Commentary / Japan

Grasping the key to innovation

by Takamitsu Sawa

The need for promoting innovation is being emphasized as part of the Abe administration’s growth strategy of encouraging private sector investments, which constitutes the “third arrow” of Prime Minister Shinzo Abe’s economic policy dubbed “Abenomics.”

The term “innovation” dates back to 1912, when economist Joseph Alois Schumpeter stated in his book written in German that the driving force of economic development is an unprecedented “neue Kombination” (new combination) of such factors as the means of production, resources and labor. Subsequently, American economists started using the word “innovation” to express this new combination.

Innovation has been defined as “the act of starting something for the first time” and “introducing something new.” In Japan, however, the same term has become synonymous with “technological innovation.”

The reason for this is found in the words of Yonosuke Goto, the chief author of the fiscal 1956 White Paper on the Economy. He said that a decade after the end of World War II, Japan no longer could rely on postwar reconstruction as the springboard for its economic development and that Japan needed to build two concepts, “technological innovation” and “modernization” — Japanese translations of “innovation” and “transformation,” respectively — into its economy.

The phrase “technological innovation,” which was coined by Goto, rapidly gained popularity throughout the country as it perfectly fitted the circumstances prevailing at the time. Thus, “innovation” and “technological innovation” became synonymous with each other in Japan.

This is the background to the frequent use of the word “innovation,” meaning “technological innovation,” in the growth strategy of Abenomics.

A question that I would like to ask in this connection is whether or not technological innovation represents both a necessary and sufficient condition for economic growth. My answer is that it is neither a necessary nor a sufficient condition. I will try to show the reasons hereunder.

During the period of rapid economic growth from 1958 to 1973, the Japanese economy grew at an amazingly high annual average rate of 9.4 percent. The Japanese people adroitly utilized technologies transferred from advanced countries of the West to manufacture fast-selling home appliances, automobiles and other products in rapid succession, which served to enhance convenience and comfort in people’s daily life. This created a “virtuous circle” of encouraging workers, who benefited from rising wages triggered by industrialization, to respond by further boosting the demand for industrial goods.

Although I may be somewhat prejudiced, I do not believe that any full-fledged technological development worthy of being called “technological innovation” ever originated in Japan during the period of high economic growth.

The driving force behind Japan’s rapid economic growth was innovation in the production process, as typified by Toyota’s just-in-time manufacturing system, which represented the kind of new combination that Schumpeter referred to in defining innovation.

When the prices of crude oil jumped fourfold in the oil shock of October 1973, Japan’s annual economic growth rate plunged to between 4 percent and 5 percent because Japan relied on imports for 99 percent of its petroleum needs.

In and after the latter half of the 1970s, the principal players supporting the nation’s economic growth were the electric and automobile industries. Japan led the world with its technologies for developing electric appliances that consumed less power and highly fuel efficient motor vehicles.

In Japan, there is a saying that one can “turn a misfortune into a blessing.” Indeed, Japan’s manufacturing sector, in a country with little or no natural resources, endeavored to promote energy-saving innovations out of sheer necessity and the electronic products and automobiles resulting from those endeavors were welcomed by consumers the world over who had been hit hard by spiraling oil prices.

Japan was able to maintain an average annual economic growth rate of 4.2 percent between 1974 and 1990 because of a steady expansion of car and appliance exports that incorporated the fruit of many years of innovation.

After the March 1991 start of a protracted recession, the Japanese economic growth rate in real terms remained at an unprecedented low level of 0.9 percent through fiscal 2013. The principal factor behind this sluggishness was that the Japanese electric industry was challenged by competitors in South Korea, Taiwan and China, which caught up fast.

Generally speaking, industrial products can be copied relatively easily through the process of reverse engineering in which a finished product is dismantled to learn how it is made. This process enables less developed countries with relatively low wage levels to catch up with and surpass advanced nations within a matter of a quarter of a century. This figure is based on the time it took Japan to catch up with and surpass the United States and European countries after World War II, South Korea and Taiwan to overtake Japan, and China to do the same once it enacted its economic reforms.

Japanese manufacturers of smartphones and tablets have been moribund because of a pincer attack by the U.S.’ Apple Inc. and South Korea’s Samsung Electronics. During the past few years, meanwhile, Samsung, which once boasted the largest global market share, is fighting an uphill battle against a new challenge mounted by Xiaomi Inc. of China, which was founded only in 2010.

The reason why Apple has been able to maintain a predominant position is that it has its own proprietary operating system, known as iOS. Users of iPhones, developed and marketed by Apple, can easily download the latest version of this operating system. On the other hand, smartphones made in Japan, China and South Korea rely on the Android operating system developed by Google and users cannot easily download the latest version of the operating system because the software maker is different from the hardware makers.

The same thing can be said about laptop computers. Apple’s products have an advantage because they use Apple’s own operating system. But most PC makers have to adopt the Windows operating system developed by Microsoft to run on their computers, which puts them at a disadvantage.

In short, since the 1990s, the field in which the decisive factor takes place in realizing innovation has shifted from hardware to software. This has caused Japan, which was not competitive in software to start with, to capitulate to the U.S.

The field in which Japan has made conspicuous progress in recent years is tissue engineering in regenerative medicine, especially development of induced pluripotent stem (iPS) cells. Another field in which we can place hope on Japan for innovation is pharmaceuticals.

Innovation in medical science is welcome news to those suffering from illnesses. But its contribution to macro-economic growth is quite limited. While the Japanese economy grew at an average annual rate of only 0.9 percent during the past 25 years, innovation in the field of medicine these days is poles apart from what it was 25 years ago. Although such innovation contributes greatly to elevating the nation’s gross national happiness, it makes little, if any, contribution to economic growth.

This means that in a mature economy, innovation contributes greatly to humankind but does little to make the economy grow. This also means that innovation is not a sufficient condition for economic growth.

During the past quarter of a century, Japan has followed the motto of becoming bigger, moving higher and running faster. Modernism innovation made people’s living more convenient and more comfortable and boosted the growth rate of the national economy. But the large majority of such modernism innovation had already attained perfection by the end of the 1980s.

The center stage for post-modernism innovation in and after the 1990s has shifted to digital software and life science. But post-modernism innovation generates little ripple effect in inter-industrial relations. It is not qualified to play a leading role in a growth strategy of encouraging equipment investments in the private sector.

Would it not be more appropriate for Japan to place Schumpeter’s “new combination” innovation at the nucleus of its growth strategy?

Takamitsu Sawa is president of Shiga University.

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