1

Unedited Transcript Conference: Abenomics' Progress in Reforming Japan's Economy Panel I: Corporate Workforce and Competitiveness Chair: Adam S. Posen, Peterson Institute for International Economics Panelists: Michael Chui, McKinsey Global Institute Lindsay Oldenski, Peterson Institute for International Economics Peterson Institute for International Economics, Washington, DC March 26, 2015 Adam Posen: I'm Adam Posen, President of the Peterson Institute for International

Economics and it's my pleasure to welcome back many old friends and new for a conference today on Abenomic’s progress in reforming Japan’s economy.

We have gathered today a variety of people, all of whom are extremely

well qualified, having been in the trenches of both analysis and action. And, of course, we will be highlighted today but Luncheon Keynote by Heizo Takenaka, Director of a Keio University's Global Security Research Institute, Member of the Board of the World Economic Forum, old dear friend of Fred Bergsten and mine here at the institute. In fact, Fred deserves credit for having had him as a fellow here before anyone in the US had a clue that great things were destined for Heizo, which they were.

But we, also, have many other friends and colleagues who are here today,

and I'm grateful them, and want to express that in front of all of our friends watching online that our colleagues at McKinsey Global Institute have delivered, just recently it turns literally, I think this week, a new study on competitiveness and change in the Japanese economy and they're going to be giving us some of their newest work on that.

Our colleagues at the IMF Japan Desk continue to be a source of

unfettered but highly expert analysis, independent even within the building. I'm allowed to say, even though my friends at the desk might not want me to emphasize that. And we have the head of that group, [inaudible 0:01:36], speaking to us later today.

But we also have distributed here and will be distributed on the website,

an excerpt from their new book on Japan which I actually gave a back cover blurb to, and so I'm a big fan of that.

2

And, of course, we are grateful to the support of our colleagues at the Sasakawa Peace Foundation (SPF-USA), many of whom will be joining us for the last session on trade and international relations of Japan taking the economics very seriously.

I will introduce our various colleagues, specifically, I'm just going to take

one more minute to say, perhaps unnecessarily for this group, but I hope for the world at large, it's much too late to have forgotten about Japan. It's much too late to have given up on Japan and it's much too late to be frustrated with Japan.

Those are, of course, the emotions that many of us, both inside Japan and outside, have felt about the reform efforts that have gone on in the country, now the world’s third largest economy over the last 20 years. But as [inaudible 0:02:49] tried to argue in my own work, I think that that is a misleading and unfair characterization, not so much, because I need to have great sympathy for all the various prime ministers who have come and gone, but because I think it misunderstands how far Japan came under Heizo Takenaka and Prime Minister Junichiro Koizumi a dozen years ago and the recovery of Japan had in the 2000s, and how far Japan has come in recent years under the new government of Prime Minister Abe.

We have had several events here and we have stressed in particular and, I

think, rightly what is referred to as womanomics, the fact that female labor force participation in Japan is up 2 percent in the last two years. This is the best thing that Japan could’ve done for itself. This is real. We can trust labor market data in a way we might not be able to trust other data, and this is already showing up in the growth and temporarily, in the downward pressure on wages, but will be a huge benefit to Japan in the years to come.

But given that progress, we're choosing to focus today’s events on two

other areas: First, primarily reforming the corporate sector which includes, of course,

labor market treatment, equal treatment of women and minorities, but also more broadly, issues of corporate governance, financial management, openness and accountability. The ability of Japan to compete in a global context. We've got the illustration from McKinsey up there but I'm also very proud, this morning, to be having Lindsay Oldenski of Georgetown and now a resident senior fellow here at Peterson, presenting her and Ted Moran’s superb policy brief from last month, looking at the incredible record of resurgence of Japanese FDI in the US and the benefits from that. We'll be having more on that.

And then, after lunch, we will be turning critically to the trade issue where

more than, in any place else, we can imagine that it isn’t a communist

3

country. The opening to trade could be a huge reform lever in Japan and, at least, nominally, the Abe Government seems to understand this now. And I think a number of us are hoping that in time for Prime Minister Abe’s upcoming visit with President Obama here in Washington. We will have, at least, the bilateral aspect of a TPP deal done. And, of course, the highlight will be Heizo Takenaka, who is uniquely, qualified to knit all this together.

So, that all having been said, let me now turn to my colleagues and invite

Michael Chui of McKinsey Global Institute and Lindsay Oldenski of Fireplace, to come and join me on stage for the first panel. Thank you.

So, as I mentioned, competitiveness remains a key concept no matter how

many times economists try to kill it and we all, sort of, know what it means and, in a sense, nobody knows better what it means in the practical sense than the scholars of McKinsey Global Institute. And we're very grateful today to have our friends from McKinsey provide some of the best of their people on their new product.

Michael Chui, is partner at MGI, but he's worked on Big Data, he's

worked on the Internet of Things, of course, has a PhD like any good scholar. But has also worked extensively as the Chief Information Officer in the public sector and the private sector and has a very deep Indiana roots.

But I know that for the last couple of years, he has immersed himself

deeply in Japan’s economy, helping to lead the new report from McKinsey on Japan’s global competitiveness, and I invite Michael to take the podium and lead us through.

Michael Chui: Thank you and good morning. It's a pleasure to be able to introduce some

of the research that we've done as a team at McKinsey. The McKinsey Global Institute has worked with our McKinsey Japan Practice to take another look at the Japanese economy.

I'll highlight some of the workforce findings and policy options that we

outlined as part of that research and then my colleague, [inaudible 0:07:40] will join in the second panel and describe some of the other findings that we had.

It isn’t the first time that MGI has actually looked at the Japanese

economy. We actually looked at it back in 2000, and just by way of context before I dive in to some of the workforce implications just to set a little bit of context. At the time we described Japan’s economy as being to speed, there were a set of export oriented industries, advance

4

manufacturing, consumer electronics, et cetera, which we found to be global leaders in productivity and the rest of the economy lagged.

In the intervening couple of decades or a decade and a half, the bad news

part of the story is that Japan’s productivity growth has in fact stagnated, not only in the broad economy but even in those industries which we had identified previously as world leaders.

And of course, during that time period, the demographic challenge has

only increased as folks in the room, I'm sure are aware, Japan reached a tipping point in 2011, where the actual population began to decrease and certainly, the working population also is decreasing. Between 2012 and 2025, the working age population is projected to decline from 79 million to 71 million, and demographics is destiny. Of course, aging continues to increase. Even now, about a quarter of the population is 65 or older. By 2040, that share will rise to a third of the population.

So, all those challenges exist. That being said, there are lots of tremendous

strengths that the country continues to bring. Still the third largest economy in the world and will continue to be so for the next decade with a great likelihood. Fourth largest export in the world, tremendous technical and technological sophistication, a highly educated workforce and a large and tremendously affluent consumer market.

So, there's room for optimism there and certainly with Abenomic’s first

three arrows, anyway, directionally appears to be making some progress, although, still more work to be done particularly on the third arrow.

That being said, when we identified some of the enablers to growth in

Japan, I'm going to call out four of them and mostly talk about the first three:

Number one, new sources of talent or sources of a talent that are

underutilized. Women or womanomics is as I mentioned, increasing the role of experienced or older workers and immigration, challenging perhaps but increasingly necessary.

Improving education and skills where they're strengthening the hard skills

where Japan does have strengths already instilling more global mindsets in creating a more robust education to employment pipeline and then encouraging entrepreneurship whether it's the attitudinal factors, improving funding in the legal, environment, or the context and then creating a broader ecosystem for innovation. And then a set of market oriented reforms, that I think, that will do more of the topic of the second panel.

5

Again, let's just spend a few moments on female participation in the workforce, which Prime Minister Abe has described as Japan’s most underutilized resource.

Japan actually ranks 79th in female force participation and salary gap in

terms of between genders. Of course, Japanese women are highly educated, half of university graduates as we've shown on this chart are women and they are very well-represented at the entry level, professional level.

However, female labor force participation does drop off precipitously.

You could describe it at child bearing years but also right around the time when workers enter management ranks. And if you continue to look at the numbers beyond that to executive ranks and board positions, of course, it looks a lot less like a funnel and more like barrel with a tiny little whole in it. So, that is extraordinarily challenging.

Obviously, Prime Minister Abe’s comment about an incredibly

underutilized resource is absolutely true and given the fact, if you're looking at growth, you're either looking at growth in the labor force itself or the productivity of that labor force addressing the female participation is incredibly important.

Most concrete action, of course, is there are set of attitudinal factors,

again, which I will not address directly but the most obvious one, given this set of correlations would be addressing child care and increasing the availability of child care. We do see examples of that being successful, for example, in the city of Yokohama, where dozens of facilities were added and moved from being the longest lines for child care or longest wait times in child care to actually evaporating those lines completely.

Also, a set of tax incentives which favors single income or seem to incent

part-time work by the second partner which is usually the woman. And then also, while a majority of companies have reported implementing policies which would improve workforce and work-life balance, we do see additional opportunities to create targeted programs particularly to improve the pipeline for women to move into management whether it's mentorship programs, whether it's training programs, executive training programs, et cetera.

Secondly, addressing the topic of older experienced workers. Again, this is

an existing strength of Japan. Japan is one of the highest labor force participation of workers above the age of 65 and roughly 20 percent of the population that are 65 or older is an active member of the workforce right now. Japan has been raising its retirement age.

6

Given the increasing need to address these labor shortages and by the way, of course, not lose all that experience and skills which a large part of that labor force will when it retires.

We do see examples, again, where companies – we've described it as the

fourth arrow. It is the actions that companies can take right now because policy reforms have allowed these things to happen. The ability to actually create a more welcoming, effective place for older workers and some of those things are just pure ergonomics – whether it's the speed of an assembly line, lighting, the work environment in which people work. We do see additional opportunities to do that and examples of where that’s happened.

And then, finally, let me just mention immigration. Foreign workers

represent roughly 1 percent of the Japanese workforce, compare that with peer countries. In Germany, 8 percent. In the United States, about 16 percent. I live in San Francisco, roughly half of Silicon Valley tech companies have a co-founder which was foreign born. And if you believe that diversity as a set of new perspectives, actually, underlies a lot of innovation and entrepreneurship, then you could imagine that actually having more foreign workers could underpin additional innovation and entrepreneurship in the Japanese economy as well.

There is a basis for this as well; there are 140,000 foreign students in

japan. Actually, about 90,000 from China. In the United States, we have a tremendous challenge where educating the world’s – traditionally, that’s been a tremendous source, for example for this Silicon Valley Innovation. Unfortunately, some of our policies have pushed people out.

Again, if you think about the Japanese equivalent, how could Japan

actually encourage more of those people who are actually studying in Japan to stay?

And also again, back to the fourth arrow of private sector action, we've

seen some news recently about Japanese companies welcoming more executives that are foreign into their companies.

So, thinking about how to source global talent and how to develop that

global talent within Japanese companies, also, could be a significant lever on the labor side.

A few comments about education and training, again, this is the strength

of Japan. If you look at the [inaudible 0:16:24] studies, Japanese students consistently have scored over the years in the top 10 in reading, math and science. And it's actually quite an efficient system on a per pupil basis, spending as below the OECD average. So, tremendous strength there.

7

That being said, some of what we're showing on this chart, for instance,

that Japanese students actually rank lowest amongst OECD countries in their confidence in their ability to solve complex tasks and actually just even ask for explanations about things.

So, tremendous hard skills but if you think about a world in which

technology innovation is just increasing, the pace of change is increasing. The ability to develop, what I sometimes describe as, meta-skills becomes even more important. So, things like flexibility, experimentation, risk taking, leadership and collaboration. Again, trying to inject those more on to the educational system would be quite powerful.

Also, developing more global mindsets. While English is required in the

Japanese educational system, Japanese students consistently score the lowest on test of English as a foreign language scores amongst OECD countries. Not that English is the only foreign language that Japanese students ought to be learning, it is certainly one indicator of a need to promote more global mindsets in the education system.

Then the number of university students who are studying abroad in Japan

has declined. For instance, in 2002, there were 64,000. Ten years later, only 34,000. And finally increasing the education or improving the education to employment pipeline, particularly around transparency. We find this as a global trend which needs to be addressed but addressed in Japan as well. Better understanding, particularly as the labor force needs change providing that transparency, not only to the educational institutions but to the students who are making choices about what to study.

There are few comments about entrepreneurship. There's a funny issue,

maybe here, with how that chart is being showed but pay attention to the top numbers. So, if you look at the percentage of the Japanese labor force that’s involved in entrepreneurship that’s roughly 3.7 percent that compares to 4.5 percent in France, 5.1 percent in Germany, 7.2 percent in the United Kingdom, and then 12.9 percent in the US.

So, again, just the sheer amount of entrepreneurship that’s occurring in the

Japanese economy is below that of its peers, in some cases, far below that of its peers. And if you think about this need for productivity, it's going to be underpinned by competition and that competition could come from existing Japanese companies but in many countries, it comes from new firms that are being generated through entrepreneurship. So, it's incredibly important in order to push the productivity lens.

A few policy or a few options, again, not just policy that could underpin

additional entrepreneurship. Certainly funding, if you just compare the

8

United States, again, perhaps the challenging comparative with Japan -- $24 billion worth of early stage funding available in the US in 2013.

Since 1997, again, by one measure, Japan has only invested 113 million in

angel funding. And it's not just the sheer amount, but also the degree to which potential investors understand the ability to do so. So, there was a Ministry of Economics Industry and Trade survey that showed a third of potential angel investors, wealthy people who could invest in these types of startups were unaware of how to do so.

And so, one lever there, the raw material, i.e. yen are there. The question

is, how do you provide a platform? How do you provide the information so that investment can actually occur? By the way, that dirth occurs not only in the angel stage but further in VC stage and all the way through IPO type funding.

And then secondly, on entrepreneurship, just providing a vibrant

ecosystem and do one thing that – I live in Silicon Valley area. I think one of the things that we talked about is many places have the raw materials, right? And Japan has the raw materials to a certain extent – world class universities, educated talent, capital, tremendous infrastructure, but how do you actually combine those things together so that actually underpins entrepreneurship?

Many of times, that actually has to do with the personal connections

amongst people and how do you actually create the education, the knowledge, and one other powerful vector is the ability to create ways to commercialize research that is being done in universities.

So, a set of things around creating that context, creating a vibrant

ecosystem around entrepreneurship, and then as I mentioned before, supporting that in the education system as well, supporting the idea of risk taking. It could be everything from venture competitions or just entrepreneurship competitions, projects within the school that would allow people to flex that muscle.

So, in some, creating new sources of talent, addressing the education and

skills, encouraging entrepreneurship and then of course, the market oriented reforms have the potential to under pin tremendous productivity gains. Actually, double the productivity growth rate in Japan.

But the other thing that I pointed out is, to a certain extent, Japan is a

leader here, a leader in multiple ways. It's a leader in aging. It's a leader in technology and these aren’t just things that will improve the Japanese economy. If Japan can understand how to solve those problems, it could potentially be a leader for North America, for Western Europe, for China,

9

other countries which have a similar set of issues – different, but a similar set of issues going forward. Thank you.

Adam Posen: Just to pick up on Michael’s rousing conclusion, I think there are two

things we need to focus on in light of these kinds of very solid productivity recommendations.

The first is that despite its recent downturn, Japanese productivity growth

from 2002 to 2008 until the global financial crisis was at the highest among the G7 economies. And the reason I bring this up is not just for score keeping, it's in the spirit of what Michael said. There is a tendency to say that Japan never came. It was two lost decades which contributes to sometimes the sense of hopelessness that some people have in Europe or in the US in various context and it's important to recognize that Japan actually did come back for an extended period in the 2000s.

But the second thing to note is in a world where people worry a great deal

about secular stagnation and distinguished technological experts like Peter Teal on the investment side and Robert Gordon on the research side, talk about us being at a fundamental slow down or the absence of the next big thing.

We've always known that there are still room for productivity

improvement country by country and policy by policy that nobody, certainly not the US and certainly not Japan, is fully at the frontier and fully efficient and so that’s many years of improvement remain available to all of us and I think Michael and his colleagues have done a great job of emphasizing that in the Japanese context.

Michael Chui: We pointed out that 50 to 70 percent of the productivity improvements

that we've identified come from applying best practices which have already been implemented in other places.

Adam Posen: Right and there you go. I'd now like to turn to my colleague Lindsay

Oldenski who has been an on resident senior fellow here at the Peterson Institute since December, 2013. She is also an assistant professor at Georgetown School Foreign Service. She's taught previously at a number of schools, worked as an economist at the Department of Treasury and also the Federal Reserve Bank of Boston. But importantly for our purposes, she and her co-author Ted Moran is with us today, have done a series of important studies empirically grounded very sound and I think, in many ways, groundbreaking on the impact of foreign direct investment flows both out of the US and into the US.

And a few months ago, I came to them and I said, “Hmm, some Japanese

colleagues have pointed out to me that there's been a surge in Japanese

10

foreign direct investment in the US in the last couple of years, does this matter? Is this interesting? Is there anything useful you can say about it?” Well, it turns out that thanks to Ted’s and Lindsay’s insights and their strong empirical work, there is something very interesting to say about this I think for all of us.

I'd, now, like to ask Lindsay to come up and present their recent work. Lindsay Oldenski: All right. Thanks Adam. So, today, as Adam mentioned, I’m mainly

focusing on one particular aspect of Japanese firm strategy which is their outward foreign direct investment, and specifically, foreign direct investment in the US. And again, as Adam mentioned, everything I'm presenting today is from joint work with Ted Moran, who is here with us today.

So, over the past several years, outward foreign direct investment on the

part of Japanese firms has been growing very rapidly and for a while now, the US has been the number one destination for a foreign direct investment leaving Japan. But in 2013, which is the most recent year for which data have been published, Japan was actually the largest source of inflows for the US for the first time since 1992.

In the intervening years, investment in the US was dominated by mostly

countries in Europe as well as Canada and, to some extent, Australia. This is a trend that’s expected to continue when the 2014 data are released and then on into coming years.

So, what I’ll be talking about now is what's driving that growth both the

push factors coming out of Japan as well as the pull factors on the US end. And more importantly, what are the implications of this surge in investment both for the Japanese firms and for the US economy.

So, this graph here shows outward foreign direct investment flows from

Japan. So you can see there is an uptick in the late 80s, early 90s, but then fell in ’92, remained relatively low until it started increasing again in the mid to early 2000s. And, of course, it took away the hit in the crises years, but total Japanese outward flows have increased, recovered very rapidly from that and are now above the pre-crisis levels.

This one shows the top 5 destinations of outward foreign direct investment

by Japanese firms and you can see the US has been at the top for a while, but particularly in 2012, Japanese investment into the US, direct investment took off very, very rapidly.

So, why is this happening? Well, there's factors within Japan that make

outward foreign direct investment desirable. First of all, the demographics,

11

as were mentioned, declines in the population lead firms to be looking elsewhere for customers and looking to enter other large markets such as the US. The rate of return on FDI is also much higher than it is on domestic investment within Japan.

However, there are a number of characteristics of the US economy that

make it a particularly desirable place for Japanese firms to locate affiliates and these are important for the Japanese firms but also can give some lessons for Japan in looking at what are some of the characteristics that make a country a desirable location for attracting inward foreign direct investment.

So, particularly, US firms are much more globally connected and globally

integrated than Japanese firms are. They do a lot more offshoring. They have much more international supply chains and this is very important and this is due to not just the corporate culture but also very due to relatively liberal trade policy on the part of the US.

Also, many of us complain with RD that the US, the high skilled

immigration, H1b Visa program is too restrictive but it is much, much less restricted than immigration in Japan. That’s important as well. There's a much larger share of international and immigrant workers in the US than in Japan. So, this is part of this global connectedness that makes the US a great base of operations not just for serving US customers but for serving the world as a whole.

And also, language is important as well and there's a lot of the reason for

Japanese firms to locate in the US is the access to English speaking workers both in terms of connecting to these global supply chains but also for things like sales, marketing, customer service and so forth.

So, perceptions of Japanese investment in the US have also changed over

the past decades. In the 1990s, Japanese investment in the US was met with a lot of fear, a lot of trepidation, a lot of concerns that the Japanese firms were going to keep the high skilled work in Japan and just use the US as a base for assembly.

So, there’d be a lot of imports, not much value added, and not many jobs

for skilled workers doing research and development, and other high value activities, but this did not turn out to be the case. So, I'll just highlight one study that was put out by the Perterson Institute by Money Gram and Paul Krugman in the 1990s which demonstrated very clearly that this was not the case, that Japanese firms in the US were doing very high value activities and that they were increasingly relying on domestic US suppliers.

12

Today, we see that that continues that these Japanese firms are very important contributors to the US economy in terms of the wages and benefits they play, their total sales, the value added, the research and development and both exports and imports from and to the US.

In terms of wages, we know it's been very well documented that multi-

nationals pay higher wages, are much more productive than their purely domestic counterparts and you can see that in the first two columns, but what's what gets less attention is that foreign firms, foreign multi-nationals in the US actually pay US workers higher wages than US multi-nationals which are the most productive of US firms and if you look at the last part, it shows the total wages and benefits paid by Japanese firms in the US to their US workers. That’s even higher than the average for all foreign firms.

So, when Japanese firms are coming to the US, they're paying very high

wages because in part of they’re doing very high value work, particularly focused in research and development, and so this shows R&D spending for workers and I don’t know if you can tell there's a very faint blue line there that didn’t show up quite as well in addition to the darker blue line but in 1997, which is the first year shown here, Japanese firms were spending less per worker on research and development than the average foreign firm in the US, however, that R&D spending on the part of Japanese firms increased much more rapidly.

So, you can that by 2011, you have Japanese firms spending more than

$10,000 per worker per year on research and development, whereas the average foreign firm in the US is spending only about $8,000 per worker per year on research and development. This is really important because this is important for the productivity of the US economy. It's also important for creating these very high skilled jobs.

So, this slide shows you the second bullet point there which is the

spending per worker but also in absolute terms, the growth of total Japanese R&D spending in the US grew by 160 percent, which is quite a bit more than the most modest 73 percent that total RND spending by foreign firms in the US increased by.

A lot of these is driven by software. Software patents have become an

increasingly important share of overall patenting. The US environment for software patenting is much stronger than it is in Japan. You can see this by looking at the numbers of patents that firms have in software as a share of total patents in different locations.

So, Japanese firms in the US, of all the patents that they get in the US, 24

percent of them are for software. That’s compared to 17 percent among

13

other foreign firms and even more strikingly, this compares to only 6 percent in the Japan.

So, for a number of reasons, this patenting environment, in general, but

more specifically, software patenting is really a key and is one of the reasons that Japanese firms are drawn to the US.

Moreover, in previous work that Ted and I have done, we've shown that

especially these value R&D activities have important benefits, for, not only the firms that come to the US but also for overall US productivity as a whole. And so we've shown that by looking at very, very detailed firm level data over a couple of decades that having a greater number of foreign firms investing in your economy leads to important productivity growth, not just on the part of those firms, but also on the part of the other firms in the industries in which those firms are operating. And so this is referred to as productivity spillovers, some of these can be just pure competition effect but you also have learning by watching when you have other firms nearby that are doing similar things. You can observe what they're doing and learn from it. When you have workers moving from foreign firms to domestic firms, they take their knowhow with them and this raises the productivity of all the firms – the domestic ones the foreign investors.

So, thinking about strategies in Japan and productivity, taking advantage

of these multi-national companies and these positive spillovers is very, very important.

So, just to wrap up, as you can see, foreign direct investment by Japanese

firms in increasing globally but in particular, it's been rising very rapidly in the US and this investment is good for the Japanese firms that allows them to improve their software patenting to increase their global engagement and also to get the higher returns to serve the large US market and to access skilled US workers but it also benefits the US in terms of wages, the R&D investment, and, most importantly perhaps, the productivity spillovers that the US firms get from this.

Adam Posen: Thank you. Lindsay, before you leave the podium, since you were

admirably concise, in fact, more concise than our fellows ever are, myself included, I'd like to ask you if you could to expand just a bit off the cuff maybe on two points, I think are, in your research but you didn’t feature in your presentation.

The first is, just, a bit of speculation of comparison on how and why the

Japanese investment seems to be particularly high yield or high value added compared, to say, Dutch or British or others?

14

And second, you and Ted, I believe, did some work looking at the auto industry, in particular, and whether that’s what's driving these results, and so, if you could say a few words on those things, I'd appreciate it.

Lindsay Oldenski: Certainly, yes, so I'll start with the second part which is that the

automobile industry is still the single largest area in which investment by Japanese firms is happening in the US but it's still is a very, very small share. So the total FDI by Japanese firms in the US breaks down about one-third manufacturing, one-third wholesale and about one-third services and other.

And of the manufacturing, just a small portion of that is the US which is

the largest single category but there's also quite a bit of investment particularly in computers, electronics, semi-conductors, chemicals, then there's quite a bit in wholesale and finance, and insurance are also very large as well.

So, it's not just – and there is a lot of innovation in the automobile sector,

that’s traditionally been one of the largest and the most important and still is but when you're looking at the importance of the RND, it goes well beyond the automotive sector, alone.

And then what was the other question? Adam Posen: Well, just a little bit on – you sort of said this but just to be clear, there are

other wealthy advanced economies like the Dutch or the British who have particularly large investments in the US, but it seems like the Japanese investments look a little even bigger win-win than they do, so could you say something about what happened to the case?

Lindsay Oldenski: So, it is a combination of both the characteristics of the Japanese firms.

They are historically very strong technologically and so they're able to do all these investment and R&D, but you have this technological strength on the part of the firms which is then paired with a lot of very restrictive policies.

And so you have firms that have the ability to do these types of activities

but just don’t necessarily have the same home environment because there's barriers to greater global market access, greater global supply chains, intellectual property and so forth. And then, of course, another difference is the very similar corporate tax rates, similarly high corporate tax rates between the US and Japan, which of course can explain all of it. The Japanese companies don’t have to come to the US, they could go to some place with lower corporate tax rates, but just relative to producing at home, that’s less of a barrier to entering the US than it would be for firms in other countries.

15

Adam Posen: Great, thank you very much. So, what we've heard in a sense from Lindsay who gave a very rich

presentation of her and Ted’s work, is still in the end something that Michael – that echoes a lot of what Michael was saying that this is outward looking Japanese companies in part being driven by lack of best practice at home in certain areas. But that the underlying strengths in technology remained real even despite that. And so I think there's an interesting commonality there.

Let my now open this up for discussion. If anybody has a comment or a

question; you can direct it to either of our panelists. As usual, we have just got front with the travelling mic. People sitting in back, if they wish, can go to the standing mic and I'll recognize you if you could identify yourself. Right there.

Arthur Alexander: Thank you. Arthur Alexander from Georgetown. When I saw Lindsay and

Ted’s study online on the PIA online site I thought this was- Adam Posen: The www.piie.com Arthur Alexander: I thought this is just what I would’ve expected because both from

anecdotal evidence that so many Japanese RND leaders have told me, I forgot, one guy says, “Have you visited our labs?” I said, “Yes, in Kamakura.” He says, “No, no, that’s not the good stuff. Go to Cambridge, Massachusetts or Silicon Valley. That’s where we're doing our good stuff.” And the overall rationale that I hear for that is a weakness of basic research in Japan and the software situation that you cite and the software, I think, is tied to the innovation – that software traditionally in the US is done in small firms. In Japan, it was done in large firms.

When I saw the innovation chapter in your study, I said, “I got to see what

he’s suggesting there,” because one survey I saw asked people, “Would you want your daughter to marry one, an entrepreneur?” and Japan was about at the very bottom of the list and if you explain why Japanese households continue to put 50 percent of their savings into zero return deposits it may help explain why innovation ranks so low in Japan.

The difficulty of taking chances, of taking risk is endemic and as much as

I agree with you about you’re improving the institutions. I wonder about the whole source of the lack of innovation as being something deeper and how you would attack that.

Adam Posen: Michael, do you want to?

16

Michael Chui: There are certainly tremendous challenges in attitudes around innovation and risk taking. I think it is also important to remember that there are also positive examples of where, not just Japanese companies going to others as innovation hubs around the world, but in Japan have innovated and there's a long history of that in technology.

So, I think one of the things you can do is try to learn from those because

those are cases where in Japan, that innovation has occurred. But I take your point as well which is that, while you can address some of the contextual structural institutional factors, at the end of the day, innovation is driven by people and what people choose to do and we can encourage that. We can encourage that through an educational system, we can encourage that through role modeling, we can encourage that through a number of things that for management consultants, we fit in the category of change management, transformational change, et cetera. And it is important to address those as well.

Adam Posen: Lindsay, do you want to add anything on that or you? Lindsay Oldenski: Yeah, I'll just jump in as an educator myself. I mean, this is something that

Ted and I and I'm sure you too grapple too with our students, with teaching, and it's difficult to teach innovation and to teach creativity but we find ways to do that and I think that it really lies in the educational system as well as the culture.

Adam Posen: Again, as Michael was, I mean, we're all kind of squeamish taking about

culture. Arthur, you’ve been immersed in Japan for decades and you're allowed to get away with that, but I mean, I do think it's important for Japan but also again, [inaudible 0:44:31] of what Michael was saying and I hope this whole meeting. What happens in Japan is not necessarily a representative of what might happen with other advanced economies and particularly with some other Asian economies.

There was, I forget who coined it, but there was this wonderful expression

from a couple of sociologists a few years ago referring to the Galapagos effect in Japan that increasingly, if there was innovation, it was directed at totally the domestic market and not at things that could be universal.

The image everybody used which sadly was appropriate was the particular

things for young Japanese women on their phones that were forms of software and hardware that just simply would not translate in a broad sense to anywhere else.

The statistic associated with this that I found most scary was that we saw a

period of unremitting growth of Japanese women and men studying abroad, particularly in the US, and then that went down and continued to

17

go down long after the acute crisis in Japan at the same time when China and Korea and others were going up.

And so, in the issue of education that Lindsay raises, yes, I want to give

credit to all of you who can somehow figure how to teach creativity, but also we got to get people out there in different forms of education and so that’s been a worrisome trend as well.

I recognize that gentleman at back. Oh sorry. Michael Chui: Can I build on that comment? Adam Posen: Yeah. Michael Chui: We work with specific firms. A couple of things that we identify in our

report and in the research: one is this idea that increasingly Japanese companies ought to be looking at global standards and being more open in their innovation processes and architectures. So, that’s incredibly important because I think the effect you described, sometimes, it's not so much about the customer need that Japanese companies actually address but the ability to address that in a way so that the it could be actually taken elsewhere. So, there's a bit of that.

But the other factor is, as we have worked with clients who look at Japan

as a market, and I think, inappropriately decide, the Japanese customer needs and consumer needs are so much different as you described it than in another marketplace.

We certainly believe that consumers are different in different places and

different markets but I think that is often over emphasized in the ability for inbound FDI to Japan is another great opportunity and one that would improve the competitiveness as well as productivity of Japanese companies by having to compete with MNCs going after the Japan market in a serious way.

Adam Posen: I'm not going to resist throwing in one more thing on this. So that you

know, last week we had Richard Trumka of the AFL-CIO speak here and we have a discussion about trade and my colleague dear friend, Fred Bergsten raised an issue about barriers up and down, and who’s breaking down more barriers. And I somewhat snappily said, “Well, remember if you're not talking to congress people, the reality is the trade isn’t about jobs, it's about productivity.” And this is an important point.

So a bunch of people spent years, both parties complaining about Japanese

trade barriers that they would insist that you couldn’t digest American apples or grapefruit, you need a different baseball bat, you needed

18

different skis. And everybody held this up as saying, “Well, this horrible trade barriers, Japanese Government is using to keep Americans out.” But of course, what happened was it didn’t really cost the Americans much of anything. It cost the Japanese because their firms were not forced to become more productive, their firms were not put under competitive pressure, they didn’t have to innovate.

This is again an illustration that trade is really – and we’ll come back to

this in the third session today. Trade is really about knocking down barriers for your own sake, it is not about opening up markets in some old neo-mercantilist way. Gentleman at the back.

Mark Levinson: Mark Levinson with the Congressional Research Service. I actually

wanted build on the point that you just made. One of the sources arguably of innovation and productivity growth in the United States has been particularly in manufacturing has been vertical disintegration. And we tend to associate Japanese companies with much more monolithic soup to nuts enterprises. Have we seen any trends in Japan that they're following the same tendency of US companies in terms of disintegrating vertically in terms of specializing and outsourcing things that are deemed by them to be non-core?

Adam Posen: Do you guys, Lindsay – Lindsay Oldenski: Well, certainly the Japanese firms that are investing in the US are, to a

much greater extent than domestically. As I mentioned in my presentation as one of the reasons a lot of these firms are coming to the US is because it's much easier to do so here. And so that’s in the focus in my research. I don’t know so much about the domestic firms in Japan but the ones that are internationalized look very much like other multi-nationals in terms of the degree to which they do vertically fragment.

Michael Chui: If you think about automotive for instance the tier 1, tier 2 et cetera, I

mean, there are interesting Keiretsu effects as well, but also the ability to integrate in thoughtful ways. So again, at least, certainly the industries which traditionally had been global leaders have been sophisticated about sourcing.

Adam Posen: Great. I've Alicia, Kalpana, Fred and Howard. Alicia Ogawa: I'm Alicia Ogawa at Columbia Business School. Just one other comment,

the problems of the Takata and the airbag industry, the world’s leader supply is accelerating this trend. And the effects of the earthquake and the disruption on the supply chain, I think, is driving some of this change as well.

19

I have two comments. One for Michael and one for Lindsay. Michael, you referred to world class Japanese universities as a source of strength for future innovation and I just wanted to repeat, I'm not going to take responsibility for this comment, Mr. Takenaka made this comment in New York just two days ago that one of the problems is that Japanese universities are not world class and when you look at the top 100 universities in the world, there's only two that occasionally make it into the ranking and they're very low. I would offer my own humble suggestion that if you really wanted to change the idea of risk taking innovation and education, that you would start in primary school and make it a feature of a child’s evaluation to be the number of questions he asks the teacher and the quality of the questions because as you probably know, that’s completely discouraged.

I'll be short, but I had one comment for Lindsay. I was very intrigued by

your figure about Japanese multi-nationals paying more than other companies in the United States. I'm from the financial industry and I've looked at this with some headhunters. And the financial industry, Japanese financial companies hiring in Europe and in the United States always pay top dollar. They pay top dollar because the American employee is making a tradeoff. He is taking this higher salary knowing that he will never reach a senior level position and that therefore also the turnover in Japanese financial companies of the foreign staff is quite high. Have you found that to be the case in other industries or do you think that this is – what would be your explanation for the ability or the desire to pay higher salaries?

Lindsay Oldenski: All right, I haven’t looked at, at turnover. I'm sorry, I can't speak to that.

But this is something that holds across industries. It's not unique to just finance or just automotive or any one area. It's across industries and part of the reason is that if you look at what they're – it's really hard to measure. There is no data. I don’t have measures on perceptions of workers of these firms. So, that could be a part of it, I don’t know but what we do know is that it is spread across industries and that the types of work that these firms are doing in the US tend to be very high value added things.

And so, when you get one fact, you generally have several causes and so

we know that those are some causes, but could be as well. Michael Chui: Your point is well taken about university quality and obviously in lots of

different dimensions against which you can measure that. I do think the idea that what gets measured is what gets done. Of course, the trick is to have the right set of measurements because as we know, for example, doing sales force work with people, people respond to the incentive and it wouldn’t be hard to teach someone to ask a lot of questions and it didn’t really reflect a lot of curiosities. But I think your point is well taken. How

20

do we actually measure and encourage and teach the behaviors and mindsets and attitudes that we think underpin success in an innovation economy.

Adam Posen: Great. Kalpana. That’s Kalpana Kochhar, who will be speaking from the

IMF who will be speaking later. Kalpana Kochhar: I just wanted to confirm something that in fact there is a lot of outsourcing

going on by Japanese firms in Japan. We did some work looking at the export response to the big yen depreciation that’s taking place and it's much slower than we would’ve expected. It's happening now, but once you factor in the outsourcing component, the outward FDI, it starts to explain much better what's going on. So, it is happening I think into a much larger extent than people realize.

The other point I wanted to make was on – we too, talk about using older

workers more and so on. Now, the same time you talked about innovation and risk taking and even in companies, not just in new companies, but even existing companies. To me, it seems like one of the things that’s really holding them back is this very hierarchical structure in society, where people simply don’t question their elders because they're elder and so on.

I think the only thing that’s going to make a difference is to bring in

talented foreign workers and have them be the ones that question the old ways of doing things and I just don’t see how that’s going to happen in any period of time that we think is reasonable.

Michael Chui: So, to be clear, first of all, I also believe that there are older experienced

workers who can be innovative but I think your point is also well taken that a source of innovation can be immigrants as we pointed out, it's an “and” not an “or”. And then I think it is also important, I mean, a friend of mine runs a startup. He brought his entire company to Japan for a month or two just to put them in a new place and run into this underbelly of Japanese software entrepreneurs who exist. And so that energy, that type of risk taking attitude, that willingness to innovate does exist. It's not completely.

So, how do you accelerate that, scale it up in addition to bringing in

foreign workers, I think is important to think about as well? Adam Posen: Okay. Fred. Fred Bergsten: Fred Bergsten at the institute. Question for Lindsay. You presented this

sharp rise in Japanese FDI in the US is kind of a structural phenomenon. At least you implied that, you said it’s likely to continue. An alternative

21

hypothesis might be that this was at least in part a response to several years of a very strong exchange rate for the yen as Kalpana mentioned. I mean, that had both push effect from Japan. They became less competitive out of the whole market and of course, it was a great time, if nothing else, to pursue your FDI plans in the US in terms of the cost involved.

Now, if that were the case, and since the yen has now weakened

dramatically, maybe there would be a temporary burst, rather than a prolonged structural burst. Have you looked at that variable as a possible explanation? What's your thought on its impact and its implications going forward?

Lindsay Oldesnki: So, we haven’t actually looked at exchange rates specifically. However,

even given the latest data, the 2014 data haven’t been released yet but Japanese firms continue to invest both new investments as well as mergers and acquisitions are still going. There's certainly a lot of sound business reasons that they're doing. So again, one effect, potentially many causes, there's evidence that even though we haven’t looked at exchange rates, all of the other factors are so strong that it's just not something that could be completely driven by exchange rates, right?

So, clearly, the global integration, the R&D, the software patenting being

one of the most important keys, are things that are really not looking like they're going to change anytime soon but that’s a good point. We should identify the exchange rate effect as well.

Adam Posen: It's also, if you look at Lindsay’s chart, a little bit strange on the timing

Fred, because the surge continues in 2012 and 2013, and as you all know, there was a 20 percent correction in depreciation of the – we'll get to you in a second Mustafa.

Mustafa Muhatarem: [inaudible 0:58:36] corporate decision that obviously gets implemented

with the lag. So, in fact when [inaudible 0:58:43] two years ago [inaudible 0:58:45] I will think that if that were a [inaudible 0:58:49] but now begin to show up [inaudible 0:58:51] but we're still seeing in [inaudible 0:58:53]

Adam Posen: That’s interesting. We should ask Lindsay and Ted as experts in the FDI

MNA literature to look at that. My assumption would be that a lot of corporates, if you saw that material and exchange rate moving a short preventative time might call off a move, but maybe not.

So, we have the gentleman here and then Mustafa. Howard Spector: Hi, thanks. Howard Spector, Goldman Sachs. Actually, I wanted to

follow-up another question Lindsay on FDI. Have you any insight or have any thoughts into the nature of the funding of these outbound MNA deals

22

from Japan into the US or anywhere for that matter? Is it cash? Is it stock? Any thoughts on the leverage that’s being taken in these MNA transactions both historically and in going forward? Any view on, again, sort of the cash versus stock mix? Is it cash that’s coming off of balance sheets or are they using script to pay for the deals?

Michael Chui: In which bank would they prefer? Lindsay Oldenski: Goldman clearly. Now, we haven’t actually looked at that. That’s actually

a really good point. That’s something that would be certainly very interesting to look at. One thing though that would maybe give kind of a clue into that is the fact that there was such a striking depth in foreign direct investment by Japanese firms in the US during the global crises years and that’s something that was relevant globally by firms from all destinations to all destinations.

And so, one of the main reasons for that was difficulty getting credit and

particularly during those years, and so, this is just suggestive. Like I said, we haven’t actually looked at any of the funding details of these firms but I would expect if that given the depth that might lead me to suspect that there could be some credit issues. I mean, that could also be driven by US domestic demand on the part of the multi-nationals that are coming to the US to sell to US customers in the US market. But in terms of the ones that are accessing global supply chains and so forth, then I would wander if maybe that it reflects some sort of a credit issue, but I don’t know. That’s through speculation of my part. As I said, I haven’t actually looked at that data. It's a good suggestion.

Adam Posen: Mustafa. Mustafa Muhatarem: Mustafa Muhatarem with General Motors. Following up on what Fred

said. If you look at Japanese, the first wave of Japanese FDI investment, it was in the mid-90s when the yen strengthened dramatically and you could go on across Southeast Asia and see the Japanese moving as fast as they could out of Japan.

The second wave comes obviously in the more recent episode of very

strong yen. I follow the auto industry very closely and you can see the Japanese auto companies have been very open in discussing that a driver, a key driver for them to invest in the US was the currency. And you can already see, just in less than a year of weak yen, that the Japanese are backing off or delaying some of the investment announcements in the US.

So following up on what the IMF reported on that, yes, there's been a lag

but you can already see that exports in Japan are taking off. Japanese FDI is declining or slowing down abroad.

23

So, I think exchange rate is a much more important driver on these

investments and you’ve given credit for. Adam Posen: Please. Priscilla Baek: Go ahead, if you have, I have a separate question. Adam Posen: No, please go ahead. Priscilla Baek: Priscilla Baek with Mitsui, it's a Japanese trading company and one of the

things that I guess hasn’t been mentioned is the whole energy revolution is the US which I think from an internal strategy perspective and for Japanese companies was a huge driver in terms of their desire to invest and the huge capital investments that were made. And then, I think Mark had asked about the vertical disintegration.

Just from my personal perspective, it does seem that at least for a lot of

trading companies, they still operate on a very – a lot of their investments are still directed in a Japan-centric way, in terms of trying to bring it back to Japan on finding a way to connect it back to Japan.

And so the vertical kind of – they focus a lot on this value chain kind of

trying to combine every aspect of like the 360-degree kind of our company motto. It's interesting to me as we're discussing it, coming from the inside and from more of a US perspective. It's a very different business model and I think the weight, the decisions that they're making in terms of their investment in the US, it is.

They do take a global perspective, but a lot of it does come back to

Japan’s needs in terms of their energy and what they see in the US being able to provide.

Michael Chui: Two quick comments, the energy revolution Shell gas, [inaudible 1:04:12]

oil has tremendous implications obviously for, not just Japanese FDI but for US domestic companies, the competitiveness of the US economy. It has been revolutionary, not to mention the geopolitical implications as well. I'll leave it at that.

And then, in our report, one of the things that we do identify is that there is

tremendous opportunity to improve Japanese supply chain performance. And it is in some cases, smart sourcing, but again, I think it would be an over exaggeration to say vertical disintegration hasn’t happened. And of course, some of the US firms continue -- and not just US but other companies in general globally-- have tried to adopt some of the things that Japanese companies have done before in terms of improving their supply

24

base collaboratively, et cetera, et cetera, et cetera. So they are sharing both ways.

One of the things that we have found as we looked at productivity is that

many companies outside of Japan arguably have adopted the best parts of Japanese productivity from previous generations of productivity increases whether it's lean or otherwise. And in fact to have improved their productivity above those of Japanese companies. And so that suggests – everyone has to raise their game now, including Japanese companies and especially Japanese companies.

Adam Posen: I just want to emphasize and thank the three people at this table for their

emphasis on trying to see some of the FDI trends in the bigger picture. One of the great things that Lindsay and Ted’s work does is it gets into the nitty gritty and looks at firm level data. But that obviously, by choice or by design, ends up not as [inaudible 1:05:56] in this context and I think one thing to take away from this is, if Lindsay and Ted are interested, is to have them not look so much specifically at Japan but go back through the literature and their own work on the exchange rate or the energy price effects and how that’s dealt with energy with FDI flows. I think that would be really interesting.

There's two gentlemen and unless Ted wants to respond directly on that,

those two gentlemen at the table back there. Participant: [Inaudible 1:06:28] from US Labor Department. I'd like to raise some

questions about the workforce and ability to adapt to change and also firm’s ability adapt in the employment relationship with their employees. If you could address the issue of labor mobility and loyalty to firm and also, what improvements might be made to make a more productive workforce in Japan.

Michael Chui: So, loyalty firm, obviously, there's a long history of lifetime employment,

et cetera. And this one of those cases where we've seen some of the structural barriers, some of the regulatory barriers to additional labor mobility be addressed. So then, it actually – we do things sometimes comes down to the, as we've described it, the fourth arrow, what is it the private sector leaders actually have the ability to do and how much are they actually doing it in order to enable more labor mobility.

So, I think there's considerable opportunity on the part of both the

employees as well as the employers to have more mobility. I think there's a lot more that can be done in a research we talked about for instance. The tremendous rise of the contingent workers, is another way to put it right at being getting up to nearly third of the workforce, et cetera. And the fact that in fact, we often view labor force mobility and contingent workforce

25

as being an improvement in productivity because it implies lots of labor mobility. But having this underclass sometimes dis-encourages investment in their development, for instance, and in their skills building, et cetera.

So, sometimes that balance gets a little out of whack and we’d suggest that

perhaps in Japan that it has and so that ought to be addressed. Sorry, your second question was just around improving productivity? Participant: More on the employment relationship. You touched a little bit about

contingent workers and part-time and other aspects of the firms adapting to, I guess, increase flexibility and the employment relationship.

Adam Posner: Before you respond, Fred had a [inaudible 1:09:01] Fred Bergsten: Lifetime employment [inaudible 1:09:06] Takenaka speak earlier this

week, and he said that only 20 percent of the Japanese workforce was not [inaudible 1:09:13] employment. So that was really [inaudible 1:09:17] phenomenon and he suggested [inaudible 1:09:19]

Adam Posner: Yeah, and that’s pretty well established, I think. Michael Chui: Yeah, we observed that as well. I think the mindset still exist to a certain

extent though. Adam Posner: I mean it is something that – this is actually one of those parallels Japan

with Western Europe, if not US, that is underappreciated is that there has been a major breakdown in the seniority system. So initially, it was always overstated, it was only the biggest companies, the trading companies, the auto companies that have the lifetime employment really. And then it broke down for the new generation that came up in the recession and then now with the initiatives on and female labor force. So everything’ just broken down further and it presents many of the same issues as in Western Europe. It's liberalization but it puts a lot of pressure on people who are not used to pressure and it's not always popular because it's not always equalizing.

I mean, you're right to raise that. I mean, it's a very fundamental issue. Did

you want to just come in on this? Okay. I don’t know if we can get you the mic. Good.

Participant: [Inaudible 1:10:29] I think as of January, 2015, 38 percent of all workers

are non-regular as they call them; 22 amongst men, 57 amongst women; 68 percent of non-regular workers are women. That’s something that – one of the things that we have actually in the book for which the fliers are sitting outside. In one of the chapters is, we're actually describing this as

26

excessive duality. I mean, this flexibility stuff has probably gone a little too far. There are impacts on productivity because of the training channel, non-regular workers are less trained. There's an effort channel that we describe over there.

So, I just wanted to confirm that this notion that everybody has lifetime

employment is completely wrong and probably gone a little too far. Adam Posner: We're going back to that gentleman for the next question, unless anybody

else wants to come in on labor markets. I'll just make a very shallow but important pitch. Those of you who join us in person at these events know that you received lots of nice free copies of publications. And so for those of you who are here with us today, you will receive a copy of the new McKinsey report. You will receive a key excerpt, a large nice pretty from the IMF’s new book on Japan. Our friends who are watching online or who come to the website later will be able to download some of these parts as well from our website and I encourage you to do so.

In addition to, of course, Lindsay and Ted’s policy brief and [inaudible

1:12:15] publications. Thank you for that commercial break. Gentleman in the back. Participant: [Inaudible 1:12:21] from the IF. Basically, I have the same thing question

on labor regulation. So, I just wanted to, to make that one point, maybe Michael can comment on that, but it also has an impact on the willingness to go for entrepreneurship. If you're in a highly protected job, you're less willing to give that up and move into self-employment and that maybe something you also see in Western Europe and in Germany.

So, even though with the flexibility may be increasing, maybe for the

young people who come in who may be less willing to go for entrepreneurship rather than those with experience.

Michael Chui: Absolutely agree. That’s a disincentive in the non-regular worker issue is

one that we agree with well. Adam Posner: Yes, please. If you could go to the back mic or just- oh good Jessica fine,

hand it to her. Sorry didn’t realize you were there. Robin White: Thank you, Robin White, retired Foreign Service. Still on the labor force

and looking again at women and womanomics. I haven’t seen too much breakdown and I hope you can help me about where women are going to work and the assumption seems to be that the barriers are in the old line companies.

27

Going back to the 80s and 90s, when I was working in Japan, we found that the US Embassy and certainly the American and foreign firms coming in at that time benefited greatly from the fact that the young educated Japanese women applying for a job was far better than the young Japanese men. The young Japanese men had other opportunities. The young Japanese women knew that in the big company, she wasn’t going to get anywhere, so she did wonderful things for US firms and certainly for the US Embassy where I was.

So, my question I guess to Michael is, are you looking at where the

women want to go work and how that’s going? Michael Chui: I do think there are limits to the US Embassy hiring, but the truth is we

actually don’t have hard data on women’s work preferences. But that being said, I would say, if in fact, there are large segments of the economy where women can't compete for whatever reason, that is not going to improve the incentives to improving labor productivity in those areas of economy where you could potentially get the best people.

So, we do think that the ability to hire women ought to improve not just at

the US Embassy but through the rest of the economy as well. Adam Posner: I think, again, including with consultation or cooperation, I should say

with our friends at the IMF, we've done some previous reports here on the womanomics and we’ve got to trace all that out. You're absolutely right but I think it's also important again not to lose sight of the scale. Even though there's a lot of room for additional changes particularly to [inaudible 1:15:23] code the child care and other such things as Michael mentioned. We are talking a move of 1 percent labor force participation overall – 2 percent of female, 1 percent of the overall labor force which is enormous if you think about how in the US we're debating whether or not there's still 1 percent left. And I know this wasn’t your point, I'm not trying to take away from the specifics, but an interesting dynamic is that because these are in a sense, the women who enter or re-enter are inherently less senior as well as being victims of sexism.

This is a downward pressure on wages in transition and so even if we

could hope that this is a permanent shift and moves forward, just as when the labor regulations changed in Germany after reunification and then again in 2004, there is a downward pressure on wages in that period and we haven’t been talking about macro side. But as my colleague Jay Chopra has pointed out and Angel Ubide pointed out in Europe, the same thing. This is an argument for the multiple arrows in Japan. That if you're going to have this kind of labor force participation shift, even though it's long term beneficial, it's another argument for the stimulus on the other side. Anyway, bit of a digression.

28

Ted, you’ve been very patient. Ted Moran: I'm Ted Moran. I'm a senior fellow here at the Peterson Institute but I also

teach at Georgetown. Let me make an observation that where reinforce some of what Michael had to say and it goes back to focusing on entrepreneurship, creativity, what Arthur referred to as cultural factors.

So, I've been teaching at Georgetown for more than 20 years and I would

say when I began at this Jesuit institution that was much more of a passive obedient lecturer institution. And now as Lindsay knows, we're all about case studies where there's not necessarily one correct answer, oral presentations in the classroom, teamwork – I'm sure it's the same at the Columbia Business School. So that’s one generation. I mean, in 20 years, you really can turn things around if people would listen, Michael, to some of what you would say.

Now, is the problem with the students, the big problem is with the faculty.

I mean, you have to get faculty who actually are willing to change what they do or you have a generational change to younger faculty. But it seems to me that you can change culture, at least at the margin within the generation.

Adam Posner: That’s exciting. So, [inaudible 1:18:30]. The lady in the back there, if you

could please. Kim Frank: My name is Kim Frank and I work at the US Government Accountability

Office and I had a chance to go to Japan several years ago to look at what they were doing to promote the manufacturing sector. And the small and medium size enterprise sector and kind of applied R&D seemed to be where a lot of – there was a lot of energy and there was a lot of very interesting stuff happening. So I was wondering if you might be able to speak to that as sort of a bottom up source of innovation and growth for the Japanese economy.

Michael Chui: Certainly, in some ways it's easier to turn a smaller ship. And so

innovation and growth in small or medium size enterprises, I think, is definitely a potential source of innovation. The other thing that I think is also worthwhile to recognize and perhaps less in the manufacturing although to a certain extent. Certainly we found it in retail is that not having skill, not having sophisticated management can be a significant drag on productivity as well. And so in some parts of the Japanese economy, additional consolidation, the application of skill, the application of technology, the application of more sophisticated management can underlie significant productivity increases and we think that there's real

29

potential to do that in addition to finding through driving innovations through smaller firms.

Unfortunately, not all small firms are innovative. Participant: I want to continue on this point that you mentioned something very

interesting earlier, Michael, that there's this underbelly of software developers and there is a professor at UC San Diego Ulrike Schaede who’s done a very interesting study looking at about 10 firms who have the highest returns to a capital. These are very, very different kinds of firms than the standard hierarchical firms that we know.

One hypothesis is that there are these smaller firms who are not like the

older firms who maybe bubbling up to the surface. On the other hand, there may have always been these underbelly of small productive innovative companies who have never gone anywhere.

And so I would say, here’s a great research project with the capabilities of

your institution, your company to see whether this is something where these new younger dynamic firms, smaller ones, will replace the old ones, produce a new Japanese economy or will they just continue to kind of bubble along at the bottom and never go anywhere and just be this little layer of yeast that doesn’t rise the loaf.

Michael Chui: It's a terrific question. I would like to believe there have always been

innovative people; the question is how can you scale an innovation? Lindsay Oldenski: The other point on that, and this is true not just in Japan but everywhere,

it's the most small firms are not necessarily innovative or going to grow and it's hard to identify the ones that are.

Think about small businesses, it’s dry cleaners and things like this and

even in the manufacturing, many of them are not small. So the keys are looking at things like – it's not just small firms, but it's new firms and growing firms as well. And so I think it's important in Japan or anywhere to caution against focusing too much on small businesses, but to identify what type of small business is which are very small minority that might have the potential.

Adam Posner: I want to strongly commend Lindsay’s caution in two senses. First, there's

been a bunch of work done particularly at the OECD, but also World Bank and elsewhere on sort of demographics and life cycle firms. And the key seems to be those small firms that scale up which relates to Michael’s thing and again, it's not about the barbershop or the cleaning service. It is about the small firms that grow and one of the key differences of say,

30

between US and Western Europe, that’s often remarked on is that you don’t see the same expansion of even leading small firms.

The second thing is, our colleague here at Peterson Institute, Carolyn

Freund, has a new book coming out in the next couple of months but building on her academic work on the idea that almost every country without exception, whether it's rich or poor, tends to have a couple of leading export firms that provide the bulk of employment growth, the bulk of export growth and this is very much in keeping with where the state of the our literature is now.

And so, while there is a tendency understandably particularly after the

financial crisis to be concerned about the incumbent large firms, it's very hard to get away from the idea that Japan needed a Toyota or Sony just as the US needed the Boeing, GM, Caterpillar to advance or just as Finland needed Nokia. You can't really quite get your success away from those large firms.

This has been a great discussion. I'm grateful to my panelists and to

everyone for engaging so much. Alicia Ogawa gets the last question if she wants.

Alicia Ogawa: I wanted to ask Michael, I assume that you deal with a lot of VC

companies who are looking to invest in Japan. I regularly interview VC companies when I go over there and the complaint I always get is that yes, there are innovative small companies and they have very exciting new technologies but that they don’t want to relinquish any kind of control over decisions to outsiders as VC normally expect. They don’t want to give away equity and they also complain about some of the taxation both high corporate income tax that Lindsay referred to and also the high inheritance tax that they claim is a disincentive to entrepreneurship. I wonder if you have any comments about any of that.

Michael Chui: This is anecdotal as opposed to – I've heard about all the rest. I haven’t

heard as much about the inheritance tax issues. But then again, my VC friends would say the same things about California entrepreneurs.

Adam Posen: I've already thank them for their substance and their graciousness, but I

have to thank Lindsay and Michael for showing those and these old farts that you can be pointed and concise unlike some of us who tend to rattle on. And so that means, we have ended on time after a very lively discussion. We will reconvene at 10:45 under Ted Moran’s chairmanship.