The new coronavirus crisis is causing many new and largely unpredictable challenges for the global economy in general and the Japanese economy in particular.
As with any sudden and unforeseen shock, it appears more complex and potentially disruptive than anything we’ve dealt with before. It is tempting to either overestimate or underestimate the potential disruption. The only real certainty is that the COVID-19 crisis is developing into a full-blown crash test for Abenomics.
Chances are very good Japan will pass the test and emerge as a stronger, more competitive economy, for a number of reasons.
History has proven time and again the incredible ability of the Japanese people to never waste a good crisis. Turning misfortunes into a catalyst for positive change is something Japan tends to do very well.
First, the bad news. Yes, Japan’s economy is poised for recession. Before the COVID-19 outbreak, the 2020-2021 economic outlook was a relative dull and unexciting one, with most forecasters predicting more or less flat growth of around 1 percent. If you wanted excitement, you looked to the Olympics and tried to pontificate how much of a “boom-bust” cycle would be forced. If you wanted depth, you discussed and lamented the still-too-slow progress of structural reform and Prime Minister Shinzo Abe’s “third arrow.”
More importantly, if you were an investor, entrepreneur, business leader or policymaker, you simply got on with your business-as-usual procedures and strategies because Japan’s macro conditions were a bastion of stability and ideal backdrop for kaizen, small and incremental but steadfast improvements, just as business leaders prefer.
Now suddenly this comfort zone has been ripped apart. Just as the self-inflicted cyclical damage done by the consumption tax hike was supposed to fade, the coronavirus crisis hit, adding a round of serious downward pressure on the four major engines of Japan’s private economy: consumption, business investment, exports of goods and exports of services, i.e., inbound tourism.
At the time of this writing, hard evidence from January and February is still scant, but the fact that by the end of January, manufacturers’ inventories had surged to levels last seen at the depth of the global financial crisis, suggesting we’re in for severe production cuts in the months ahead. And when production gets cut, so will work hours and income. Before long, the hit to corporate profits will feed negative expectations for summer bonuses and consumers will tighten their purse strings.
All said, it now looks highly likely Japan’s economy has been pulled into a classic self-enforcing downward cycle with two or possibly even three consecutive quarters of negative economic growth. Within a couple of weeks we’ve gone from dull but stable to a serious “bust” as the most likely scenario in the first half of the year.
The good news is that the potential severity of this “bust” is already beginning to trigger a counter-reaction. Investors, business leaders and policymakers have now been forced out of their complacency. As the “bastion of stability” is now under attack, business-as-usual and kaizen will get replaced not just by the standard defensive tactics but also by genuinely new strategies and reform.
Make no mistake : The real crash test of Abenomics is not whether Japan can avoid a recession; but whether private sector corporate governance and leadership have changed enough to have a vision and now use this crisis as a catalyst to break through internal complacency, vested interests and whatever else that were the excuses to continue business as usual and avoid genuine reform. Call me an optimist, but I have high hopes that several of Japan’s leaders will rise up and begin to invest in the future of their business, ie., not waste this crisis.
Why the optimism? Because the underlying trends forcing genuine private sector reform were set in motion before the current crisis. The COVID-19 outbreak will add a turbo-charge that allows leaders to act and overcome entrenched resistance to change and new growth strategies. Specifically, the following three fundamental Japan trends will now get turbo-charged, and if I’m right, the net effect will be a stronger base for raising productivity, for higher competitiveness and more sustainable corporate profitability.
The domestic M&A boom is poised to accelerate. As the risks of a deep recession rise, more companies will be open to being acquired. It is not just entrenched and stubborn management of small and medium-size companies being pushed to the wall, but also corporate valuations becoming more attractive. Japan suffers from excessive competition and extreme industry fragmentation. The crisis will speed up industrial consolidation in both the industrial and the domestic service sectors. The crisis becomes a catalyst for greater CEO focus on strategic core competence which also allows for stepped-up divestitures and main-business-line concentration. The winners will become bigger, more focused and better at what they do.
Investment in human capital is also on the agenda. A big focus will be the introduction of a greater pay-for-performance culture. As the crisis deepens, so will the “war for talent.” Corporate leaders and corporate cultures slow to react or slow to define a strategic future vision will begin to lose talented and better educated younger employees. This will be the first recession where Japan has a full-blown and deeply entrenched labor and talent shortage, so “grassroots” pressure on managers and leaders will become more intense than ever. Expect corporate investment in, for example, IT literacy and global jinzai (global leadership skills) to be stepped up significantly in order to retain and motivate employees.
Japan’s global ambitions and strategic partnerships will intensify. Many corporate leaders have well thought-out strategic plans for global expansion but have been reluctant to pull the trigger to actually make overseas acquisitions because the price was too high. Here, the primary focus is on U.S. companies, as well as Indo-Pacific opportunities.
Of course, the current crisis will stress-test many more nuanced developments. Many more detailed countermeasures and trends are poised to evolve. However, the underlying forces point to a greater streamlining of Japan’s industrial and economic structure.
Importantly, private corporate leaders have an ample war chest of financial resources to finance investments for growth, given the record-high cash balances built up over the last decade. Against this, the fact that the public war chests are depleted and that neither the Bank of Japan nor the Finance Ministry have much room to act suggests that Japan’s old-style preference to cushion against structural change through stepped-up government intervention and financial socialism may be more exhausted than ever. Capitalism is coming to Japan.
Abenomics has always been about a more forceful, less consensual and focused leadership style. The true structural change it champions is the desire for greater competitiveness through more emphasis on self-reliance and entrepreneurship rather than big-government intervention and the socialization of risks. The current crash test will prove whether private sector leaders have embraced this spirit and are ready to turn crisis into opportunity.
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 .
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