Japanese prime ministers tend to be gray, unimpressive placeholders who don’t last very long in office. But every once in a while, an important leader shows up who gets big things done and stays in office for a while — Koizumi Junichiro in the 2000s and Abe Shinzo in the 2010s were the two most recent examples.
It’s not always easy to tell who is going to be one of these when they come into office — Abe himself even had a short, unimpressive first term in the 2000s before he came back in 2012 and changed Japan utterly.
There’s a lot of hope that Takaichi Sanae, who just became prime minister, will be one of the transformative ones. She’s modern Japan’s first female leader, which may have contributed to her very high popularity, especially among young people. She’s also a tough-minded conservative, famous for her hawkish views on defense and on China.[1]
And in a party known for gray leaders who blend into the background, she stands out as a colorful individual, with her history as a biker and a heavy metal drummer (in fact, she still drums for fun).
Most coverage of Takaichi so far has focused on her personality, on boundary-breaking or on her relationship with Donald Trump. Indeed, Takaichi seems to have charmed Trump on his first trip there:
President Donald Trump hailed the US’s alliance with Japan, reaffirming ties with a longstanding partner and praising new Prime Minister Sanae Takaichi on her plans to ratchet up defense spending as the pair met in Tokyo.
“I want to just let you know anytime you have any question, any doubt, anything you want, any favors you need, anything I can do to help Japan, we will be there,” Trump said. “We are an ally at the strongest level.”
But while maintaining good relations with the US is certainly a very important task, there are also lots of other economic problems that urgently confront the new Takaichi administration. The country’s living standards are stagnant, having fallen behind those of South Korea some time ago:
And in fact this is doubly important for Japan right now, because it’s being menaced by its much larger neighbor, even as American power in the region slowly fades. Even if Japan continues to rearm to defend itself against a potential Chinese threat, it will need an economy that’s capable of supporting that rearmament.
Fortunately, Japan is in an OK macroeconomic situation right now. Government debt, the country’s thorniest problem, is actually falling as a percent of GDP, thanks in part to higher inflation and in part to rising corporate profits and tax revenues:
Source: CEIC Data
The deflation problem that bedeviled Japan for decades has finally been defeated. And at the same time, unemployment in Japan remains very low:
This means that Takaichi and her cabinet don’t need to focus as much energy and attention on macroeconomics, as Abe did. There is no need for further stimulus, monetary or fiscal. Instead, Takaichi is free to concentrate on improving Japan’s underlying economic model, in order to promote productivity and growth.
So here are a few things I think the Takaichi Cabinet should try to tackle while they’re in power.
1. Get Japan, Inc. investing again
Japan’s economy actually has fairly robust investment levels as rich countries go. But compared to its East Asian rivals, Japan actually puts far less of its GDP into capital formation:
Source: World Bank
China is probably overdoing it on the investment, but there’s no reason to think Korea is; again and again, Korean companies like Samsung have managed to outcompete their Japanese rivals by plowing more money into the next generation of factory technologies. When you’re a manufacturing-intensive economy, as Japan still is, you’ve got to keep investment levels high in order to compete.
How does a country increase investment? You can basically try to increase capital demand and capital supply. Capital demand is how much companies want to invest; capital supply is how much banks want to lend.
Japan’s major problem with capital demand is the shrinking population. If the consumer market is going to be smaller every year, that’s a disincentive for companies to invest in the country, because it’ll mean fewer customers in the future.
Immigration can only do a little bit to help, in the quantitative sense, so the real thing Japan needs to do in order to increase capital demand is to become a more export-oriented economy. If Japan is a production base from which to produce things that foreigners buy, that’s a reason for companies to invest there.
Compared to other developed medium-sized economies, Japan exports very little, despite a recent surge connected to the weak yen:
Source: World Bank
Japan’s government needs to build on its recent progress and encourage its companies to export more — not just to a reluctant America, but to Europe, India, Southeast Asia, Latin America, and the Middle East. I’ll write more about Japanese export promotion later, but I’m sure the people at METI and the Ministry of Finance can think of some good ideas here.
As for capital supply, this really just means the financing system. Currently, big Japanese companies tend to sit on huge piles of cash, and use this for their investment needs, so prodding banks to lend more to these companies won’t accomplish much. Instead, banks need to lend more to smaller, growing companies looking to scale up their operations.
Japan’s early-stage startup ecosystem, including venture capital financing, is pretty robust. But the minute a Japanese company gets past the early stage, it finds itself in trouble, because it’s very hard to get the cash to grow from a medium-sized company to a big one. For hardware startups — which are crucial in a manufacturing-intensive economy like Japan’s — this is a “valley of death.”
In order to scale up, hardware companies (and AI companies) need bank loans. Equity financing is just too expensive, and bond markets are fickle; bank loans provide patient long-term financing. The government can also put its thumb on the scale, using “policy banks” like the Development Bank of Japan, the Japan Finance Corporation, the Japan Bank for International Cooperation, and so on.
It’s understandable that Japanese banks have become cautious and conservative after the go-go years of the 1980s ended in a giant crash, and a decade of zombie lending kept weak companies afloat. And letting more zombies fail is certainly important for freeing up financial and human resources for more productive uses.
But helping small companies scale up quickly is very different from the bad old practice of allowing weak old companies to stumble onward. If Japan accelerates growth, much of it is going to have to be bank-financed, and that’s going to require banks to have a greater appetite for risk.
2. Boost greenfield FDI
The final way to increase investment in Japan is to boost greenfield FDI. This is what my book, “Weeb Economy“, is about. Japanese people have become used to thinking of “FDI” as “foreigners buying Japanese companies in order to sell into the Japanese market.” This kind of transaction can be useful, but in general is of dubious value, so Japan has long resisted it.
But there’s a second kind of FDI — foreigners building factories, research centers, and offices in Japan in order to use Japan as a production base — that’s unambiguously positive. This is called “greenfield FDI”, because it’s basically like building something new in a green field.
Greenfield FDI is pretty magical. First of all, it increases demand for local workers, raising wages. It often results in more exports (“platform FDI”), because multinational companies tend to do multinational sales.
Greenfield investment will also help Japan attract the high-skilled immigrants it has had difficulty attracting, because foreign companies will hire some engineers and managers from overseas to help and teach the locals. And perhaps most importantly, greenfield FDI encourages technology transfer from abroad, rounding out a country’s technological capabilities.
Japan has traditionally had very little greenfield FDI. Its economy caught up back when supply chains were far less globalized, and capital was far less internationally mobile, so it never developed the institutional instincts for luring greenfield investment. But in recent decades, countries like Poland and Malaysia have attained developed-country status almost purely by courting FDI. The contrast here is stark:
Source: World Bank
I’m not saying Japan should become an FDI-first economy like Poland or Malaysia. Japan already has many strong, good domestic brands. But courting greenfield FDI would result in a “missing piece” being added to the Japanese economy — another source of investment, labor demand, technology, and exports on top of the existing substrate of domestic brands.
Now is the perfect time for Japan to make a big push for more greenfield FDI. Japan’s relatively efficient land use permitting, good infrastructure and cheap base of semiconductor engineers provide a powerful combination of incentives to invest. The weak yen won’t last forever, but it’s a tailwind right now.
Japan’s attractive culture and cities mean that foreigners from all over the world — and especially from Taiwan, South Korea and the United States — would like to live and work there if good jobs are available for them. And the geopolitical tensions and risks surrounding China mean that lots of companies are looking to diversify their operations out of that country; Japan can provide a natural alternative.
In fact, there are encouraging signs here. TSMC, the world’s dominant chip fabrication company, has built fabs in Japan’s Kumamoto Prefecture and is building more. Samsung is following suit. So Takaichi’s cabinet needs to make a big push to promote Japan as a destination for greenfield FDI, in order to capitalize on this moment.
3. Continue the transformation of corporate Japan
Japan’s corporate culture is widely recognized as a reason for its slow productivity growth since the 1990s. Traditional Japanese corporations had lifetime employment systems that promoted elderly managers who were unable to keep pace with changes in technology, globalization, and business models, while also keeping technology bottled up within companies and preventing it from circulating.
Japanese white-collar management focused on encouraging longer work hours rather than rapid task completion or individual initiative, leading to unproductive time use and keeping women out of management. And domination of corporate boards by managers instead of shareholders weakened the profit motive.
Under Abe and his successors, Japan’s government has worked to transform this system, with much success. Profitability at Japanese companies has improved greatly, leading to increased corporate tax revenue:
Source: GMO
Meanwhile, the Japanese labor market is becoming more flexible, thanks to a boom in mid-career hiring:
The share of Japanese companies that either hired or were in the process of hiring midcareer employees from October 2023 through March 2024 was 79.5%, according to a survey conducted by the Recruit Works Institute. This is an increase of nearly 20 percentage points from the same period 10 years ago, when the figure stood at 59.9%, suggesting that midcareer recruitment has become significantly more common over the past decade.
This is partly due to intentional government policy, and partly to a dearth of new graduates.
Meanwhile, more Japanese companies are embracing flextime working arrangements. This will naturally encourage a more results-oriented office culture, since the incentive will be to produce verifiable results instead of simply being seen to put in long hours at a desk.
These changes — along with government policy — are helping to promote more women in management at Japanese companies. Women in management are at a low level in global terms, but the percentage has been rising steadily in recent years:
Source: Nippon.com
Progress is being made, but there is still much to do. The government needs to continue pushing companies to do more mid-career hiring, to promote more women, and to allow employees to take some of their work home with them.
In addition, the government should push companies to reduce seniority-based promotion. In an aged country like Japan, there is a natural tendency for the ranks of upper management to get clogged with old people, simply because there are more of them — and fewer young people — fighting for promotions.
But companies often need young managers and executives in order to capitalize on new technologies, business models, and markets. The government should fight against the tide of aging by encouraging companies to promote more managers and executives based on initiative, performance, and potential, rather than seniority.
Finally, although profitability is important, the government should take care that it doesn’t push Japanese companies into a paralyzing short-termism. The focus should be on multi-year profitability, not on quarterly earnings.
4. Build a better defense industry
Takaichi is a well-known hawk on defense issues. Her extremely high popularity thus indicates that the Japanese people understand the necessity to rearm in the face of the overwhelming Chinese threat, and are prepared to put aside their long-standing distrust of the military.
Rearming Japan will require big economic shifts. Currently, too much defense production is done by a handful of big companies like Mitsubishi Heavy Industries. This is similar to America, where the concentration of defense procurement in the hands of a few “prime” contractors has raised alarms. Lots of people in America have been thinking about how to fix defense procurement, and Japan’s leaders should learn from these ideas.
But rearmament also gives Japan a golden opportunity to boost the country’s R&D capabilities and overall level of technology. Traditionally, the US has done a very large percentage of its research spending through the Department of Defense:
Source: Noah Smith
Research by Moretti, Steinwender, and Van Reenen (2019) shows that this defense research doesn’t crowd out private-sector research; it actually crowds it in.
[W]e uncover evidence of “crowding in” rather than “crowding out,” as increases in government-funded R&D for an industry or a firm result in significant increases in private sector R&D in that industry or firm. On average, a 10% increase in government-financed R&D generates a 5% to 6% additional increase in privately funded R&D…Finally, we find that increases in private R&D induced by increases in defense R&D result in productivity gains.
Many key inventions and innovations — the internet, GPS, and so on — famously came out of US defense research, giving America a head start on commercializing those technologies. A host of smaller, incremental innovations is less heralded, but also important.
As a small nation that can’t match China’s total productive capacity, Japan will need to rely on cutting-edge technology to maintain an effective deterrent against its much larger neighbor. It will need better drones, better AI, better hypersonic missiles, and so on. Defense research is crucial for all of that. But at the same time, defense research will spill over and boost the civilian economy.
5. Bring down electricity prices
Japan’s industrial electricity prices are lower than Europe’s, but higher than those in most of the world. In particular, they’re higher than South Korea or China:
Source: GlobalPetrolPrices.com
Japan has very few fossil fuel supplies, and will always be at the whim of a capricious global market when it comes to imports. Imports of LNG, coal, and oil will also always be vulnerable to cutoff by China’s navy in the event of a war. Japan should therefore focus as much as possible on energy sources it can produce at home — solar and nuclear. Currently, Japan doesn’t use much of these, so there’s plenty of room to grow them:
Source: EIA
Japan has been slow to restart its nuclear reactors after the Fukushima disaster fourteen years ago. Only around half of the existing 33 reactors have come back online or will soon, thanks to cumbersome approval processes:
Source: EIA
Accelerating the restart of all of the reactors should be a priority. Nuclear power can be a sensitive cultural issue in Japan, but the fact that the public hasn’t punished the ruling Liberal Democratic Party for restarting 17 out of 33 reactors suggests that the backlash to Fukushima is fading, and it’s politically safe to restart the rest.
Building solar is hard in Japan because of a lack of land — the whole country is about the same size as California, and has more than three times as many people. The government is trying to accelerate solar deployment, including innovative workarounds like panels over agricultural fields and on top of buildings. Those are good efforts, and should continue.
Solar needs batteries in order not to be intermittent. Japan used to be the world leader in lithium-ion battery production, but China has taken over the market. Continuing efforts to free Japan from China’s rare-earth supply chain, as well as industrial policies to promote the use and manufacture of batteries, should be made a priority.
6. Train more software engineers
Japan’s software industry is incredibly weak. This forces it to rely on expensive software imports, creating a huge “digital deficit”:
Japan is mired in a digital services trade deficit, with the red ink reaching 3.48 trillion yen ($23.6 billion) in the first half of 2025, reflecting the country’s reliance on overseas tech giants…The digital balance consists of three categories within the services account: telecommunication, computer and information services, like cloud services; specialized and management consulting services, which includes online advertising; and royalties and license fees for content like videos and music streaming…The January-to-June digital deficit…was the second highest on record. It was 2.6 times larger than in 2015.
Japan’s weakness in software is also hurting its manufacturing, as production processes become more digitized and AI promises to revolutionize the factory floor.
Why is Japan so bad at software? The most likely reason is that it simply lacks the one key input into creating good software: trained software engineers. In Japan, software traditionally isn’t a very prestigious career path; smart young people tend to go into hardware engineering, leaving software starved of talent. Various regulations are also problematic, and need to be fixed, but these are probably secondary to the deficiency of raw talent.
Fortunately, thanks to AI, this may be a more surmountable problem. AI boosts the capabilities of weaker software engineers, allowing even mediocre performers to create functional code. This may make the training gap easier to bridge.
AI will also help with translation, solving the problem of a lot of foreign code being documented in English. Japanese educational institutions should take the lead in teaching software engineers how to code natively with AI.
But even with AI, Japan is going to have to work to make coding a more prestigious profession. One solution might be to have government ministries hire more people trained in software. Another idea is to leverage the defense buildup and have the Japanese military establish elite AI and cryptography units.
Creating those plum jobs will lure talented Japanese youngsters into studying software in order to get in; the ones who don’t quite make the cut, or who do those jobs and then quit, will fuel the rise of a better software industry.
Anyway, those are the sketches of six basic ideas for the Takaichi cabinet to restore Japan’s economic growth and technological might. These won’t solve all of Japan’s problems — low fertility, trade tensions, and resource shortages will all still be huge issues. But they’re a start.
Notes:
1 The role of the military in Japanese society is the country’s most important political cleavage, by far — think of it as all of America’s culture wars rolled into one. This is a legacy of the 1930s, when the military took over Japan’s society, destroyed democracy and pluralism, implemented a nightmarish repressive state, and plunged the country into a foolish war that devastated it. But, of course, the military is also a pragmatic issue.
This article was first published on Noah Smith’s Noahpinion Substack and is republished with kind permission. Become a Noahopinion subscriber here.
