The List

5 Reasons the Japanese Elections Matter

The results of Sunday's contest could rock the global economy and destabilize Asia. Maybe the world should pay attention?

Three and a half years ago, Japanese voters delivered what appeared to be a knockout blow to the Liberal Democratic Party (LDP), which had ruled Japan almost without interruption since 1955. The LDP, which was not so much a party as a political institution, presided over Japan's astonishing rise from a nation rebuilding from the rubble of World War II to a global colossus -- and then over a 20-year period of economic stagnation. In the interim, other East Asian countries caught up with Japan in terms of economic, political and military might.

To replace the LDP and dismantle the rotten edifice it had built, Japanese voters in 2009 gave a mandate to the Democratic Party of Japan (DPJ) -- a dispassionate alliance of LDP defectors, market liberals, and socialists. It was supposed to not only be a political changing of the guard but a revolution: The DPJ would become the country's new ruling class, leading Japan back to economic growth and regional preeminence.

What a difference a few years makes. On Sunday, Japan will hold its first general election since that would-be revolution -- and the party projected to emerge in the driver's seat is the much-maligned and still much-loathed LDP.

For cynics and skeptics, this projection is a cause for glee. Japan cannot and will not change, they argued in 2009, and the LDP's resurgence proves it. They say the country is destined to be a wealthy but declining dowager, reliving memories of its past glories while demographics, bad governance, and the rise of new powers erode its global significance.

So why should we care about who is who in Japan today -- or which parties will win big on Dec. 16? Here are the top five reasons the Japanese elections matter.

1. Japan's economy could get a lot worse

Japan has suffered two decades of subpar economic growth. The fundamentals of its economy are dismal: It is locked in a seemingly unbreakable deflation spiral, its workforce is in decline, immigration levels are too low, and the combination of a global economic slowdown and a strong yen are decreasing the volume of its exports.

The recipe for growth of LDP president Abe Shinzo, who will be prime minister if his party wins, is to increase the monetary supply until the country achieves an inflation rate of 2 percent. Liberal economists have praised the plan, even though it dodges a discussion of what happens to Japan's government bonds in the face of inflation. Servicing Japan's astronomical nominal debt already consumes 25 percent of the national budget. An inflation-triggered rise in interest rates could lead to disaster as the likely liquidation of international investments and the devaluation of the yen sends new waves of turmoil through the weak world economy.

2. Conflict with China could increase

It is difficult to imagine Japan, whose Self-Defense Forces (SDF) have never fired a shot in anger, getting into a war with China. Nevertheless, the paramilitary forces of the two countries are in an intense stare down over the Senkakus (which the Chinese call the Diaoyus), a group of uninhabited -- and basically worthless -- islands off the northeast coast of Taiwan. China is engaging in what amounts to economic warfare against Japanese companies, seemingly with the goal of breaking Japan's will to keep the islands.

While the Sino-Japanese relationship is already fraught, the outlook post-election is dire. The LDP promises not to reduce tensions but to increase them: Its election manifesto calls for studying the permanent basing of "civil servants" on the islands -- a transparent and cheesy bit of word play. Because Japan's constitution forbids the maintenance of armed forces, Japan's SDF are not classified as soldiers and sailors, but "special employment civil servants." Putting these military "civil servants" on the Senkakus would cross a clear red line with China. The LDP manifesto also makes grandiose pledges to defend Japan's lands, seas, and remote islands: In his speeches, Abe calls for the protection of Japan's "beautiful land" and "beautiful territorial waters" from China's depredations.

While Abe takes a hard line, the Japan Restoration Party (JRP) -- Japan's No. 2 or No. 3 party (depending upon the poll) is even more radical. Party leader Ishihara Shintaro jumpstarted this year's row over the Senkakus with his plan, unveiled in Washington, to have the Tokyo metropolitan government purchase three of the islands from a private owner. He has unleashed a constant stream of insults at China, memorably calling it a "thief" intent on stealing Japan's land and wealth.

If the territorial rows were not enough, the LDP is looking to recast the history of Japanese imperialism in a rosier light. It has promised to set up a special commission to promote a revisionist view of Japan's expansion into East Asia, and also vows to review Tokyo's statements regarding its responsibility for World War II and "comfort women."

All the major parties are sprinkled with deniers of the events of Japan's imperial age. For instance, one of the officials of the oddly-named Japan Tomorrow Party (Mirai no To), which champions women's issues, told a delegation of visitors from Nanjing that the 1937 Japanese massacre in their city was not as bad as reported. 

Regardless of their views on history, cooperation with the United States is on the agenda of all the major parties. Just prior to the calling of the election in November, the purportedly soft-on-China DPJ asked for a review of the defense guidelines that define Japan's cooperation with U.S. military forces. The Japanese government asks for such reviews only when it is looking to respond to new threats in the region (the last time was in response to the 1994 North Korea nuclear crisis). Given the economic and military rise of China, it is not hard to guess what changes the Japanese government wants to make provisions for this time around.

3. Japan could seek the bomb

All of the 12 parties contesting the upcoming election are committed to reducing Japan's dependence on nuclear power -- a legacy of the March 2011 disaster at the Fukushima Daiichi nuclear power station, which leaked radiation and forced the evacuation of tens of thousands of residents. But just how far Japan will go in weaning itself from nuclear power remains in question.

Before the Fukushima disaster, Tokyo had hoped to increase the country's reliance on nuclear power. The expansion of nuclear power generation was projected to fulfill half of the country's energy needs, and play a huge role in fulfilling Japan's ambitious carbon emissions reduction targets. Japan's new allergy to nuclear power generation is now playing havoc with its international climate change commitments and significantly affecting global hydrocarbon markets. 

Even as Japan cools toward civilian nuclear power, it is warming toward the idea of acquiring a nuclear arsenal -- and this election could lay the groundwork for a historic shift. Ishihara talks openly of the need for Japan to study the development and deployment of an independent nuclear deterrent.

Though it could never be publicly discussed in the only country to have suffered from a nuclear attack, the development of civilian nuclear power in Japan has always had a security component. The government coyly denies this, saying only that Japan's anti-war constitution did not forbid Japan from possessing nuclear weapons as long as they were for defense only.

For the first time, however, the government has acknowledged that civilian nuclear power is indivisible from security. The law controlling nuclear power has been ambiguously amended, now saying that nuclear power is vital because it has a security component. The official government interpretation -- that "security" means only energy security -- is a transparent but necessary lie. Ishihara and others have drawn direct lines between Japan's civilian nuclear power industry and its ability to defend itself in a region where three of its four closest neighbors possess nuclear weapons.

Japan's pursuit of nuclear weapons would trigger a cascade of regional upheaval -- the collapse of the world's nonproliferation regime, international sanctions on Japan, the end of the Japan-U.S. alliance, a nuclear arms race in East Asia. That would seem to preclude Tokyo from taking such a step -- but nonetheless, Ishihara's open discussion of the nuclear option, along with and similar musings by LDP leaders, indicate that Japan's allergy to nuclear weapons is fading.

4. Japan could shake up world trade

With the Doha Round of trade liberalization on permanent hiatus, regional economic partnership and trade agreements are the rage. Japan is involved in a number of such negotiations, including a trilateral agreement with South Korea and China, the broader Regional Comprehensive Economic Partnership, and an EU-Japan partnership.

Japan is also mulling whether to join the Trans-Pacific Partnership (TPP), a proposed trade and investment partnership among 11 Pacific countries, including Australia, the United States, Vietnam, and Peru. Japan's participation would give the partnership undeniable heft, and emphasize TPP's character as a partnership of democratic states, with a few exceptions.

However, Japan's entry into the TPP has become a political football due to the country's electoral system, which is biased toward rural constituencies. Agriculture, forestry, and fisheries, major components of rural economies, are all threatened by the pact, as they might not survive competition from lower-cost and more efficient foreign competitors allowed free access in to Japan's market through the TPP.

The LDP election manifesto states the party will lead Japan into negotiations to join the partnership. However, its preconditions would make Japan unwelcome at the negotiating table. The other two major parties also want Japan to join the TPP -- but each party is papering over internal divisions that would render actual decisions difficult. Almost all of the remaining parties oppose the partnership.

Both the business and security communities in the United States and Japan want broader and deeper economic engagement between the two countries. They will likely be disappointed. It didn't have to be this way: The TPP serves many of the political goals of Japan's three major parties, as it provides a counterweight to Japan's involvement in the more China-dominated East Asia regional trade and investment negotiations.

5. If Tokyo acts, Washington will be forced to react

Creating a more militarily robust Japan has long been a dream of key players in the U.S.-Japan relationship, who envision it reshaping the East Asian balance of power. The first step toward implementing such a vision has been the revision of Article 9 of the Constitution, which limits Japan's capacity to engage in collective self defense.

The revision of Article 9 has long been a staple of the LDP's policy platform -- and now that the JRP has taken an even more militant line, they will have an important ally in their efforts. The barriers are still high: Both houses of the legislature must approve constitutional amendments by a two-thirds majority, and then the amendments must win a majority in a nation-wide referendum. However, the possibility of constitutional revision is now on the table.

If a victorious LDP forms a government that confronts China, the United States could be drawn into the showdown on the side of Japan. America's Japan hands have highlighted Abe's solicitous attitude toward China in his first term as prime minister from 2006 to 2007. But unfortunately, the lesson Abe seems to have learned from his first, unsuccessful, term is that he has to be himself -- in other words, the hawkish figure we've seen on the campaign trail.

Writing Japan's 1947 Peace Constitution and nailing down an asymmetric partnership through the U.S.-Japan security arrangements were two of the smartest moves the United States ever made. A secure Japan with a low military profile has been an effective yet autonomous instrument of American foreign policy goals in East Asia. Japan today is an ideal security partner for nations ranging from India to Australia to the Philippines -- a huge market, a great overseas investor, a major source of development aid, yet for the most part uninterested in great power politics.

The rise of China is disrupting Asia and the world. Americans should hope that the government that emerges in Tokyo following the upcoming elections is both moderate and stable -- but unfortunately, all indications are that it will be neither.

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The List

You Didn't Build That

Is the future of manufacturing really in America?

The news that several manufacturing giants are planning to bring some of their production back to the United States has dominated the headlines in recent months. Perhaps that's because Americans see it as a bellwether of economic recovery, or perhaps it simply reflects their collective yearning for America's past industrial dominance. Either way, the interest in these moves demonstrates the unique hold that manufacturing has on the public imagination.

But precisely because it captures our imagination, a powerful belief system has grown up around manufacturing that limits the policy debate as well as the range of strategic options Americans are willing to consider. This will need to change if U.S. business leaders and policymakers are going to make the most of emerging opportunities. Meanwhile, the global manufacturing sector continues to diversify and evolve in surprising ways -- as the return of some manufacturing production to the United States indicates. Understanding this evolution is the key to the future.

Indeed, we see the potential for a new era of manufacturing growth, fueled by innovation as well as new sources of demand. But we also see an era that is fraught with new challenges that call for strategies and policies based on actual knowledge of manufacturing -- not blind faith in conventional wisdom. Here are six things you need to know about the future of manufacturing.

1. Manufacturing is dynamic

The role of manufacturing in any economy isn't static. By providing the tools to raise agricultural productivity, build critical infrastructure, and lift populations out of rural poverty, manufacturing remains the clear path to economic development. But once countries climb from developing to middle-income status (around $10,000 in GDP per capita), their economies become more diverse. At later stages of development, more consumers can afford to spend money on services, making that sector the fastest-growing sector in the economy.

Moreover, as wages rise, manufacturers must increase productivity in order to sustain their profits. As a result, manufacturing's share of GDP peaks at 20 to 35 percent in middle-income countries and then falls, following an inverted U curve. Today, manufacturing represents 12 percent of GDP in the United States, 18 percent in Germany, and 33 percent in China.

As they recover from the Great Recession, some advanced economies may see a rebound in hiring in manufacturing. Some might even see moderate export gains. But because of continuing improvements in productivity, the faster growth of service sectors, and the focus on higher-skilled jobs, manufacturing's share of overall employment will remain under pressure.



2. Manufacturing still has a productivity and innovation edge

Even as manufacturing's contribution to growth slows in advanced economies, the sector continues to make outsize contributions in productivity, innovation, and trade. In the United States, for example, manufacturing contributes more than twice the expected rate of productivity growth for its level of GDP and employment. One result of this productivity advantage is a massive consumer surplus. While services counted in the U.S. Consumer Price Index have risen by more than 150 percent over the past 25 years, prices of consumer durables (like cars and refrigerators) have risen by one-tenth of that rate.

Even as advanced economies have shifted toward services, manufacturing continues to lead in innovation. In advanced economies, manufacturing companies fund as much as 90 percent of private-sector research and development. Finally, manufacturing continues to dominate global trade: 70 percent of global exports are manufactured goods. These contributions -- in productivity, innovation, and exports -- strongly influence global competitiveness.



3. Manufacturing and services are more intertwined than you think

The notion that manufacturing and services are two completely different economic realms has become increasingly anachronistic. Much of what goes into getting a new kind of soap on the supermarket shelf or putting a new car in the showroom requires a growing number of services. Today in the United States, for every dollar of output, manufacturers purchase 19 cents of services -- everything from trucking and logistics to advertising.

Moreover, more than one-third of manufacturing sector employees work in service-type jobs, such as design, marketing, and office support. In globally-traded high-tech industries like semiconductor manufacturing, the number is more than half. If all the service jobs created by manufacturing outsourcing are counted, manufacturing employs more service workers in the United States (9 million) than production workers (7 million). Meanwhile, some service industries are beginning to resemble manufacturing in the way they compete globally and contribute to exports.



4. Manufacturing is diverse

A full understanding of manufacturing means knowing the subsectors. Manufacturing is not monolithic, and one-size-fits-all approaches -- by manufacturing leaders and by nations -- are not likely to succeed. We break manufacturing into five broad categories based on how labor, capital, or research and development (R&D) intensive they are, and how dependent they are on low-cost transportation or high-skill talent. The five categories vary considerably in sources of competitive advantage and necessary conditions for success.

The largest group, which accounts for 34 percent of manufacturing value added, we call "global innovation for local markets." It consists of industries, such as automotive and pharmaceutical manufacturing, in which companies compete by introducing a steady stream of new products, features, and models, but also must operate in or near end markets, often because of governmental regulations (e.g., drug safety standards).

The next biggest group, "regional processing," is closely tied to local markets. Food companies, for example, need to cater to local tastes and ensure freshness. Only two of the groups are heavily traded: "labor-intensive tradeables" (apparel and toys, for example) and "global technologies," which includes electronics, a high-tech industry that relies on low-cost assembly. The difference in subsector performance can be stunning. Advanced economies, for example, run a surplus of $726 billion in goods from the "global innovation for local markets" group and a $342 billion deficit in "labor-intensive tradeables."



5. The future consumers are in the developing world

Manufacturing is entering a dynamic new phase. Over the next 15 years, McKinsey projects that 1.8 billion people -- mainly in developing economies -- will join the global consuming class, bringing the total number of people with disposable income to around 4 billion and raising annual consumption to $64 trillion. By 2025, we project that emerging markets will account for fully half of global consumption. These new consumers will demand everything from mobile phones to soft drinks, expanding markets for established manufacturers that can figure out how to compete for these new customers.  

At the same time, scientific innovation will undoubtedly produce new kinds of products, change how they are designed and made, and enable companies to meet the needs of consumers and business customers more quickly, with more tailored products, and with new forms of after-sale service. Innovations in production methods will also likely enable manufacturers to make new goods with less material or with recycled material, thereby reducing greenhouse gas emissions.



6. Old ways of thinking about manufacturing are increasingly risky 

The manufacturing opportunities of the post-Great Recession world are considerable, but making the most of them will require changing old ways of thinking. Not only do manufacturers have to figure out how to serve billions of new consumers, they also need to meet the growing demand for variation, customization, and after-sales service. At the same time, manufacturers must navigate a minefield of new uncertainties -- including volatile resource costs, greater supply-chain risks, upward wage pressures, and the difficulty of locating high-skill labor. 

In the coming era, following the path of low-cost labor -- as numerous multinationals did in the 1990s and 2000s -- is unlikely to pay off. Manufacturers will need to carry out nuanced, multi-factor analyses of all the issues that affect landed costs (what it costs to bring a product to market), including risk. Likewise, policymakers and business leaders will need to understand exactly how their industries respond to changes in factor inputs (like rising energy costs) in order to make effective strategy and policy decisions. A one-size-fits-all manufacturing policy will not suffice.

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