How Japanese risk aversion explains reactions to Brexit and whether UK should join the CPTPP

I was a panellist for the UK Trade Forum on 25th September 2018, on Japanese business and government viewpoints in response to the UK’s request to join the Comprehensive and Progressive Agreement for the Trans-Pacific Partnership (CPTPP, TPP as was, often known in Japan as the TP11)

The Chatham House rule was invoked, but I believe that I am allowed to report what I said, so long as I don’t attribute any comments to the other speakers.

As I only had 10 minutes, I decided to focus on risk aversion to explain Japanese reactions to Brexit and the UK joining the CPTPP.  Even so, I had to drop the final part of my speech, so I will add this back in at the end:

“I have spent more than 45 years now living in or visiting Japan and working with or for more than 200 Japanese companies, and one generalisation I feel I can make, even though I am well aware of the dangers of stereotyping, is that Japan as a nation – as well as Japanese companies – are highly risk averse.

The geopolitical angle

I was reminded of this when I attended a lecture by Koji Tsuruoka last week, the current Japanese Ambassador to the UK, who was also the chief negotiator for Japan for the TPP. He gave a very powerful, thought-provoking speech, tackling head-on controversial subjects like Japan’s behaviour in WWII, whaling, defending Big Pharma IP interests in trade negotiations and so on, in a way that didn’t seem strictly necessary given it was an audience of Japanophiles, but I think his message, on reflection, was very clear.  Japan feels very vulnerable, with neighbours such as China and North Korea and Russia, and supposed allies and defenders such as the USA now behaving unpredictably, and it needs a rules based international order because it is energy and resource poor and relies on other countries for imports of these things.  WIthout a rules based international order being adhered to, countries behave unpredictably, and this can lead to war.

So this is why Tsuruoka and other Japanese government representatives and ministers have been very positive and welcoming of the UK wanting to join the CPTPP or roll over the EU-Japan EPA, even if the practicalities of this are not clear. They worry that the UK leaving the EU means the UK is also leaving that rules based international order, so needs to be roped back in somehow.

Why are Japanese companies so risk averse?

So that’s the geopolitical side to this – for the rest of my ten minutes I want to look at the Japanese business side, and three sectors in particular, what kind of trends we are seeing and how they are reacting to Brexit and what TPP might contribute in terms of mitigation or otherwise.

So why are Japanese companies so risk averse?  I think it’s because they operate on a very different model to the Anglo Saxon, short term, shareholder value model. It could be called a stakeholder model, but primarily the motivation is not to make a quick profit, but long term survival. So they don’t want to do anything so risky as to jeopardise that, and they are very hot on ESG – Environmental, Social and Governance – issues.  It’s one of the really good things about Japanese companies, why I am still a fan.

So when the Japan bashing started happening in the 1980s, and many Japanese remember Americans taking hammers to Japanese cars, Japanese companies decided that foreign direct investment was the way forward, and started up factories in the USA and of course also in the UK, with Nissan, and then Honda and Toyota.

They chose the UK – and the UK is the recipient of 40% of Japan’s cumulative FDI into the EU, and has the largest Japanese population in the EU, including intra-company transferees – (but both those numbers are declining these past couple of years – I leave that to you to conclude why, but a hostile environment certainly isn’t helping) – because the UK was seen as a stable, rules based system, low risk place to invest, and of course because we were then members of the EU and a gateway into the EU.

So what is happening now with Brexit in terms of Japanese risk aversion, is that it is tipping them into making decisions and directions they were going in anyway.  Looking at the three main sectors of Japanese investment in the UK – automotive and supply chains, IT and electronics and “pure” services – these sectors make up the bulk of the around 1000 Japanese companies in the UK, employing around 140,000 people.  Actually many of the 1000 don’t really count because they are paper companies, brass plates, or several versions of the same company, but there are 30 or so really big employers who make up more than half of those 140,000 employees.

Automotive supply chains – a pivot to a new chain of right hand driving nations?

So for Japanese companies, trade negotiations aren’t really about trade in products so much any more, more about protecting their foreign investments.  Even then, to be realistic, the EU only makes up around 10% of Japanese companies’ turnover.  Asia is still the really big market outside of Japan, and within that, China, and then secondly the US.  And the UK is probably only around 10% of the EU total.  But the UK is also host to a lot of regional HQs and of course the three car plants.

The main trends you see in the automotive supply chains is that they are shifting eastwards in Europe, to the Czech Republic, Slovakia, and Japanese car manufacturers also have factories in Russia and Turkey, and the suppliers – of wire harnesses for example – have factories in Africa.  So Brexit is accelerating that shift.

Can the CPTPP help with this?  Well I suppose there are a large number of CPTPP members who are right hand driving like the UK, but when you look at what sells in Australasia for Toyota, it’s pick up trucks like the Hilux, whereas Toyota in the UK is manufacturing the Auris/Corolla.  I suppose that shift could happen – at least then there is access to a market of over 100 million, which is supposed to be the minimum to sustain an automotive supply chain.  Honda is already trying to sell half of its Civic production from Swindon to the US, so it could happen, despite the distance.

Information technology and electronics – integrated disintegration

You’re also seeing a shift in the power balance in those supply chains, towards the components suppliers, and IT, because of Big Data, the Internet of Things and so on.  Which brings me to the second major sector – information & communication technology, electronics etc.  Here you’re seeing what I call an integrated disintegration. Japanese companies are becoming more B2B, solutions based, and trying to integrate back office functions, but also customer support, technical support into low cost locations with multilingual educated workforces – so in Europe this would be Portugal, or Poland.

But at the same time, the regional management and sales are becoming more dispersed.  Anyone who has worked in a multinational as I did working at Fujitsu will know what this means – endless fights about who gets what in terms of money or actually doing the work, and whereas the UK often won those fights, I am beginning to see signs that Japanese companies are reverting back to the country model, are finding the matrix system just too tough.  If you’ve ever run a global or regional virtual team, as I did, you can understand why.  So there is a drift away from the UK and to Germany or the Netherlands, as we’ve seen with Panasonic, and it would seem also Sony now, accelerated by Brexit. And that’s bad news for UK suppliers of services to those Japanese companies.

Pure services also need a rule based international order

But Panasonic did not just cite Brexit as a reason for moving its headquarters to the Netherlands. It was also to do with the tightening of Japan’s tax haven rules from April of this year. Dividends and other “passive income” in Japan’s overseas subsidiaries will be the subject of attention of Japanese tax authorities, regardless of how much real business activity they are undertaking, if the corporate tax rate is below 20%.  And of course the UK’s is 19% and due to decrease further – reiterated by the Chancellor after the referendum to show that the UK is still open for business.

But actually this is not appealing to Japanese companies.  Nor is the “chlorinated chicken” approach about deregulating or having looser environmental or other regulations of much interest to Japanese companies. They want to maintain high standards, and like robust, thorough rules – again, because of the risk aversion.

But there are cultural issues beyond the need for a rules based international order

Although Japanese companies really like being in the UK and I think a lot of the commercial and financial sector companies, like Japanese banks, or trading companies like Mitsubishi Corporation that I used to work for, have no intention of entirely shifting their regional headquarters out of the the UK despite Brexit, if they can help it, one thing that keeps me in business is the cultural gap between Japan’s very process and rule oriented way of managing and the more principles based, some might say “winging it” approach of British management.

I believe Japan is still very reluctant to open up its public procurement and professional services sector, even to the UK, and I can see why. There is not really a developed set of professional specialists the way we have in the UK.  Most Japanese employees follow a generalist track.  So in trade negotiations, such as the CPTTP or the EPA, it must be very difficult to find common terminology in order to agree any rules for recognition of qualifications, or mutual understanding of governance principles for services, much more difficult than defining standards for products.  “Risk” in Japanese is the same word that is used for “crisis”. So it has a very negative meaning, and the neutral concept of risk management is not translatable into Japanese as a result.

 

 

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