Exclusive Interview

Leaders in Japan
No.3

Chairman of the Japan Chamber of Commerce and Industry (JCCI)

Ken Kobayashi

The Future Growth of Japan’s Small &Medium-Sized Enterprises
By Noyuki Haraoka
In the third installment of our exclusive interviews with leaders in Japan, Ken Kobayashi, Chairman of
the Japan Chamber of Commerce and Industry (JCCI), shares his perspectives on small and medium-sizedenterprises (SMEs), which account for 99.7% of all companies in Japan. He offers insights into the futureof SMEs amid the current economic landscape.
(Interviewed on June 12, 2024)

Current State of the Japanese Economy
Haraoka: Japan’s GDP is expected to grow 1.2% in realterms in FY 2023, which is well above the initiallypredicted growth rate of 0.5%. But inflation is aconcern because of the rise in prices of raw materials
and other items, plus the depreciation of the yen.
However, wages are also rising, and a virtuous cycleof increasing wages and prices may be on the vergeof being achieved. Would you say that the Japanese
economy is emerging from deflation?

Kobayashi: I would like to focus mainly on SMEs. While theJapanese economy is currently moving toward overcoming deflation,
it still has a long way to go. We recognize that complete recovery
requires sustained efforts to achieve a virtuous cycle of growth anddistribution.
The positive GDP in FY 2023 can be attributed to two main factors:
a recovery in consumption following the pandemic and a significant
boost in tourism-related consumption due to the weak yen.
Additionally, domestic investment in FY 2023 is projected to reach
100 trillion yen for the first time in 30 years. We are optimistic aboutaiming for over 115 trillion yen in FY 2027 through public-private
partnerships.
However, there are concerns. Consumer spending in real GDP for
the January-March 2024 period was down by 0.7% from the2 Japan SPOTLIGHT • July / August 2024

previous quarter. This indicates a mixed economic situation withboth positives and negatives. If the yen’s depreciation stabilizes andincome tax cuts take effect, the economy could gain momentum.
SMEs are crucial to Japan’s economy, accounting for 99.7% of allenterprises. Of the 47 million private sector workers (excluding
government employees, teachers, and primary industry workers), 33
million are employed by SMEs. Including family members andothers, SMEs support the livelihoods of 60 to 70 million people. In
other words, more than half of Japan’s population derives its
livelihood from SMEs and the vitality of them is essential for a robust
economic cycle.
At the Japan Chamber of Commerce and Industry, we take our
responsibility seriously. The wage increase rate for companies withless than 300 employees is 3.62% as of April 2024, a notable
improvement compared to previous years. This trend must continue
to ensure wage growth for SMEs.
In addition, approximately 70% of SMEs have either increased
wages or plan to do so. However, 60% of these wage increases are“defensive”, aimed at retaining human resources rather thanreflecting rising earnings.

Productivity Growth to Maintain a WagePrice Virtuous Cycle
Haraoka: Productivity must be increased in order tocontinue a wage-price virtuous cycle. It is not good if
https://www.jef.or.jp/journal/

real wages do not grow because of inflation, so I
think it is very important to improve productivity,
including for SMEs, in order to improve real wages.
Kobayashi: That is correct. For SMEs to thrive, they must transform,
boost productivity, add value, and pay wages from their profits,creating a favorable cycle. However, high raw material prices andelevated electricity and gas costs, coupled with the impact of the
weak yen, pose significant challenges. I fear that the second half of
this year could be very difficult for SMEs.
There is a perception in the media that SMEs have low
productivity. However, the “SME White Paper 2023” reveals that in
the manufacturing industry, real labor productivity has increased by
2.4% per year for large enterprises and by 2.3% for SMEs (Chart).
The difference lies in price pass-through: large companies have a
0.9% pass-through rate, resulting in a nominal value-added growthrate of 3.2%. In contract, SMEs face a -2.3% price pass-throughrate, meaning their productivity gains are not reflected in priceincreases but are instead absorbed by larger enterprises. To breakthis cycle, SMEs must enhance their ability to pass on prices.

Gross profit is necessary to raise wages. To boost productivity andimprove SMEs ability to pass on prices, we launched the“Partnership Building Declaration” in 2020 with the government and
Keidanren. This initiative promotes coexistence and co-prosperity
between large and small companies. Since I took office in November
2022, the number of companies registered for the declaration has
grown 2.7 times, reaching 50,000 by July 11, 2024.
Historically, Japan’s technological prowess has been bolstered bycollaboration between large and small companies, enhancing skills
and competitiveness – a concept known as the “Ishigaki Theory” by
Shigeo Nagano, the 15th chairman of the JCCI. He compared suchcollaboration between large and small companies to the stone wall ofJapan’s Imperial Palace that was solidly built up with a combinationof small and large stones collected from all over Japan. However,there has been a recent focus on cost reductions, neglecting theneed to pass on added value throughout the supply chain.
We aim to create a nationwide movement to ensure prices trickle
down to subcontractors, which are becoming increasingly multilayered. Out of approximately 12,000 large companies in Japan, only
about 2,300 have registered their declarations, with the rest being

CHART

Trends in real productivity & price pass-through power
Large manufacturing companies

SME manufacturing companies(Annual rate of increase)(Annual rate of increase)
10%

Indicator of price pass-through8%

Nominal value-added per person

6%
4%

10%

Real labor productivity

4.9%

4.0%

3.2%
1.6%

2%
0%

▲2%

▲2%

▲4%

▲4%
▲5.2%

0.8%

0.4%

1.3%

1.1%
▲0.0%

▲1.4%

▲6%
▲8%

▲8%
▲10%

Nominal value-added per person

4%

0%

▲6%

Indicator of price pass-through

6%

4.9%

2%

Real labor productivity

8%(Fiscal year)
00-04

05-09

10-12

13-15

16-18

19-21

▲10%

(Fiscal year)
00-04

05-09

10-12

13-15

16-18

19-21

Source: White Paper on SMEs in Japan 2023

Japan SPOTLIGHT • July / August 2024

3

SMEs. The Japan Fair Trade Commission is significantly supporting
our efforts. To strengthen SMEs, we must improve productivity andenhance their price pass-through capability from -2.3% to at least
zero.
Additionally, it is important for consumer-facing businesses toraise prices courageously. The nation must understand that quality
products, services, and food come at a cost, and price increases will
ultimately benefit everyone. This mindset will positively impact theeconomy.
Haraoka: In order to create strong SMEs, in addition tofostering venture businesses and promoting
entrepreneurship, we should implement policies toenhance metabolism, by which I mean having
companies that are losing competitiveness exit themarket promptly and have new companies enter themarket.

Kobayashi: The JCCI is well aware of the situation. We are notmerely providing subsidies to struggling companies. Instead, we
support those aiming to reform and grow. Metabolism is becoming areality, particularly with the aging management members of the baby
boomer generation, now over 75 years old, making businesssuccession a pressing issue. Many companies see businesssuccession as an opportunity for growth, and we support them withvarious options, including M&As.
When I took office, there was a reluctance to discuss businesssuccession due to continuity concerns. However, nearly two years
later, this attitude has changed dramatically. We now emphasize theurgency of generational change and the need to consult and discussbusiness options as soon as possible. The JCCI provides acomprehensive range of options for business restructuring andproductivity improvement using digital technology, as well as
support for business succession, entrepreneurship, startups, andM&As.

The Importance of Innovation
Haraoka: Innovation is, I believe, the primary source ofgrowth. What do you think is needed to promote theability of SMEs to innovate?

Kobayashi: SMEs have significant potential to innovate, particularly
with the adoption of technologies like generative AI. One of their key
strengths is the proximity to management and the frontline, enabling
4 Japan SPOTLIGHT • July / August 2024

quick decision-making and swift action, unlike larger companies that
require lengthy consensus-building.
SMEs are inherently interested in innovation as they strive for
growth. They often collaborate with fellow companies, despite having
fewer human, financial, and information resources than large
companies. It is crucial for SMEs, especially in rural areas, toinnovate and restructure their management to achieve growth. In
rural areas, SMEs account for about 90% of total private-sector
employment, compared to only 40% in Tokyo. They are vital tomaintaining the local commercial infrastructure for daily life.
Many young people do not intend to live permanently in Tokyo;
some move to other cities, while others return to their hometowns.
However, if the local commercial infrastructure weakens, their daily
lives become challenging. Supporting SMEs in these areas toinnovate and start new business is a major mission of ours, as it
helps sustain local economies and ensures a viable living
environment for returning residents.

Labor Mobility as a Key to Development
Haraoka: I think it is very important for the Japanese

economy that people move to the regions outside ofmajor cities and that those regions are revitalized. I
believe this is exactly the countermeasure for the
declining birthrate and aging population. However,such labor mobility is not being greatly enhanced
due to the still deeply-rooted Japanese management
customs of lifetime employment, seniority-based
promotions, and salary increases, although this does
seem to have started to collapse, according toresearch. These customs provide a strong incentive
for workers to continue to work for the same
company all their life, and due to this, humanresources are not easily transferred to sectors withrobust growth potential and needs. In an age of
declining birthrates, and an aging and shrinking
population, is the mobility of the labor force
sufficient, and if not, what should be done about it?

Kobayashi: Labor mobility naturally increases with changing
economic conditions. Today’s young people do not expect to staywith one company until retirement, and job-changing is becoming
more common and accepted as a right of corporate workers.
On the other hand, we must also address the needs of the elderly.
Many healthy elderly individuals could be reemployed to contributeactively. Incorporating the elderly and women into the labor force
requires various measures, including adjustments to social security
and pensions.
Human capital remains the most important factor for SMEs. Many
employees are mid-career hires, and managers are keen to attract
talent from large companies. While Japanese-style employment,
including lifetime employment, has its merits and has driven
development thus far, it needs to adapt to contemporary changes.
Managers must discern which aspects of the traditional employment
system to retain and which to discard.
In a virtuous cycle of wages and prices, labor mobility will
naturally increase, even without government intervention. Re-skillingand other supportive measures are necessary, but secondary. The
labor force’s desire to work more effectively will drive natural
increases in labor mobility.

Investments and Profit Returns
Haraoka: There is a trend of Japanese companies notinvesting in new businesses as much as they used
to, and holding on to their retained earnings andshrinking. In other words, as a result of the collapseof the bubble economy, risk-averse management has
become widespread, and a kind of social norm. Whatdo you think should be done to reverse this trend?

Kobayashi: One consequence of a strong yen and globalization has
been the shift of corporate investments overseas. The problem isthat these investments and the resulting profits have not returned toJapan. While tax reductions for repatriation exist, I believe that
substantial tax exemptions and preferential treatment forreinvestments in Japan could change the current trend.
Intuitively, about 70% of Japanese companies’ earnings arereserved overseas, which is a waste. In shareholder capitalism, ourgeneration of business leaders cut costs, invested overseas due tothe strong yen, and returned the profits directly to shareholders. Thishas been the dominant business behavior for a long time, explaining
the lack of domestic investment.
I advocate for government policies that boost domestic investment
and shift from a defensive to an offensive management mindset,
particularly regarding domestic investments. Subsidizing companies
like Rapidus and TSMC, which have bases in rural areas and makedomestic investments, is beneficial, especially for regional
revitalization.

Haraoka: In order to achieve this, I think it is importantto create new demand. As you mentioned earlier, interms of regional revitalization, Japan is potentiallyvery rich in tourism resources, so there is new
demand as a tourism-oriented country. At the sametime, there are also growth strategies to solve social
problems, such as green growth to solve global
environmental problems, silver growth to support anaging society, and security growth to solve security
issues, such as in the space industry, which will
become more important in the future. What do you
think about creating new demand by exploring suchnew forms of growth?

Kobayashi: This is the direction that aligns with the evolution ofJapan’s economy and industrial structure, involving large and small
companies. Over the past 15 years or so, the perception ofcompanies has shifted – companies are now seen as social entities
that must provide economic, environmental, and social value
simultaneously. This shift is positive, moving away from a sole focus
on shareholder capitalism. Pursuing policies for industries with asocial dimension, such as the green or silver industries, is crucial.
Companies must now balance providing economic value with
contributing to environmental sustainability and social well-being.
This holistic approach can drive new demand and foster sustainablegrowth.

Stabilizing Overseas Activities
Haraoka: Looking at the external activities of Japanesecompanies, geopolitical risks are increasing, and theconcept of economic security is rapidly emerging. I
think there are aspects of this that require
cooperation between the private sector and thegovernment. For example, regarding rules for
economic security, if the WTO cannot be expected tofunction well and the rules are not sufficient, there
will inevitably be protectionism and economic
confusion. What do you think about restoring the
WTO’s dispute settlement function in order to build arules-based international trade regime, expanding
regional trade agreements, and expanding plurilateralagreements for advanced technologies?

Kobayashi: Japan, a trade-oriented nation with scarce natural
Japan SPOTLIGHT • July / August 20245

resources, must remain a trading nation in whatever form it chooses.
Thus, external economic policy is crucial for Japan’s national
interests.
2024 is an election year with elections in Taiwan, Indonesia,
Russia, South Korea, India, and some EU states, as well as Japan’s
LDP presidential election in September and the US presidential
election in November. Election years often lead countries to turninward, posing challenges for trading nations like Japan that rely on
selling products and services abroad.
The WTO, TPP, RCEP, and various regional economic agreements
will continue to emerge, but Japan needs to consider a multilateral
trading system as the ultimate goal for its trade policy. The world
population is now 8.1 billion, with one out of every three people
being either Indian or Chinese. Japan must enter these massive
markets to sell consumer goods and services, which requires
maintaining good relationships. If political solutions are difficult,addressing economic security issues through cooperation andpartnership with like-minded countries.
While the United States is not a member of the TPP, Japan is, andJapan is also a member of the RCEP, along with China. Japan must
maintain a wide variety of channels with various countries, including
active cooperation with the Global South. It is important to establish
relationships with countries where the population growth andconsumption will increase. China has achieved remarkable economic
development, but India’s per capita GDP is still only about US$2,700(2024 IMF Forecast), and motorization is just beginning. Once theper capita GDP exceeds US$3,000, motorization will acceleratesignificantly. We must pay attention to Africa and other regions in
the future, making cooperation with as many countries as possible
crucial.
With the WTO dispute settlements barely functioning, Japan must
respond bilaterally. However, it is essential to keep our options as
wide as possible in the face of geopolitical risks and economic
security constraints.
Haraoka: I think it is important to build stronger

Tackling Depopulation
Haraoka: Population decline is not only an economic

issue, but also a security issue in the sense that acountry’s presence will become smaller as a result. In
this context, some European countries maintain their
populations through immigration. What do you think
about the idea that Japan should be more proactivein accepting labor from overseas?

Kobayashi: Japanese SMEs face a significant manpower shortage
and demand an expansion in overseas labor acceptance. However,human rights issues and language barriers must be considered. In
Japan, language barriers can lead to isolated communities, as seen
with immigration issues in Europe. Nevertheless, due to the serious
labor shortage, we must accept some overseas labor. In rural areas,such as Hiroshima Prefecture’s Seto Inland Sea, Filipino workers
dominate the shipyards, while Chinese workers are prevalent in
Shikoku. These communities are essential for the survival of theJapanese shipbuilding industry. In light of this reality, and taking into
consideration the declining birthrate, we need to plan for the next
100 years, focusing on labor-saving measures while carefully
considering the acceptance of overseas nationals.
Haraoka: In the United Kingdom and Canada, there is apoints system, which makes it easier for those whohave reached a predetermined level of language
proficiency or specialized knowledge to enter.

Kobayashi: That is one way to do it, particularly for accepting highly
skilled human resources. However, accepting a large number of
immigrants requires significant readiness from Japanese society,historically a monoculture, to integrate and coexist with new arrivals.
Haraoka: Thank you very much.

relations with the ASEAN countries.

Kobayashi: Having been stationed in Singapore from 2001 to 2004, I
recognize ASEAN’s significance. This region, with its diverse politicalsystems and cultures, has its own national interests. Some ASEAN
countries are still developing, and Japan can aid their environmental
efforts by sharing transitional technologies on the path to carbon
neutrality. This cooperative approach aligns with Japan’s geopoliticalstrategy, fostering growth through co-creation with ASEAN.
6 Japan SPOTLIGHT • July / August 2024

Interviewer: Naoyuki Haraoka is the executive managing director and editorin-chief of Japan SPOTLIGHT. He translated this interview from the original
Japanese.