Japan Update: Japan’s Economic Shift—Size Matters…

Back in March, Japan’s central bank made a bold move by raising borrowing costs for the first time since 2007, ending 14 years of negative interest rates. Governor Kazuo Ueda led this policy change, aiming to spark a positive cycle of rising prices and wages. This week (at the time of writing), global markets are anticipating that the BOJ will outline a detailed plan for quantitative tightening after years of heavy easing.

Globally, Japan appears to be doing well. Inflation has returned, and stock markets have finally surpassed their 1989 peak. However, behind the scenes of Tokyo’s major corporations, smaller businesses are struggling to adjust prices amidst rising costs. These smaller firms often feel pressured by larger clients to keep prices low, with any attempts to increase prices perceived as greed. This resistance is deeply rooted in Japan’s long-standing tradition of price stability.

In Japan’s economy, the large corporations hold all the power. If they withdraw their orders, smaller firms might collapse. This fear looms over business owners when they negotiate price hikes. The fragility of smaller companies is evident, as it is a well-known fact that even a small interest rate increase of 0.1% could lead to a significant rise in the number of firms struggling to pay off debt with profits.

There’s an old Japanese saying, “ikasazu, korosazu,” which means “don’t let them live, but don’t let them die.” It originally described how feudal lords treated peasant farmers, but today it relates to an industrial policy where smaller suppliers are bound to serve the large enterprises driving the economy. This dependence prevents smaller companies from raising prices, as they need to keep contracts under strict terms with bigger firms. Consequently, they can’t pass gains to their employees, stalling the wage-price cycle needed for economic growth.

Wage increases have mainly benefited larger companies so far, with employees seeing the highest annual wage hike in 33 years at 5.1% this spring. Smaller firms, which make up 90% of the economy, saw much smaller wage gains. In a country with minimal state welfare, people rely on companies for a safety net and accept lower-paying jobs with the expectation of job security and well-being. However, while consumer inflation was at 2.8% in June, the costs of food and utilities have surged more significantly, putting huge pressure on household budgets. Lower-income groups are being pushed to the breaking point in their efforts to make ends meet.

Large export companies keep costs low by controlling smaller suppliers, generating higher profits and charging more for exports. The shipping industry, however, is a different story. Shipping firms have shifted from serving large domestic operators to catering to international clients. This strategic pivot has allowed them to compete on a level playing field, facing international pricing rather than domestic bargaining pressures. Those who embraced this shift over the past two decades have started to achieve higher margins without being forced into lower pricing by larger companies.

With the Bank of Japan expected to continue raising interest rates, changes are imminent. However, outside of the tonnage provider sector which has broken out of this cycle, whether small businesses can follow suit and increase prices remains a significant question.

Japan’s economic landscape is at a critical point. Balancing the needs of large corporations and the sustainability of smaller firms is vital. The challenge is to ensure that economic policies benefit the backbone of the economy—small businesses—without worsening existing vulnerabilities. This situation contrasts with the highly competitive environments in other developed countries, where job performance directly impacts employment stability and pay.

 

By Eugene Quek, Partner & Head of Projects in Japan.