Given that SMEs account for a substantial share of Japan’s economic output, the greater internationalisation of Japanese SMEs could be a new growth driver for both Japan and Asia.

Traditionally, Japanese SMEs largely operated as suppliers for large enterprises as part of the keiretsu (系列) system of integrated supply chain groups. With some exceptions, SMEs tend to be domestically oriented and export indirectly via the value chains of large multinational enterprises and general trading houses (shōsha, 商社). In the post-GFC and March 2011 triple-disaster economic environment, these arrangements are increasingly suboptimal. As the country’s population continues to shrink at an alarming pace, Japanese SMEs urgently need to seek opportunities in faster growing regional markets to diversify demand and remain viable. Despite being the backbone of the Japanese economy, accounting for more than 99 per cent of all Japanese enterprises and about two-thirds of private sector jobs, only about 10 per cent of Japan’s medium-sized enterprises engage in direct export as compared to 15 per cent and 32 per cent from the US and EU, respectively.

Japanese SMEs are held back by external factors in the business environment and internal factors within firms. External factors include impediments in regional markets, such as inadequate infrastructure, underdeveloped legal systems, political risks, risks related to the collection of receivables, and high or rising labour costs. Tariff and non-tariff barriers are also troublesome, particularly in countries with which Japan has no FTA. Even then, FTA usage entails fixed costs which Japanese SMEs may find challenging to surmount.

Among internal factors, a key constraint faced by Japanese SMEs is the inward-oriented labour market. Close to 75 per cent of SMEs that do not pursue business abroad also do not have access to human resources capable of handling overseas operations, such as Japanese employees with foreign language proficiency or an international outlook, or foreign employees. Among the Japanese SMEs that do engage in overseas business, about 60 per cent reported that they are in short supply of or do not have any ‘global human resources’.

Constraints in the domestic supply of suitable candidates limit Japanese SMEs’ ability to pursue overseas business opportunities. Although some Japanese SMEs have looked to hire foreign employees, such workers are discouraged by the challenges of integrating into the Japanese work environment and learning the Japanese language.

While existing government policies for promoting the internationalisation of Japanese SMEs are robust, more can be done. First, it is imperative that Japan join the TPP and RCEP. This would greatly improve the depth and coverage of protection for Japanese SMEs and help to lock in structural reforms among regional partners. While these agreements may not resolve every challenge in the regional business environment, they include legal disciplines in services trade, investments, intellectual property, movements of persons and dispute settlement that could meaningfully reduce the cost of doing business in overseas markets.

Second, competency in international commercial languages among the Japanese population must be improved to enable Japanese SMEs to draw from a larger pool of domestic job candidates who can succeed in the international business environment. To this end, the proposal to introduce the Test of English as a Foreign Language (TOEFL) to university entrance exams should be seriously considered. In addition, immigration restrictions should be further eased and Japan’s high standard of living leveraged to position Japan as the preferred destination for high-skilled foreign workers. This would allow Japanese SMEs to tap into a larger pool of foreign workers. For this to be possible, Prime Minister Abe must decisively implement the third pillar of his ‘Abenomics’ strategy, which involves liberalising the domestic labour market and encouraging the inflow of international talent.

Japanese business also has a proactive role to play in bringing about a more outward oriented Japan. As a collective via business associations, Japanese SMEs could collaborate with government to establish more industrial zones like the Ota Techno Park in Thailand, which is an industrial park to facilitate the establishment of foreign subsidiaries of SMEs from Tokyo’s Ota Ward. At the firm-level, Japanese SMEs could complement outward-oriented labour market reforms by lowering the bar for international employees to integrate. SMEs should also adopt the progressive elements of the corporate practices of globally ambitious Japanese firms like Rakuten (楽天) and Fast Retailing.

Japanese SMEs stand to benefit from Asia’s ongoing dynamism through trade, investment, and the movement of people. But for Japanese SMEs to play a greater role in Asian regionalism, Japan must support improving the regional business environment and push for domestic reforms, as well as upgrading human resources and other firm-level capabilities. By becoming more outward-oriented and using outward-oriented policies to drive structural reform at home, Japan could fundamentally change the regional economic landscape.

Kensuke Yanagida and Boon-Loong Ngiang are Research Associates at the Asian Development Bank Institute, Tokyo.