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Japan: Sailing into rough weather

Feb 19 Andrew Cornell in Tokyo

Japan, one of the world's economic supertankers, has run aground. Again.

A massive revision of the latest gross domestic product data last week, from barely positive to negative growth, indicates the world's second-largest economy is already in a recession.

That would make the fourth recession since Japan's bubble economy collapsed in 1991, the second in less than a year.

Japan is listing badly and unable to right itself. With a weakening United States, it threatens to foul the global economy.

"The only way to be optimistic on the Japanese economy is to turn the charts upside down," Goldman Sachs Asia president Kenneth Courtis told the recent World Economic Forum meeting in Davos, Switzerland.

But Japan's problems - and the world's - are not just economic.

Australia's largest trading partner, accounting for more than $37 billion in trade last year and 15 per cent of the global economy, faces four fundamental and enormous challenges: structural, demographic, financial and political.

According to McKinsey and Co, despite Japan's reputation for manufacturing excellence, just 10 per cent of the economy is more efficient than the US. The other 90 per cent is less than two-thirds as efficient.

Japan has the world's oldest citizens and the world's lowest birth rate; it is ageing and shrinking rapidly and does not have the pension system nor immigration policy to support such a shift. That in itself indicates growth must shrink in the years ahead.

It is also the world's most heavily indebted country, with government debt - excluding unfunded pensions which would probably double the figure - of ¥645 trillion ($10.5 trillion), more than 130 per cent of GDP.

But overwhelming these monumental challenges is the political one.

Japan's problems are not all of its own making; the seas have been rough. In 1998, it was caught in the Asian crisis with a strengthening currency. This time around the tech boom exploded just as Japan was getting on board, torpedoing an export-led recovery while painful restructuring was taking place.

But in both cases it was the Japanese leadership which wilfully kept the ship on course for the rocks. In 1998, the Government tightened fiscal policy at exactly the wrong time. In 2000, it backed off on economic reform just as it was paying dividends.

That's where the seafaring metaphors end, however. While negligent skippers of such vessels in the real world face the sack and criminal charges, Japan's demonstrably incompetent and reckless captain, the Liberal Democratic Party, continues at the wheel, pushing the ship further aground.

Racked by corruption and bribery, haemorrhaging popular support and gasping for policies, the party which has led Japan for all but a few months since 1955 is morally and operationally a zombie.

This year alone, the LDP has been embroiled in a bribery scandal costing it two leading parliamentary figures, together with a rorts scandal in the foreign ministry. Both scandals appear destined to drag more under.

Other scandals, exposed last year, continue to run, and in a trial of a corrupt former minister one of the LDP's most powerful policy makers was implicated. Lest one think these are isolated cases, they have been cropping up almost monthly. And the latest influence-peddling scandal is almost identical to the one which toppled the LDP briefly from power in the mid-90s.

Also among the living dead are the sectors such as construction, retailing and agriculture which stagger along with the LDP, sheltered by protectionist policies and taxpayer handouts while keeping the LDP in power.

Fitch IBCA managing director David Marshall says Japan's only hope is drastic structural reform to bring the lame majority of the dual economy up to the level of the world beaters such as cars and electronics.

"Japan needs to raise the efficiency of these inefficient sectors through structural reform. Things probably have to get worse before they can get better," he says.

But this, he acknowledges, would be "political suicide" for the LDP because those sectors which are most inefficient are exactly the ones keeping the LDP in power.

The LDP has long since lost the ability to govern with any transparency or steer the economy away from trouble, but it maintains a tenacious ability to stay in power.

Just before Christmas, Koichi Kato, a member of the LDP mainstream, publicly decried the party and its puppet Prime Minister, Yoshiro Mori, while scandal-tainted LDP policy chief Shizuka Kamei says: "Japan doesn't need a strong prime minister." Kato said he and his large LDP faction would vote for an Opposition no-confidence motion.

Kato won immense public support for his campaign, which came on top of victories by independent candidates taking on the LDP in regional elections.

But as experienced as he was in the LDP, he was no match for the powerbrokers who banded together, threatening his supporters with a withdrawal of funding, cajoling others with offers of more prestigious positions, offering generous incentives; cutting the legs from under Kato at the 11th hour.

That kept Mori in power but further eroded public support.

There are some positive signs. Many in corporate Japan have manned the lifeboats without waiting for orders from the LDP. They are restructuring, starting to pay attention to return on investment, listening to shareholders.

Foreign direct investment in Japan and merger and acquisition activity, encouraged by the brief summer of deregulation and reform two years ago, continues and is impossible to roll back.

That in itself brings direct pressure onto the corporate world. Global giants such as General Electric, Renault, DaimlerChrysler and Cable & Wireless, together with the investment funds which have bought failed Japanese banks to turn them into Western-style institutions, have acted aggressively in the market.

"Given the increasing globalisation of the economy, the spiral of FDI to Japan and the ongoing structural changes in the Japanese economy are the major factors influencing the recent growth [in M&A]," says the Bank of Japan. "That is, structural changes in Japanese industry stimulate FDI to Japan, while FDI to Japan accelerates the speed of structural changes."

FDI to Japan posted a second record year for the 2000 fiscal year, up 79 per cent to $US23 billion ($43 billion). The value of deals may be slightly lower this year, but indications are that the number of deals continues to climb.

Macquarie Bank rates Japanese equities as cheap and sees structural reform, driven by globalisation and the realities of the market, not the Government, continuing.

"Given the tight lending environment in the past five years, which will probably continue in the near future, Japanese companies will be forced to adopt a more market-oriented approach in their operation," says the bank in a new report, Japan: The Sleeping Giant Stirs.

"The restructuring efforts will also continue with the pressure from the market."

Japanese citizens are also raising their voices. Despite Japan remaining a long way from a functioning democracy, independents won shock victories in two major prefectures late last year, one a long-time LDP stronghold and hefty recipient of pork-barrelling.

Polls show the public is increasingly disgusted with the corruption in the LDP and is also growing anxious about the mounting public debt, yet has not yet begun to believe it can change the political process.

A joint survey by Yomiuri Shimbun and Gallup found that while 75 per cent of American voters believed they could get their opinions heard in national politics, only 10 per cent of Japanese thought the same.

Japan remains a country with a massive gerrymander - some of the LDP's favourite rural strongholds (it has none in the cities) have five times the voting power of city electorates - where village elders or company presidents determine how the whole group will vote.

Change is coming to Japan, inevitably. The LDP is running out of money to pursue its pork-barrelling, the new economy is emerging, the old system is crumbling rapidly. Like it or not, the debt-ridden corporate sector is being cleaned out. But all these changes are double-edged swords. They increase public anxiety, further eroding the willingness to spend, and consumer spending is 60 per cent of Japanese GDP.

"The prospects for the next six months are a serious concern," says ING Barings Japan economist Richard Jerram, one of the more bullish commentators in Japan. "Foreign demand is weakening at just the time that domestic financial-system strains appear to be undermining small firms' confidence."

Corporate failures, so necessary for Japan, chip away more confidence. Bankruptcies in 2000 rose 23 per cent year on year to 19,070, the fourth-worst post-war result, leaving debts 77 per cent higher at ¥24 trillion, the largest amount since 1945.

According to Nobuo Goto, president of credit research firm Teikoku Data Bank, bankruptcies will rise whether the LDP attempts to prop up its support base or not, but the long-term effects will be far worse without structural reform.

"All I can say is that the Government cannot put off action for much longer," he says. "I believe that corporate failures will remain at high levels for the next few years, with major companies being no exception. The Japanese economy is likely to slump temporarily. But I am sure that these painful and drastic changes will lead to important structural reforms."

Small business failures mean growing bank debt. Already given almost ¥8 trillion two years ago to bail out their bad loans from the bubble economy, Japan's banks are back in trouble. When the stockmarket was rising, they were selling their shares for profits to cover bad loans; now they can't. More bank failures are looming while the radical redirection promised by the banks in return for public funds is yet to emerge.

Again, the only change is coming from outside: foreign investors are buying banks, internet banks are starting up, Sony and retail giant Ito-Yokado are getting banking licences, good credits are moving to capital markets.

Ironically, the double-edged sword cuts in Australia's favour sometimes. As Australia's biggest trading partner, buying $22 billion of exports last year and selling $15 billion in exports, a strong Japan would appear to be a necessity.

But Australian Government and trade representatives say it is actually easier for Australian corporates to get a toe in today than it was at the peak of the bubble economy.

Japanese manufacturers are looking for cheaper resources and inputs outside of Japan, and with the problems in Japan and its need to rapidly improve information technology, Australian companies are finding it easier to move in. Last year alone, 35 new companies set up in Japan, close to a record year; another 35 are close to getting going.

Japan is still unfathomably rich, with private savings of ¥1,400 trillion. The LDP aside, it may yet be able to produce the kind of miracle it did after the war and after the oil shocks of the 70s, when devastation became a springboard for rapid development.

But it is a race against time, literally. On demographic trends, Japan's population will start shrinking in about a decade. In the 10 years to 1998, Japan's workers increased by about 5 million and GDP per worker by 1.3 per cent a year.

In the next decade, the workforce will shrink by more than 3 million and GDP per worker by around 1 per cent a year.

Add to that Japan's elderly, who are the only such group in the world which saves more as it gets older - due to anxiety about pensions and health care, say some, and because the Japanese are "dynastic savers", keen to hand on wealth to grandchildren.

"Japan's No1 problem arises from demography," says Japan specialist funds management adviser Andrew Smithers, of Smithers & Co.

"This causes a structural savings surplus through inadequate domestic demand."

A growing number of Japanese see immigration as the only solution, but in this most homogenous of societies, with the number of foreigners at less than 1.5 per cent, it is politically unpalatable.

Despite its outward harmony, Japan harbours strong racist tendencies. Police were forced recently to withdraw pamphlets asking people to phone in if they heard Chinese being spoken because, the police claimed, Chinese were responsible for rising crime rates.

This is yet another fundamental issue the LDP is yet to tackle - although its elderly male leaders did manage to delay legalisation of the contraceptive pill for three decades while approving Viagra in just six months.

But that was mainly because another of the LDP's special interest groups is the medical profession and it runs very lucrative abortion practices.

http://afr.com/asia/2001/02/19/FFXF0ZPLBJC.html

-- Martin Thompson (mthom1927@aol.com), February 22, 2001