The Japanese government’s plans to increase economic efficiency and productivity through digitalisation reflect Japan’s growing need to develop new and innovative technologies in software and big data. However, Japanese firms’ incremental and often secretive R&D approach and risk-averse attitude to investments in startups undermine these efforts.
The International Institute for Management Development (IMD) released its 2020 World Digital Competitiveness Ranking that ranks the capacity of countries to utilise digital technologies for government, business and society at large. These results show that Japan lags behind other countries, dropping to 27th place from 23rd in 2019. In the Asia-Pacific region, it ranked below countries like Singapore and Malaysia. In contrast, Japan’s economic near-peers have drastically improved: South Korea went from 14th in 2018 to 8th, whereas China went from 30th to 16th.
Digital competitiveness particularly matters for Japan given their ageing population. IMF statistics suggest that Japan’s labour force is set to drop by around 24 million people between 2018 and 2050. To compensate, Japan will need to better leverage innovative technologies and further encourage digitalisation to keep up current levels of production and productivity. Boosting tech competitiveness is also likely to be important for Japan so that it can remain competitive with digitalising economies like China, India and South Korea.
Why the Decline?
Japan’s tech innovation efforts are hindered by its underdeveloped startup company ecosystem. Tech startups have the potential to bolster innovation and motivate the development of new technologies. Startups often have advantages over larger firms for innovation in the form of entrepreneurial flexibility, less rigid business cultures and closer team communication. Illustrating Japan’s underdeveloped ecosystem, Japan only has 3 ‘unicorn’ startups (privately held startups valued at over $1 billion) whereas the USA and China have approximately 242 and 119 respectively, including established companies like ByteDance and SpaceX. South Korea has more than 10 unicorn startups.
These figures suggest that Japan is not reaching its potential in the creation of a favourable startup ecosystem. One contributing factor is the unwillingness of Japanese investors to make large investments in young startups. In 2019, startups between 1-3 years old received on average $91,000USD in funding, while 5-7 years old startups received over $2.5 million USD on average. For young startup companies, the difficulty in securing valuable funding in their early years poses a barrier to a robust startup ecosystem in Japan. This lack of investment may be the result of a high degree of risk aversion on the part of Japanese investors; older startups, due to clearer track records, may appear to be safer investments.
Moreover, the attitude of large Japanese companies to research and development (R&D) poses an obstacle to the country’s competitiveness. Japanese R&D has been described as occurring in an isolated ‘in house’ manner. This approach slows the capacity of Japanese firms to respond to emerging technologies and industries in comparison to companies like Google or Amazon that have collaborated with or acquired various startup companies. A 2018 Bank of Japan white paper substantiates this R&D attitude, which identified that Japanese R&D focuses more on incremental improvements as opposed to the creation of innovative products.
Although the aforementioned details convey a negative picture of Japan’s business and tech environments, signs of improvement have emerged over the past few years owing to steps taken by the government and in the increasing availability of capital.
A report by Japanese startup information platform INITIAL shows that the proportion of venture capital as part of total startup investment has increased yearly, making up 46.4% of 2019’s total of JP¥446.2 billion ($4 billion USD). Moreover, there has been an increasing establishment of Japanese investment funds; the INITIAL report notes that 95 new investment funds were established in 2019, up from 81 new funds in 2018. Yet, new funds are not a guarantee of funding for young startups. After all, even Japan’s SoftBank’s tech-focused Vision Fund has invested little in Japan. Nevertheless, the growing number of funds is a positive sign for a reinvigorated startup ecosystem in Japan.
Improvements in access to capital and the promotion of cooperation between startups and established firms are not just occurring in the private sector. The government hopes to encourage firms through a new tax system in April, in which investments over JP¥100 million in domestic unlisted startups will receive a 25% tax deduction. This incentive for firms to invest in startups might foment cooperation, which would likely improve the capacity of larger firms to innovate due to the possibility of information sharing and exchanges of staff with the startups they invest in. However, this policy may not mitigate the aforementioned issue regarding low funding for younger startups as there are no indications of such an investment by the Japanese government.
Japan has started to address its decline in tech competitiveness. However, there remains much room for improvement. In the immediate term, owing to the COVID-19 pandemic, established firms are likely to be cautious about coordinating with and investing in startups. This prediction appears quite likely given recent statistics illustrating a sharp decline in venture capital funding in 2020.
In the long-run, the aforementioned trends towards capital availability and higher levels of investment in startups are likely to continue. Nevertheless there remains room for improvement, such as the reorientation of Japanese firms’ attitudes towards startup cooperation or engaging in mergers and acquisitions of startup companies. Such a change would likely help Japan’s big companies to innovate more quickly and boost tech competitiveness, leveraging the know-how, motivation and flexibility of startup companies.
The Japanese government is likely to step up initiatives to promote a further shift in firms’ attitudes towards startups and digitalisation, as suggested by the aforementioned tax system change and other recent efforts to support cooperation between foreign startups and domestic firms, albeit few comparable measures have been taken to date. Should the government cooperate with private firms and venture capital funds to increase support for young startups, it is highly probable that Japan’s startup ecosystem and prospects for tech innovation will flourish over this decade.