Japan’s New Effort Is Not A New Model

Japan's effort to address structural problems using investment reallocation is late to the game 

Einar Tangen 

 

 

Japan’s New Effort Is Not A New Model

A recent Reuters article on Japan’s efforts to shift its massive pension funds into domestic assets has sparked a rally in yen and bonds. The desire is to change the trajectory of Japan’s economy. But from Beijing’s perspective, this is less about monetary policy than an attempt to correct four decades of economic drift—and it is not a new growth model.

Japan’s latest effort to steer pension funds toward domestic investment reflects a growing recognition that the economic model established after the 1985 Plaza Accord is no longer sustainable. The Plaza Accord fundamentally altered Japan’s trajectory. The rapid appreciation of the yen undermined export competitiveness, contributed to the asset bubble of the late 1980s—fueled by low interest rates meant to counter the strong currency—and ushered in what became known as the “Lost Decades.” Nearly forty years later, despite being one of the world’s largest economies, Japan’s economy is worth less in nominal U.S. dollar terms than it was when the Accord was signed, largely because of prolonged stagnation and the sharp depreciation of the yen. The lesson from Beijing’s perspective is that exchange rates can reshape an economy, but they cannot substitute for competitiveness. The government hopes redirecting pension assets toward domestic investment will revive growth. That may help at the margin, but it does not address Japan’s underlying constraints.

Japan’s greatest economic challenge is not capital. It is people. The population is shrinking, the workforce is aging and births continue to fall. Investment can improve productivity, but it cannot replace millions of workers or create consumers who do not exist. Every developed economy is competing for skilled labor, making immigration an increasingly difficult political choice. Across the OECD, Japan’s labor productivity remains among the lowest, and weak business dynamism—firm entry and exit rates are roughly half those of the United States—means too many resources remain trapped in low-productivity “zombie firms.” No pension reform can resolve that. Consumers spend when they expect tomorrow to be better than today. Japanese households have accumulated more than $14.76 trillion in financial assets because three decades of slow growth, deflation and wage stagnation rewarded saving rather than spending. A dual labor market, with a growing share of non-regular workers, has suppressed wage pressure further. Redirecting those savings into equities or infrastructure will not fundamentally change consumer behavior unless real wages consistently outpace inflation.

A stronger yen lowers import costs but hurts exporters. A weaker yen helps exports but raises the cost of imported food, energy and industrial inputs—a hidden tax on households in a country that imports roughly 85–90% of its energy and about 60% of its food. Japan remains caught between competing pressures. Its economy still depends heavily on exports while relying on imported raw materials. Pension fund reform cannot eliminate that structural dilemma. Moving savings from bank deposits and foreign assets, including U.S. Treasuries, into domestic investment may increase capital available for Japanese industry. But capital has never been Japan’s primary constraint. The country already possesses abundant domestic savings. The question is whether profitable opportunities exist at sufficient scale. Investment cannot overcome shortages of labor, land, energy or natural resources.

Japan imports most of its energy, many industrial minerals and a significant portion of its food. Even if domestic investment accelerates, manufacturing expansion still depends on reliable access to imported resources and the ability to efficiently process them. China remains central to processing many rare earths and strategic minerals—accounting for roughly 85–90% of global processing capacity—essential for advanced manufacturing, electric vehicles, robotics and electronics. Japan has explored deep-sea mining alternatives, but these remain commercially unviable at current costs (exceeding $50/kg) and are more strategic reserves than near-term substitutes. Building alternative supply chains will require years of investment, higher production and end-user costs. Japan increasingly competes in industries where labor, environmental compliance and regulatory costs continue to rise. At the same time, competitors across Asia are improving rapidly while maintaining lower production costs. Vietnam, Indonesia, India, South Korea and China are all moving up the manufacturing value chain, making it more difficult for Japan to preserve technological leadership. South Korea, in particular, has shown stronger productivity growth in recent decades, while Japan’s productivity gains have lagged.

From Beijing’s perspective, economics ultimately outweighs politics, unless it involves red-lines, like Taiwan. China remains Japan’s largest trading partner despite strategic competition. The two economies remain deeply integrated through manufacturing, supply chains and investment. Bilateral trade still exceeds US$300 billion annually. China’s export controls on selected rare earths and strategic metals are viewed in Beijing as targeted national security measures rather than economic coercion. They also remind Japan that economic resilience depends not only on diversification but also on maintaining stable regional relationships.

Japan cannot consume its way to prosperity without first producing internationally competitive goods and services. Its long-term economic model has always been straightforward: import raw materials, apply technology, engineering and innovation to create high-value products and export them to global markets. Export earnings pay for imported resources, support higher wages, maintain living standards and generate the domestic demand that sustains the broader economy. That model remains Japan’s best path forward. The challenge is that it is now the ambition of nearly every major Asian economy. China is moving further into advanced manufacturing. South Korea remains highly competitive. India seeks to become a global industrial hub. Vietnam and Indonesia are climbing the value chain while attracting foreign investment. Even developed Western economies are pursuing industrial policies designed to bring manufacturing home. From Beijing’s perspective, redirecting pension savings into domestic investment is a rational policy. But it is not a new growth model. Ultimately, Japan’s future will depend less on where its pension funds invest than on whether it can maintain technological leadership, secure access to resources, raise productivity faster than its competitors—while addressing weak business dynamism and labor market dualism in the process—rebuild consumer confidence and preserve constructive economic relations across Asia. Capital can finance growth, but it cannot by itself create competitiveness. Competitiveness has and will continue to be the basis of Japan’s success. The issue is how it rekindles the spark it had in the 1970s, given the constraints it faces today—a question countries around the world continue to wrestle with.