China has issued a major directive to "learn from Japan" as a priority measure for this year - But strong measures are needed in order to obtain the cooperation of Japanese companies

Fundamental Principles for management of this year's economic policies

On December 16, 2016, Chinese Premier Li Keqiang announced in the Central Economic Work Conference the fundamental principles for management of the economic policies for the following year of 2017.

Last year, the Chinese government was unable to make a complete consensus on whether to focus on achieving growth targets or on promoting structural reforms, and sounds of discord surfaced within the administration of Xi Jinping. For example, in May 2016 the People's Daily published an opinion piece from the upper echelons of the Communist Party urging the State Council (the chief administrative authority) and local governments across the country to focus on promoting reforms.

As a result, considerable attention was focused on the form in which this year's fundamental principles on management of economic policy would be announced. The content of the fundamental principles announced stresses the promotion of structural reforms.

The first of the three overarching policies calls for a "new normal." This well-known phrase was used in a piece published in the People's Daily in August 2014, and it can be described as the consistent foundation on which the economic policies of the Xi Jinping administration have been based since it took office in November 2012.

In sum, it calls for normalization of the speed of economic growth and strengthening of the economic structure. Under this overarching policy, the Chinese economy has maintained stability in employment and prices and sustained strong performance in macroeconomic policies since 2012.

At the same time, in the area of economic structural reforms there is an enormous backlog of problems left unaddressed by previous administrations. Of particular severity are the issues of overcapacity, centered on heavy industry, and excess stock of real-estate assets in small and medium-sized cities.

The goals of the "new normal" are to accelerate the reduction of these and improve the fat, inefficient economic structure into a slimmer, more efficient one.

The second is supply-side reforms. This is a policy that is central to the overarching policy of the "new normal" and a concept aiming to realize goals such as qualitative improvements in the economy, improved efficiency, a fairer economy and society, and sustainable development through structural reforms.

The third is a policy calling for aiming to make progress while maintaining economic stability. This describes the basic thinking on macroeconomic policy management under the "new normal."

From a look at the above fundamental principles, it could be said that the direction of economic policy management this year basically is a continuation of last year's approach. From the details described through now, the content of these policies would appear to be temperate and based on the policies of the past year, without anything particularly surprising.

The major directive to "learn from Japanese firms" as a priority policy

However, the four priority policies announced after these fundamental principles included a surprise. The four priority policies were identified as details of policy management under the three fundamental principles mentioned above.

The first of these was the same as one of last year's priority policies: promotion of restructuring consisting mainly of reducing overcapacity and excess stock of real estate, along with complementary policies. The second called for promoting structural reforms in agriculture, the third for vitalizing the real economy, and the fourth for promoting sound growth in the real-estate market.

Of these, the surprise was in the details of the third policy calling for vaitalization of the real economy.

Stressing the fact that improvements in quality are of utmost importance to realizing this policy, it calls for doing so by promoting a "spirit of craftsmanship," building stronger brands, fostering "one-hundred-year excellent companies," and strengthening product competitiveness.

Truly the expressions "spirit of craftsmanship" and "one-hundred-year excellent companies" are bywords for Japanese firms and expressions that can be relied on to evoke the concept of "learning from Japanese firms."

When I asked a person involved in industrial policy in the Chinese government directly about these expressions, I was told that they were meant to evoke Japan and Germany. It is true that Germany, like Japan, is a country where the spirit of craftsmanship is shared widely among the populace, and with about 8,000 companies founded more than one century ago it ranks third after only Japan (about 30,000) and the United States (about 12,000).

What's more, since taking office in November 2005 German Chancellor Angela Merkel has adopted an approach that stresses the importance of China, having visited China nine times in total since then. She has promoted economic exchange between China and Germany in a wide range of fields. In light of such ties, it could be said to be only natural that China would adopt a policy of learning from Germany.

At the same time, relations between Japan and China fell to their worst state in the postwar period with the outbreak of the Senkaku Islands dispute in September 2012.

Since the Japan-China summit meeting between Prime Minister Shinzo Abe and General Secretary Xi Jinping in April 2015, relations have been moving in a gradually improving direction, and both showed a conciliatory approach in the summit held following the APEC conference in September 2016.

After that, a group of Japanese business leaders visiting China in October was greeted by Vice Premier Zhang Gaoli with a long welcome that proved more cordial than had been expected. Furthermore, in November the first cabinet-level Japan-China Energy Conservation and Environment Forum in four years was held. In these and other ways, relations between Japan and China are improving one step at a time.

Even so, relations between the two countries remain unstable compared to the time when General Secretary Hu Jintao visited Japan and met with Prime Minister Fukuda in 2008 and a far cry from those of the honeymoon period when the Emperor and Empress of Japan visited China in October 1992.

It was a considerable surprise to see that even under such conditions the major directive to "learn from Japanese firms"--using an expression that anybody in the know in China would see was referring to Japan--would become a priority measure in this year's economic policy management.

The background of this policy focusing on Japanese firms

But why was this policy of "learning from Japanese firms" adopted at this time?

It can be surmised that this was a result of a situation in which the Chinese government was forced to do whatever was necessary.

A look back at China's economy over the last year shows that while the economic growth rate remained stable in the upper 6% range, there was significant cause for unease from the start of the year: a large-scale slowing of private-sector capital investment with no signs of recovering.

In recent years, even as growth in private-sector capital investment in China has remained in a steadily decreasing trend it had greatly surpassed growth in investment in fixed assets as a whole, including investment by government and state-owned enterprises as well as housing investment.

However, in 2015 its growth was only about 10%, the same as that for investment in fixed assets as a whole. In 2016, overall growth fell to the lower 8% range, while growth in private-sector capital investment fell much lower to the mid-2% range.

The first cause of this decrease is the substantial drop in growth of exports, which once had continued to grow at high rates of more than 20% each year. There are expectations that in the future exports will grow by rates in the low-single-digit range at most, and as a result it is difficult for export-related firms to increase investment.

The second cause is restraints on capital investment by companies subject to reductions in investment under policies intended to reduce overcapacity and by companies affiliated with such firms.

The third is difficulty in raising funds, resulting from a stricter approach to lending to private-sector firms by financial institutions.

Factors behind this include the shrinking of the gap between deposit interest rates and loan interest rates as a result of progress on financial deregulation and a more cautious approach to lending on the part of financial institutions, faced with difficulties in increasing their earnings. Financial institutions are prioritizing lending to state-owned firms, for which the government can be expected to guarantee debts, while tightening their lending to private-sector firms, which have relatively higher levels of insolvency risk.

Since each of the above three factors is one that cannot be resolved quickly, there is little hope for a recovery in private-sector capital investment.

On the other hand, since most state-owned firms are not managed very efficiently, their business performance is expected to see decreasing rates of growth and a gradual worsening. For this reason, there is a high likelihood that unless the industrial competitiveness of private-sector firms improves private-sector capital investment will not recover, and as a result the Chinese economy could enter a period of stagnation along with the worsening of performance of state-owned firms.

As one method for mitigating this future risk, since 2015 the Chinese government has been stressing the promotion of innovation and strengthening priority industries under its "Made in China 2025" policy aimed at strengthening China's manufacturing competitiveness.

However, it would be difficult to realize these goals through the power of local Chinese firms alone.

The driving forces behind China's remarkable economic growth since 1980 have been its reforms and open-door policies. Technology transfer through increasing investment by foreign firms has been an important part of these policies.

While the three countries of Japan, the United States, and South Korea have played particularly important roles, as the level of China's technology has risen recently its firms are becoming more competitive with American and Korean firms. On the other hand, the technological gap with Japanese and German firms persists, and there remains a strong need to learn about technologies from these two countries.

Japan in particular has invested large amounts in China for a long time and has a cooperative approach to technology transfer. Many Japanese firms have adopted management policies of growing together through transferring technologies to local Chinese firms and strengthened the cooperative relations between the two. Such management policies by Japanese firms are regarded highly across China, especially in coastal regions.

It is natural that there would be increased expectations for growing together with Japanese firms as China returns to the fundamentals of reforms and open-door policies in order to improve quality and competitive strength on the part of Chinese firms amid the nation's difficulty in finding a solution to sluggish private-sector capital investment and steadily worsening performance of state-owned firms.

It can be surmised that it is because of the backdrop described above that the Chinese government has issued the major directive to "learn from Japanese firms" as a priority of this year's economic policies.

Conditions for growing together with Japanese firms

For the Chinese government to move forward to put fully into practice its priority policy of "learning from Japanese firms," a recovery of direct investment in China by Japanese firms is essential.

Just last autumn, signs began to appear of a more proactive approach to investment in China by Japanese firms for the first time in several years, chiefly in connection with the automotive and retail industries.

If, together with this change in the attitude of Japanese firms, the Chinese government were to introduce a clear and practical policy of focusing on Japanese firms, it is possible that many Japanese firms might revise their overly cautious approaches to doing business in China.

However, doing so requires policies to attract attention accordingly. There have been hopes that the Chinese government would implement policies in areas such as protection of intellectual property rights, lessening the risks involved in payments of settlements, and providing a degree of relief for losses due to sudden changes in government policies.

It also would be effective to work out policies that would attract the attention of Japanese firms in fields where there are high expectations for their future advancement, such as automotive, robotics and more efficient machinery, retail, the environment, medicine and long-term care, and food products.

Examples include designation of hybrids as eco-friendly vehicles and raising the level of environmental standards to rival that of Japan, as proposed in this space in November of last year.

Since many Japanese companies still have a mentality apt to follow majority, there is sufficient likelihood that once a trend toward more proactive investment in China develops many firms would once again direct their efforts toward China.

However, it is a fact that in consideration of the worsening of sentiment toward China since 2012 it would be difficult for a large-scale trend to develop without the implementation of some quite strong policies.

Since this year marks the 45th anniversary of normalization of relations between Japan and China, there is a higher possibility that considerable results could be achieved if improvement in Japan-China relations were to be supported politically and Japanese firms were able to grow their investment in China through the establishment of joint development projects between companies from both Japan and China in the economic field.

I expect that the intent of the major directive to "learn from Japanese firms" will be realized, contributing to laying the foundation for restoring bright prospects to the Chinese economy.

---

(This article was translated from the Japanese transcript of Mr. Seguchi's column published by JBpress on January 27, 2017.)