Japan's new grand strategy is emerging. Achieving aspirations requires enhanced capabilities in faster technology adoption; labor market flexibility; corporate and national governance, and fiscal efficiency. Disruption may occur in five key industries: energy, agriculture, IT/AI, healthcare, and education. But the result would likely raise income for both capital and labor.

What is grand strategy?

Historian John Lewis Gaddis defines grand strategy as “Alignment of potentially unlimited aspirations to necessarily limited capabilities.” He adds that “grand” relates to the scope of the needed work “across time, space, and scale.” Prime Minister Fumio Kishida’s New Capitalism qualifies as a grand strategy, because it attempts to improve the nation’s capabilities across time, space and scale, in order to achieve national aspirations.

The two major aspirations in New Capitalism are the same two aspirations that have dominated Japanese policy for decades. One is national security, so that Japan can maintain its political independence and security of supply chains. The other is economic prosperity, so that living standards are high and rising.

While the aspirations are the same, new capabilities are needed. Moreover, there are two types of capabilities. One is the military/diplomatic power that allows Japan to play a constructive role in geopolitics. The other is economic/financial power, which brings higher productivity, which in turn maintains high standards of living and fair income distribution.

Historically, there has been a bifurcated assignment of capabilities to aspirations. National security was achieved mostly by reliance on military/diplomatic power, while economic prosperity was achieved mostly by reliance on economic/financial power. However, there was little cross fertilization—military/diplomatic power contributed relatively little to economic prosperity, and economic/financial power contributed relatively little to national security.

Due to changes in demographics and geopolitics, this bifurcated assignment of capabilities to aspirations is now obsolete. Both capabilities must contribute to both aspirations. This reality makes it all the more important for public and private sector capabilities to work together, in order to achieve both aspirations. There are four big jobs.

The four big jobs

How can Japan enhance capabilities and their impact on aspirations? 

1. Faster technology diffusion 
Economic transformation depends on the rapid diffusion of technology. The process has four parts: (a) Recognition: recognize the problem; (b) Technology: find or develop a technology to solve the problem; (c) Consensus: create consensus to use the technology; (d) Action: spread the technology quickly.

Historically, Japan has been skilled at Recognition and Technology, but has lagged on Consensus and Action. Success will depend on faster consensus creation, and faster action.

2. Enhance labor market flexibility 
New technology cannot spread without a retrained and re-allocated labor force. Both reskilling and higher labor metabolism are needed. The lifetime employment system is collapsing, but the legal structure that has supported it remains in place. Thus, more and faster labor mobility depends on how quickly laws and customs can be adapted to the realities of the labor market.

3. Enhance governance of both private and public sectors 
The private sector has made great progress, but still needs more attention to financial efficiency and flexibility of both business portfolios and internal procedures—especially human resources. The public sector has improved as well, but remains hamstrung in many cases by legacy rules, siloed structure, and incentive incompatibility between electoral/bureaucratic procedures and the urgency of public needs.

4. Fiscal rebalancing 
Japan’s debate on fiscal reform was dormant during the 2013-2019 period. Interest rates were low, primary deficits (i.e., deficits excluding interest costs) were shrinking, and the Bank of Japan was buying the equivalent (or more) of net issuance. With COVID, the primary deficit ballooned to 8% of gross domestic product, but this debt was justified as a way of preventing economic collapse. After 2020, the primary balance began to improve, standing at 5.2% of GDP in fiscal 2021.

There are two parts to fiscal rebalancing, the static and the dynamic. The static part is to reduce costs. Cost reduction requires both use of technology in traditional spending areas (medical, pension, welfare) but also requires changing rules (e.g., raising pension receipt age). The dynamic part of fiscal rebalancing is using the savings from cost reductions both to invest in new needs (reskilling, R&D) and to achieve a primary surplus large enough to stabilize the debt-to-GDP ratio.

Fast enough? Not yet

What is happening now? On June 6, Japan announced the “Revised Grand Design and Implementation Plan for New Capitalism." The document demonstrates continued progress on a number of the key elements in the emerging grand strategy. However, many are still under discussion. In this document, one frequently sees phrases such as "will promote the consideration of ..." or "will consider in a speedy manner… " or "will come to a conclusion within the fiscal year." There are few hard deadlines for implementation and few specific actions.

One can look at this state of affairs in two ways. One is to recognize the progress so far (e.g., in corporate governance, and good progress in improving technology diffusion), but also to lament the lack of progress elsewhere (e.g., labor markets, national governance, and fiscal reform).

One can also view the current situation as a momentous opportunity—in five industries in particular: (1) energy, (2) agriculture, (3) healthcare, (4) AI/IT, and (5) education. Disruptions will likely raise income for both capital and labor, raise economic sustainability, and approach the "New Capitalism" that Kishida seeks.

Empress Shoken’s Advice

Good advice for Japan today comes from Empress Shoken’s 31-syllable waka poem of the early 20th century. She wrote:

Okotarite / Migakazari seba / Hikari aru / Tama mo kawara ni / Hitoshiku karamashi (If left unpolished / Even a shining gem / Is nothing more than / A mud roof tile)

Japan is a shining gem, but it needs polishing.

Robert Robert Alan Feldman is Senior Advisor to the Research Department of Morgan Stanley MUFG Securities, where he has worked since 1998. As part of Morgan Stanley’s global economics team, he is responsible for thematic research on the Japanese economy. Robert has a Ph.D. in Economics from the Massachusetts Institute of Technology. The views expressed here are his own.