Upheavals in economy and food security

Japan Today | 23 September 2008

By Terrie Lloyd

The news this last week has been dominated by two strong alternating images which really speak to the realignment of world business and power. The first was of course the near meltdown of the U.S. economic system, with the collapse of Lehman Brothers, the rescue of AIG, and the buy-out of Merrill Lynch.

Looking at these events unfold, I was reminded that the laws of nature certainly do apply to economics, even though these basic laws (e.g., you can only spend what you earn, what goes up must come down, etc) have been skillfully postponed and re-routed by Greenspan and company, over the last decade.

Despite the quick and decisive action of the U.S. Treasury, I suspect that the financial meltdown is far from over. You can’t print up half a trillion dollars and throw them at four essentially bankrupt companies (Bear Stearns, Fannie Mae, Freddie Mac and AIG) and not expect to devalue your currency or stoke inflation. I do find it interesting how U.S. Treasury Secretary Henry Paulson and company have managed to get the central banks of other major Western (plus Japan’s) economies to come along for the ride and share the pain. Certainly this will help keep the dollar from dropping for another few months—perhaps at least until after the elections.

Then there are those $6 trillion yen worth of non-transparent CDS derivatives floating around in the financial system, which still have to be accounted for or settled. No one really knows what the fall-out from settling these will be—especially since some of their issuers are now no longer in business.

The contrasting image in the news was of China, now the USA’s largest economic competitor, and shows that that country is also running into the realities of its own systemic problems. The China event was a meltdown of public trust (I think economic and political problems are still to come), with the melamine-in-the-milk-powder scandal. Images of hundreds and now apparently thousands of babies lying sick in hospital due to contamination of infant milk formula is creating a level of anger rarely allowed to surface in that country.

I feel that the China incident points to the fact that you can’t take a country that just 20 years ago was an economic and educational backwater, and expect it to suddenly start behaving like a modern fully functional state. Peasant attitudes borne of a harsh life economically and high mortality rate still linger just below the surface, and as Japan has proven, you need at least 1-2 generations of educated citizens to adopt a set of values that they actually believe in and will work toward. Values such as the sanctity of human life, rule of law, government for the people, clean and safe living environment, safe food, etc, are still in short supply in China.

While in the past, a third world country’s internal development was naturally regulated by its own ability to educate and provide for its population, gradually interconnecting with global commerce, the advent of first-world companies jumping head-first into China (and now India and Vietnam) with bags of cash and large, modern plants and technology, has turned the natural order of things on its head. Because of this, it’s no wonder that those not working in the factories, the farmers in particular, have looked on with envy at the newfound wealth and status of their luckier worker-bee compatriots.

It doesn’t take much to see that this envy of the “haves” naturally leads the “have-nots” (the farmers) to try to improve their own earnings through whatever means possible, including tainted fertilizers, counterfeit pesticides, risky animal drugs, and other dubious business practices. The attitude of Chinese authorities appears to be that they are willing to accept some collateral damage in the pursuit of growth. As a result, as of 2005, China became the world’s largest exporter of food, with exports in excess of $53.3 billion in that year (certainly a lot higher now). Until this year, 27% of that food was coming to Japan, 12% to the U.S., and another 18% to South Korea, Hong Kong and Germany. Thus, the cultural problems that occur in China have become inextricably linked to to those countries who import its products.

Certainly the tainted milk scandal is going to have some severe repercussions on the Chinese-sourced food market in Japan. When insecticide-tainted gyoza started showing up in Japan in January of this year, it highlighted the fact that Japan is in fact addicted to the huge volume of low-cost food coming in from China. The Japan-inbound food trade at the time was around approximately 1.6 trillion yen, and was (and still is) by far the largest food source for Japan. With an average salary of just 5%-10% of a Japanese farmer, the economics are irresistible.

Even so, the Japanese are particularly sensitive about the quality of their imported food, especially since around 60% of all food is now imported, and after the gyoza scandal the year-on-year volume of produce imports from China fell by 32% in March this year, and by 26% in June. Yes, Mrs Watanabe likes low-cost dumplings, potatoes, and onions, but not if her family are going to get sickened by them.

This latest food scandal has already touched Japan’s shores. Much like Singapore and Hong Kong, which have found melamine contamination in liquid milk imported from China and which have subsequently both issued urgent recalls of milk products, Japan’s supply chain also includes milk that is sourced from China. Osaka food maker Marudai has recalled at least three products on the possibility that they are contaminated, and the Ministry of Health is checking with hundreds of other companies to make sure that they follow suit. The government does not want a repeat of the recent tainted rice scandal (insecticide tainted industrial-purpose rice from China that got diverted into the human food chain) which in this last week claimed the job of the farm minister.

To improve its food security, Japan is already in the throes of slowly changing its farming and food source systems. Firstly, moves are afoot to allow corporations to run farms and for farmers to be able to sell their land without having to go through their local agricultural cooperatives. This will mean that over the next 10 years or so, thousands of acres of fallow rice paddies, which farmers have to leave unplanted to receive rice subsidies, will now come under the ownership of companies which can invest to move such land from rice to other crops, who will be much more economically competitive, and who may repopulate the countryside with younger laborers, even if they are imported from China and elsewhere.

Secondly, Japanese food corporations are stepping up their diversification and security of food sources, in particular taking ownership of the entire supply chain, from owning the farms in other countries, through to the processing and distribution of the food stuffs. We see this in China where Japanese supermarkets have started their own company farms and in Australia, where the likes of Nippon Meat Packers and Itoham breed beef, monitor or own abattoirs, pack the meat, and ship the finished product to their own distribution centers in Japan.

This start-to-finish control of the production process is of course nothing new to the Japanese. They have been practicing the same approach for car and electronics manufacturing, where the trading companies own the mines and transport, and send the raw materials in to their group-owned factories in Japan, so as to churn out superior quality products.

A new Asahi Breweries dairy farm in China is a good example of the total supply chain approach. In May last year, the company announced that it would start the operation of a 100-hectare dairy farm outside the Shandong Province city of Laiyang. The farm was developed at a cost of 1.5 billion yen, and included side investments by Sumitomo Chemical and Itochu Corp. The farm is now fully operational, and Asahi last week started marketing its milk output to Chinese consumers with the angle that it is a safer alternative.

Asahi’s safety point is that they control every aspect of the farm and its produce, and thus they are not prone to the rorts practiced by farmers who form the lowest (and uncontrollable) level of the supply chain of other leading dairy producers. And I do mean “control.” Apparently the pasteurization and other machinery Asahi uses are all imported from Japan, milk production and animal health are conducted by in-house specialists, and only milk from the farm is sold by their marketing arm.

Although the Asahi milk is 50% more expensive than its competitors, already Japanese supermarket chains such as Ito-Yokado and Aeon have said that they will start selling the product in their stores. My guess is that with all the media coverage going on, Asahi’s approach will gain wide acceptance by consumers and competitors alike.

Terrie Lloyd writes a weekly newsletter for entrepreneurs and business people about business and political opportunities in Japan


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