Executive Summary

Japan is the world's second largest economy after the US, accounting for
nearly one fifth of world GDP and more than two thirds of East Asian GDP. Its
individual regions alone constitute major Asian markets in their own right.
Japan has been Australia's largest trading partner for three decades, and is
its third largest foreign investor. Japan buys one fifth of Australian
exports, supplies nearly one sixth of Australian imports, provides one fifth
of inbound tourists, is Australia's principal market for major commodities and
is an increasingly important buyer of high-value-added goods and services.
Japan and Australia also enjoy strong people-to-people, cultural, academic and
strategic ties, creating the basis for an increasingly important partnership
in the twenty-first century.

The significance of this relationship makes it important for Australians to
understand the dynamics of the Japanese economy and society. This report
analyses the changes occurring in Japan today, highlighting the implications
for Australia of socioeconomic and political trends, economic and structural
reform, liberalisation priorities and sectoral developments.

The report is divided into five parts. The first evaluates the major issues
facing Japan and examines the socioeconomic, political and economic
environment, in effect setting the scene for the rest of the book. The second
part analyses the international side of the Japanese economy and the factors
contributing to changing trade and investment patterns. It discusses how this
can translate into bilateral business opportunities, as well as joint projects
in third countries. The third section studies major domestic influences on the
structure and competitiveness of Japanese industry, revealing how reform is
proceeding quite differently in finance and distribution.

The fourth part of the report deals with market access. It examines the
market liberalisation measures that Japan has adopted to date and major issues
in bilateral and multilateral trade negotiations. This section also looks at
market access techniques, evaluating the advantages of entering the Japanese
market through some of its smaller regions, each of which is larger in terms
of consumer purchasing power than many other Asian economies. The final part
examines issues and opportunities in sectors of particular interest to
Australia: agriculture and food, energy, transport and services. The report
concludes with a summary of the major findings and their possible implications
for Australia.

Choices for the Twenty-First Century

A number of major issues are confronting Japan as it heads into the
twenty-first century. The choices it makes will determine its direction over
the next 10 to 15 years and will have an important impact on Australia. Most
of the key issues facing Japan are not new; many have been debated for years.
While some are being addressed effectively, others may not be resolved in the
short to medium term. The central themes and issues explored in this report
include:

• socioeconomic change
• the broad impact of a declining labour force and a rapidly growing
  proportion of aged people
• the role of government in the economy
• macroeconomic management and sustainable growth
• the factors influencing the exchange rate
• globalisation and the impact of changing trading and investment patterns
• the direction of deregulation and reform in government administration,
  financial markets, transport and distribution, agriculture, industry and
  education
• market protection and access
• innovation and emerging industries.

Socioeconomic Change Has Broad Impact

A sluggish economy, a dramatic increase in the population aged over 65,
internationalisation and unprecedented affluence are challenging Japan's
socioeconomic fabric. At home, at work and at leisure, rising expectations and
changing attitudes are affecting the labour market, the role of women and
consumer preferences.

The rising share of the elderly in the population will have the broadest
impact. Indeed, it is the imperative underlining many current reforms. With
one third of Japanese expected to be over 65 years of age in 2040, double the
1995 level, and with the population peaking around 2010, Japan must prepare
for a potentially serious labour shortage, declining savings and investment,
and heavy pressure on health and welfare facilities. Companies are already
preparing for the opportunities, targetting the 'silver market' with a range
of new goods and services. The need to bolster national savings to fund future
retirees is also influencing macroeconomic policy.

Proportion of Elderly to Rise Dramatically

Japan's Population by Age Bracket (1995 to 2065)

Note: Figures in parenthesis indicate the total population (millions)
projected for that year. Other projections (Ministry of Health and Welfare,
1997)show the population peaking as early as 2007.

Source: Management and Coordination Agency, Statistics Bureau, 1997, p. 33.

Family life is changing as nuclear families replace extended families as
the norm, and more people live alone. Consumers are increasingly sophisticated
and discriminating, demanding value-for-money above all. This has altered the
traditional preference for Japanese-made goods and has intensified
competition.

Labour practices are undergoing fundamental changes as companies endeavour
to become more efficient and innovative in a fiercely competitive business
environment. Performance and merit will increasingly determine advancement,
better suiting a younger generation seeking more rewarding careers and workers
willing to retrain to meet increasingly sophisticated employment needs. With
the looming labour shortage, some companies have begun to evaluate how they
might better utilise female employees. In addition, the stigma of working for
foreign companies is fading as ambitious younger people value their more
flexible, merit-oriented labour practices, making it easier for foreign firms
to recruit quality staff.

Reform Within Conservative Politics

Following four years of political instability, the Liberal Democratic Party
(LDP) is back in power, albeit in a minority government. Its survival will
depend on how successfully the Hashimoto Government manages political dynamics
in the Diet and the electorate, and delivers administrative and economic
reforms.

The LDP held power for 38 years (1955 to 1993), fulfilling its main policy
goals of catching up with the West economically and improving Japanese living
standards. It achieved these by the 1980s, but failed to reach a consensus on
how to deal with new problems that emerged in the 1990s. In the midst of a
major recession, policy-making paralysis and numerous scandals weakened the
conservatives' long-standing unity. Several groups broke away from the LDP,
forming new conservative parties with reformist platforms. In the 1993
elections, the LDP was replaced by an eight-party coalition government led by
pro-reform conservatives. However, in the next three years, four prime
ministers achieved little policy unity and few reforms, apart from electoral
reform. A record low turnout in the 1996 election underlined voter
disillusion. Lack of viable alternatives and a desire for stability helped the
LDP win enough seats to form a reasonably stable minority government. The
Hashimoto Government has targetted six key areas for reform: public
administration, banking and finance, the fiscal system, social security,
education, and general economic and structural problems.

Conservatives Remain Dominant

Japanese Lower House Elections 1955 to 1996

Party Votes by Number of Seats*

Source: Compiled by Economic Analytical Unit from various sources.

With conservative forces expected to continue to dominate the Lower House
of the Diet, several patterns of government could emerge: a single large
conservative party (effectively a reunified LDP); two medium-sized parties
(traditional conservatives and more progressive conservatives); or fluid
alliances of several conservative parties. In the first case, if a majority of
conservatives can agree on a new central policy platform with broad appeal
(for example, continued reform, but with minimal social cost), chances for
stability will be enhanced. However, the process of consensus decision-making
that this could entail would reduce the pace of reform. In the case of other
regroupings, the party in control would set the pace for reform.

Growth Depends On Reform, Demographics

Following a prolonged recession, Japan's broad macroeconomic environment is
now reasonably attractive, with improved growth prospects and negligible
inflationary pressures. Over the longer term, however, the potential growth
rate will decline unless deregulation, innovation, and structural and fiscal
reform offset the economic impact of a higher ratio of elderly to working-age
population.

Demographics will have a number of further longer-term macroeconomic
implications. A shrinking workforce combined with a growing proportion of
elderly will have enormous budgetary implications. The savings rate will
decline as retirees draw down savings, making recourse to fiscal stimulus more
difficult. In addition, as the savings rate decreases, the current account
surplus and capital outflows could shrink.

These long-term pressures will drive economic reforms aimed at allocating
savings more efficiently, increasing productivity, raising the potential
growth rate and reducing the need to resort to regular fiscal stimulus
measures.

Changing Trade Structures: New Business

Yen appreciation, investment overseas (especially in Asia) and a more
streamlined distribution sector have altered substantially Japan's trade
structure over the last decade. Exports of high-value-added parts and capital
goods are becoming more significant than final products, particularly consumer
goods. At the same time, purchases of intermediate and final products,
especially consumer goods and processed foods, are surging, while imports of
raw materials are expanding more slowly. Trade in services is expanding
rapidly.

Despite rapidly growing exports of higher-value-added manufactured items
and processed food, Australia's share of Japanese imports declined from 5.8
per cent in 1985 to 4.8 per cent in 1996. This is because primary commodities
continue to dominate Australia's exports to Japan while their share in
Japanese imports is declining overall. While such commodity trade remains
vital to Australia, excellent opportunities exist to tap into Japan's fast
growing demand for high-value-added products. Processed foods, housing and
construction materials, alcoholic beverages, jewellery, cosmetics, apparel,
even refined copper, are growth segments in which Australia has a comparative
advantage.

Japan's Globalisation Can Benefit Australia

Although Japan's overseas production (based on foreign assets) is a small
proportion of its total output and less than half that of other major
industrialised nations, Japanese firms are the fastest growing group among the
world's 100 most internationalised companies (UNCTAD, 1996). Rising import
penetration and strengthening global competitive forces will drive
internationalisation and liberalisation in Japan. Outbound direct investment
will continue to be motivated by overseas market development opportunities and
the need to transfer offshore labour-, land- and energy-intensive processes
which have become unviable at home.

After bottoming out in 1993, Japanese foreign direct investment (FDI) has
resurged, with new outlays exceeding US$20 billion in 1995. This FDI is
shifting from an emphasis on mass consumer goods assembly to a focus on
higher-value-added goods and services. As with trade, these changing patterns
have affected Japanese direct investment in Australia. While this generally
has declined since 1989, due to contracting property and financial sector
interests, Australia has attracted more export-oriented manufacturing and
mining investment. Sustaining this trend in the face of strong competition
from other host countries will require persistent microeconomic reform aimed
at providing an internationally competitive business environment. Surveys of
Japanese companies in Australia reveal that Australian suppliers also need to
lift their performance.

FDI inside Japan totalled just US$5.3 billion between 1988 and 1995, or 2.5
per cent of Japanese outbound FDI over the same period. It represents just
0.02 per cent of GDP, compared to 0.77 per cent in the G7 less Japan (USA,
Canada, UK, France, Italy, Germany) and 1.33 per cent in Australia. Australia
accounted for just under 1 per cent of FDI in Japan between 1988 and 1995.

Although low, foreign direct investment in Japan can still play a critical
role in trade facilitation and establishing specialised distribution networks.
Over the past 15 years, regulatory and bureaucratic barriers to foreign
investment have eased significantly under a policy officially encouraging
inbound investment.

Key success factors for investors in Japan include strongly differentiated
product portfolios (such as unique technology), ability to effectively
transfer core competences, appropriate structure, realistic goals, a positive
corporate image, good management, quality staff and the right partners. Given
the relatively strong 'trade-pull' effect associated with FDI in Japan to
date, Australian companies may find that a stronger presence in Japan will
greatly assist their business efforts. Both the Australian and Japanese
Governments offer assistance to potential investors, as well as to exporters.
These are listed, together with useful contact details, in the section
entitled Information for Companies, at the back of the book.

Japanese trading houses are important potential partners for Australian
businesses. In reducing their reliance on low-margin trading activities, the
sogo shosha are moving into more sophisticated intermediary functions (such as
setting up infrastructure financing consortia), and investing directly in
resource processing, manufacturing, services and infrastructure development.
Australia and Australian companies are well placed to attract trading company
investment and to engage in joint activities in third countries.

Financial Reform Crucial

Japan's financial sector, burdened by heavy regulation and inefficiency,
constrains economic revitalisation. Liberalisation to date has intensified
competition; however, faster reform is required if Japan is to meet retirees'
needs and cope with constant innovation in international financial markets.
The Hashimoto Government's 'Big Bang' 1996 to 2001 financial market
liberalisation plan, if fully implemented, will be an important step forward
and should serve as a catalyst for futher reform.

While gradual and incremental in nature, reforms are producing change in
the financial sector. Diversification of funding sources has reduced large
firms' dependence on banks, forcing banks to develop new services to sustain
relationships and broaden their client base. Many financial institutions are
restructuring to improve efficiency and overcome bad loan problems, and
compete in a fast-moving, increasingly sophisticated market. Foreign financial
firms are establishing a stronger presence. Indeed, for many years, some have
been at the forefront of financial market innovation, particularly in the
securities sector. Foreign companies, with lower costs and stronger capacity
to price risk, are expanding their share in the insurance and pension markets,
which are under considerable pressure to reform.

Barriers Hurt Competition, Efficiency

Although Japan is perceived as a very difficult and complex market, its
tariff and core nontariff barriers are often lower and less distorting than
those of the European Union (EU) and the USA. Even some of Japan's business
practices, widely regarded as unofficial entry barriers, are similar to EU and
US practices. The major barriers to market access arise from Japan's excessive
regulation, lack of transparency, weak enforcement of competition policy and
numerous exemptions to the antimonopoly act. These barriers affect local as
well as foreign companies, reducing competition and efficiency in the economy
in general.

Over the years, commercial and economic necessity and foreign (especially
US) pressure have combined to produce varying degrees of liberalisation in
many sectors. Indeed, deregulation now is increasingly accepted as beneficial,
and foreign goods encounter far few barriers to entry than in the past. The
Hashimoto Government strongly supports deregulation and is widely expected to
achieve more than previous governments. Nevertheless, the pace and substance
of reform remain major issues. Some commercial pressure for deregulation has
eased with the weakening of the yen, and strong links among government,
bureaucracy and business interests continue to stall deregulation in key
sectors. In addition, some parts of the bureaucracy, reluctant to trust the
market and facing a reduction in its influence under regulatory and
administrative reform, may reregulate as it deregulates.

Despite these cautions, liberalisation has gathered momentum, and major
reversals are unlikely to occur, particularly under the current government. In
coming years, many existing barriers will weaken or disappear.

Streamlining Distribution Cuts Costs

A fragmented, multitiered distribution system has contributed significantly
to Japan having the highest prices in the OECD. Since the 1980s, external
pressure, deregulation and especially, market forces (yen appreciation,
recession and consumer and business pressure) combined to bring about change.
This has produced more streamlined distribution networks, strong emphasis on
efficiency and costs, technological innovation, greater choice and above all,
lower prices. Prominent Japanese retailers such as Daiei and Ito-Yokado lead
the change.

The previous retail structure of a few department store and supermarket
chains alongside hundreds of thousands of very small shops is changing as
large-scale stores and shopping complexes burgeon and the small-retailer
sector shrinks. The wholesale tier similarly is reshaping into fewer, larger
players. Having gained control over pricing and merchandising, the largest
retailers are replacing manufacturers as controllers of the distribution
system. They are acquiring products more directly, often bypassing wholesalers
to take delivery straight from manufacturers and, increasingly, from overseas
suppliers. Japanese retailers and wholesalers also are expanding offshore, not
only to actively source cheaper products, but also to invest in fast-growing
Asian distribution systems. These trends will continue, producing fewer but
larger retail and wholesale companies over the medium term. Foreign firms
should consider these trends in reviewing their Japan distribution strategies.

Japan's Regions Are Attractive Markets

Each of Japan's eight regions constitutes a major Asian market. The Kanto
(surrounding Tokyo), Kansai (centring on Osaka-Kobe) and Chubu (adjoining
Nagoya) economies each far surpasses any other Asian market, including China.
Even the smallest region, Shikoku, has a higher per capita income than any
other Asian economy.

Each Region a Major Asian Market in Its Own Right

Japanese Regional Economies Compared to the Rest of Asia

GRP/GDP*, US$ billion, 1994

Note: GRP: Gross Regional Product; GDP: Gross Domestic Product (measured in
terms of official exchange rates); GDP for India and Pakistan are for
respective (March, June) financial year 1994.

Source: International Monetary Fund, 1997; Economic Planning Agency, 1997.

The regions play a pivotal role in Japanese life. Historically the main
instigators of change, today the regions are taking an increasingly
independent approach to revitalising their economies, actively encouraging
both local and foreign investment and forging closer ties with Asia. Many
companies based in Tokyo and Osaka are developing regional strategies, seeking
growth opportunities and lower production costs.

Foreign companies, too, should consider the advantages of adopting a
regional approach to the giant Japanese market. Distribution systems are not
so entrenched, companies are not so huge, and competition, while strong, is
not so fierce as in the main centres. Indeed, numerous Australian small and
medium-sized companies have forged lucrative business ties with Japanese SMEs
(although what is 'small' in Japan may be relatively large in Australia). The
Australian Government encourages such an approach through its network of
regional Austrade offices. Direct Qantas and Ansett services to Japan's major
regional gateways bypass the congested Narita Airport and facilitate doing
business in the regions.

Agrifood Challenges Remain

Despite very high rates of protection, Japan relies heavily on imported
food. Indeed, it is Australia's most important agrifood market. Except for
1995 and 1996, agrifood exports to Japan have grown strongly over the past
decade, especially in the higher-value processed food category. Dependence on
beef, which comprises nearly half of the value of Australia's agrifood exports
to Japan, has recently declined, and the variety of nontraditional products
has expanded.

Traditional ties to the land and the weighting of the rural vote make
agricultural policy sensitive, despite the irrefutable economic arguments
favouring reform. However, with the younger generation leaving the fields for
the cities and the proportion of elderly in the farming population increasing
rapidly, the urgency for reform may eventually overcome political wariness.

Demand for imported food will continue to grow, stimulated by changing
lifestyles and the shrinking agriculture sector. The planned reform of Japan's
Agricultural Basic Law offers some hope of fundamental policy change. However,
the pace is likely to be slow and the reforms incremental.

Energy Reform: Lower Prices, More Imports?

Japan's ongoing energy market reform and restructuring is vital to
Australia, which supplies 56 per cent of Japan's coal and a rising share of
its liquid natural gas imports. Indeed, Japan takes nearly half of Australia's
energy exports. Industry's share in energy consumption is falling as
manufacturing shifts from heavy- to less energy-intensive industries. At the
same time, the energy share of the residential, commercial and transport
sectors is growing, reflecting rising living standards and an expanding
services sector. Dependence on oil will continue to decline slowly, as nuclear
energy and gas become more prevalent in electricity generation. While a
declining population may lower energy demand in the long term, this will
probably be outweighed by the relatively strong growth in consumption per
capita, particularly in the residential sector.

Japan's electricity and gas tariffs, and petroleum product prices are among
the highest in the OECD. With manufacturing facing stiffer competition, the
business community is pressing for deregulation and reform of energy utilities
to reduce their production costs. Reforms allowing new entrants and imports
are now underway in the electricity, gas, coal and petroleum refining and
distribution industries. While reform plans in sectors like electricity and
household gas are cautious, industrial gas, petroleum products and retail
gasoline prices could decline significantly, potentially increasing import
demand. Phasing out domestic coal industry subsidies in 2001 should benefit
Australian coal exporters. However, if Japan achieves its target of
stabilising greenhouse gas emissions at 1990 levels by 2000, it could have a
significant negative impact on energy exporters.

Transport Problems A Long-Term Challenge

Economic recovery will place Japan's transport infrastructure under
significant pressure. Even during recent years of sluggish economic
performance, heavily regulated and unionised transport systems have hindered
companies' efforts to streamline distribution and cut costs. It still costs
twice as much to move a container within Japan as to ship it from Australia to
Yokohama. International shippers - and even firms shipping goods from one port
to another - often use cheap feeder lines out of Pusan (Republic of Korea)
into less expensive, less congested Japanese regional ports.

To reduce these constraints, the Japanese Government is encouraging a modal
shift in domestic distribution systems, including greater utilisation of rail
and coastal shipping to ease road congestion. Restrictions on road freight
(such as limitations on vehicle size, container cargoes, regional service
boundaries) are gradually being eased. Nevertheless, road transport's
reliability, speed (despite congestion) and convenience will be difficult for
rail and coastal shipping to match unless the authorities resolve important
regulatory and efficiency issues. While progress on rail freight may remain
stymied by entrenched interests, coastal shipping may be sufficiently
liberalised to become an efficient mode within 10 to 15 years. Australia's
fast ferry industry is in a good position to participate in the revitalisation
of this sector.

Australia-Japan trade and tourism flows are directly affected by problems
in international aviation and shipping. These include capacity constraints at
Japan's main air and seaports, especially Narita, which handles 60 per cent of
outbound passengers and 70 per cent of international air cargo with only one
runway. Other major issues include rigid fare structures, high operating and
expansion costs, low labour flexibility and productivity, lengthy and opaque
customs clearance and quarantine procedures, and ineffective use of electronic
data networks.

Over the next 10 to 15 years, many of these problems will be tackled.
Additional runways are planned for all major airports by 2010, and 15-metre
deep berths are being developed at ports around Japan to accommodate the most
modern container vessels. Customs clearance will become increasingly
automated, reducing approval times (especially important for perishables) and
improving regional port procedures. Competition is being introduced in
domestic aviation, including easing the rigid fares and slots systems, and
allowing new discount carriers. In addition, government and business are
encouraging airlines and shipping companies to tackle labour rigidities and
install new technology to improve productivity. Costs, however, will remain
high, primarily because many new runways, airports and container terminals
will be built on costly reclaimed land sites.

Considerable Scope For Tourism Growth

Japanese tourism to Australia is rising steadily, totalling 800 000 in 1996
and expected to exceed 1 million by 2000. This represents an approximate 5 per
cent share of Japan's outbound tourism, indicating considerable scope for
development. Although Australia remains a popular destination, competition
from other countries is intensifying. With pricing and packaging the key
determinants of tourists' choice of destination, innovative marketing and
industry cooperation are vitally important. Bilateral negotiations on Japanese
pricing and packaging restrictions should eventually produce a more
competitive environment.

Services Sector Offers New Opportunities

Within the broad tertiary sector, which represents 54 per cent of Japan's
GDP, 'miscellaneous services' are a major engine of growth, providing 86 per
cent of employment expansion from 1991 to 1996 and accounting for 16 per cent
of GDP in 1995. These services include:

• leisure
• leasing
• information industries, such as information technology and multimedia
• cleaning, catering and linen services
• broadcasting
• advertising
• entertainment venues, such as theme parks, cinemas and sporting
  facilities
• personal services, such as childcare, hairdressing and housekeeping
• professional services such as legal, accountancy and consulting
• business support services such as temporary staffing, logistics,
  building maintenance and security
• education and training
• environmental management such as waste disposal
• health care and pathology services.

While some areas are regulated tightly, the general trend toward
deregulation in nonmanufacturing will facilitate growth and innovation. Some
newer segments, such as personal services and certain leisure and information
segments, enjoy minimal government intervention (so far) and virtually
nonexistent traditional barriers; these offer particularly attractive
opportunities for international companies to develop innovative goods and
services for the Japanese market. Importantly, changing attitudes toward
foreign companies over the past decade or so should help investors in the
services sector. Consumers and businesses increasingly view foreign companies
not only as sources of new products, technologies and services, but also as
important contributors to competition, employment and innovation.

Implications For Australia

A New Japan? Change in Asia's Megamarket encourages Australian companies to
take a new look at Japan. While the business environment in Japan is
expensive, competitive and challenging, it is in many ways less complex than
other markets in the region. Japan has a strong institutional framework;
regulation is being reduced and becoming more transparent; and business
practices are becoming less opaque. Consumer tastes are changing, making
foreign products easier to market. The distribution system is becoming more
streamlined and the financial sector is more internationalised. Regional Japan
offers attractive gateways to the market, and niche segments are emerging that
are often unfettered by the restrictions that hinder access to more
traditional sectors. In planning for the coming decade, companies should
seriously assess the Japanese market for trade and investment opportunities,
as well as for strategic alliances.

The report also has messages for Australian state and federal governments
which are seeking to increase exports to and investment from Japan. Japanese
investors in Australia generate strong net exports and are major users of
locally sourced inputs. However, governments and industries alike will find it
a major challenge to attract quality Japanese investment in coming years, due
to competition from countries offering lower costs, higher returns and faster
growing domestic markets. Australia must therefore continue to market strongly
in Japan its strengths and comparative advantages, while proceeding with
microeconomic reform at home. As Japan-Australia trade and investment move up
the value chain, important new opportunities will emerge in a variety of
complementary areas. While the government can assist in facilitating market
access and identifying opportunities, it is up to companies to capitalise on
them.

[Go back to the Economic
Analytical Unit Homepage]