TOKYO: For much of its 72 years, Hitoshi Fujita’s company was just another mom-and-pop business grinding out metal parts.

Then it did something unusual for a small Japanese manufacturer. It expanded, buying two neighbouring firms in the last decade.

If more small companies don’t follow suit, Fujita said, the country that transformed global manufacturing in the 20th century is looking at a dim future.

Years of faltering growth and population decline left many of Japan’s small and medium firms squeaking by on state help and almost-free funding.

These companies, which account for around seven out of 10 jobs, now face a shake-up as pandemic-era support dwindles and interest rates rise for the first time in 17 years.

Japan’s government is willing to let more underperforming companies fail, three senior government officials said.

This is a previously unreported acknowledgment that they said reflects an urgent need to replace sclerotic businesses with those able to deliver growth.

While the officials did not expect such a change to occur quickly, they described the shift in thinking as a clear departure for a country that has typically sought to avoid bankruptcies and protect existing jobs at the cost of productivity.

The move will help Japan channel workers and investment to its most productive companies in a tight labour market, boosting wages, said the officials, granted anonymity to discuss a sensitive issue.

To be sure, the government expects the change to come via mergers and acquisitions (M&As) rather than large-scale bankruptcies and layoffs, one of the people said.

The government has help centres to advise small businesses on M&As.

This rethink of Japan’s traditional approach to business faces several hurdles, not least the social contract that has governed the postwar economy, according to interviews with 20 people, including five government officials, bankers, industry experts and three business owners.

“Many owners of small manufacturers are from the generation before me and tend to manage their businesses as engineers,” said the 46-year-old Fujita, who runs Sakai Seisakusyo in Kakamigahara, central Japan.

“They don’t really have applicable skills when it comes to buying another company.”

Fujita’s firm makes parts for faucets and semiconductors, and he wants to expand more into higher-value components.

In a response to questions, Japan’s Economy, Trade and Industry Ministry said it would continue to support small and medium-sized enterprises (SMEs) with funding and other measures, adding that companies needed to boost their earning power through investment and increased productivity.

It said bankruptcies were now “on a slight upward trend” and had returned to pre-pandemic levels, while workers were changing jobs for better conditions, including higher wages.

“We will continue to closely monitor the situation to ensure bankruptcies do not increase at an inappropriate level that would cause the unemployment rate to rise,” it said.

Some 251,000 companies were “zombies” last year, meaning their profits didn’t cover interest payments over an extended period, according to research firm Teikoku Databank.

This was the highest in more than a decade. The vast majority had 300 or fewer employees.

Under government measures released in March, banks are encouraged to help turn around weak companies instead of continuing to prop them up with loans.

The measures don’t directly mention zombies or “economic metabolism”, a term policymakers use to refer to stronger companies replacing weaker ones.

When asked if more companies would be allowed to fail, one of the senior officials said: “Yes, that is correct.”

But the government “cannot say that explicitly” as it would risk a public backlash that would be unwelcome for the ruling party, the official added.

“By stealth, we are doing this, gradually doing this,” the official said. “Japan’s future will be bleak if we can’not raise productivity.”

Japan ranks below the Organisation for Economic Co-operation and Development average for annual wages and per capita gross domestic product.

The latter, a barometer of labour productivity, showed Japan at US$33,834, behind France and Italy.

Still, there are limits to how much creative destruction Japan can stomach.

In some rural areas, underperforming businesses remain essential to communities, a fourth official said.

The government is careful not to be seen as “abandoning” support for small companies, said Tatsuro Oya of law firm Ohe Tanaka and Oya, who has experience restructuring small companies.

“They are trying to ease the pain as much as possible through the safety net of redirecting workers to growing companies,” he said.

Prime Minister Fumio Kishida has pressured companies to boost pay.

They delivered the biggest increase in three decades this year, averaging 5.1%, with smaller ones averaging 4.5%, according to the Rengo union group, although that doesn’t reflect wages at many non-unionised small companies.

SMEs shouldn’t be recipients of “welfare policies”, said Akira Amari, an influential lawmaker from the ruling Liberal Democratic Party.

The ultimate aim is to help them increase productivity, increase profits and increase wages so they can pay taxes, he said.

 - Reuters