The strengths of Japan’s financial system
We have recently quoted a number of surveys that have seen Japan sliding down the global rankings (“Tokyo sliding to #16 among Global Financial Centers”, “Japan’s steady digital decline continues”, “More FinTech rankings: Tokyo #24”). So it is good to read through a report that highlights the strengths of Japan. As always, the type of comparisons matter, as do the factors that go into the rankings, so let us unpack this.
First, the report is about China. The Atlantic Council has just published its “China Pathfinder Annual Scorecard”, which contrasts China across six dimensions with ten open economies. So inherently, it also provides a comparison of Japan with these economies, and it accomplishes that in a very elegant way, by showing the developments over the last decade, from 2010 to 2021. Please allow us to highlight some of the charts most meaningful to us as Finance and FinTech professionals.
Financial system development
In terms of financial system development, Japan has made the biggest strides over the last decade, and ranks comfortably above the open economy average. It has overtaken Korea and Australia, while getting very close to the UK, with the latter two actually regressing since 2010. This result was more positive than we would have expected based on other recent surveys, so it is worth taking a look at the underlying indicators:
- Efficient Pricing of Credit (Japan is best-in-class)
- Direct Financing (just below open economy average for debt, only behind the US & Canada for equities)
- State Ownership in Top Ten Financial Institutions (slightly higher than open economy average, on par with the UK & France)
- Financial Institutions Depth (above open economy average)
- Financial Markets Access (just below open economy average)
Market competition
With regards to the competitive environment, most economies have become less competitive over the last decade. This also applies to Japan. However, it remains the second most competitive economy among this peer group. A key factor here is the below-average market concentration as measured by the top five firms’ share of total sector revenue, which is only surpassed by China and the US.
Modern innovation system
In terms of innovation openness, Japan actually comes out on top. Its R&D expenditure as a percentage share of GDP is within a 3 to 3.5% range together with Germany (lower end) and the US (higher end). Korea ranks supreme on this indicator, with close to 5% of GDP invested in R&D.
A slight fly in the ointment, which still left Japan leading the “innovation system” composite score, is the venture capital investment, where it place second but last. Here the comparison between Japan and Korea is remarkable, with both almost even in the 2010 ranking, and Japan showing little improvement, while Korea surges ahead into third place behind the US & UK.
Japan has a globally leading level of private sector spending on R&D, however, and its patent filings are unparalleled when adjusted for GDP. Korea in second place files less than half the patents. When looking at the attractiveness of that IP as measured by royalty payments adjusted for GDP, Germany surpasses Japan, i.e. the value of Japanese patents is about a quarter of those German patents.
Summary
To conclude, Japan has a strong financial system that has made significant strides over the past decade. It services a highly competitive and innovative economy that reinvests significant funds into R&D to secure its future. While the innovation output in absolute numbers is world-beating, the efficiency of innovation could be improved, and the overall ecosystem could be supported by more risk capital. There are government programs in place to support these changes, it remains to be seen whether they will have the desired effect.
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