Firing the Fourth Arrow: The Private Sector and the Future of Japan

On June 15, 2015, the Federal Reserve Bank of San Francisco hosted an Asia Financial Forum entitled Firing the Fourth Arrow: The Private Sector and the Future of Japan. The event featured a panel of Japan experts, including Michael Chui, Partner, McKinsey Global Institute, Tasuku Kuwabara, Principal, McKinsey & Company, and moderator Sean Creehan, Japan Analyst in the Country Analysis Unit at the Federal Reserve Bank of San Francisco. The panelists discussed Japan’s process of reinvention amid ongoing economic reform and aggressive central bank easing after two decades of economic stagnation. Panelists addressed the McKinsey Global Institute’s report, The Future of Japan: Reigniting Productivity and Growth, which argues that Japan’s private sector should take the lead and fire a “fourth arrow” of economic reforms by improving labor and capital productivity, instituting global best practices, deploying new technologies, and introducing greater competition.

Key takeaways from the discussion include the following points:

• According to the McKinsey experts, Japan has the potential to grow further if it can increase worker productivity; so far, Japan has only increased productivity in the past decade by reducing labor hours, compared to the United States and Germany, which have increased value-added productivity per hour.
• Nonetheless, Japan boasts strong technology and manufacturing capabilities, world-class infrastructure, and a position as the world’s third-largest economy with well-funded companies. Japan can leverage these strengths to address developing global trends, which include aging demographics, internationalization through increasing global trade and connectedness, disruptive technology, and urbanization.
• The Japanese government can spur productivity by implementing reforms such as cultivating new talent (increasing the participation of women and skilled foreign workers), improving business education, increasing entrepreneurship through access to funding and a more supportive legal framework, and promoting global competitiveness and market-oriented reforms.
• The private sector also has the power to spur productivity by adopting global best practices, creating global powerhouses that can adapt to the competitive landscape, and innovating through next generation technologies.
• Japan’s intensive investment in research and development and its large technology base are not driving productivity. Japanese companies excel in manufacturing and development, but the process is not well-linked to global economy’s needs or the global end-user’s requirements. Companies need to deeply understand their customers and increase engagement during the product development process.
• The financial sector should also play a role in fostering innovation and entrepreneurship – for example, asking for loan guarantees beyond corporate assets can hinder risk-taking. The sector faces challenges from a low-interest rate environment, but it can make improvements by implementing more customer-driven products and services and innovative technologies like mobile and online banking.
• Finally, increasingly sophisticated robotics have the potential to replace the rapidly aging workforce. Robotics have boasted steadily decreasing costs of development and increasing ease of programming and use. The scope of applications has also widened, including use in food production and elder care.

The Japanese economy, with its aging population and shrinking work force, is a harbinger for other developed countries, which will face similar demographic challenges in the future. If Japan can solve its demographic challenges, many other economies can use the country’s reforms as a blueprint.