Japan’s industrial policy grants market forces a director’s role

Industrial policy is back, globally. In their quest to lead global innovation, countries from the United States of America to China are leaning on multi-billion-dollar policies to bolster their industrial technologies, hoping these measures get them ahead in one way or another. Japan is taking a more deliberate path.

Instead of throwing large amounts of public money at companies outright, Tokyo plans to encourage its industrial giants—long at the forefront of chips, cars, batteries and machines—to invest in startups and pique technological progress at home, and that too, with the help of not-so-glamorous tax reforms.

Focusing companies’ capital would be a sharp move. Big spending does not necessarily lead to immediate results, as shown by the case of China, which is the world’s second-largest research and development (R&D) spender.

While Japan has used R&D tax credits for years, its latest corporate incentive is closely targeted in comparison: Firms can claim deductions for a quarter of the amount they purchase in a startup. They need to take a minimum 50% stake, however, and hold it for at least five years.

Meanwhile, another new incentive that helps push stock-trading profits into new ventures will boost re-investment in businesses. All told, Japan wants fresh ideas and committed capital.

As part of this strategy, policymakers are putting in place programmes to support new businesses focused on industrial technology from Sapporo and Hokkaido in the north to Fukuoka in the south. These include funds to help bridge the gap between research and commercialization and developing prototypes—typically key barriers for startups.

On the face of it, such corporate tax reforms will help drive investment without straining Japan’s fiscal coffers. The approach stands out in the current context because it avoids the traditional condition-based subsidies or war-gaming to block the rise of other countries. Instead, the domestic measures spread the burden of innovation across industries—from iPhone-making equipment to semiconductor-production machines and factory-automation systems—to stimulate overall productivity.

By helping large lumbering companies free up capital and invest in startups, the government is putting decisions on which technologies to back in the hands of these corporates, rather than making those calls itself. [No cherry-picking here.]

That calculus matters: Businesses will back money-making projects or those with practical aims, over basic research that is not driven by a specific goal and often serves as a foundation for future ideas. This also creates a financing channel for nascent firms at a time that venture capital is shying away from big investments in physical industrial hardware that won’t be showing hockey-stick growth anytime soon, unlike the rapid rise of cloud-era startups.

Stirring Japan’s big businesses into action is not an easy feat. The country, while still highly ranked on a broad measure of global innovation,has stagnated on several measures. The likes of Toyota Motor and Honda Motor Company are still among the biggest corporate R&D investors, while high-tech goods account for around 55% of total manufacturing output, largely flat for the past decade. Its share of new patents has fallen over the last 20 years, while expenditure on research domestically has remained flat and well below the increasing outlays by the US and China, on a purchasing power parity basis. American companies that spend top dollar on future projects end up with much faster productivity growth, compared to Japanese ones that don’t see the same rates of return, according to a study by the Bank of Japan.

Clearly, the country’s waning status as an innovator needs a lift.

If Tokyo can grow a class of corporate venture capitalists through its latest tax reforms, then it stands a chance at refreshing its storied industrial companies. When big firms back innovative and nimble startups, they are focused on leveraging new-age technology to produce synergies —an investor favourite. It’s more a strategic investment than a financial one—a large pot of money that’s meant to generate high returns, akin to the traditional venture-capital world. It could also set up a new playbook for driving domestic innovation for other countries.

It is still too early to say whether huge subsidies and inducements will work better as we go into the current industrial cycle, compared to the more targeted tax approach. Returns on innovation can take years to materialize. However, it’s already quite easy to see what will prove more sustainable.

Anjani Trivedi is a Bloomberg Opinion columnist covering industrials across Asia Pacific.