Japan itself. Just as a hybrid car combines the distinct advantages of petrol and electric propulsion systems, Japan has been developing a new hybrid model of capitalism that brings together aspects of the old Japanese model, which ran into trouble in the early 1990s, with carefully chosen elements of the more dynamic American or Anglo-Saxon variety of capitalism. The resulting hybrid model has been adopted by many firms and has already helped to transform Japan's fortunes. After wrenching political and corporate reforms, the country in 2002 emerged from over a decade of economic stagnation. Since then the recovery, originally export-led, has spread to the economy as a whole (see chart 1). Japanese firms have restructured, paid down their debts and are now posting record profits. The banking system has been cleaned up. Yet despite this progress, Japan still faces huge problems.
Government debt, at around 180% of GDP in the current fiscal year, is the highest for any developed economy (see chart 2). The government will soon have to raise consumption taxes just to stop the debt from growing. Japan also faces a painful demographic squeeze as its population ages and the workforce starts to shrink. This will put a premium on increasing labour-productivity growth, which at 1.2% is only half the OECD average, largely thanks to the hugely inefficient service sector, which accounts for 70% of GDP and two-thirds of employment. Japan's average labour productivity in services fell from 88% of the American level in 1993 to 84% in 2003. This highlights another of Japan's problems: its two-tier economy, made up of an efficient, globalised manufacturing sector and an inefficient, inward-looking services sector.
Japan also risks losing its edge in innovation. Although it spends far above the OECD average on research and development (R&D) as a share of GDP, this money is not always put to good use. The Science Council of Japan estimates that Japan's R&D is only about half as efficient as Europe's and America's. Entrepreneurial start-ups account for only around 4% of firms in Japan, compared with 10% in Europe and over 14% in America, and Japan comes bottom in several rankings of entrepreneurship. Despite the might of its big exporters, Japan is also a laggard in globalisation, with the lowest levels of foreign direct investment, imports and foreign workers in the OECD. With a domestic market that offers little scope for growth, Japan is missing out on opportunities overseas.
Time for a new model
Its old industrial model, which formed the basis of the “Japanese miracle” in the second half of the 20th century, was devised under very different circumstances: high growth and a pyramidal population structure, with far more young people than old, notes Atsushi Seike, a labour economist at Keio University in Tokyo. This old model was founded on three main elements: first, lifetime employment, in which workers spend their entire career at the same firm, slowly working their way up the ranks; second, seniority-based pay, which links wages to length of tenure rather than ability; and third, company-specific unions, which promoted close co-operation between unions and management.
Another typically Japanese practice was a close relationship with a “main bank” and other companies organised into corporate groups known as keiretsu, bound together by a web of reciprocal cross-shareholdings. The old model was well suited to the times: it delivered social stability and cohesion as Japanese workers pulled together to catch up with Western nations, and helped Japan to become the world's second-biggest economy.
But the population structure has changed beyond recognition and Japan is no longer a developing country, so the old model no longer fits and many of its strengths have become weaknesses. It hinders consolidation among Japanese firms, which is necessary if they are to become more globally competitive. It prevents the efficient redeployment of labour and a proper use of women and elderly workers, which will be vital if Japan is to cope with its ageing population and shrinking workforce. The old model hampers entrepreneurship and innovation in small companies, an important component of a dynamic and responsive economy. All of this acts as a brake on growth. At the same time, Japan needs to become more closely integrated into the global economy, both to gain access to fast-growing foreign markets and to enable competition from foreign firms to spur improvements in the stodgy services sector. That is why a new, more flexible model is needed.
In the late 1990s, when Japan had endured almost a decade of stagnation, the American model seemed to have all the answers—a reversal from the 1980s, when American firms were trying to emulate the seemingly unstoppable Japanese model. America's economy was booming, fuelled by a flourishing technology industry. Its approach seemed more successful at promoting innovation and growth in the internet era, and its vibrant start-up scene was a far cry from Japan's staid big-company capitalism.
So policymakers rewrote corporate law to allow Japanese companies to adopt an American-style model of corporate governance, and some companies began to adopt Anglo-Saxon practices such as performance-based pay, share options, outside directors, promotion based on ability, pursuit of shareholder value and hiring new employees in mid-career. The banking system was recapitalised, cross-shareholdings were unwound and companies embarked on a programme of restructuring. “But a funny thing happened on Japan's way to the American model—it never got there,” observes Steven Vogel, a political scientist at the University of California, Berkeley. Many of the reforms met with opposition and were scaled back. Then the dotcom crash and the Enron scandal caused the American model to lose its lustre, to the delight of Japan's old guard.
Instead, forward-looking Japanese firms have devised a hybrid model that combines elements of both the old Japanese and the Anglo-Saxon model. “We have been going through a process of trial and error, of what to change and what not to change,” says Fujio Cho, the chairman of Toyota. The effect has been to move Japan somewhat closer to the American way of doing things, at least in some areas and in some companies. “You pick and choose which bits you adopt,” says Hirotaka Takeuchi, dean of the school of corporate strategy at Hitotsubashi University. “Japan has tilted more towards the Anglo-Saxon model, but wants to go its own way. The debate is about how far to tilt.”
Sir Howard Stringer, the first non-Japanese boss of Sony, the Japanese electronics giant, embodies the attempt to combine Japanese and Anglo-Saxon approaches. “In our company, as in others, there was a lurch towards the Western model,” he says. “My job is to manage that without alienating Japanese sensibilities. Some of the virtues of the Japanese model have to be retained. It is a balancing act, sometimes stimulating, sometimes frustrating, but there is merit on both sides.” It helps that he is a foreigner but not an American, admits Welsh-born Sir Howard.
Finding the right balance
But now that the economy is growing again, there is much debate about whether Japan has found the right balance or whether more reform is needed—or even whether it is time to reinstate some of the old ways. After the departure of Junichiro Koizumi, the charismatic and reformist prime minister who held office between 2001 and 2006, there is a sense that the political momentum for change has been lost. Instead, there is growing concern that the spoils of the recovery have not been equitably distributed, and that inequality is rising—a worrying phenomenon for a society in which 75% of people once identified themselves as middle-class.
“There has been a backlash recently, particularly since we recovered from the recession,” says Mr Seike. This contributed to the fall of Mr Koizumi's successor, Shinzo Abe, who resigned in September. Japan's new prime minister, Yasuo Fukuda, said in his first policy speech in October that “in promoting structural reform, we have seen disparity and other problems surface.” He was committed to further changes, he said, but would also address the inequalities arising from previous reforms.
Japan is now at a crucial stage. “Owing to the recent resurgence of the Japanese economy, support for reform is beginning to fade and the future of Japan can be said to be hanging in balance,” notes a report from Keizai Doyukai, a business lobby. Much of the political wrangling in Japan, and the various takeover battles and showdowns between activist investors and corporate executives, can be seen as part of the debate about how much more Japan needs to change, and how large a component of American or Anglo-Saxon capitalism ought to be incorporated into the new hybrid industrial model. “Japan has to Anglo-Saxonise, but in a Japanese way,” says Yasuchika Hasegawa, the vice-chairman of Keizai Doyukai. “Japan has to find its own capitalism style.”
Not everyone shares his enthusiasm for the hybrid model, which pays more attention to shareholders at the expense of other stakeholders in a company—in particular, its employees. There is obvious ambivalence about the adoption of American practices at Nippon Keidanren, Japan's conservative big-business association, which has campaigned to slow the pace of reform. When there are two models, says Masakazu Kubota, Keidanren's managing director, globalisation means the more competitive model will prevail. “Unfortunately, the most competitive system is in the United States,” he says.
In part, Keidanren is trying to shield its more dinosaur-like members from reform. But its scepticism reflects a wider concern. Japanese companies are social institutions, providing social cohesion and taking on many roles that in other countries are performed by the state. By contrast, the Anglo-Saxons view companies as money-making machines that can be freely bought, sold, merged and dissolved in order to maximise returns to shareholders. “What makes Japan interesting is that it's a society having a debate about shareholder versus stakeholder capitalism,” says David Marra, a Japan specialist at A.T. Kearney, a consultancy. “Japan is at a potential tipping point for the next few years.”
Yet despite the current political paralysis, reform has taken on its own momentum. The slow drip of legal and regulatory changes, many of them passed by previous administrations or introduced by Japan's powerful bureaucracy, continues. Individually, some of them do not amount to very much, but collectively they add up to a change in the Japanese business environment. “Retrospectively, the changes during the past decade were significant, and we are a different country now in many respects,” says Mr Hasegawa.
This special report will look at four of the most important areas of change: corporate governance, the labour market, the climate for entrepreneurs and innovation, and Japan's response to globalisation. It will examine what has changed and what has not; how and where Japan has struck compromises between the Japanese and Anglo-Saxon models; how widely the new hybrid model has been adopted; and whether it will be able to solve Japan's many problems.
Nov 29th 2007
From The Economist print edition
ONCE it was the Walkman. Then it was the PlayStation. Today it is the Toyota Prius that epitomises Japan's technological and industrial prowess. Built by Japan's largest company, which is now on the verge of becoming the world's largest carmaker, the Prius is a hybrid car propelled by the combination of a petrol engine (for range) and an electric motor (for energy-efficiency). The Prius was the first commercial hybrid car and has become by far the most successful, with sales of over 1m since its launch in 1997. Although that is a modest figure compared with Toyota's annual output of around 8m vehicles, it has transformed the company's image. Toyota is now known for greenery and innovation as well as manufacturing efficiency.
But the Prius also symbolises another transformation: that of Japan itself. Just as a hybrid car combines the distinct advantages of petrol and electric propulsion systems, Japan has been developing a new hybrid model of capitalism that brings together aspects of the old Japanese model, which ran into trouble in the early 1990s, with carefully chosen elements of the more dynamic American or Anglo-Saxon variety of capitalism. The resulting hybrid model has been adopted by many firms and has already helped to transform Japan's fortunes. After wrenching political and corporate reforms, the country in 2002 emerged from over a decade of economic stagnation. Since then the recovery, originally export-led, has spread to the economy as a whole (see chart 1). Japanese firms have restructured, paid down their debts and are now posting record profits. The banking system has been cleaned up. Yet despite this progress, Japan still faces huge problems.
Government debt, at around 180% of GDP in the current fiscal year, is the highest for any developed economy (see chart 2). The government will soon have to raise consumption taxes just to stop the debt from growing. Japan also faces a painful demographic squeeze as its population ages and the workforce starts to shrink. This will put a premium on increasing labour-productivity growth, which at 1.2% is only half the OECD average, largely thanks to the hugely inefficient service sector, which accounts for 70% of GDP and two-thirds of employment. Japan's average labour productivity in services fell from 88% of the American level in 1993 to 84% in 2003. This highlights another of Japan's problems: its two-tier economy, made up of an efficient, globalised manufacturing sector and an inefficient, inward-looking services sector.
Japan also risks losing its edge in innovation. Although it spends far above the OECD average on research and development (R&D) as a share of GDP, this money is not always put to good use. The Science Council of Japan estimates that Japan's R&D is only about half as efficient as Europe's and America's. Entrepreneurial start-ups account for only around 4% of firms in Japan, compared with 10% in Europe and over 14% in America, and Japan comes bottom in several rankings of entrepreneurship. Despite the might of its big exporters, Japan is also a laggard in globalisation, with the lowest levels of foreign direct investment, imports and foreign workers in the OECD. With a domestic market that offers little scope for growth, Japan is missing out on opportunities overseas.
Time for a new model
Its old industrial model, which formed the basis of the “Japanese miracle” in the second half of the 20th century, was devised under very different circumstances: high growth and a pyramidal population structure, with far more young people than old, notes Atsushi Seike, a labour economist at Keio University in Tokyo. This old model was founded on three main elements: first, lifetime employment, in which workers spend their entire career at the same firm, slowly working their way up the ranks; second, seniority-based pay, which links wages to length of tenure rather than ability; and third, company-specific unions, which promoted close co-operation between unions and management.
Another typically Japanese practice was a close relationship with a “main bank” and other companies organised into corporate groups known as keiretsu, bound together by a web of reciprocal cross-shareholdings. The old model was well suited to the times: it delivered social stability and cohesion as Japanese workers pulled together to catch up with Western nations, and helped Japan to become the world's second-biggest economy.
But the population structure has changed beyond recognition and Japan is no longer a developing country, so the old model no longer fits and many of its strengths have become weaknesses. It hinders consolidation among Japanese firms, which is necessary if they are to become more globally competitive. It prevents the efficient redeployment of labour and a proper use of women and elderly workers, which will be vital if Japan is to cope with its ageing population and shrinking workforce. The old model hampers entrepreneurship and innovation in small companies, an important component of a dynamic and responsive economy. All of this acts as a brake on growth. At the same time, Japan needs to become more closely integrated into the global economy, both to gain access to fast-growing foreign markets and to enable competition from foreign firms to spur improvements in the stodgy services sector. That is why a new, more flexible model is needed.
In the late 1990s, when Japan had endured almost a decade of stagnation, the American model seemed to have all the answers—a reversal from the 1980s, when American firms were trying to emulate the seemingly unstoppable Japanese model. America's economy was booming, fuelled by a flourishing technology industry. Its approach seemed more successful at promoting innovation and growth in the internet era, and its vibrant start-up scene was a far cry from Japan's staid big-company capitalism.
So policymakers rewrote corporate law to allow Japanese companies to adopt an American-style model of corporate governance, and some companies began to adopt Anglo-Saxon practices such as performance-based pay, share options, outside directors, promotion based on ability, pursuit of shareholder value and hiring new employees in mid-career. The banking system was recapitalised, cross-shareholdings were unwound and companies embarked on a programme of restructuring. “But a funny thing happened on Japan's way to the American model—it never got there,” observes Steven Vogel, a political scientist at the University of California, Berkeley. Many of the reforms met with opposition and were scaled back. Then the dotcom crash and the Enron scandal caused the American model to lose its lustre, to the delight of Japan's old guard.
Instead, forward-looking Japanese firms have devised a hybrid model that combines elements of both the old Japanese and the Anglo-Saxon model. “We have been going through a process of trial and error, of what to change and what not to change,” says Fujio Cho, the chairman of Toyota. The effect has been to move Japan somewhat closer to the American way of doing things, at least in some areas and in some companies. “You pick and choose which bits you adopt,” says Hirotaka Takeuchi, dean of the school of corporate strategy at Hitotsubashi University. “Japan has tilted more towards the Anglo-Saxon model, but wants to go its own way. The debate is about how far to tilt.”
Sir Howard Stringer, the first non-Japanese boss of Sony, the Japanese electronics giant, embodies the attempt to combine Japanese and Anglo-Saxon approaches. “In our company, as in others, there was a lurch towards the Western model,” he says. “My job is to manage that without alienating Japanese sensibilities. Some of the virtues of the Japanese model have to be retained. It is a balancing act, sometimes stimulating, sometimes frustrating, but there is merit on both sides.” It helps that he is a foreigner but not an American, admits Welsh-born Sir Howard.
Finding the right balance
But now that the economy is growing again, there is much debate about whether Japan has found the right balance or whether more reform is needed—or even whether it is time to reinstate some of the old ways. After the departure of Junichiro Koizumi, the charismatic and reformist prime minister who held office between 2001 and 2006, there is a sense that the political momentum for change has been lost. Instead, there is growing concern that the spoils of the recovery have not been equitably distributed, and that inequality is rising—a worrying phenomenon for a society in which 75% of people once identified themselves as middle-class.
“There has been a backlash recently, particularly since we recovered from the recession,” says Mr Seike. This contributed to the fall of Mr Koizumi's successor, Shinzo Abe, who resigned in September. Japan's new prime minister, Yasuo Fukuda, said in his first policy speech in October that “in promoting structural reform, we have seen disparity and other problems surface.” He was committed to further changes, he said, but would also address the inequalities arising from previous reforms.
Japan is now at a crucial stage. “Owing to the recent resurgence of the Japanese economy, support for reform is beginning to fade and the future of Japan can be said to be hanging in balance,” notes a report from Keizai Doyukai, a business lobby. Much of the political wrangling in Japan, and the various takeover battles and showdowns between activist investors and corporate executives, can be seen as part of the debate about how much more Japan needs to change, and how large a component of American or Anglo-Saxon capitalism ought to be incorporated into the new hybrid industrial model. “Japan has to Anglo-Saxonise, but in a Japanese way,” says Yasuchika Hasegawa, the vice-chairman of Keizai Doyukai. “Japan has to find its own capitalism style.”
Not everyone shares his enthusiasm for the hybrid model, which pays more attention to shareholders at the expense of other stakeholders in a company—in particular, its employees. There is obvious ambivalence about the adoption of American practices at Nippon Keidanren, Japan's conservative big-business association, which has campaigned to slow the pace of reform. When there are two models, says Masakazu Kubota, Keidanren's managing director, globalisation means the more competitive model will prevail. “Unfortunately, the most competitive system is in the United States,” he says.
In part, Keidanren is trying to shield its more dinosaur-like members from reform. But its scepticism reflects a wider concern. Japanese companies are social institutions, providing social cohesion and taking on many roles that in other countries are performed by the state. By contrast, the Anglo-Saxons view companies as money-making machines that can be freely bought, sold, merged and dissolved in order to maximise returns to shareholders. “What makes Japan interesting is that it's a society having a debate about shareholder versus stakeholder capitalism,” says David Marra, a Japan specialist at A.T. Kearney, a consultancy. “Japan is at a potential tipping point for the next few years.”
Yet despite the current political paralysis, reform has taken on its own momentum. The slow drip of legal and regulatory changes, many of them passed by previous administrations or introduced by Japan's powerful bureaucracy, continues. Individually, some of them do not amount to very much, but collectively they add up to a change in the Japanese business environment. “Retrospectively, the changes during the past decade were significant, and we are a different country now in many respects,” says Mr Hasegawa.
This special report will look at four of the most important areas of change: corporate governance, the labour market, the climate for entrepreneurs and innovation, and Japan's response to globalisation. It will examine what has changed and what has not; how and where Japan has struck compromises between the Japanese and Anglo-Saxon models; how widely the new hybrid model has been adopted; and whether it will be able to solve Japan's many problems.
China's Quest for Resources: The Perils of Abundance
CHINA'S QUEST FOR RESOURCES
The perils of abundance
Mar 13th 2008
From The Economist print edition
China must learn to do more with less
THE irony of China's struggle with energy intensity is that until recently its policymakers did not even have to try to encourage sparing use of resources: it just happened naturally. By the late 1970s, thanks to the party's ill-conceived industrialisation drive during the era of central planning, the country found itself saddled with lots of inefficient, loss-making, power-guzzling factories. As the reforms launched by Deng gathered speed, many of these cast-iron albatrosses were either forced to operate more efficiently or closed down. At the same time lots of light manufacturing plants sprang up. The growing export sector was much more profitable and used far less power than the heavy industry it was replacing, so China's energy intensity began to fall.
Indeed, it kept on falling consistently and dramatically for a quarter of a century. Between 1978 and 2000 it dropped by two-thirds, according to a recent paper by Daniel Rosen and Trevor Houser, respectively of the Peterson Institute for International Economics and City College of New York. But in 2002 this virtuous cycle went into reverse. Energy consumption, which had been growing at half the pace of the economy as a whole, suddenly began to grow one-and-a-half times as fast. An increase in the pace of economic growth compounded the effect.
The authorities were taken by surprise, and so were the global commodities markets. Analysts instantly increased their estimates for Chinese economic growth, commodity consumption and imports. Mining and oil firms, which had been investing on the assumption that sales would grow slowly and steadily, suddenly found themselves struggling to cope with China's ballooning demand. The resulting rapid inflation continues to this day.
In retrospect, however, the surge in energy consumption is easily explained. It stems from the spectacular renaissance of heavy industry. Firms such as Shougang had been investing in steel mills, cement plants, aluminium smelters and the like without let-up. Between 2000 and 2005 the share of metal-processing in national output doubled and that of petrochemicals rose by two-thirds. Cement, glass, paper and other energy-intensive industries also boomed. Although the new factories tend to use fewer resources and less energy per unit of output than most of China's older stock, the surge in their number has dwarfed the gains in efficiency.
Economists offer two opposing, although not entirely incompatible, reasons for this unexpected flowering of heavy industry. Some believe that China has reached a stage in its development when labour becomes relatively scarce and growth begins to rely more heavily on investment. At this turning point, the theory runs, shortages of labour lead to rising wages and so to higher incomes. Consumers with more spending power, in turn, start to buy homes, cars and televisions, gobbling up huge volumes of natural resources in the process.
Last year, in a report funded by Rio Tinto, Ross Garnaut and Ligang Song of the Australian National University argued that in countries where income per person has passed $2,000, as it did in China in 2006, demand for natural resources begins to grow at a much faster pace than previously, and continues to do so until income per person reaches roughly $20,000. That pattern has been particularly pronounced in Japan and South Korea, they argue, because of high levels of investment, exports and urbanisation. China also has high and rising levels of all three, so the authors expect its consumption of natural resources to follow a similar path.
“The increase in China's demand for metals during the next two decades may be comparable to the total demand from the industrialised world today,” they conclude. Prices, they add, “will remain on average much higher in real terms than they were during the last quarter of the 20th century.” Mr Albanese, Rio Tinto's boss, agrees. China's appetite for his firm's wares may not keep on jumping by a fifth or a quarter each year, he says, but he expects growth to remain in double digits. There could always be political or economic hiccups, but the more he and his staff look at China, the more confident they are that growth in demand will remain high.
A capital mess
Messrs Rosen and Houser contend that the boom in heavy industry is a product mainly of poor regulation rather than of inexorable demographic forces. They believe that China's development is becoming more capital-intensive not so much because labour is getting scarce but because capital is too abundant.
Local officials, keen to register impressive increases in output that might earn them promotion, lean on state-owned banks to lend to state-owned firms for investment in heavy industry. The banks can lend cheaply because the government sets the interest they pay to depositors at a very low rate (in real terms, it is currently negative). The industrial firms, in turn, seldom pay dividends, usually receive land free of charge and often ignore environmental regulations that push up costs. All this makes them much more profitable than less privileged companies, providing further funds for investment.
China's rapid transformation from a big importer of steel to a big exporter suggests that global production is moving there to take advantage of the exceptionally favourable investment climate. In other words, much of China's industrial bonanza exists only thanks to subsidies paid by its frugal households and its long-suffering taxpayers.
If this argument is correct, it is heartening because it suggests a clear remedy: an overhaul of the financial sector. Indeed, such reforms are all the more necessary if Messrs Garnaut and Song are right that demography is helping to spur the expansion of heavy industry. To their credit, the authorities are already trying to rein in overgenerous loan officers and overenthusiastic industrialists. They have repeatedly raised interest rates and reserve requirements and instructed banks to steer clear of dubious industrial projects. Last year, for the first time, they started demanding dividends from some state-owned enterprises, albeit on a modest scale.
But such measures, like environmental controls, must be implemented by officials whose heart may not be in them because their first priority is economic growth, Moreover, they are essentially administrative in nature and do little to tackle the underlying problem: that capital is too cheap and that Chinese banks are not very good at allocating it. Even the central government has repeatedly shied away from root-and-branch reform of China's opaque financial sector.
The vast supply chain that stretches from the pot-holed streets of Lubumbashi and the fly-blown bush of the Pilbara to China's proliferating steel mills and cement plants is raising all sorts of concerns as it cranks into action. Governments around the world are struggling to adapt to the scale and pace of the change. But the biggest strains, and the greatest risk of serious damage, are concentrated at the end of the chain: in China itself.
So far, China's leaders have managed to keep the tensions brought on by rapid development under control. But doing so has not been easy, especially given their country's unwieldy and undemocratic system of government. Now China is importing even more environmental and social pressures along with the raw materials with which it feeds its hungry industries. Long before the world runs short of the commodities China needs, those pressures are likely to come to a head.
The perils of abundance
Mar 13th 2008
From The Economist print edition
China must learn to do more with less
THE irony of China's struggle with energy intensity is that until recently its policymakers did not even have to try to encourage sparing use of resources: it just happened naturally. By the late 1970s, thanks to the party's ill-conceived industrialisation drive during the era of central planning, the country found itself saddled with lots of inefficient, loss-making, power-guzzling factories. As the reforms launched by Deng gathered speed, many of these cast-iron albatrosses were either forced to operate more efficiently or closed down. At the same time lots of light manufacturing plants sprang up. The growing export sector was much more profitable and used far less power than the heavy industry it was replacing, so China's energy intensity began to fall.
Indeed, it kept on falling consistently and dramatically for a quarter of a century. Between 1978 and 2000 it dropped by two-thirds, according to a recent paper by Daniel Rosen and Trevor Houser, respectively of the Peterson Institute for International Economics and City College of New York. But in 2002 this virtuous cycle went into reverse. Energy consumption, which had been growing at half the pace of the economy as a whole, suddenly began to grow one-and-a-half times as fast. An increase in the pace of economic growth compounded the effect.
The authorities were taken by surprise, and so were the global commodities markets. Analysts instantly increased their estimates for Chinese economic growth, commodity consumption and imports. Mining and oil firms, which had been investing on the assumption that sales would grow slowly and steadily, suddenly found themselves struggling to cope with China's ballooning demand. The resulting rapid inflation continues to this day.
In retrospect, however, the surge in energy consumption is easily explained. It stems from the spectacular renaissance of heavy industry. Firms such as Shougang had been investing in steel mills, cement plants, aluminium smelters and the like without let-up. Between 2000 and 2005 the share of metal-processing in national output doubled and that of petrochemicals rose by two-thirds. Cement, glass, paper and other energy-intensive industries also boomed. Although the new factories tend to use fewer resources and less energy per unit of output than most of China's older stock, the surge in their number has dwarfed the gains in efficiency.
Economists offer two opposing, although not entirely incompatible, reasons for this unexpected flowering of heavy industry. Some believe that China has reached a stage in its development when labour becomes relatively scarce and growth begins to rely more heavily on investment. At this turning point, the theory runs, shortages of labour lead to rising wages and so to higher incomes. Consumers with more spending power, in turn, start to buy homes, cars and televisions, gobbling up huge volumes of natural resources in the process.
Last year, in a report funded by Rio Tinto, Ross Garnaut and Ligang Song of the Australian National University argued that in countries where income per person has passed $2,000, as it did in China in 2006, demand for natural resources begins to grow at a much faster pace than previously, and continues to do so until income per person reaches roughly $20,000. That pattern has been particularly pronounced in Japan and South Korea, they argue, because of high levels of investment, exports and urbanisation. China also has high and rising levels of all three, so the authors expect its consumption of natural resources to follow a similar path.
“The increase in China's demand for metals during the next two decades may be comparable to the total demand from the industrialised world today,” they conclude. Prices, they add, “will remain on average much higher in real terms than they were during the last quarter of the 20th century.” Mr Albanese, Rio Tinto's boss, agrees. China's appetite for his firm's wares may not keep on jumping by a fifth or a quarter each year, he says, but he expects growth to remain in double digits. There could always be political or economic hiccups, but the more he and his staff look at China, the more confident they are that growth in demand will remain high.
A capital mess
Messrs Rosen and Houser contend that the boom in heavy industry is a product mainly of poor regulation rather than of inexorable demographic forces. They believe that China's development is becoming more capital-intensive not so much because labour is getting scarce but because capital is too abundant.
Local officials, keen to register impressive increases in output that might earn them promotion, lean on state-owned banks to lend to state-owned firms for investment in heavy industry. The banks can lend cheaply because the government sets the interest they pay to depositors at a very low rate (in real terms, it is currently negative). The industrial firms, in turn, seldom pay dividends, usually receive land free of charge and often ignore environmental regulations that push up costs. All this makes them much more profitable than less privileged companies, providing further funds for investment.
China's rapid transformation from a big importer of steel to a big exporter suggests that global production is moving there to take advantage of the exceptionally favourable investment climate. In other words, much of China's industrial bonanza exists only thanks to subsidies paid by its frugal households and its long-suffering taxpayers.
If this argument is correct, it is heartening because it suggests a clear remedy: an overhaul of the financial sector. Indeed, such reforms are all the more necessary if Messrs Garnaut and Song are right that demography is helping to spur the expansion of heavy industry. To their credit, the authorities are already trying to rein in overgenerous loan officers and overenthusiastic industrialists. They have repeatedly raised interest rates and reserve requirements and instructed banks to steer clear of dubious industrial projects. Last year, for the first time, they started demanding dividends from some state-owned enterprises, albeit on a modest scale.
But such measures, like environmental controls, must be implemented by officials whose heart may not be in them because their first priority is economic growth, Moreover, they are essentially administrative in nature and do little to tackle the underlying problem: that capital is too cheap and that Chinese banks are not very good at allocating it. Even the central government has repeatedly shied away from root-and-branch reform of China's opaque financial sector.
The vast supply chain that stretches from the pot-holed streets of Lubumbashi and the fly-blown bush of the Pilbara to China's proliferating steel mills and cement plants is raising all sorts of concerns as it cranks into action. Governments around the world are struggling to adapt to the scale and pace of the change. But the biggest strains, and the greatest risk of serious damage, are concentrated at the end of the chain: in China itself.
So far, China's leaders have managed to keep the tensions brought on by rapid development under control. But doing so has not been easy, especially given their country's unwieldy and undemocratic system of government. Now China is importing even more environmental and social pressures along with the raw materials with which it feeds its hungry industries. Long before the world runs short of the commodities China needs, those pressures are likely to come to a head.
China's Quest for Resources: A Large Black Cloud
A large black cloud
Mar 13th 2008
From The Economist print edition
Rapid growth is exacting a heavy environmental price
CHINA will not continue to grow at the same pace as it has done recently, or suck in as many raw materials, if its leaders get their way. The 11th Five-Year Plan, which lays out their main economic goals for the period from 2006 to 2010, calls for growth to slow to 7.5% a year from its current double-digit pace and for consumption of energy—a good proxy for resources in general—to decelerate even more.
The government has several motives for stepping on the brakes. One is simply to allow its bureaucrats time to plan for and direct growth. Its chief aim is to redress the growing inequality between the prosperous coastal provinces and the poorer interior ones, and between cities and the countryside. But slower, more carefully orchestrated growth might also avoid wasteful and disruptive bottlenecks.
In 2003, for example, electricity consumption surged so unexpectedly that China began suffering from repeated brownouts as the grid ran short of power. That prompted millions to buy diesel generators, which in turn led to a 10% jump in oil imports in 2004. Since then electricity companies have been building power stations with gay abandon. In 2005 and 2006 they added more generating capacity than France has in total. That has boosted demand for coal, since most of the new plants are coal-fired. But most of China's coal comes from the country's interior and must be transported to coastal power stations by train. That is using up a lot of diesel (on which the trains run) and clogging up the rail network. So power stations have begun shipping in coal from overseas, turning China into a net importer in the first half of 2007 and prompting the huge queues of freighters outside coal ports such as Newcastle, Australia. These lurches in demand for different resources have added to the jitters in commodity markets and helped to amplify price rises.
The government is also worried about security of supplies. Senior figures still daydream about self-sufficiency, looking back to Maoist doctrine and to the terrible man-made famine of the late 1950s. They fret, too, that foreigners might attempt to blockade the country in the event of a war over Taiwan. In particular, the government is anxious about its oil imports from the Middle East and Africa, all of which pass through the narrow Singapore Strait. So it has been pushing for alternative routes, such as a pipeline from Kazakhstan, which opened in 2006, and another one from Russia, which has been under discussion for the past decade. The government has also created, and started filling, a strategic reserve, which should eventually hold 30 days' worth of imports, says the IEA.
The environmental fallout from China's burgeoning demand for natural resources is another source of concern. Processing iron ore, timber or oil requires electricity, and 80% of China's electricity comes from coal. But the sulphur that spews from the smokestacks of coal-fired power stations causes acid rain and the soot generates smog. In many Chinese cities, a thick shroud of pollution literally blots out the sun much of the time. Acid rain, meanwhile, reduces agricultural yields and eats away at buildings and infrastructure. The OECD cites a finding that air pollution alone reduces the country's output by between 3% and 7% a year, mainly because of respiratory ailments that keep workers at home.
A dry subject
China's water supply, too, is in a parlous state, thanks to ever-increasing industrial and agricultural use. The amount of water available per head of population is only a quarter of the global average. In the arid north and west of the country that figure falls to a tenth. Two in three cities already suffer from shortages. Groundwater is being pumped out much faster than it is being replenished.
Not even Beijing treats all its sewage; other cities treat none at all. Famous beauty spots, such as Taihu Lake near Shanghai, are often afflicted by hideous algal blooms, while effluent from polluted rivers has contaminated 160,000 square kilometres of ocean off China's shores, officials say. Over half the water in the seven biggest river basins is unfit for consumption, according to a recent report from the World Bank. The resulting health problems reduce rural output by 2%, it found, and the costs to industry and agriculture of dirty and scarce water sap GDP by another percentage point.
All told, the World Bank put the price tag for China's air and water pollution at $100 billion a year, or about 5.8% of GDP. It is said that the same report originally put the number of deaths caused by the two scourges at 750,000 a year—until the Chinese government complained and asked for the figure to be removed. Pan Yue, a deputy minister at the State Environmental Protection Administration (SEPA), China's paramount environmental regulator, estimates the annual cost of environmental damage at 8-13% of GDP—much the same as the overall economic growth rate. If it continues like this, he expects levels of pollution to double over the next 15 years.
Then there is global warming, which is already exacerbating China's environmental problems. The latest report from the Intergovernmental Panel on Climate Change notes that temperatures in China are rising and extreme weather, including cyclones, droughts and floods, is on the increase. Worse, the Himalayan glaciers that feed China's biggest rivers (and account for a large portion of flows during dry spells) are melting. “If the present rate continues,” the report says, “the likelihood of them disappearing by the year 2035 and perhaps sooner is very high.”
Among other things, this will make life even more difficult for China's farmers. Northern China, which lost some 36,000 square kilometres to desertification between 1990 and 2000, will become even more arid. Its water supply, the IPCC predicts, will fall 30% below requirements. Moreover, rice yields will drop by 10% for every degree the temperature increases. Rising sea levels and the associated intrusion of salt water are likely to reduce the amount of arable land even further.
As it is, in villages like Beihuadan, in Hebei province, just a few hours' drive from Beijing, the water table is already falling rapidly. A shuffling farmer in a flat cap and worn woollen sweater pumps furiously at the well in the courtyard of his house to show that it has run dry. It is only 19 metres deep, he explains, but there is no water these days for at least 70 metres, and often not for 100 metres or more. A few houses away a group of old men interrupt a game of cards to point out another dry well. For five years, they say, there has been no water in the Beijuma river, which runs past the edge of the village, and the authorities do not provide adequate alternatives supplies through the local irrigation network.
The government is planning to invest billions in a system of canals, pipelines and aqueducts to divert water from the soggy south to the parched north. But the scheme is only a temporary fix, and is just the sort of grandiose engineering project that tends to cause environmental problems of its own. Many NGOs and hydrologists are adamantly opposed.
As it is, the environment is the second most frequent subject of public protests after disputes over land, according to Mr Pan. In 2005 the authorities recorded 50,000 such protests, he says, and that was a 30% increase on the year before. Last year 10,000 people turned out to demonstrate against a planned chemical plant in the city of Xiamen. Earlier this year hundreds of Shanghainese protested against a proposed extension to the city's maglev train, worried about health risks. Such protests are particularly unnerving for the authorities because they involve educated, articulate and well-organised urbanites, not the country folk who normally suffer most from abuse by officials.
The best response to all these worries is to encourage more sparing use of resources, and that is what the government is trying to do. The current five-year plan, which contains few other numerical targets, envisages a 10% reduction in concentrations of the worst air pollutants and a 20% increase in energy efficiency over the period. The central government has assigned specific energy-efficiency goals to each of China's 1,000 biggest enterprises and encouraged lower levels of government to do the equivalent.
Eyepress
Still belchingThe government has set relatively stringent fuel-economy standards for cars, as well as minimum energy-efficiency requirements for all manner of appliances. On average, cars in China are about 50% more efficient than in America. Subsidies on energy consumption have also been falling steadily. The IEA calculates that their total value in 2006 was roughly $11 billion, less than half the amount for 2005. That is all the more remarkable given that international oil, coal and natural-gas prices were rising rapidly at the time. Petrol prices, for example, have been going up even faster for Chinese drivers than they have for Americans or Europeans, although they remain low in absolute terms.
To discourage energy- and import-intensive metals-processing, the government raised export duties on iron, steel and related alloys to 25% in December. It also abolished all duty on imports of copper, in the hope that higher imports of finished metal might displace some domestic smelting. And on two previous occasions it has reduced the level of tax rebates that exporters of energy-intensive goods can claim, in some cases down to zero.
There is also a move to diversify away from coal. In big cities (especially Beijing, in preparation for the Olympics), coal-fired heating and power plants are having to be modified to run on natural gas. In the Beijing suburb of Fengtai, where the switch has already taken place, residents recall how the constant dusting of soot from the power plant used to stop them drying clothes outdoors or even opening their windows. Now they can hang out their washing without fear, and sometimes even sit outside.
Nuclear options
The government is planning to increase the country's nuclear generation capacity almost fivefold by 2020. It has ordered new reactors from two of the world's nuclear giants, Areva and Westinghouse, and is also building some of its own design. Power from wind turbines is meant to double by 2010 and grow by a factor of 12 by 2020. Hydropower is supposed almost to triple by the same date. Overall, renewable sources should account for 15% of energy consumption by 2020.
At the same time SEPA is trying to clean up China's coal-fired plants. All new ones are required to install filters in their smokestacks to remove sulphur dioxide, the main cause of acid rain. The biggest existing plants are supposed to retrofit such equipment. Roughly half of China's coal-fired generating capacity is now said to have installed this kind of technology. Between 2000 and 2005 SEPA tripled the fines on polluters. The government has also hired Veolia, a French conglomerate, to build and run model waste-water treatment plants in several big cities.
An open-and-shut case
As the big power plants, factories and coal mines raise their environmental standards, the small ones are meant to shut down altogether. Cyrille Ragoucy, the local head of Lafarge, a cement giant, says that the authorities have encouraged the firm to expand rapidly in the south-west of the country in order to replace the existing stock of old-fashioned, energy-intensive and polluting cement kilns. At the same time local governments have been ordered to close coal-fired power plants with a capacity of less than 25MW and to bar the construction of any new plants of less than 300MW. The larger scale, along with more modern technology, should improve efficiency dramatically. All told, the government plans to close 50,000MW-worth of small plants by 2010.
The biggest push concerns small coal mines, in which thousands of workers perish every year. They also tend to produce poor-quality coal which generates relatively high levels of pollution when burned. In addition, many of the mines contaminate local water supplies and produce unhealthy, smog-inducing dust in great quantities. So the central government has instructed local officials to shut down any small, dirty and unsafe mines. According to Xinhua, China's state-run news agency, 11,155 such facilities have been closed since the campaign started in 2005. The government wants to eliminate another 4,000 by the end of this year.
But a visit to the province of Shanxi, in the heart of China's coalbelt, reveals why such plans should be taken with a pinch of salt. The Jinhuagong mine, a spokesman explains, is something of a model. It produces 4m tonnes of high-quality coal a year, using the latest British and German machinery. There have been no fatal accidents for two years. The mine's managers are so proud of it that they have opened it up to tourists. Visitors can dress up in jumpsuits and hard hats and descend in a creaking elevator to the coalface 300 metres below the surface. There, a bone-jarring miniature train hauls them a few kilometres deeper into the mine, where they can look at an exhibition on the gradual improvements in safety standards over the years. All the mines in the area that did not comply with safety regulations, the spokesman explains, have been closed.
Yet a taxi driver hailed outside Jinhuagong's gates says he knows of plenty of mines that remain open in defiance of the central government's orders. Waving at Shanxi's bleak landscape of barren, eroded hillsides and jagged valleys, he says: “There's coal everywhere. Wherever there's a road, there's a coalmine.” Sure enough, a half-hour drive through the hills reveals several tiny operations where jerry-rigged conveyor belts carry coal to waiting lorries and workers scatter at the sight of an inquisitive foreigner.
The incentive to continue mining is overwhelming, locals explain. The same shortage of coal that is driving up imports has also pushed up the price. In January power companies had to shut several coal-fired plants because they did not have enough fuel to go round. The government has withdrawn all export credits on coal and imposed taxes instead, but supply continues to fall short of demand. Moreover, the officials who are responsible for closing mines are often shareholders in them too. And even if they have no financial interest in them, they still view economic growth and job creation as the chief gauge of their success.
The intentions are good
SEPA did come up with an alternative yardstick, dubbed “green GDP” and intended as a joint measure of both environmental and economic stewardship. But sceptical officials rebelled, so the central government quietly shelved the scheme. Regulators concede that poor enforcement is undermining most of their attempts to improve the state of the environment. SEPA has less than a tenth of the staff of its American equivalent to police a country with over four times the population. To enforce its rulings, it relies on local bureaucrats over whom it has no authority. “Overall, environmental efforts have lacked effectiveness and efficiency, largely as a result of an implementation gap,” as the OECD's report puts it.
That is why Jim Brock, a consultant to domestic and foreign energy firms in China, thinks it is unlikely that many small power plants are in fact being closed down. Even those plants that have the equipment to remove sulphur dioxide from their flue gas often do not bother, officials concede, because the process uses power and so reduces profits. At any rate, emissions are not yet falling fast enough to meet the government's targets.
What is more, the proliferation of coal-fired plants is swamping the growth in renewable power. Some 90% of the power plants built in 2006 run on coal, the IEA notes, against 70% of those built in 2000. And heavy industry such as steelmaking continues to grow, says Rui Susheng, the director of the China Coal Society, despite the government's attempts to curb it.
All this means that the government is falling short of its energy-efficiency targets. In 2006 China's energy intensity (the ratio of energy consumption to economic output) fell by 1.2%, well short of the government's goal of 4% a year until 2010. That was an improvement on the previous few years, when it actually rose. Yet the impression remains that the government is fighting a losing battle.
Mar 13th 2008
From The Economist print edition
Rapid growth is exacting a heavy environmental price
CHINA will not continue to grow at the same pace as it has done recently, or suck in as many raw materials, if its leaders get their way. The 11th Five-Year Plan, which lays out their main economic goals for the period from 2006 to 2010, calls for growth to slow to 7.5% a year from its current double-digit pace and for consumption of energy—a good proxy for resources in general—to decelerate even more.
The government has several motives for stepping on the brakes. One is simply to allow its bureaucrats time to plan for and direct growth. Its chief aim is to redress the growing inequality between the prosperous coastal provinces and the poorer interior ones, and between cities and the countryside. But slower, more carefully orchestrated growth might also avoid wasteful and disruptive bottlenecks.
In 2003, for example, electricity consumption surged so unexpectedly that China began suffering from repeated brownouts as the grid ran short of power. That prompted millions to buy diesel generators, which in turn led to a 10% jump in oil imports in 2004. Since then electricity companies have been building power stations with gay abandon. In 2005 and 2006 they added more generating capacity than France has in total. That has boosted demand for coal, since most of the new plants are coal-fired. But most of China's coal comes from the country's interior and must be transported to coastal power stations by train. That is using up a lot of diesel (on which the trains run) and clogging up the rail network. So power stations have begun shipping in coal from overseas, turning China into a net importer in the first half of 2007 and prompting the huge queues of freighters outside coal ports such as Newcastle, Australia. These lurches in demand for different resources have added to the jitters in commodity markets and helped to amplify price rises.
The government is also worried about security of supplies. Senior figures still daydream about self-sufficiency, looking back to Maoist doctrine and to the terrible man-made famine of the late 1950s. They fret, too, that foreigners might attempt to blockade the country in the event of a war over Taiwan. In particular, the government is anxious about its oil imports from the Middle East and Africa, all of which pass through the narrow Singapore Strait. So it has been pushing for alternative routes, such as a pipeline from Kazakhstan, which opened in 2006, and another one from Russia, which has been under discussion for the past decade. The government has also created, and started filling, a strategic reserve, which should eventually hold 30 days' worth of imports, says the IEA.
The environmental fallout from China's burgeoning demand for natural resources is another source of concern. Processing iron ore, timber or oil requires electricity, and 80% of China's electricity comes from coal. But the sulphur that spews from the smokestacks of coal-fired power stations causes acid rain and the soot generates smog. In many Chinese cities, a thick shroud of pollution literally blots out the sun much of the time. Acid rain, meanwhile, reduces agricultural yields and eats away at buildings and infrastructure. The OECD cites a finding that air pollution alone reduces the country's output by between 3% and 7% a year, mainly because of respiratory ailments that keep workers at home.
A dry subject
China's water supply, too, is in a parlous state, thanks to ever-increasing industrial and agricultural use. The amount of water available per head of population is only a quarter of the global average. In the arid north and west of the country that figure falls to a tenth. Two in three cities already suffer from shortages. Groundwater is being pumped out much faster than it is being replenished.
Not even Beijing treats all its sewage; other cities treat none at all. Famous beauty spots, such as Taihu Lake near Shanghai, are often afflicted by hideous algal blooms, while effluent from polluted rivers has contaminated 160,000 square kilometres of ocean off China's shores, officials say. Over half the water in the seven biggest river basins is unfit for consumption, according to a recent report from the World Bank. The resulting health problems reduce rural output by 2%, it found, and the costs to industry and agriculture of dirty and scarce water sap GDP by another percentage point.
All told, the World Bank put the price tag for China's air and water pollution at $100 billion a year, or about 5.8% of GDP. It is said that the same report originally put the number of deaths caused by the two scourges at 750,000 a year—until the Chinese government complained and asked for the figure to be removed. Pan Yue, a deputy minister at the State Environmental Protection Administration (SEPA), China's paramount environmental regulator, estimates the annual cost of environmental damage at 8-13% of GDP—much the same as the overall economic growth rate. If it continues like this, he expects levels of pollution to double over the next 15 years.
Then there is global warming, which is already exacerbating China's environmental problems. The latest report from the Intergovernmental Panel on Climate Change notes that temperatures in China are rising and extreme weather, including cyclones, droughts and floods, is on the increase. Worse, the Himalayan glaciers that feed China's biggest rivers (and account for a large portion of flows during dry spells) are melting. “If the present rate continues,” the report says, “the likelihood of them disappearing by the year 2035 and perhaps sooner is very high.”
Among other things, this will make life even more difficult for China's farmers. Northern China, which lost some 36,000 square kilometres to desertification between 1990 and 2000, will become even more arid. Its water supply, the IPCC predicts, will fall 30% below requirements. Moreover, rice yields will drop by 10% for every degree the temperature increases. Rising sea levels and the associated intrusion of salt water are likely to reduce the amount of arable land even further.
As it is, in villages like Beihuadan, in Hebei province, just a few hours' drive from Beijing, the water table is already falling rapidly. A shuffling farmer in a flat cap and worn woollen sweater pumps furiously at the well in the courtyard of his house to show that it has run dry. It is only 19 metres deep, he explains, but there is no water these days for at least 70 metres, and often not for 100 metres or more. A few houses away a group of old men interrupt a game of cards to point out another dry well. For five years, they say, there has been no water in the Beijuma river, which runs past the edge of the village, and the authorities do not provide adequate alternatives supplies through the local irrigation network.
The government is planning to invest billions in a system of canals, pipelines and aqueducts to divert water from the soggy south to the parched north. But the scheme is only a temporary fix, and is just the sort of grandiose engineering project that tends to cause environmental problems of its own. Many NGOs and hydrologists are adamantly opposed.
As it is, the environment is the second most frequent subject of public protests after disputes over land, according to Mr Pan. In 2005 the authorities recorded 50,000 such protests, he says, and that was a 30% increase on the year before. Last year 10,000 people turned out to demonstrate against a planned chemical plant in the city of Xiamen. Earlier this year hundreds of Shanghainese protested against a proposed extension to the city's maglev train, worried about health risks. Such protests are particularly unnerving for the authorities because they involve educated, articulate and well-organised urbanites, not the country folk who normally suffer most from abuse by officials.
The best response to all these worries is to encourage more sparing use of resources, and that is what the government is trying to do. The current five-year plan, which contains few other numerical targets, envisages a 10% reduction in concentrations of the worst air pollutants and a 20% increase in energy efficiency over the period. The central government has assigned specific energy-efficiency goals to each of China's 1,000 biggest enterprises and encouraged lower levels of government to do the equivalent.
Eyepress
Still belchingThe government has set relatively stringent fuel-economy standards for cars, as well as minimum energy-efficiency requirements for all manner of appliances. On average, cars in China are about 50% more efficient than in America. Subsidies on energy consumption have also been falling steadily. The IEA calculates that their total value in 2006 was roughly $11 billion, less than half the amount for 2005. That is all the more remarkable given that international oil, coal and natural-gas prices were rising rapidly at the time. Petrol prices, for example, have been going up even faster for Chinese drivers than they have for Americans or Europeans, although they remain low in absolute terms.
To discourage energy- and import-intensive metals-processing, the government raised export duties on iron, steel and related alloys to 25% in December. It also abolished all duty on imports of copper, in the hope that higher imports of finished metal might displace some domestic smelting. And on two previous occasions it has reduced the level of tax rebates that exporters of energy-intensive goods can claim, in some cases down to zero.
There is also a move to diversify away from coal. In big cities (especially Beijing, in preparation for the Olympics), coal-fired heating and power plants are having to be modified to run on natural gas. In the Beijing suburb of Fengtai, where the switch has already taken place, residents recall how the constant dusting of soot from the power plant used to stop them drying clothes outdoors or even opening their windows. Now they can hang out their washing without fear, and sometimes even sit outside.
Nuclear options
The government is planning to increase the country's nuclear generation capacity almost fivefold by 2020. It has ordered new reactors from two of the world's nuclear giants, Areva and Westinghouse, and is also building some of its own design. Power from wind turbines is meant to double by 2010 and grow by a factor of 12 by 2020. Hydropower is supposed almost to triple by the same date. Overall, renewable sources should account for 15% of energy consumption by 2020.
At the same time SEPA is trying to clean up China's coal-fired plants. All new ones are required to install filters in their smokestacks to remove sulphur dioxide, the main cause of acid rain. The biggest existing plants are supposed to retrofit such equipment. Roughly half of China's coal-fired generating capacity is now said to have installed this kind of technology. Between 2000 and 2005 SEPA tripled the fines on polluters. The government has also hired Veolia, a French conglomerate, to build and run model waste-water treatment plants in several big cities.
An open-and-shut case
As the big power plants, factories and coal mines raise their environmental standards, the small ones are meant to shut down altogether. Cyrille Ragoucy, the local head of Lafarge, a cement giant, says that the authorities have encouraged the firm to expand rapidly in the south-west of the country in order to replace the existing stock of old-fashioned, energy-intensive and polluting cement kilns. At the same time local governments have been ordered to close coal-fired power plants with a capacity of less than 25MW and to bar the construction of any new plants of less than 300MW. The larger scale, along with more modern technology, should improve efficiency dramatically. All told, the government plans to close 50,000MW-worth of small plants by 2010.
The biggest push concerns small coal mines, in which thousands of workers perish every year. They also tend to produce poor-quality coal which generates relatively high levels of pollution when burned. In addition, many of the mines contaminate local water supplies and produce unhealthy, smog-inducing dust in great quantities. So the central government has instructed local officials to shut down any small, dirty and unsafe mines. According to Xinhua, China's state-run news agency, 11,155 such facilities have been closed since the campaign started in 2005. The government wants to eliminate another 4,000 by the end of this year.
But a visit to the province of Shanxi, in the heart of China's coalbelt, reveals why such plans should be taken with a pinch of salt. The Jinhuagong mine, a spokesman explains, is something of a model. It produces 4m tonnes of high-quality coal a year, using the latest British and German machinery. There have been no fatal accidents for two years. The mine's managers are so proud of it that they have opened it up to tourists. Visitors can dress up in jumpsuits and hard hats and descend in a creaking elevator to the coalface 300 metres below the surface. There, a bone-jarring miniature train hauls them a few kilometres deeper into the mine, where they can look at an exhibition on the gradual improvements in safety standards over the years. All the mines in the area that did not comply with safety regulations, the spokesman explains, have been closed.
Yet a taxi driver hailed outside Jinhuagong's gates says he knows of plenty of mines that remain open in defiance of the central government's orders. Waving at Shanxi's bleak landscape of barren, eroded hillsides and jagged valleys, he says: “There's coal everywhere. Wherever there's a road, there's a coalmine.” Sure enough, a half-hour drive through the hills reveals several tiny operations where jerry-rigged conveyor belts carry coal to waiting lorries and workers scatter at the sight of an inquisitive foreigner.
The incentive to continue mining is overwhelming, locals explain. The same shortage of coal that is driving up imports has also pushed up the price. In January power companies had to shut several coal-fired plants because they did not have enough fuel to go round. The government has withdrawn all export credits on coal and imposed taxes instead, but supply continues to fall short of demand. Moreover, the officials who are responsible for closing mines are often shareholders in them too. And even if they have no financial interest in them, they still view economic growth and job creation as the chief gauge of their success.
The intentions are good
SEPA did come up with an alternative yardstick, dubbed “green GDP” and intended as a joint measure of both environmental and economic stewardship. But sceptical officials rebelled, so the central government quietly shelved the scheme. Regulators concede that poor enforcement is undermining most of their attempts to improve the state of the environment. SEPA has less than a tenth of the staff of its American equivalent to police a country with over four times the population. To enforce its rulings, it relies on local bureaucrats over whom it has no authority. “Overall, environmental efforts have lacked effectiveness and efficiency, largely as a result of an implementation gap,” as the OECD's report puts it.
That is why Jim Brock, a consultant to domestic and foreign energy firms in China, thinks it is unlikely that many small power plants are in fact being closed down. Even those plants that have the equipment to remove sulphur dioxide from their flue gas often do not bother, officials concede, because the process uses power and so reduces profits. At any rate, emissions are not yet falling fast enough to meet the government's targets.
What is more, the proliferation of coal-fired plants is swamping the growth in renewable power. Some 90% of the power plants built in 2006 run on coal, the IEA notes, against 70% of those built in 2000. And heavy industry such as steelmaking continues to grow, says Rui Susheng, the director of the China Coal Society, despite the government's attempts to curb it.
All this means that the government is falling short of its energy-efficiency targets. In 2006 China's energy intensity (the ratio of energy consumption to economic output) fell by 1.2%, well short of the government's goal of 4% a year until 2010. That was an improvement on the previous few years, when it actually rose. Yet the impression remains that the government is fighting a losing battle.
China's Quest for Resources: Intrepid Explorers
CHINA'S QUEST FOR RESOURCES
Intrepid explorers
Mar 13th 2008
From The Economist print edition
China's mining and oil firms pop up everywhere
DO CHINA'S state-owned mining and oil firms have an unfair advantage over their Western rivals? They certainly have deep pockets: in 2006, for example, Sinopec, one of China's three big state-owned oil firms, raised eyebrows when it offered a record price—over $2 billion—for the right to explore for oil in three parcels of Angola's territorial waters. In 2005 one of the others, CNOOC, lined up billions of dollars in cheap loans from state-owned banks to fund its ill-fated takeover bid for Unocal, an American oil firm.
That hints at the official backing China's big resources firms seem to enjoy. Since 2002 the government has exhorted them to seek their fortunes overseas. The National Development and Reform Commission, a planning ministry of sorts, keeps a list of countries where it encourages Chinese investment with special incentives. Chinese aid to Africa seems to be concentrated in countries where Chinese resources firms are also investing heavily, such as Sudan and Angola.
All this has stirred fears that Chinese firms, in cahoots with their shareholders in government, are squeezing out Western competition and locking up supplies of natural resources for the future. But, points out Erica Downs of the Brookings Institution, a think-tank, Chinese oil firms usually invest overseas in partnership with Western firms or other national oil companies (NOCs). Moreover, they tend to be passive shareholders, not operators that exercise day-to-day control over the investment. And they mostly sell their share of the oil produced on the open market, rather than spirit it back to China.
Wood Mackenzie, a consultancy, has examined the prices paid by Chinese oil firms for acquisitions and exploration rights and calculated that most of them are likely to earn a very respectable rate of return of 15-20%. “The contention that ‘win at all costs’ tactics are being pursued by the Asian NOCs in asset acquisitions is simply not substantiated,” Wood Mackenzie concluded.
Chinese firms do have access to countries that many Western ones do not, such as Sudan and Iran—but if they are exploiting oil that would otherwise go undeveloped, they are increasing the global supply and so reducing the price. They also seem to have access to cheaper capital, and are not being required to pay onerous dividends to the state. But again, that means Chinese banks and taxpayers are subsidising oil production, reducing the price the rest of the world has to pay.
Besides, Chinese firms are not as invincible as they are made out to be. After all, Chevron, an American oil firm, managed to snatch UNOCAL from CNOOC's jaws. And Chinalco is struggling to prevent BHP Billiton's proposed takeover of Rio Tinto.
Intrepid explorers
Mar 13th 2008
From The Economist print edition
China's mining and oil firms pop up everywhere
DO CHINA'S state-owned mining and oil firms have an unfair advantage over their Western rivals? They certainly have deep pockets: in 2006, for example, Sinopec, one of China's three big state-owned oil firms, raised eyebrows when it offered a record price—over $2 billion—for the right to explore for oil in three parcels of Angola's territorial waters. In 2005 one of the others, CNOOC, lined up billions of dollars in cheap loans from state-owned banks to fund its ill-fated takeover bid for Unocal, an American oil firm.
That hints at the official backing China's big resources firms seem to enjoy. Since 2002 the government has exhorted them to seek their fortunes overseas. The National Development and Reform Commission, a planning ministry of sorts, keeps a list of countries where it encourages Chinese investment with special incentives. Chinese aid to Africa seems to be concentrated in countries where Chinese resources firms are also investing heavily, such as Sudan and Angola.
All this has stirred fears that Chinese firms, in cahoots with their shareholders in government, are squeezing out Western competition and locking up supplies of natural resources for the future. But, points out Erica Downs of the Brookings Institution, a think-tank, Chinese oil firms usually invest overseas in partnership with Western firms or other national oil companies (NOCs). Moreover, they tend to be passive shareholders, not operators that exercise day-to-day control over the investment. And they mostly sell their share of the oil produced on the open market, rather than spirit it back to China.
Wood Mackenzie, a consultancy, has examined the prices paid by Chinese oil firms for acquisitions and exploration rights and calculated that most of them are likely to earn a very respectable rate of return of 15-20%. “The contention that ‘win at all costs’ tactics are being pursued by the Asian NOCs in asset acquisitions is simply not substantiated,” Wood Mackenzie concluded.
Chinese firms do have access to countries that many Western ones do not, such as Sudan and Iran—but if they are exploiting oil that would otherwise go undeveloped, they are increasing the global supply and so reducing the price. They also seem to have access to cheaper capital, and are not being required to pay onerous dividends to the state. But again, that means Chinese banks and taxpayers are subsidising oil production, reducing the price the rest of the world has to pay.
Besides, Chinese firms are not as invincible as they are made out to be. After all, Chevron, an American oil firm, managed to snatch UNOCAL from CNOOC's jaws. And Chinalco is struggling to prevent BHP Billiton's proposed takeover of Rio Tinto.
China's Quest for Resources: No Strings
CHINA'S QUEST FOR RESOURCES
No strings
Mar 13th 2008
From The Economist print edition
Why developing countries like doing business with China
CONGO'S experience of China is fairly typical of most resource-rich but otherwise poor countries. For both Africa and Latin America, China is still only the third-biggest trading partner, after the United States and the European Union—although its trade with both continents is growing very fast. In terms of investment, China ranks even lower.
The only countries where China has become the pre-eminent ally and commercial partner are those that have been ostracised by the West, such as Myanmar and Sudan. In both places China's diplomatic support and investment has made it easier for nasty regimes to defy international pressure. And in both places China's pay-off comes in the form of natural resources.
Chinese firms have invested $15 billion in Sudan since 1996, largely in the oil industry. That has allowed the country to raise its production from almost nothing to over 500,000 b/d, hugely boosting government revenue. The arrangement has been particularly beneficial for Sudan because American sanctions in place since 1997 have kept some of the biggest international oil companies out of the country. But it has also been a boon for China because Sudan is one of the few foreign countries where China National Petroleum Corporation (CNPC) has been able to buy a big stake in some prolific oilfields and been allowed to manage them directly (see article). Some 10% of China's oil imports now come from Sudan.
That has given China an incentive to reject sanctions on Sudan whenever they have been proposed in the UN Security Council. The oil revenue, meanwhile, has provided the Sudanese government with the cash to wage war. In fact, Chinese firms have gone further and built arms factories in Sudan, which have proved particularly handy since the UN imposed an arms embargo in 2004.
Myanmar is a source of timber, gems and food for China. If all goes according to plan, it will soon serve as a transit route for oil from the Indian Ocean to southern China, providing an alternative to the crowded Singapore Strait. Myanmar is also said to play host to a Chinese military surveillance station which provides critical intelligence on India. Myanmar's military junta, in return, can count on China to defend it against other countries. Last year, when it began shooting at protesters, China vetoed the sanctions that America proposed in the Security Council.
But the West was at loggerheads with Sudan and Myanmar long before China developed its appetite for natural resources. Chinese diplomats say they did not cause the abuses that Westerners are complaining about, so should not be held responsible for dealing with them. China has not been the only country to break ranks: Malaysia's and India's state-owned oil companies also have investments in Myanmar and Sudan. Russia, for its part, vetoed America's bid to impose sanctions on Myanmar last year, and Thailand buys Myanmar's natural gas.
China is not just cultivating these countries so that it can lay its hands on their natural resources. He Wenping, of the Chinese Academy of Social Sciences, says it also wants to counter Taiwan's efforts to win diplomatic recognition and to garner support in bodies such as the World Trade Organisation and the United Nations. Encouragingly, that seems to suggest that China is trying to bolster its position within existing international institutions, rather than to create rival networks of disaffected pariah states.
As a repressive regime itself, the Chinese government clearly has an interest in advancing the principle that outsiders should not interfere in the affairs of other countries, however repressive their regimes. But as China's international ties become more complicated, argues Chris Alden of the London School of Economics, Chinese diplomats are beginning to moderate their reflexive stand against interference. Wen Jiabao, China's prime minister, has called for democracy in Myanmar. China has also changed its stance on Sudan as international outrage about events in Darfur has grown and activists have branded the Beijing games as “the genocide Olympics”. Last year China helped to persuade Sudan to admit UN peacekeepers—a move it had long resisted, with China's blessing. China has even sent troops of its own to join the UN force.
Play by the rules
At the same time resource-rich countries are becoming more demanding. In 2006 the government of Gabon, having discovered that Sinopec, another Chinese state-owned oil firm, did not have the required environmental permits, ordered it to halt a big drilling project in a national park. Peru has fined Shougang Group several times for abuses of labour law and breaches of its initial investment contract. The government of the Philippines has suspended a Chinese firm's $3.8 billion scheme to grow grain for export after a series of Chinese investments became the subject of a bribery scandal. Chinese mines in Zambia have suffered from labour unrest. The naive notion that stronger commercial ties offer lots of painless “win-win” opportunities to both China and the resource-rich countries of Africa and Latin America is coming under greater scrutiny on both sides.
Developing countries are understandably keen to ensure that they get the maximum economic benefit from their extractive industries. Russia, for example, is gradually ratcheting up its export tax on raw timber so that the Chinese firms now simply harvesting wood in the forests of Siberia will have to set up sawmills there as well. That will spell the end of the dozens of wood-processing firms that have sprung up across the border in the Chinese town of Manzhouli.
The governments of both Brazil and Argentina have said they want to export more than just minerals and food to China, and have begun to stem the flood of cheap Chinese imports they are receiving in return. As Thabo Mbeki, South Africa's president, has put it, “China cannot just come here and dig for raw materials and then go away and sell us manufactured goods.”
The benefits of China's growing appetite for natural resources to the producer countries are clear. Increased Chinese demand and the higher prices that go with it have boosted both the volume and the value of their exports. For countries that also sell manufactured goods the calculation is less clear-cut but probably still positive. Chinese competition may have driven up the cost of inputs of raw materials, kept wages low and reduced the selling price of manufactures, yet in most cases this is more than outweighed both by growing Chinese demand for imports and by the global boost to purchasing power from cheap Chinese manufactures.
A recent World Bank study simulated the effects of China's and India's growth on the rest of the world, starting from various assumptions. In every case it came up with positive results for all but a handful of European and Asian countries.
Similarly, a series of reports from the World Bank, the Inter-American Development Bank and the Organisation for Economic Co-operation and Development concluded that China's emergence is beneficial to Latin America. The most recent one, from the World Bank, found strong evidence that Chinese demand was boosting Latin American exports and little indication that Chinese exports were crowding Latin American ones out of other markets. It seems that for resource-rich countries the main risk of China's hunger for commodities is that it might wane.
No strings
Mar 13th 2008
From The Economist print edition
Why developing countries like doing business with China
CONGO'S experience of China is fairly typical of most resource-rich but otherwise poor countries. For both Africa and Latin America, China is still only the third-biggest trading partner, after the United States and the European Union—although its trade with both continents is growing very fast. In terms of investment, China ranks even lower.
The only countries where China has become the pre-eminent ally and commercial partner are those that have been ostracised by the West, such as Myanmar and Sudan. In both places China's diplomatic support and investment has made it easier for nasty regimes to defy international pressure. And in both places China's pay-off comes in the form of natural resources.
Chinese firms have invested $15 billion in Sudan since 1996, largely in the oil industry. That has allowed the country to raise its production from almost nothing to over 500,000 b/d, hugely boosting government revenue. The arrangement has been particularly beneficial for Sudan because American sanctions in place since 1997 have kept some of the biggest international oil companies out of the country. But it has also been a boon for China because Sudan is one of the few foreign countries where China National Petroleum Corporation (CNPC) has been able to buy a big stake in some prolific oilfields and been allowed to manage them directly (see article). Some 10% of China's oil imports now come from Sudan.
That has given China an incentive to reject sanctions on Sudan whenever they have been proposed in the UN Security Council. The oil revenue, meanwhile, has provided the Sudanese government with the cash to wage war. In fact, Chinese firms have gone further and built arms factories in Sudan, which have proved particularly handy since the UN imposed an arms embargo in 2004.
Myanmar is a source of timber, gems and food for China. If all goes according to plan, it will soon serve as a transit route for oil from the Indian Ocean to southern China, providing an alternative to the crowded Singapore Strait. Myanmar is also said to play host to a Chinese military surveillance station which provides critical intelligence on India. Myanmar's military junta, in return, can count on China to defend it against other countries. Last year, when it began shooting at protesters, China vetoed the sanctions that America proposed in the Security Council.
But the West was at loggerheads with Sudan and Myanmar long before China developed its appetite for natural resources. Chinese diplomats say they did not cause the abuses that Westerners are complaining about, so should not be held responsible for dealing with them. China has not been the only country to break ranks: Malaysia's and India's state-owned oil companies also have investments in Myanmar and Sudan. Russia, for its part, vetoed America's bid to impose sanctions on Myanmar last year, and Thailand buys Myanmar's natural gas.
China is not just cultivating these countries so that it can lay its hands on their natural resources. He Wenping, of the Chinese Academy of Social Sciences, says it also wants to counter Taiwan's efforts to win diplomatic recognition and to garner support in bodies such as the World Trade Organisation and the United Nations. Encouragingly, that seems to suggest that China is trying to bolster its position within existing international institutions, rather than to create rival networks of disaffected pariah states.
As a repressive regime itself, the Chinese government clearly has an interest in advancing the principle that outsiders should not interfere in the affairs of other countries, however repressive their regimes. But as China's international ties become more complicated, argues Chris Alden of the London School of Economics, Chinese diplomats are beginning to moderate their reflexive stand against interference. Wen Jiabao, China's prime minister, has called for democracy in Myanmar. China has also changed its stance on Sudan as international outrage about events in Darfur has grown and activists have branded the Beijing games as “the genocide Olympics”. Last year China helped to persuade Sudan to admit UN peacekeepers—a move it had long resisted, with China's blessing. China has even sent troops of its own to join the UN force.
Play by the rules
At the same time resource-rich countries are becoming more demanding. In 2006 the government of Gabon, having discovered that Sinopec, another Chinese state-owned oil firm, did not have the required environmental permits, ordered it to halt a big drilling project in a national park. Peru has fined Shougang Group several times for abuses of labour law and breaches of its initial investment contract. The government of the Philippines has suspended a Chinese firm's $3.8 billion scheme to grow grain for export after a series of Chinese investments became the subject of a bribery scandal. Chinese mines in Zambia have suffered from labour unrest. The naive notion that stronger commercial ties offer lots of painless “win-win” opportunities to both China and the resource-rich countries of Africa and Latin America is coming under greater scrutiny on both sides.
Developing countries are understandably keen to ensure that they get the maximum economic benefit from their extractive industries. Russia, for example, is gradually ratcheting up its export tax on raw timber so that the Chinese firms now simply harvesting wood in the forests of Siberia will have to set up sawmills there as well. That will spell the end of the dozens of wood-processing firms that have sprung up across the border in the Chinese town of Manzhouli.
The governments of both Brazil and Argentina have said they want to export more than just minerals and food to China, and have begun to stem the flood of cheap Chinese imports they are receiving in return. As Thabo Mbeki, South Africa's president, has put it, “China cannot just come here and dig for raw materials and then go away and sell us manufactured goods.”
The benefits of China's growing appetite for natural resources to the producer countries are clear. Increased Chinese demand and the higher prices that go with it have boosted both the volume and the value of their exports. For countries that also sell manufactured goods the calculation is less clear-cut but probably still positive. Chinese competition may have driven up the cost of inputs of raw materials, kept wages low and reduced the selling price of manufactures, yet in most cases this is more than outweighed both by growing Chinese demand for imports and by the global boost to purchasing power from cheap Chinese manufactures.
A recent World Bank study simulated the effects of China's and India's growth on the rest of the world, starting from various assumptions. In every case it came up with positive results for all but a handful of European and Asian countries.
Similarly, a series of reports from the World Bank, the Inter-American Development Bank and the Organisation for Economic Co-operation and Development concluded that China's emergence is beneficial to Latin America. The most recent one, from the World Bank, found strong evidence that Chinese demand was boosting Latin American exports and little indication that Chinese exports were crowding Latin American ones out of other markets. It seems that for resource-rich countries the main risk of China's hunger for commodities is that it might wane.
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