The Floodgates of Reform Are Poised to Open


The yen dwindles in value, but there is more important news from here, and it illustrates why Japan will never be the same.

The purchase by Travelers Group of half of Nikko Securities, following Merrill Lynch's expansion in Tokyo, signals that Japan's closed financial and economic system--despite skepticism around the world--is going to open up dramatically in the next few years.

As outsiders wring their hands over Japan's seeming obliviousness to demands for reform, big changes are in fact occurring beneath the calm surface.

"There is a legal and official undercurrent that people don't notice. In corporate finance, we are going to become more like the United States," says T. Yoshitami "Tom" Arai, a consultant who years ago was in on the ground floor of Sony's dramatic success.

"The administrative and legal system is going to change very rapidly because the government is going to require more disclosure by publicly owned corporations," Arai says.

Forty years ago, Arai helped Akio Morita open Sony's first warehouse and distribution center in New York. He was part of Japan's decades-long rise to industrial eminence as its well-made cars, appliances, television equipment and industrial machinery swept to world leadership.

A renowned corporate-government system carried Japan to that eminence. Exports were prized, foreign competition and investment in Japan were tightly controlled, and financing was plentiful from Japan's banks under the tutelage of the Ministry of Finance. It was a system praised for long-term views of investment and capital.

But glaring flaws in the system have been showing up in this current economic crisis.

Lulled by easy finance, Japanese industry has built vast overcapacity to supply markets that are no longer buying. They expanded overseas and liberally financed product development. But under a system that put priority on increasing exports and keeping the work force employed, many Japanese companies never put a priority on profits.

Japanese businessmen routinely admit that half the country's major companies are unprofitable by international accounting standards. And Akio Mikuni, founder of Mikuni & Co., Japan's first credit-rating agency, puts the credit-worthiness of 60% of Japan's major companies at junk bond levels.

The bills are now coming due on all that easy capital. Japan's banks are loaded with $800 billion to $1 trillion in bad loans, some dating to real estate speculation in the 1980s, others to Southeast Asian ventures. To meet international banking standards, they can no longer simply roll over unpaid company loans. They must write them off or collect.

More worrisome is that inattention to profit has left Japan's pension funds seriously underfunded, with only 60% of the money they will need to pay retiree benefits. The pension funds, in turn, have performed dismally, earning an inadequate 1.5% a year by investing almost totally in Japanese government bonds.


Pension inadequacy, along with doubts about the banks, has aroused anxieties among the Japanese people, who are demanding higher-yielding investments. That's why the Japanese government is inviting Travelers and Merrill, Goldman Sachs and Morgan Stanley to offer mutual funds and other investment products to Japan's household savers.

That's a huge potential market: Japanese households have piled up an incredible $10 trillion in savings in post office and bank accounts.

It's extraordinary and unprecedented for Japan's government to open such opportunities to foreign concerns. That it's doing so is testimony to how seriously the government views the political and financial problems.

Other revolutions are to come with demands from international investors and the Japanese government that companies adopt international accounting standards. Traditional Japanese accounting has favored fiction over fact. The method, expressly approved by the Finance Ministry, blithely refuses to acknowledge bad news, such as losses in business operations, explains Iwao Tomita, 74-year-old founder of Deloitte Touche Tohmatsu, a leading Tokyo accounting firm, and a longtime campaigner for Japan to adopt international accounting standards.

For years, false accounting has made Japanese companies look more successful than they are, says Tomita, who holds an MBA from University of Pennsylvania's Wharton School. The aim, he says, was to "keep financial order--by cheating shareholders."

But now, with pension reform, shareholders will count. And an overhaul of Japanese industry is inevitable, similar to what American business went through in recent decades as pension fund managers demanded that U.S. companies be restructured to produce higher returns on retirement savings.

For Japanese companies, the model is clear. "Japanese companies need to become as efficient in using capital as they are at producing automobiles," says Kenneth Courtis, Tokyo-based chief Asia economist for Deutsche Bank.

Restructuring has already begun. Hundreds of companies have announced intentions to buy back shares, a classic U.S. method of boosting shareholder value. Nissan Motor is trying to sell a stake in its Nissan Diesel subsidiary to Daimler-Benz. Mitsubishi Electric, a $30-billion sales producer of machinery, semiconductors, elevators and household appliances, recently replaced its chief executive amid pledges that the company would consolidate loss-making divisions.

Look for Japanese conglomerates to start breaking up, perhaps selling operations to managers who are increasingly being paid in stock options in order to link their pay more closely to the stock price.


And the same fears and uncertainties that afflicted the U.S. Midwest in the 1980s are now evident in Japan. Indeed, layoffs have begun. Unemployment is at 4.1% and rising, and the Japan Research Center, a Tokyo think tank, predicts 9% unemployment early in the next century.

"The government will have to prepare a safety net so the relocation of people and talent can take place," says Minoru Makihara, chairman of Mitsubishi Corp., a giant trading and investment firm.

How can Japan, home of a lifetime employment social contract, have growing unemployment?

"That social contract is eroding," says Arai. "Permanent employment was never a formal accord, and it only made sense when Japan's economy was growing 5%. But we are now mature, growing 2% a year when we can. So we have to restructure."

The implications of Japan's restructuring for the rest of Asia and for global investment will be profound. For Asia, Japan's investment in other countries may well increase as Japanese companies seek to maximize profit through adroit use of lower-cost overseas operations.

For global markets, savvy investors will recall that the U.S. bull market began when American companies started restructuring in earnest in 1982.

New models for success are emerging in Japan. The most admired companies are "international firms, meaning those that are capable of operating comfortably in any country," says Takeo Nishitani, president of IPR Shandwick, a Tokyo public relations firm.

In fact, says Nishitani, Sony is the most admired company now--which is illustrative and ironic. Sony was once an outcast in Japan's closed culture because its founders, Morita and Masaru Ibuka, started it without guidance from the Ministry of International Trade and Industry and financed it outside Japan, avoiding Finance Ministry restrictions.

To be sure, conventional wisdom cautions that it's risky to predict change in Japan. But the reality is that Japan has always changed when it had to--in 1870 when Meiji-era reformers opened Japan to Western technology, and in 1945 when Gen. Douglas MacArthur and U.S. occupation forces opened it to Western democracy.

Now it must change again, says Frank Gibney, longtime expert on Japan and editor of "Unlocking the Bureaucrat's Kingdom," a new book of essays by Japanese politicians and officials on how their country will change.

This time, Gibney notes, "there is no Commodore Perry or General MacArthur to threaten them into it." Japan's own people are pushing the reforms.

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