The Night May Be a Long One, but Japan’s Sun Will Rise Again

The comments on Japan’s economy by many market watchers last week were more appropriate to Halloween than Thanksgiving--all sorts of witches and hobgoblins threatening meltdown and evil spirits.

But keep a clear head: Japan’s economy is not about to collapse.

The correct way to think about Japan’s nearly $4-trillion economy--roughly half the size of the U.S. economy--is as an old friend who has struggled with a painful disease for a long time and is now finally undergoing surgery.

The surgery will be painful but therapeutic. The recovery may be slow, but ultimately health will be restored.

How long is “ultimately”? “In 10 years we’ll see a sizable net plus to our economy from the reform process beginning now,” says Takashi Kiuchi, chief economist of Long Term Credit Bank of Japan, a leading government institution. “But the first two years will be a minus.”

He is not saying that Japan will fall into recession. Kiuchi predicts 1% growth for Japan in 1998. But times will be difficult, he says: “We may see a series of business failures, beginning with financial institutions. But if the government stands behind depositors, then optimism can return.”

So far the Japanese government has stood behind depositors and small-investor clients of Yamaichi Securities, Hokkaido Takushoku Bank and other failed institutions.

It must keep doing so, says Kenneth Courtis, the Tokyo-based economist of Deutsche Bank. Courtis worries that the government, intent on reducing Japan’s budget deficit, will hold back on necessary public spending as President Herbert Hoover did at the start of America’s Great Depression.

Note well: Kiuchi and Courtis live and work in Japan and see its complex economy up close. We need to look at it up close too to understand the prospects for this major economy, which will affect the U.S. and global economies no matter how it performs.

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First, as Japan goes through its own restructuring, it cannot be the engine of Asia’s recovery that President Clinton asked it to be last week. “It cannot be the engine of Asia without a robust economy,” observes economist Lawrence Lau of Stanford University.

Yet in the very cure for some of its economic ills Japan can become a vigorous economy once again.

Some of its problems are familiar to most developed nations today: Japan is trying to get its citizens to pay more for medical insurance and to retire at 67 rather than 65 to ease strains on the pension system. The U.S. and other countries are trying the same remedies.

Japan has a government budget deficit of roughly $130 billion, or 3.4% of its total output of goods and services. That’s not extreme but it’s not small, either--the U.S. had a comparable percentage deficit in 1993. The point is, such problems ultimately get dealt with by responsible nations, and Japan is responsible.

But aspects of Japan’s economy are unique and need changing. Of Japan’s 100,000 or so leading companies, only 30% are profitable, says Kiuchi. He means that in the world market’s generally accepted accounting sense of the word, the companies don’t make a profit. They make products, employ people and follow marching orders from Japan’s government and the banks that own their stock, in a system that served the country well in the decades after World War II.

But it is a system producing diminishing returns today: No profit means insufficient pensions; investments without returns; and the need for a closed, regulated system that can only continue if competition from abroad or at home is discouraged. It is a system that has created trade problems for other countries even as it has yielded Japan a stalled economy for the last seven years.

The antidote to most of Japan’s ailments, says Kiuchi, is “deregulation, such as occurred in mobile telephones.” In 1994 Japan deregulated the cellular telephone business in some cities. “The result was a surge of investment--$10 billion in one year--into the mobile phone industry,” he says.

Similarly, when Japan deregulated gasoline distribution, more gas stations sprang up, price competition gave a better shake to Japanese drivers, and the economy benefited from heightened economic activity.

So in the years ahead, the extent of its deregulation will be a good indicator of how well the Japanese economy is doing.

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There is ample room for improvement, Lau of Stanford points out. The competitive, exporting Japan that the world sees actually represents less than 20% of Japan’s economy, which is no more dependent on foreign trade than is the U.S. economy.

But the rest of Japan’s economy--jobs on the railroads and in retail and banking and countless small firms--is highly inefficient, Lau says.

The changes that are coming, starting with formal deregulation of the financial sector in April, could unleash enormous energy.

Yes, but: Can Japan, so averse to change, really deregulate its economy? For the answer to that question we should recall the many examples of Japan’s resilience, says William Ouchi, professor at UCLA’s Anderson School and the author of several books on Japanese industry.

“When Japan was hit by the oil shock of the early 1970s, many people said it was finished,” Ouchi says. “Japan could have no further productivity gains because it was so dependent on imported oil.”

But Japan adapted and the world came to see that it possessed the most important “commodity” of modern economies: educated people. “It has educated, healthy and hard-working people today,” Ouchi observes.

To be sure, Japan also has a banking crisis, with roughly $200 billion in bad loans. But the extent of that crisis, in the context of Japan’s economy, is proportionately no larger than the savings and loan debacle was for the U.S. economy.

The bottom line: Japan’s economy won’t collapse. And how well it recovers will depend on how vigorously it can deregulate. Restructuring can be a painful process, as Americans know. But then, so are stagnation and decline, which is what Japan has had for seven years.