The history of modern Japan’s manufacturing is emblematic of the nation’s industrial growth since 1868 when it opened its doors to the West. The long-term goal was to catch up with the world’s industrialized powers. Achieving that aim required that resources-poor Japan earn precious foreign exchange through exports.

Initially, the mainstay of the export trade was raw silk. The hard currency earned through silk sales was used to import the materials and machinery needed to modernize infant domestic industries. The main line of export products changed with the times, from textile goods to home appliances, automobiles, semiconductors and so on. But the pattern of export-driven production remained basically unchanged.

The manufacture of these and other world-beating products — all results of hands-on devotion to quality control — made Japan a trading powerhouse, laying the groundwork for its ascent as the world’s second-largest economy. Now, however, this traditional mode of industrial development is changing. Call it the “hollowing out” of domestic production: the erosion of the industrial base that has supported Japan’s economic growth.

What is happening, more specifically, is that a growing number of manufacturers are setting up shop abroad, particularly in Asia, to get around high production costs at home, such as high wages and land prices. This is manifest in the nation’s balance of international payments, an accounting statement of its external transactions. In 2001, the surplus in the income balance, or profits from overseas investments, exceeded the merchandise trade surplus for the first time. For fiscal 2001, which ended in March, external investment profits totaled a record 8.6 trillion yen, slightly below the trade surplus.

These changes in the payments balance are of great significance. They point to a reversal of roles between trade and investment, a shift from an “export behemoth” to a “creditor colossus.” In other words, Japan appears set to earn less from exports than from overseas investments, deriving its external incomes chiefly from interest, dividends and other returns on assets abroad.

Pessimists say the trade surplus will disappear five years from now, setting off a glacial process of industrial and economic decline. But such pessimism seems overdone. It is unlikely that Japan’s superiority in manufacturing — a position it has built painstakingly over the past century and more — will crumble like a house of cards. Still, the steady “hollowing” of domestic industry is worrisome.

What is needed is a redoubling of efforts by manufacturers to boost or revive their competitiveness. To that end, companies, large and small, must strive to open up new frontiers through stepped-up self-help and self-reform. Innovation is a key to success, as illustrated by the medium-size textile firm that introduced an integrated computerized process using information technology and now rivals Western fashion houses. The lesson, as always, is that adversity can be turned into prosperity through ingenuity and resourcefulness.

From the consumer’s point of view, price is the main concern, providing that quality is the same. But mass-producing quality products at low cost is becoming increasingly difficult in Japan. It will be better if the manufacture of these products is left to low-cost developing countries. Instead, domestic manufacturers should concentrate on high-value products tailored to the more sophisticated needs of consumers. In fact, that is how U.S. and European economies have developed.

Japan’s successful “growth through exports” policy was once described as a “miracle” of the world. Exports do count, but their role is beginning to change. The challenge ahead is to maintain manufacturing competitiveness at home, or prevent a real erosion of domestic industry, by developing sophisticated products that other countries may find difficult to copy. To that end, R&D programs should be promoted through concerted efforts by industry, government and academia.

From here on, what really counts is who makes that products, rather than where they are made. In other words, we shouldn’t worry much as long as given products are made by Japanese or Japanese-affiliated companies. Profits from products they make and sell abroad are sent home, as are interest and dividends from loans and investments abroad. These funds create a surplus in the income balance.

Britain, for one, has followed this path. Now Japan is poised to take a similar course as a mature investor-creditor nation. The test for Japanese companies is to pursue global investment and management strategies that will bring them high ratings and profits in the rough and tumble world of international finance.

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