We interview Noah Smith, finance professor at Stony Brook university and economics blogger, on lingering misperceptions of the Japanese economy and what is going to happen with Abenomics.

Noah Smith is a finance professor at Stony Brook university in New York. He blogs at Noahpinion and writes for several magazines about economics and public policy. Before he went to grad school, Noah lived in Osaka for two and a half years. He now works two months out of the year in Japan, doing research with professors at Keio, Aoyama Gakuin, and Osaka University.

MYTHS OF THE JAPANESE ECONOMY

Can you help debunk us the main myths of the Japanese economy?

Myth #1: “Japan is an export-dependent country.”

Actually, exports are a smaller part of Japan’s economy (16%) than that of most rich nations’ (though bigger than the U.S.). Also, Japan hasn’t had a big trade surplus for a while.

Myth #2: “Japanese households save a lot.”

This used to be true, but isn’t true anymore. The household savings rate nearly hit 0% in 2008 and is only around 2% now (America’s is around 5%).

Myth #3: “Japan is a top-down economy guided by industrial policy.”

This used to be true, but isn’t anymore. The influence of METI (formerly MITI) has been curbed substantially. The Ministry of Finance still has a lot of power over banks, but this is true in other rich countries too and is generally what happens after a big banking crisis.

Myth #4: “Japan is a manufacturing-based economy.”

Manufacturing makes up slightly more than one-fifth of Japan’s economy, which is more than most rich countries (only Germany and Korea beat it), but is a lot less than most developing nations. India, for example, is more manufacturing-intensive than Japan.

Myth #5: “Japan has lifetime employment.”

Sure, for the top half of the workforce. For everyone on the bottom, it’s a constant struggle with little hope of big raises or promotions. And among those with so-called “lifetime employment,” maybe half are in danger of losing their jobs to layoffs.

Myth #6: “Japanese companies aren’t innovative.”

This is just wrong in so many ways, I could write a book about it (and maybe I will).

Myth #7: “The Japanese buy government bonds out of patriotism.”

Unlikely. They probably buy Japanese government bonds out of fear, pessimism, and a lack of knowledge of good alternative investment opportunities.

Another one seems to be high prices.

Not everything is expensive in Japan! Go to a ¥100 shop and see if you can find the same stuff at an American dollar store. I bet it will be impossible. (And I just paid $7 for a shot of Jack Daniels at a grungy punk bar in Oakland, so we’re not in the 1980s anymore.)

Also, remember that Japan lists after-tax prices, while America lists pre-tax prices, so stuff in America feels cheaper relative to stuff in Japan, but it’s partly an illusion.

In addition, there are some quality differences. Milk in Japan tastes as good as organic milk tastes in America. Saran wrap in Japan is much better than in the U.S. And Japanese restaurants,cafes, and stores are much cleaner than most of their American counterparts. Those quality differences add costs, which raise prices, but you get more for your money.

Finally, remember that Japan is just not as rich of a country as the United States. Productivity is significantly lower, and Japan is also not endowed with natural resources. That means prices will tend to be higher relative to incomes — that’s the definition of being poor!

Also high prices don’t lead to profit if they come from higher costs. Many costs in Japan are high. These include land costs, labor costs, regulatory compliance costs, and corporate taxes.

During Japan’s post-war development, retailers increasingly emphasized quality product and high-end experiences over selling volume at low prices. Was there an economic rationale for this?

Possibly. Because Japanese cities are very dense and people walk everywhere, people are willing to pay a premium to shop at local stores. You can’t just drive your SUV to Wal-Mart and load up the trunk like you can in America. So big department stores have to make higher margins to stay in business (I know everywhere in Japan looks crowded, but many department stores are surprisingly empty). Higher margins typically mean higher quality products or branded products.

Why did it take so long for low priced retailers like Uniqlo to emerge?

Japanese regulation traditionally favored small stores. There was a law for a long time called the Large Store Law, which was only revised in 1994 and replaced with a much more lenient law in 2000. Reduced trade barriers also probably had something to do with it. The rise in inequality may have been a factor; the huge emerging Japanese underclass needs low-priced stuff to survive.

Japanese households have long seemed content with putting their money into bank accounts that accrue only the tiniest fraction of interest. Will this continue forever?

No. As I mentioned above, Japan’s households aren’t saving much anymore. So they just won’t have the money to put into savings accounts. (It’s Japanese corporations that do all the saving, by sitting on mountains of cash.)

Second of all, one of the purposes of Abenomics and Kuroda’s monetary policy is to create inflation and make real interest rates go negative. That punishes people for keeping their money in savings accounts, and — hopefully — forces them to invest in things like stocks. That’s the outcome the BoJ is hoping for. The bad outcome would be if households just invest in foreign bonds — the so-called “carry trade.” That won’t help Japan’s economy much.

What are some examples of Japanese business innovation?

Famous examples include the Prius, which started the hybrid craze, and the Canon 5D, which put high-quality movie cameras into the hands of millions. Traditionally, Japanese electronics companies have been very innovative; they were the first to market hand calculators, digital cameras, clamshell laptops, modern console video gaming, and a lot of other things. Car and motorcycle companies are very innovative too. And there is a huge amount of technological innovation in parts and components, which you don’t hear a lot about because it’s not glamorous.

In terms of business processes, Japanese companies have always been very innovative. They invented the “keiretsu” system, which did supply chain management before there was an Internet. Toyota’s management system is also famous and original. There are other examples. Japan has a lot of companies on Forbes’ “Most Innovative” list.

In art and design, Japan is obviously extremely creative. Maybe more than any country out there, though in a different way. A lot of the designs Japanese companies create are popular in Japan but strike foreigners as too “weird.” But “weird” is just another term for “creative.”

Japan gets pegged as an “innovation-poor” society for three reasons, I think. One is that Japanese basic research is not quite as good as in the U.S. Another is that Japanese startup companies have big trouble securing late-stage funding and are kept from growing by the actions of large established players and the government. And third, Japan is usually compared only to the U.S.; try comparing to Germany, France, and the UK instead.

ABENOMICS

What do we know is actually in the plans for Abe’s structural reform?

Abe is pushing the TPP, which would have big effects if passed. He is also pushing targets for women in top management positions, which is something I think could have a bigger effect than people realize if it sparks a cultural change toward more rational and efficient labor markets. Other than that, not much. He was talking about making it easier for companies to lay off workers, but he looks to have backed off of that.

Would these lower costs for consumers in Japan?

More free trade — in other words, the TPP — will lower prices for Japanese consumers. It would be a very important part of structural reform. The biggest impact would be on food prices.

How much Japanese employment can be attributed to Japan’s current system of regulation and high costs? In other words, if you take away the regulations and high costs, does that mean rationalizing employment?

To be honest, I’m not sure. First of all, the data don’t really tell us who is employed and who is unemployed. Japan is famous for having “low unemployment,” but the truth is that about the same percentage of working-age people have jobs in Japan as in the U.S. This is because a lot of women and young people in Japan don’t work. If Japan deregulated, would these people start working? I don’t know, and I don’t think anybody knows. (If anyone knows, it would be my friend Ohtake Fumio, a labor economist at Osaka University.)

One type of deregulation that would “rationalize” employment is the loosening of laws against firing workers, but that now looks unlikely to happen. (See this New York Times piece.)

Japanese firms already employ way more people than are “necessary” for operations. If firing restrictions are loosened, won’t that just mean laying off employees without them being picked up somewhere else in the labor market?

There would be some of that. But getting rid of unproductive workers would mean companies would have more money to hire productive workers. And new businesses will spring up (or old businesses will expand) to hire the workers who get fired — probably for much lower wages.

What would have to happen for firms to raise wages or increase hiring?

Those are two very different things.

For those both to happen at once, you probably need an investment boom. That could be caused by an expansion in trade or a surge in productivity. So the TPP and deregulation could both boost wages and hiring, conceivably, although the wage gains would not be evenly distributed and many individuals would lose out.

Also, getting Japan out of deflation and back to inflation with Abenomics should theoretically cause an investment boom, but so far we’re not seeing that happening. Give it a year and see where we are.

How crucial is international competitiveness for Japan’s total economic growth? Could there be a period of expansion that just relied on domestic spending without an increase in exports?

Well, the problem with international competitiveness is that it requires one of two things: high productivity, or low labor costs. Japan can gain competitiveness by letting wages fall, but that might not be a good thing. Higher productivity would boost competitiveness, but this would probably require the kind of deregulation that produces unemployment.

So Japan’s corporatist social model is maintaining equality but hurting competitiveness.

As for an increase in domestic spending, yes, that would help, and that is exactly what has happened as a result of Abenomics. Japan’s net exports have not risen since Kuroda started his new policies; in fact, Japan now has a trade deficit. But Japanese people are consuming more, and that is boosting the economy.

How big is Japan’s financial sector relative to similarly mature economies?

Somewhere in the middle. Finance is a little less than 6% of Japan’s economy, compared to around 4% in Germany, 5% in France, 8% in America, and 9% in the UK.

Anecdotally, a lot of Western finance firms seem to be moving workers out of Tokyo. What impact does this have on the Japanese economy?

I believe that the only way for Japan to really raise productivity growth in the near future is probably to implement “neoliberal” reforms, which would ideally include allowing financial firms to do more than they currently do — for example, hostile takeovers of companies. If Japan continues to shy away from those reforms, in order to protect its social model of “corporate welfare,” then its productivity will probably continue to stagnate over the coming decade.

But as for Western firms specifically, I think that doesn’t matter on its own; it’s just a bellwether of conditions in the sector.

Who does “corporate welfare” benefit? Is it intended to keep employment high or does it just put hands money in the pockets of executives?

Corporate welfare appeals to people because it keeps employment high, yes. It mainly benefits older workers, who get more job security and much higher pay than under a shareholder-capitalist system. It doesn’t benefit executives, who would be paid more under shareholder capitalism.

It also helps preserve Japan’s “social model,” where pay is based on seniority, meaning no one has to worry about whether they’re a “winner” or a “loser.”

What should we watch for in 2014?

Three things: 1) business investment 2) wages, and 3) the trade balance.

If the Abenomics recovery is going to be sustainable, businesses are going to need to start investing their cash. If deflation is really going to be whipped, wages need to start going up. And if the trade balance swings back to a surplus, that will be very good for Japan.

As for structural reforms, watch the TPP negotiations, but that should go without saying.