Hamish McRae: Why reform is the key issue for voters in Japan and Germany

Within a week of each other the world's second and third largest economies are holding general elections: this weekend, Japan; the next, Germany. What does this mean for the rest of us?

There are extraordinary parallels. In both cases the former star economies have been underperforming, with Japan in near-recession through much of the 1990s and Germany in a similar state through much of the 2000s. In both cases the election is being fought on a reform agenda, though in the case of Japan it is the existing government that feels is it blocked, while in Germany the opposition presents itself as the reformer.

Thus in Japan, the Prime Minister Junichiro Koizumi wants to press on with the privatisation of Japan Post, which runs savings and life insurance as well as postal services. This had been blocked by the legislature, thus pushing him to call an election.

In Germany it is Angela Merkel, the head of the Christian Democrats (CDU), who presents herself as the radical. There the main plank of the programme is not so much further privatisation - Deutsche Post is already privatised - but tax reform. Her shadow finance minister, Paul Kirchhof, has floated the idea of radical policies including a flat-rate income tax of 25 per cent and the abolition of Germany's many tax loopholes. These proposals are not official policy but have obviously hit the headlines and indicate the direction a CDU-led government would like to head.

Now of course the mechanics of the political process are very different - near hegemony by the Liberal Democratic Party in Japan, a string of coalitions in Germany - but the effect has been much the same. It is very difficult to sustain reform in either country. Both can nibble; neither can really bite.

As a result, while the casual visitor to both countries sees prosperous and reasonably stable societies, both face stagnant living standards and the probability that the next generation will actually have lower living standards than their parents.

This raises two questions. Is there enough political support to underpin a reform programme? And will the reforms envisaged actually deliver a better economic performance?

We will get an interim answer to the first within the next 10 days. The balance of probability seems to be a "yes" in both countries. There would certainly be a huge rumpus in either country were there to be a "no". But in a way the other question about the likely effectiveness of reform is the more interesting and the one that matters more to the rest of us.

Behind the "will the reforms work?" question is whether the central problem is poor governance or underlying structural weaknesses in the economy. In both countries there will have to be a long and difficult slog ahead. But if the former, then political reform ought quite swiftly to bring in the economic benefits. If the latter, then the reforms will appear ineffective until those underlying structural changes work their way through.

So what are Japan and Germany doing wrong? I suppose the soundbite answer is: being very good at making things is not enough.

Every year The Economist magazine publishes a little book pulling together global economic statistics, the Pocket World in Figures. The new one is just coming out. The first graph above shows its list of top world exporters, taking visible and invisible trade together, and showing, as you might expect, the US and Germany leading the pack. You might be surprised by the order after that, with the UK ahead of Japan, France and China.

What? The 60 million of us manage to export more than the 127 million Japanese? They all work their backsides off making Toyotas while we slope about getting drunk. But per head we earn more than double as much from abroad. It is comforting too that China is so far down the list. All 1.3 billion of them export less than the 60 million French.

The other two charts give part of the answer. In visible trade Germany is indeed the gold medallist, with its 82 million people exporting more than the 293 million Americans, an astounding performance. Japan and China do very well, as you might expect, and we are further down the list. But the third chart, for invisible trade, shows a very different pattern.

The US gets the gold, we get the silver and the Germans are far behind with the bronze. Japan is not in the medals and China doesn't qualify for the final at all.

The proposition that flows from this is: being good at making things is no longer such a crucial element in international competition. Germany and Japan are wonderful at that but China is already snapping at Japan's heels. On the other hand being good at earning money from services - as the Americans and ourselves clearly are - enables you to maintain clear ground ahead of the pack.

All this is oversimplifying of course. These figures do not take into account imports, and the US and UK have large overall deficits. Nor does it distinguish the various sorts of invisible earnings, some from services, some from investments abroad. China's performance as an invisible exporter would look much better were Hong Kong's figures added in - for some reason they are not. And so on.

The big point, however, surely stands: that Japan and Germany are more challenged by globalisation than the US and UK. The fact they are more reliant on exporting goods means they are under more pressure from the hungry, low-wage economies of Asia. For the moment Japan and Germany maintain quality leadership, offsetting their high wage costs by being wonderfully good at what they do. But competition from China and indeed India is not going to go away. Indeed it will intensify.

So the question for Japan and Germany is not just whether they will maintain their political reform process, though that will be tough enough. Look at the way we are now stuck, unable even to privatise the Post Office - on that issue we are way behind both countries. The question is whether Japan and Germany can build up invisible exports, and the additional employment and consumption these will bring.

That is a huge and complex question but stripped down it is really the only one that matters for their future prosperity. Of course to some extent both countries are already building great service industries. Germany's software producer, SAP, is the only company outside the US that can really give the Americans a run for their money. Service-sector employment is shooting up in Japan, up 5 per cent year on year in fact, helping ease the pain from the continuing job losses from the manufacturing sector. But while both countries are moving in the right direction, they may be moving too slowly. This is a race against time. Both have to keep creating more jobs and those will come only in services. Without more jobs consumption will continue to languish, as will their economies as a whole.

It would be very much in our self-interest to see a more successful Japan and Germany. Aside from the fact that Germany is an important export market for us, a world economy with numbers two and three underperforming is inherently unstable. It is just possible, too, that a revitalised Germany under Ms Merkel would introduce its flat-rate tax and provoke a tax revolution across Europe, including the UK. But reform is only a secondary objective. Economic success is the primary one and until Japan and Germany learn to export more services they will continue to disappoint their citizens and the rest of the world.