One of my favorite questions as an unashamed Japan optimist is “what is the biggest problem of the Japanese economy?”
The answer is simple: Japan suffers from too much competition. Deflation, low profitability, poor investment returns, subpar foreign direct investment, falling tax revenues, you name it. Many of the “Japanification” problems can be explained by Japan’s unique ability to feed ever-more relentless competition.
In fact, Japan has long surpassed the United States as the world’s leading example of a free market economy. This assertion may run counter to the standard mythology, in which Japan is often described as a kind of “socialism that works.” But a look at the facts leaves no doubt that Japan, not America, is the world’s beacon of free market competition.
Measuring the competitiveness of an industry is easy. The greater the number of players, the more competitive it is. More specifically, economists measure the concentration of revenues controlled by the top-players, i.e., the market share of the industry leaders. In Japan, the top four companies in each industry control approximately 11 percent of their industry’s revenues. This is true across all industries, from oshibori hand towels to hairdressers to accessories to cars, banks, etc., based on the Japan corporate census and Finance Ministry data.
In the U.S., a comparable analysis suggests approximately 35 percent of each market is locked up by the top four players (on average across all industries as classified by the U.S. corporate census). All said, Japan’s markets and industries are about three times more competitive than those of America.
Interestingly, over the past 20 years, Japan has become more competitive, while America has become more monopolistic or oligopolistic. Between 1997 and 2017, the market share controlled by the top four companies fell in Japan from approximately 15 percent to 11 percent. In the U.S., the top four domination rose from approximately 26 percent to approximately 35 percent over the same period.
America’s move away from competition has been led by finance, technology, airlines and pharmaceuticals. So make no mistake: America has moved away from being “free market” while Japan has become the role model and de facto global champion of free market capitalism.
Industry concentration and the degree of competitive pressures are a measurable outcome and fact. In turn, greater competitiveness gives rise to many other measurable symptoms that are typically part of the Japanification debate.
One of my favorite examples is that a new soft drink is launched every two weeks in Japan, a clear sign of excessive, or should I say desperate, competition in that industry (unless, of course, you’re a novelty drink junky). Financially, this forces the profitability of Japanese drinks companies to be less than half of U.S. or European ones.
At the macro level, a few of the symptoms are:
1. Structural deflation or disinflation. More competition means lower corporate price power, so Japan has a structurally lower inflation rate than America or Europe. The consumer price index on average rises approximately 1.5 to 2 percent less fast than America’s every year.
2. Lower corporate profitability and investment returns. The more monopolistic an industry, the higher its overall financial returns, with America’s de facto monopolistic tech giants having led financial return and investment performance not just against Japan but against the world. In contrast, Japan has no performance superstars because of de facto excessive competition at home.
3. Lower foreign direct investment. Higher or even excessive domestic competition levels become a de facto barrier to entry for nonlocal players.
4. Low labor mobility. Moving to a competitor in the same industry offers de facto no real upside.
Of course, there are many other forces that shape the complex system that is Japan’s economy. But when it comes to identifying a concrete problem, excessive competition is definitely an overlooked force pulling Japan toward the Japanification fears that many policy leaders in the world worry about.
The good news is that Japan’s excessive competition is about to end. A structural boom is expected in mergers and acquisitions, with more and more corporate leaders embarking on roll-ups, buying smaller competitors and consolidating their industries.
Why and why now? The simple answer is demographics. Executives say the biggest threat to their companies’ survival is the growing labor and skills shortage. Buying your competitor is the most obvious solution.
In the past, corporate history, stubborn executives and CEO pride was the de facto biggest obstacle to industrial consolidation. Now that the postwar founder CEO generation is truly beginning to retire, executive pride and stubbornness is much more easily overcome (particularly if their children have no interest in leading the family business).
In addition, Japan has just reformed the rules and regulations governing domestic M&A, making it significantly easier to absorb and integrate other companies.
And on the financial side we have two powerful forces now coming together to put pressure on domestic executives to act: domestic investors in general, the Government Pension Investment Fund in particular, want to see higher returns and investment for growth instead of lazy cash-hoarding. Finally, the proposed reorganization of the stock exchange effectively demands greater consolidation and size for companies to be part of the prestigious big-board market.
All said, this is a good time to be a Japan optimist. Past decades have been haunted by a relentless rise in competition, with many policy programs targeting the support of low-productive “zombie companies” at the expense of suppressing superstars and national champions. Politically and socially, much of this was justified by the post-bubble fears of rising unemployment.
We often forget, but for the past 20 years or so Japan’s demographic problem was excess employment and fear of unemployment; so policymakers did whatever they could to keep companies afloat and thus ensure against rising unemployment. Now, Japan’s demographic destiny has inflected and as we move from excess to shortage, shrinking worker numbers will force a consolidation of industries.
Those CEOs who see this opportunity and lead the charge are poised to become big winners. Of course, it is doubtful that Japan will ever truly allow a “winner takes all” type industrial structure, but for the next three to five years an M&A boom and accelerating industrial consolidation are poised to drive a structural upturn in corporate returns. Too much competition has been too much of a good thing.
Jesper Koll is the senior adviser to Wisdomtree Investments and is consistently ranked as a top Japan strategist/economist. He publishes blogs at www.wisdomtree.com/blog .