Foreword. Masataka Nakano Chairman Japan Small Business Research Institute

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2 Foreword In the last five years, Japan s economy has continued in a recovery phase on the back of the development of favorable export value and active private-sector capital investment. However, regional disparities are found along the whole length of the archipelago in indices including those of employment and business confidence. Compared with large enterprises, the recovery at Small and Medium Enterprises (SMEs) continues to lag, and the capital security of SMEs may be affected by the end of zero interest rates. Japan s SMEs thus continue to face a severe business climate. However, among all these difficult economic conditions, SMEs have activities that are closely related to local communities or to the flexible responses of small and medium manufacturing against changes in transaction patterns. Accounting for 99 percent of all enterprises in Japan, there are further expectations for SMEs activities. This publication is a complete translation, made by the JSBRI with the approval of the Small and Medium Enterprise Agency, of the Agency s annual report on recent trends among SMEs in Japan entitled The 27 White Paper on Small and Medium Enterprises in Japan: Harnessing Regional Strengths and Confronting the Changes. This year s white paper analyzes and researches SMEs economic environment, using regionalism as a keyword. Its content has been specifically verified with a large amount of data on and examples of SMEs that have expanded their business through the accumulation of traditional industries or the use of regional resources such as natural resources or local culture, as well as those that have been involved in regional revitalization, all of which the reader may find of interest. This white paper moreover refers to the effects on SMEs of varied transaction patterns, and introduces many examples of trade conditions. I hope that this publication will help to improve understanding of the conditions facing Japan s SMEs among those overseas, including researchers, who have an interest in SME policies and trends in Japan, and that it also makes its own modest contribution to the development of SMEs around the world. Masataka Nakano Chairman Japan Small Business Research Institute

3 Ministry of Economy, Trade and Industry Japan Small Business Research Institute 27 First printing : October 27 All rights reserved. This publication, or parts thereof, may not be reproduced in any form for resale or other commercial purposes unless written permission has been expressly given. Private, educational, institutional or other non-profit organizations may consider permission to have been herein granted for any necessary reproduction provided that a copy of any publication in which it appears is forwarded to Japan Small Business Research Institute, Sanbancho-KS Bldg., Sanbancho 2, Chiyoda-ku, Tokyo 12-75, Japan. Edited by SMALL AND MEDIUM ENTERPRISE AGENCY MINISTRY OF ECONOMY, TRADE AND INDUSTRY Translated by JAPAN SMALL BUSINESS RESEARCH INSTITUTE

4 27 White Paper on Small and Medium Enterprises in Japan Small and Medium Enterprises: Harnessing Regional Strengths and Confronting the Changes

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6 On publication of The 27 White Paper on Small and Medium Enterprises in Japan It is said that the Japanese economy has at last emerged from a long recession tunnel and is starting to see bright prospects for the future. The situation remains, however, one in which small and medium enterprises, in particular, are still unable to feel the broad merits of the economic recovery. SMEs create new industries, generate employment, and shoulder local economies and communities. In short, they support the backbone of the Japanese economy. I firmly believe that the Japanese economy can truly be revitalized by harnessing the wisdom and motivation of the 4.3 million SMEs across the nation and increasing their dynamism. To make this a reality, I intend to apply a full range of policy instruments and take all possible measures to support SMEs. This fiscal year s white paper analyzes the reasons why many SMEs are not feeling the economic recovery and the challenges facing SMEs under these circumstances. We have made an effort to answer the questions being asked by SMEs, which continue to challenge themselves amid the large wave of economic structural changes. One of the reasons that are given for the delay in the economic recovery of SMEs is the difficulty in setting a selling price that meets the costs, including raw material prices. I believe this situation can be improved, however, by taking advantage of regional strengths such as local resources and differentiating products and services. In addition, the white paper also analyzes the strengths and potential of small and medium retailers for which conditions are still particularly severe. Furthermore, it analyzes the nature of the relationship between SMEs and main banks with regard to the current situation of local finances. Next, the white paper describes the current situation with the decentralization and diversification ( meshed ) of SME customers, taking into account the structural changes occurring in what used to be long-term, stable business relations and in the labor market. It notes measures for improving trade practices that are unfavorable to SMEs, and then highlights the major points of recruiting and developing core human resources of SMEs. On the basis of these analyses, we will take all necessary measures to assist SMEs to develop new businesses that make use of local recourses as mentioned earlier, support SMEs that are working to revitalize their businesses, and strengthen and enforce measures for developing an environment that encourages the launch of new businesses and the relaunch of former businesses. I hope that this white paper will have various uses as a compass or signpost for SME entrepreneurs and others involved in SME policy. Finally, I would like to express my deep gratitude to SME entrepreneurs and the many other people involved in the creation of this white paper for their enormous cooperation. Akira Amari Minister of Economy, Trade and Industry June 27

7 Contents Part I Trends among SMEs in fiscal 26 Chapter 1 Trends among SMEs Section 1 The Japanese economy in fiscal Section 2 Variation between regions and variation between industries in economic recovery Section 3 Business conditions among SMEs Section 4 Summary Chapter 2 Entries, exits, and the environment of small enterprises Section 1 Trends in entry and exit rates in Japan Section 2 Attributes of startup founders and the startup environment Section 3 Effects of entries and exits on overall economy Section 4 Business successions among SMEs Section 5 The environment surrounding small enterprises Section 6 Summary Part II SMEs that grow with the community Chapter 1 Measures for the effective utilization of community resources Section 1 Locally unique management resources and trends of local industry Section 2 Effects of the utilization of community resources Section 3 Community resource utilization process Section 4 Summary Chapter 2 The role of community businesses such as community-supporting small and medium retailers Section 1 Market trends for the retail, service, and eating and drinking industries Section 2 Consumer s expectations for community small and medium retailers, etc Section 3 Local governments expectations for community enterprises, etc., to be leaders of community development Section 4 Measures of community small and medium retail and other industries Section 5 The means for small and medium retail and other industries to respond to consumer needs in the future Section 6 Summary Chapter 3 The Role of Regional Finance in the Development of SMEs Section 1 Current status of regional financial institutions Section 2 Relationship between Regional Financial Institutions and SMEs Section 3 Efforts to Facilitate Fund Raising Section 4 Summary vi

8 Part III SMEs: Rising to the challenge of a changing economic structure Chapter 1 The changing structure of inter-enterprise transactions Section 1 Division of labor among large enterprises and SMEs according to existing statistics Section 2 Identifying transaction patterns between enterprises based on new data Section 3 Situation regarding transaction patterns and the position of SMEs Section 4 Is meshing progressing? Section 5 Summary Chapter 2 Effects on SMEs of terms and conditions of transactions between enterprises Section 1 Determination of sales prices Section 2 Clarification and documentation of terms and conditions of transactions Section 3 Terms and conditions of transactions after production Section 4 Trends in inter-enterprise credit transactions Section 5 Cooperation in R&D Section 6 Terms and conditions of transactions in service transactions Section 7 Summary Chapter 3 SMEs initiatives to accumulate human capital Section 1 Employment environment at SMEs since the 199s Section 2 Personnel structures in SMEs Section 3 Key persons who underpin SMEs Section 4 Measures for securing and developing personnel Section 5 Summary Conclusion Toward the formation of a new image of SMEs SME policies planned for fiscal 27 Appended notes Bibliography Supplementary statistical data Index of figures vii

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10 Introductory notes 1. In this report, the term small and medium enterprises (SMEs) refers to small and medium enterprises as defined under Article 2, Paragraph 1 of the Small and Medium Enterprise Basic Law, and the terms small enterprises and micro enterprises refer to small enterprises as defined under Article 2, Paragraph 5 of said law. More specifically, they may generally be categorized as follows. Industry 1) Manufacturing, construction, transport, other industries (excluding 2)-4)) 2) Wholesale 3) Services 4) Retail Small and medium enterprises (meet one or more of the following conditions) Of which small enterprises Capital No. of regular employees No. of regular employees Up to 3 million Up to 3 Up to 2 Up to 1 million Up to 1 Up to 5 Up to 5 million Up to 1 Up to 5 Up to 5 million Up to 5 Up to 5 2. Business establishments are sometimes regarded as enterprises for the purposes of analyses in this report that make use of statistics based on the number of business establishments. In such cases, SMEs are business establishments that satisfy the above conditions regarding number of employees. In some cases, therefore, the business establishments of large enterprises may be treated as SMEs. 3. This report draws largely on statistical data published by the Japanese Government and Bank of Japan (BOJ). However, use is also made of analyses based on these data and studies conducted by various entities in the private sector. Sources, methods of calculation and other relevant information are specified where data are cited. However, the main sources cited in this report are described briefly below. (Unless otherwise noted below or in the main text, the unit of measurement used in statistical data is the enterprise.) (1) Ministry of Economy, Trade and Industry (METI), Census of Manufactures This survey provides statistics on numbers of business establishments. Surveys conducted in years ending in, 3, 5 and 8 are of the total number of business establishments, and surveys in other years are of business establishments and similar entities with at least four workers. Analyses based on these statistics are therefore only of business establishments with four or more workers. In this report, the data on business establishments in each year are concatenated for analysis. It is important to remember, however, that if a business establishment has three workers one year and four the next, it is treated as a new entry in that year. (Conversely, a business establishment that goes from having four workers to three will be treated as having exited.) (2) METI, Census of Commerce This survey provides statistics on numbers of business establishments. (3) Ministry of Finance (MOF), Financial Statements Statistics of Corporations by Industry, Annually and Financial Statements Statistics of Corporations by Industry, Quarterly As these statistics do not include sole proprietorships, they do not reveal overall trends among small enterprises. In consideration of the sample sizes and response rates, moreover, the results concerning small corporations need to be viewed with some latitude. It must also be remembered that the quarterly version does not include corporations with capital stock of less than 1 million. (4) Ministry of Internal Affairs and Communications (MIC), Establishment and Enterprise Census of Japan This census contains statistics on both business establishments and enterprises. In this report, analyses using these statistics based on enterprises also include sole proprietors (sole proprietorships). However, as statistics on sole proprietorships cannot be compiled by the nayose method of aggregating establishments that belong to the same company, the size of sole proprietorships is determined based on the number of workers at its head office or principal place of business. For example, a manufacturing sole proprietorship with 1 workers at its head office and 3 workers at branch offices would therefore be treated as an SME. 4. This report includes analyses of the results of questionnaire surveys of SMEs and other respondents conducted by the ix

11 Small and Medium Enterprise Agency (SME Agency). However, as not all enterprises surveyed responded and the response rate appears to be higher the healthier a company is, the results probably paint a better picture than the reality. In addition, totals cited based on the results of these surveys do not always sum to 1% due to rounding to the first decimal place. 5. There are two problems with trying to determine the general situation in the SME sector using only mean values from statistical data on SMEs. These are as follows: (1) Unlike large enterprises, SMEs exhibit considerable variation. Mean values are not therefore always representative of the typical SME. (2) Statistical data on SMEs may not be distributed symmetrically around the mean, but instead skewed leftwards. In this report, therefore, median, top 25th percentile (first quartile) and bottom 25th percentile (third quartile) as well as mean values are used where necessary to provide a better picture of the typical SME. 6. The universities and institutes of the researchers whose findings (both on Japan and overseas) are cited in this report are those to which the researchers belonged when the results were published. 7. The word significant is used in this report to denote a figure considered to be sufficiently meaningful using statistical techniques. The smaller the percentage, the greater the degree of certainty. x

12 Part I Trends among SMEs in fiscal 26 The recovery of the Japanese economy continued in fiscal 26. The present recovery phase had already surpassed the Izanagi boom (from 1965 to 197) and lasted 58 months as of November 26. 1) Meanwhile, the extent of economic recovery varies somewhat according to region and size of enterprise, and the economic recovery is not necessarily felt by many small and medium enterprises (SMEs). In Part I, we outline business trends among SMEs in fiscal 26 and then analyze various trends, including trends in enterprise entries and exits, which are in a sense the barometer of economic dynamism. We also assess the trends in small enterprises; the aging of small enterprise managers has been pronounced in recent years and many have gone out of business. In Chapter 1, we show that the extent of recovery of the employment index and business confidence varies between regions in the course of the recovery of the Japanese economy and that regional differences in industry location are behind this variation. In addition, we sort out the present circumstances behind why the recovery is not being felt by SMEs in comparison to large enterprises. We show that possible factors may be the fact that the benefits of a growth in exports which fuel economic recovery and an increase in capital investment do not easily reach SMEs and that it is difficult for SMEs to increase sales and profits by passing on price increases to the consumer. In Chapter 2, we make analyses around enterprise entries and exits. A point that is singled out as a problem in Japan is that of the entry rate falling below the exit rate. This white paper calculates entry and exit rates, including portions which were hard to capture by traditional statistics due to the effects of various factors such as Internet startups. We also consider the effects of enterprise entries and exits on such aspects as employment. Bearing in mind that many SMEs are currently exiting without being able to conduct smooth business successions, we also discuss where we should be aiming to ensure smooth business successions. What cannot be ignored when discussing enterprise entries and exits are the trends in small enterprises, which have been declining by a large margin. We present an overview of small enterprises, including their enthusiasm toward their business and business climate. In this analysis, variation between regions and variation according to size of enterprise will be the keywords in showing what SMEs are like today. Part II analyzes how SMEs will tackle the variation between regions, centering on local resources, local retail and service industries, and local finance. Part III focuses on the variation according to the size of the enterprise. Placed in a tougher situation than large enterprises, we reveal how SMEs will overcome the large structural changes in the Japanese economy. 1) This period represents the recovery period that was determined by the Monthly Economic Report and is not an official government figure for the period of economic expansion. To confirm the precise period of economic expansion, it is necessary to have the Reference Dates of Business Cycle established by the Working Group of Indexes of Business Conditions organized by the Economic and Social Research Institute of the Cabinet Office.

13 Part I Trends among SMEs in fiscal 26 Chapter 1 Trends among SMEs Section 1 The Japanese economy in fiscal 26 The Japanese economy entered a recovery after reaching a trough in the first quarter of 22, and the gradual improvement in business conditions continued in fiscal 26. The present recovery was initially fueled by growth in exports on the back of overseas business expansion. Subsequently, the recovery leveled off in the second half of fiscal 22 due to a slowdown in export growth. Since then, however, corporate earnings have grown substantially and capital investment has increased gradually while exports recovered. Consumption and capital investment have continued strong since fiscal 25, while on the other hand the rise in crude oil prices was one of the factors that depressed corporate earnings. Since the start of fiscal 26, consumption growth slowed down, while the rise in crude oil prices receded and exports continued to expand favorably on account of the yen s depreciation. Under these conditions, the recovery period exceeded the longest postwar period of economic expansion - the Izanagi boom - during the period of business expansion in November 26 (Fig ). 1. Characteristics of the present recovery phase Next, we compare the characteristics of the present recovery with the Izanagi boom (October July 197) and bubble boom (November February 1991) as well as the two recovery phases in the 199s (October May 1997, January November 2). Specifically, we compare the length of recovery period, strength of resilience, and the extent of the contributions of the components of final demand to recovery. The first characteristic of the present recovery phase is the length of the recovery period. Using data from The Reference Dates of Business Cycle produced by the Cabinet Office, let us then examine the length of the present recovery. The present recovery phase, counting from the trough in January 22, had lasted 58 months as of November 26, and exceeded the 57 months of the Fig Business cycles of the Japanese economy The recovery period exceeds the Izanagi boom and is the longest of the postwar period 1st cycle 2nd cycle 3rd cycle 4th cycle 5th cycle 6th cycle 7th cycle 8th cycle 9th cycle 1th cycle 11th cycle 12th cycle 13th cycle 14th cycle Average Trough Peak Trough Oct Nov Jun Oct Oct Dec Mar Oct Feb Nov Oct Jan Jan. 22 Jun Jan Jun Dec Oct Jul. 197 Nov Jan Feb. 198 Jun Feb May 1997 Nov. 2 Length in months Expansion Contraction Total cycle Oct Nov Jun Oct Oct Dec Mar Oct Feb Nov Oct Jan Jan (As of Nov. 26) Source: Created by the Small and Medium Enterprise Agency (SME Agency) based on Cabinet Office, The Reference Dates of Business Cycle. Fig Trends in real GDP Gradual improvement in business conditions continues as a whole ( 1 trillion) %/year 2.3%/year 2.1%/year I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV (Year/quarter) Source: Cabinet Office, Annual Report on National Accounts. 2

14 Chapter 1 Trends among SMEs Izanagi boom, which was the longest postwar period of economic expansion. A long-term recovery has continued unlike the last recovery, when the economy began to contract on account of the continuous strong results of overseas economies and downturn in global IT demand (Fig ). Secondly, not only is the increase in real economic growth rate not high compared with past recovery phases, but the nominal economic growth rate is also low as a result of the gradual deflation which continued until mid-26. Meanwhile, a comparison of real economic growth rates also shows that the present recovery is gradual compared with past recoveries. The annual average rate of real economic growth during the present recovery remains at 2.1%. This naturally falls below the annual Fig Real economic growth rate and nominal economic growth rate during past major recovery phases The effects of deflation are lasting: Resilience is low and nominal economic growth rate is lower than real economic growth rate compared with Izanagi boom Real economic growth rate (annual average) Izanagi boom (October 1965 July 197) 11.5 average growth rates during the Izanagi boom and the bubble boom, and slightly below the annual average growth rates of 2.4% and 2.3% during the two recovery periods in the 199s (Fig ). Thirdly, the economic recovery is underpinned by exports and private non-residential investment. The following four graphs show the extent of contributions (annual average) of the components of final demand in the present recovery period (Fig ). We see that private non-residential investment and exports make large positive contributions compared with private final consumption and public demand. It can be said that the increase in exports on the back of robust overseas economies and dynamic private non-residential investment are fueling the entire economic recovery amid the decline in public works projects and slowdown in consumption since the 199s. The graphs show that the extent of contributions of exports is particularly pronounced compared with past recovery phases and that the present recovery depends unduly on exports. Fig [1] Extent of contribution of private non-residential investment to real GDP during past major recovery phases (annual average) Capital investment continues to fuel recovery Bubble boom (November 1986 February 1991) 5.4 Izanagi boom (October 1965 July 197) 2.84 Second to last boom (October 1993 May 1997) 2.4 Bubble boom (November 1986 February 1991) 2.3 Last boom (January 1999 November 2) 2.3 Second to last boom (October 1993 May 1997).97 Present boom (January 22 ) 2.1 Last boom (January 1999 November 2) Present boom (January 22 ).87 Nominal economic growth rate (annual average) Source: Cabinet Office, Annual Report on National Accounts. Izanagi boom (October 1965 July 197) 18.4 Bubble boom (November 1986 February 1991) 7.3 Second to last boom (October 1993 May 1997) 2.2 Last boom (January 1999 November 2).6 Present boom (January 22 ).9 Source: Cabinet Office, Annual Report on National Accounts. 3

15 Part I Trends among SMEs in fiscal 26 Fig [2] Extent of contribution of exports to real GDP during past major recovery phases (annual average) The extent of contribution of exports in the present recovery is high compared with past recovery phases Fig [4] Extent of contribution of private final consumption to real GDP during past major recovery phases (annual average) Extent of contribution of consumption is small compared with Izanagi boom and bubble boom Izanagi boom (October 1965 July 197) -.24 Izanagi boom (October 1965 July 197) 5.83 Bubble boom (November 1986 February 1991) -.23 Bubble boom (November 1986 February 1991) 2.43 Second to last boom (October 1993 May 1997).5 Second to last boom (October 1993 May 1997).9 Last boom (January 1999 November 2) -.4 Last boom (January 1999 November 2).55 Source: Present boom (January 22 ) Cabinet Office, Annual Report on National Accounts. Source: Present boom (January 22 ) Cabinet Office, Annual Report on National Accounts. Fig [3] Extent of contribution of public demand to real GDP during past major recovery phases (annual average) Public demand starts to play a smaller role in recovery with public investment decreasing since 199s Source: Izanagi boom (October 1965 July 197) Bubble boom (November 1986 February 1991) Second to last boom (October 1993 May 1997) Last boom (January 1999 November 2) Present boom (January 22 ) Cabinet Office, Annual Report on National Accounts. 2. Strong corporate performance and weak household sector The trends that are fueling the recovery are the significant earnings recovery of the corporate sector (especially enterprises that increased profit through growth in exports) and the accompanying upturn in business confidence. Using data from Financial Statements Statistics of Corporations by Industry, Quarterly produced by the Ministry of Finance (MOF), let us examine the ratio of ordinary profit to sales of all enterprises. The ratio of ordinary profit to sales, which had been below 2.5% in the initial stage of the present recovery, is now nearly 4%. Such improvements in the profit margin are behind the improvement in the business confidence of enterprises (Fig ). Furthermore, let us examine the business confidence of all enterprises using the Bank of Japan s (BOJ) National Short-Term Economic Survey of Enterprises in Japan (known for short as Tankan). The business conditions DI had fallen below -4 points in the first quarter of 22, or the trough in the business cycle following the collapse of the IT bubble. On the back of strong business performance, however, the business conditions DI turned positive in 25 and is close to reaching +1 points according to the most recent data (Fig ). In contrast with the strong corporate sector, the numbers are not as impressive for the salary or income and consumption index of the household sector. According to the Ministry of Health, Labour and Welfare s (MHLW) Monthly Labour Survey, the 4

16 Chapter 1 Trends among SMEs downward trend in per capita wages throughout the recovery since fiscal 22 is at last starting to level off. If we look at only 26, we find that there is little growth in per capita wages 2) (Fig ). In addition, we see that consumption growth has been slowing down recently against the backdrop of the stagnating salary growth and other factors (Fig ). Fig Trends in ratio of ordinary profit tosales and business conditions DI (all sizes, all industries) The corporate sector that is fueling the present recovery has made a significant improvement Ratio of ordinary profit to net sales (right scale) Business conditions DI (left scale) Fig Trends in total amount of per capita cash salary While salary has recovered to a certain extent, its increase has slowed down recently (Change from previous year) (Year/month) Source: Calculated from Ministry of Health, Labour and Welfare, Monthly Labour Survey. Note: The survey covers approximately 33, businesses with 5 or more regular employees I II III IV I II III IV I II III IV I II III IV I II III IV (Year/quarter) Sources: Ministry of Finance (MOF), Financial Statements Statistics of Corporations by Industry, Quarterly; Bank of Japan (BOJ), National Short-Term Economic Survey of Enterprises in Japan. Notes: 1. The Financial Statements Statistics of Corporations by Industry, Quarterly survey covers approximately 2, corporations with 1 million or more in capital. 2. The BOJ s National Short-Term Economic Survey of Enterprises in Japan covers approximately 1, enterprises with 2 million or more in capital. 3. Ratio of ordinary profit to sales is the moving average for the past four quarters Fig Trends in private consumption integrated estimates Consumption also lags recently with slowdown in salary increase (Year 2 = 1) January January January January January January July July July July July (Year/month) Source: Cabinet Office, Private Consumption Integrated estimates. 2) Please note that wages here include not only full-time employment, but also non full-time employment such as part-time employment. 5

17 Part I Trends among SMEs in fiscal 26 Section 2 Variation between regions and variation between industries in economic recovery The previous section showed that: the Japanese economy continues to make a gradual but long-term recovery; private non-residential investment and exports are fueling the present recovery; and the household sector is struggling to grow while strong performance is being maintained by the corporate sector centering on large enterprises. In the present recovery phase, the point that should be kept in mind is that various indexes have variations between regions, such as indexes for employment and the business confidence of enterprises. First, let us examine the trends in employment indices (Fig ). The figure below represents the trends in the active opening rate provided by MHLW s Report on Employment Service and the official rate of unemployment provided by the Ministry of Internal Affairs and Communications (MIC) Labor Force Survey. It shows, for example, a marked decrease in the ratio of unemployed in labour force from 5.2% (January 22) to 4.% (January 27) and over a twofold increase in the active opening rate (representing the number of job offers per job seeker) from.51 in January 22 to 1.6 in January 27. Overall, employment indices have improved significantly. Fig Trends in active opening rate and ratio of unemployed in labor force (times) Employment indices have improved significantly during the present recovery Active opening rate (left scale) Ratio of unemployed in labor force (right scale) 6..5 January January January January January 3. January July July July July July (Year/month) Sources: Ministry of Internal Affairs and Communications (MIC), Labor Force Survey; MHLW, Report on Employment Service The employment indices are not, however, improving uniformly across the nation. For instance, the active opening rate broken down by region shows that while the ratio of job offers to applicants continues to increase mainly in the Kanto, Chubu, Kinki, and Chugoku regions, the increase has remained relatively small in regions such as Hokkaido, Tohoku, and Shikoku regions. Thus, the recovery situation varies by region (Fig [1]). In addition, while the ratio of unemployed in labour force improved in all regions compared with 22, a look at more recent figures for 26 reveals that the ratio of unemployed in labour force in the Hokkaido, Tohoku, and Kyushu regions is still close to 5.%, whereas the ratio of unemployed in labour force in the Tokai and Hokuriku regions decreased to 3.% and 3.4%, respectively. According to the BOJ s Tankan data for business conditions DI, there are also regional variations in business confidence (Fig [2]). The Kanto, Chubu, and Kinki regions have high business conditions DI, and the Hokkaido, Tohoku, and Shikoku regions have lower business conditions DI. This section studies how the variations in employment and business confidence between regions relate with the industry structure and demand in each region. 1. Industry structural differences between regions Let us examine the industry structure by region. The following two maps of Japan show the value-added percentages of the construction and manufacturing industries of total production by prefecture as of fiscal 22 according to the Cabinet Office s Report on Prefectural Accounts (Fig [1]). We can see from Fig [1] that the construction industry s value-added percentage of total production is high in the Hokkaido, Tohoku, Shikoku, and Kyushu regions while relatively low in the Kanto, Chubu, Kinki, and Chugoku regions. Furthermore, the manufacturing industry s value-added percentage of total production is high in the Kanto region, mainly in Chubu, as well as the Chugoku region, and relatively low in the Hokkaido, Tohoku, Shikoku, and Kyushu regions. Next, we compare the state of the construction and mining and manufacturing industries nationwide activities as of the first quarter in 22 and fourth quarter in 26. According to the Ministry of Economy, Trade and Industry (METI) s Indices of All Industry Activity, the mining and manufacturing industries turned upwards with the fourth quarter in 21 as the turning point. On 6

18 Chapter 1 Trends among SMEs Fig [1] Changes in the active opening rate Regional variations are apparent in the marked improvement of employment indices (January 22) (January 27) Source: MHLW, Report on Employment Service. Fig [2] Business conditions DI by region (December 26) Business confidence, like the active opening rate, also has variations Source: BOJ, National Short-Term Economic Survey of Enterprises in Japan. the other hand, the construction industry s activity indices have continued to decline during the present recovery. It appears that these differences in the state of activities between industries are, through regional differences in industry structure, giving rise to differences in employment and business confidence (Fig [1]). 3) Furthermore, let us examine the regional differences in industry structure in the manufacturing industry based on the weighted percentages used in the METI s Industrial Production Index in Fig [2]. We see that the percentage of livelihood-related industries, 4) such as the textiles and foods and tobacco industries that make up the region s manufacturing industry, is high in the Hokkaido, Tohoku, and Shikoku regions. We also see that the percentage of machinery-related industries, 5) such as general machinery, transport equipment, and electrical machinery, is markedly high in the Chubu region and low in the Hokkaido and Shikoku regions. 6) Let us then examine the difference in growth rates of the mining and manufacturing industries by industry. According to the Industrial Production Index, general machinery, transport equipment, and electrical machinery have been expanding since the trough of the 3) A comparison between 22 and 25 shows that the Industrial Production Index increased in nearly all regions. Output decreased in all regions in the Integrated Statistics on Construction Work as well, which is used to calculate the Indices of Construction Industry Activity. 4) Livelihood-related industries refer to the textiles, foods and tobacco, ceramics, stone and clay products, and pulp and paper and paper products industries. 5) Machinery-related industries refer to iron and steel, non-ferrous metal, general machinery, transport equipment, electrical machinery, information and communication electronics equipment, and electronic parts and devices. 6) According to a breakdown by region, machinery-related industries have increased production in nearly all regions since the trough of the business cycle, while on the other hand livelihood-related industries have decreased production in nearly all regions (See Appended note 1-15). 7

19 Part I Trends among SMEs in fiscal 26 Fig [1] Value-added percentages of manufacturing and construction industries by prefecture (22) and trends in activity indices by industry For example, the improvement in employment indices remains relatively small in regions that depend on the construction industry,while progress is being made in regions that depend on the manufacturing industry Manufacturing industry (22) Manufacturing industry Value-added percentage Construction industry (22) Construction industry Value-added percentage Trends in activity indices by industry Mining and manufacturing industries Construction industry 11 (Year 2 = 1) I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV (Year/quarter) Sources: Cabinet Office, Report on Prefectural Accounts; Ministry of Economy, Trade and Industry (METI), Indices of All Industry Activity. Note: Indices of All Industry Activity is a composite index of all industries business indicators. It is composed of various indices, such as the Index of Industrial Production (2%), Indices of Tertiary Industry Activity (6%), and Indices of Construction Industry Activity (7%). 8

20 Chapter 1 Trends among SMEs Fig [2] Production weighted percentages of machinery-related industries and livelihood-related industries by prefecture (2) and trends in index of industrial production by industry For example, the improvement in employment indices remains relatively small in regions where livelihood-related industries are concentrated, while progress is being made in regions where machinery-related industries are concentrated Machinery-related industries (2) Weighted percentage of machinery-related industries Livelihood-related industries (2) Weighted percentage of livelihood-related industries Notes: 1. Machinery-related industries refer to iron and steel, non-ferrous metal, general machinery, transport equipment, electrical machinery, information and communication electronics equipment, and electronic parts and devices. 2. Livelihood-related industries refer to the textiles, foods and tobacco, ceramics, clay and stone products, and pulp, paper and paper products. Trends in the industrial production index by industry Transport equipment Foods and tobacco General machinery Ceramics, clay and stone products Electrical machinery Textiles 14 (Year 2 = 1) I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV (Year/quarter) Source: METI, Indices of Industrial Production. 9

21 Part I Trends among SMEs in fiscal 26 Fig Trends in index of industrial production by region Regional variations in production expanding in reflection of industry composition Hokkaido Tohoku Kanto Chubu Kinki Chugoku Shikoku Kyushu 14 (Year 2 = 1) I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV (Year/quarter) Source: METI, Indices of Industrial Production. business cycle; while on the other hand, textiles, ceramics, stone and clay products, and foods and tobacco have been on a gradual downward trend. It appears that regional differences in the manufacturing industry s production trends emerge through the differences in production growth by industry. In the Hokkaido, Tohoku, and Shikoku regions where livelihood-related industries have a relatively large percentage, the overall growth of the mining and manufacturing industries is small. Meanwhile, there is a marked production increase in the Chubu region where many machinery-related industries are located, including general machinery, transport equipment, and electrical machinery. It appears that these production trends also influence the regional variations in employment and business confidence (Fig ). 2. Variation in demand between regions The previous paragraph showed that in regions where machinery-related industries are concentrated, such as general machinery, transport equipment, and electrical machinery, employment and business confidence improved by a greater margin relative to regions that depend on the construction industry or livelihood-related industries. Along with these variations between regions, there also are variations in demand. In particular, private non-residential investment and private residential investment differ between robust regions such as the Chubu region and stagnating regions such as the Tohoku region. Using data from Report on Prefectural Accounts produced by the Cabinet Office, let us study the regional variations in each demand item. Specifically, we examine the trends in the variation coefficient 7) of private final consumption, private non-residential investment, private residential investment, and public investment according to gross prefectural expenditure (real terms). We see that behind the high degree of variations in private nonresidential investment and private residential investment compared with private final consumption, there is little regional variation in public investment (Fig ). First, if we look at the growth rate of private nonresidential investment from fiscal 22 by region, we find that in the Kanto, Chubu, Chugoku, and Kyushu regions the growth rate exceeds the national average. Meanwhile, the growth rate decreased in Hokkaido and the growth margin became relatively smaller in the Tohoku and Shikoku regions (Fig ). Furthermore, for fiscal 24 and beyond, which cannot be assessed from the Report on Prefectural Accounts, private nonresidential investment in fiscal 25 increased in the Kanto, Tokai, Kansai, Chugoku, Shikoku and Kyushu regions compared with fiscal 22 while it decreased in the Hokkaido, Tohoku, and Okinawa regions, according to the Development Bank of Japan s (DBJ) Survey on Planned Capital Spending by Region (Fig ). 8) With regard to private residential investment, the 7) This index divided the standard deviation with the simple average and represents the extent of variations. 8) The DBJ s Survey on Planned Capital Spending by Region covers enterprises with 1 million or more in capital. Please note that the data may not necessarily represent the capital investment trends for the entire region. 1

22 Chapter 1 Trends among SMEs Fig Trends in variation coefficient by region for each final demand item Variations in private-sector capital investment and private-sector housing investment are also observed for final demand items Private-sector housing investment Private-sector final consumption Private-sector capital investment Public fixed capital formation Source: Cabinet Office, Prefectural Accounts (FY) Fig Percentage change in private-sector capital investment by region (percentage change in fiscal 24 based on fiscal 22) Private-sector capital investment decreased in Hokkaido and growth margin became relatively smaller in Tohoku and Shikoku regions Fig Percentage change in private-sector capital investment by region (percentage change in fiscal 25 based on fiscal 22) More recently, private-sector capital investment decreased in Hokkaido, Tohoku and Okinawa Hokkaido Tohoku Kanto Chubu Kinki Chugoku Shikoku Kyushu Source: Cabinet Office, Prefectural Accounts. Total Hokkaido Tohoku Northern Kanto and Koshin Tokyo metropolitan area Tokai Hokuriku Source: Development Bank of Japan (DBJ), Survery on Planned Capital Spending by Region. Note: The survey in principle covered approximately 8,2 private-sector corporations with 1 million or more in capital. Kansai Chugoku Shikoku Kyushu Okinawa 11

23 Part I Trends among SMEs in fiscal 26 Fig Percentage change in private-sector housing investment by region (percentage change in fiscal 24 based on fiscal 22) Private-sector housing investment decreased in Hokkaido, Tohoku, Kinki, Shikoku, and Kyushu Fig Percentage change in number of new housing starts by region (percentage change in 26 based on 22) Housing starts decreased in Tohoku and Shikoku Hokkaido Tohoku Kanto Chubu Kinki Chugoku Shikoku Source: Cabinet Office, Prefectural Accounts. Kyushu -5-1 Hokkaido Tohoku Kanto Chubu Kinki Source: Ministry of Land, Infrastructure and Transport (MLIT), Statistical Survey of Construction Starts. Chugoku Shikoku Kyushu Okinawa Fig Percentage change in contract amount for public works projects by region (percentage change in 26 based on 22) Contract amount for public works projects fell below national average in Hokkaido, Tohoku, Chubu, Kinki, and Shikoku Hokkaido Tohoku Kanto Chubu Sources: Hokkaido Construction Surety Co., Ltd., East Japan Construction Surety Co., Ltd., West Japan Construction Surety Co., Ltd., Public Works Contract Value. Kinki Chugoku Shikoku Kyushu Okinawa percentage decreased in the Hokkaido, Tohoku, Kinki, Shikoku, and Kyushu regions compared with fiscal 22 against the very small margin of increase in the entire housing construction demand (Fig ). According to the number of new housing starts in the Ministry of Land, Infrastructure and Transport s (MLIT) Statistical Survey of Construction Starts, the number has decreased in the Tohoku and Shikoku regions in terms of the housing investment from fiscal 24 and beyond (Fig ). In comparison with private non-residential investment and private residential investment whose variations trend at high levels, public investment is believed to have a function of leveling the variations in demand between regions in the private sector by allocating investment to meet private-sector demand. Fig also shows that the variation coefficient of public investment amount is lower than other demand items. With the recent cutbacks in public investment, however, public investment has less of a function in leveling the variations between regions overall. If we look at the trend in public investment, we see that public investment decreased in the Hokkaido, Tohoku, Chubu, Kinki, and Shikoku regions by a greater margin than in the rest of Japan (Fig ). While local economies have recently begun to show some promising signs on the whole, such as an improvement in the active opening rate and robust capital investment in many regions, the situation in each region has variations. This is attributed to the differences 12

24 Chapter 1 Trends among SMEs in industry composition between regions, such as the percentage of manufacturing and constructions industries or the concentration of machinery-related industries and livelihood-related industries, among other factors. In addition, with cutbacks in all investment amounts, public investment, which is believed to have been leveling the variations between regions, now has less of a function in leveling the variations between regions in the context of private-sector demand. Section 3 Business conditions among SMEs As we have already observed, the Japanese economy has been experiencing the longest recovery in the postwar years, while the extent of recovery varies between regions due to regional differences in industry composition and demand. Similarly, as with the variations between regions, the extent of recovery of business confidence varies according to the size of the enterprise. Section 3 sorts out the recent trends in SMEs business confidence, profit ratios, bankruptcies, finances, and capital investments, including comparisons with large enterprises. At the same time, we examine the circumstances behind the variations between SMEs and large enterprises. 1. The environment surrounding SMEs (1) Business confidence According to the BOJ s Tankan, the business conditions DI for SMEs has improved since bottoming out in the first quarter of 22, with manufacturing leading the way. Nevertheless, the gap between the business conditions DI of SMEs and large enterprises has tended to widen throughout the present business expansion (Fig ). Furthermore, the Survey on SME Business Conditions 9) conducted by the SME Agency and the Organization for Small and Medium Enterprises and Regional Innovation, Japan (SMRJ), which polled 19, SMEs, including enterprises with capital of less than 2 million that were not polled in the Tankan, gave a clearer indication of the lag in recovery of all SMEs, including small enterprises. The enterprises which said that their business conditions DI worsened not only outnumber the enterprises which said improved, but a break is also seen in the improvement of the business conditions DI. Furthermore, the business conditions DI of small Fig Trends in business conditions DI by size and industry While business conditions are improving modestly for SMEs following manufacturing s lead, gap with large enterprises is gradually widening Large enterprises Small and medium manufacturers All small and medium enterprises Small and medium non-manufacturers 3 (% change from a year earlier) I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV (Year/quarter) Source: BOJ, National Short-Term Economic Survey of Enterprises in Japan. 9) Small enterprises account for 8% of the study sample of the Survey on SME Business Conditions, and it includes smaller SMEs compared with the Tankan. 13