Despite Finance Woes, Japan Humming : Economy: While the country tries to reform its scandal-ridden securities and banking industries, the manufacturing and service sectors keep posting sales increases. And the nation’s trade surplus continues to grow.

Kabutocho, Japan’s Wall Street, is utterly depressed. Stock prices dropped more than 40% last year and show few signs of recovering. Banks’ share-holdings have suddenly lost so much value that they are being forced to cut back on their lending to meet international capital requirements. Banks also stand to lose billions of dollars from fraud and sliding land prices.

Financial leaders, tarred by scandals of pay-back schemes and stock manipulation, are being hauled before Parliament and scolded for letting down the public.

To complete the dismal picture, Japanese bankruptcies surged in August for the 11th straight month as companies continued to suffer from the bursting of the so-called bubble economy of soaring land and stock market prices, according to Tokyo Commerce & Industry Research Co., a private research company.

Such gloomy reports might lead to the conclusion that things are falling apart in Japan. But this is a tale of two economies: one weak and scandal-ridden, the other robust and frightfully competitive. They are two faces of the same industrial dynamo--Japan--which manages to insulate and protect its most important sectors.

Japan’s service and manufacturing sectors remain sturdy. Although most companies are reporting lower profits--with the exception of a few areas such as housing construction and paper products--most continue to report healthy growth in sales. New products are being announced daily, factories are under construction, and unemployment is holding steady at 2%. The main concern is not an economic downturn but a ballooning trade surplus--a problem most nations would love to have. “We are watching the figures with concern,” says Noboru Hatakeyama, vice minister of international affairs at Japan’s Ministry of International Trade and Industry.

According to the economic textbooks, the “symbolic” economy of stocks and land prices is supposed to project what the “real” economy--the manufacturing and service sectors--is likely to look like a year or so away. Long growth periods are usually followed by a few quarters during which the economy shrinks. So far Japan has proven itself to be an exception to the rule, though some voices warn that Japan can’t avoid the forces of nature for long.

After nearly five years of continuous economic growth, the longest unbroken period of expansion since before World War II, the economy should be getting tired. Real interests rates reached a peak last year when stock prices tumbled. Every few days, it seems, another giant real estate or stock speculator, unable to pay the high interest on his debt, goes insolvent with billions in unpaid loans.

Yet, overall GNP growth, settled down from an overheated 5.8% last year, is unlikely to fall much below 3% either this year or next, economists say. Japan managed to pilot that smooth landing from overexpansion that American authorities kept talking about but couldn’t manage.

“A soft landing is possible when you have a decent landing strip, a balanced economy,” says Paul Summerville, economist at Jardine Fleming in Tokyo.

What’s Japan’s secret? In part, it’s old-fashioned Keynesian government spending. With the Japanese continuing to stash away 17% of their salaries, more than triple that of the average American, the government can afford to engage in deficit spending. Government spending, which rose just 1.8% in 1989, will be up 3.1% this year, a reflection of Japan’s extra effort to invest in public infrastructure such as train lines, roads and sewage systems.

Then there’s the built-in bias toward local production. Much of Japan’s gains in increasing imports have been made in such extraneous luxuries as expensive cars, gold and other luxury goods. With few foreign products making up an intrinsic part of the economy, when things slow down, the first items to get cut are imports. Japanese imports of foreign cars have fallen far more sharply than sales of domestic cars. That preserves domestic jobs and keeps growth high.

But the most important reason Japan is able to avoid the sharp declines that seem to follow financial folly in America is Japan’s almost religious attention to investing in the future.

Whereas American industry spent the money from its boom years buying other corporations and building unneeded office space, Japan invested its cheap money in research, development and automation.

Whereas the American economy waits for consumption to pull it out of its doldrums, Japan’s economy is fueled by investments that keep spewing out new products in good times and bad.

Look at a few of the products released in a recent one-week period:

* Toyota announced a new Camry that is pricier but also larger and more powerful. The new Ford Taurus, one of its main competitors, costs more but is little changed from the old model and uses the same engine. Nissan said it will sell a new car in Japan that uses special sound waves to cancel out engine noise so passengers have a quiet ride.

* Toshiba has a new facsimile machine that stores messages and allows users to read on a screen and erase junk mail. Another of Toshiba’s fax machines gives four times the resolution of existing machines. There are no American competitors. The innovations will justify higher prices and higher profits.

* Fuji Photo Film released an all-digital-camera system that stores clear pictures on semiconductor memory cards for use by news photographers and businesses. At nearly $10,000 a system, it’s expensive, but it’s one-third to one-fifth the price of its previous system.

Such new products will fuel another export boom. Those exports, paired with lower imports, will mean that Japan’s trade surplus will balloon to $100 billion next year, almost double last year’s level, according to Stephen King, economist at James Capel and Co.

The real economy won’t totally escape the impact of the depressed financial sector.

Between 1985 and 1990, Japanese companies raised about $630 billion on the equity market, paying interest rates as low as 1%. They raised the money by issuing convertible bonds. Investors were willing to accept lower interest because the bonds could be converted into attractive Japanese stock at a time when stock prices were soaring.

With the stock market down, not only will companies be unable to issue new convertible bonds, investors will decide to cash in their existing bonds when they come due.

Thus, companies will have to refinance with normal bonds or bank loans at rates of up to 8%.

That poses a problem for Japanese companies accustomed to getting a low return on capital. “There aren’t that many areas to invest in, in which you can be assured of an 8% return,” says Josen Takahashi, chief researcher at Mitsubishi Research Institute.

Robert Feldman, economist at Salomon Bros.’ Tokyo office, believes that such costly money will force companies to revise their investment plans downward next year.

If Japan’s stock market continues to sag, a growing number of Japanese companies will be forced to trim their capital spending plans and that could reduce economic growth to less than the 3% level the Japanese consider “cruising speed.”

That worries the Ministry of Finance enough that officials say they need to quickly implement reforms that can restore investor confidence in the market.

Individual investors felt betrayed on hearing reports that selected customers of large securities houses received about $1.3 billion in compensation for stock market losses.

Other observers, however, say competitive pressures among Japanese firms will prevent them from cutting back sharply on investments even if they have to pay more for their money.

Toyota is continuing an aggressive factory construction program even though it has meant borrowing money for the first time in years.

Nissan, with even less money to spare, is expected to cut investments by close to 20%. Even Nissan, however, says it is committed to continuing investments necessary to keep up with Toyota.

“To be price-competitive, we have to keep investing,” says Nissan spokesman Shuji Kawasaki. “If that means profits will temporarily fall, that can’t be helped.”

Last year, Japanese firms invested nearly 30% more in new plant and equipment than American firms, which operate in an economy twice Japan’s size.

This year, although Japan’s economy has cooled, Japanese industry will boost investment by 8%, according to the Long Term Credit Bank.

American industry, supposedly in the midst of a recovery, is expected to increase investments by just 1.6%, according to the U.S Department of Commerce.

Japan’s experience with scandals and asset deflation could lead to less administrative guidance from the Ministry of Finance.

And more bankruptcies mean that investors will demand a higher risk premium when lending to Japanese corporations.

One Ministry of Finance official fears that Japanese markets will now show sharp fluctuations and wonders whether Japanese industry will be able to manage the risk.

But few believe that the ministry will ever bring itself to truly loosen its reigns on the economy. And even if it does, the worst thing industry has to face is the prospect of paying market rates for its money--like everybody else.