Japan’s Firms Offer More Hope Than Its Politicians

President Bush is visiting over the next three days a country that, despite being one of America’s closest allies, is said by many experts to pose a greater threat to the global economy than the Al Qaeda terrorist network.

The country is Japan, which has stagnated economically for the last decade and is in a cycle of deflation, with prices by some expert estimates declining 4% a year. Loans are going bad faster than banks can write them off as the value of property and business assets decline, creating a debt crisis worse than the U.S. savings and loan debacle of the 1980s.

Japan’s crisis is everyone’s problem. If Japan cannot end deflation and rejuvenate the banking system, its massive economy--more than $4trillion in annual output of goods and services--could be like a black hole, sucking back investments from overseas and closing down production in thousands of facilities around the world.

For the present, Japan is muddling through. Hurried moves to deal with the crisis, such as a proposed infusion of public money to the banks, are boosting the stock market and strengthening the yen.

In the longer term, the outlook is better. Some of Japan’s companies are recovering the drive and determination that made them hallmarks of world industry in the 1970s and ‘80s. More than in the past, Japan’s skilled corporations are investing overseas, restructuring at home and demonstrating a willingness to work with others to pursue ventures in technology. They may hold the key to Japan’s future.

But right now the economy is in its third recession in a decade. The country once famous for lifetime employment admits to an unemployment rate of 5.6%, but the figure is close to 8.5% on a basis comparable to U.S. measures of joblessness.

Japan’s government debt, after a decade of political paralysis, is far greater as a percentage of its economy than the United States’ national debt.

Japan’s government bonds may be downgraded by Moody’s Investors Service. And experts say there is a risk of a run on the banks at the close of Japan’s fiscal year, March 31, when the government cuts back on deposit insurance.

A Moody’s downgrade wouldn’t have much effect because Japan owes very little debt to foreigners, but “this is a critical time and a downgrade could spur foreigners to sell assets in Japan,� further hurting the weakened banks, says bond expert Bill Gross of Pacific Investment Management Co. in Newport Beach.

For all its troubles, Japan is not a poor country. It is the largest creditor to the world, investing $800 billion in overseas bond and stock markets last year in addition to $450 billion in direct investment abroad in factories, office buildings and real estate.

Experts are asking whether Japan can go from deflation to inflation through a government program of setting up a publicly funded entity to take over the banks’ bad loans, as the Resolution Trust Corp. did in the aftermath of the U.S. savings and loan crisis, and by increasing the money supply to boost consumer spending. Japan has done that in the past, notably in the 1920s under a Keynesian finance minister, Takahashi Korekiyo.

However, pursuing such policies requires political will, and Japan’s central problem over the last decade has been a lack of decision making by leaders within the majority party that is controlled by special interests. Longtime experts in Japan’s politics don’t see that system reforming itself soon.

That’s why it is a good idea to look at Japan’s companies--they are being forced to change to survive.

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Home Market Is Facing a Struggle

Only a decade ago, when they were seen as unbeatable in global competition, Japan’s companies had two things going for them. One was a home market that provided a source of steady profits, coupled with low-priced government finance.

But now the home market is very weak, and borrowing money--even at no-interest or 1% rates--is very expensive in a time of deflation, when companies’ plants and equipment are losing value daily.

Some of Japan’s largest companies, even though they have worldwide name recognition, have remained dependent on that home market: About 60% of Toshiba Corp.’s sales and 76% of Hitachi Ltd.’s sales come from inside Japan.

Japan’s biggest companies are restructuring, moving production facilities to China to avoid paying some of the highest wages in the industrial world and trying to cope with huge, unfunded pension liabilities for the employees who are entering retirement.

Much is changing. Annual reports now boast of rising returns on shareholders’ equity.

“Three years ago those companies said they could never run a company on principles of return on shareholders’ equity,� says analyst Steven Myers of HSBC Securities in Tokyo.

Demands from investment companies charged with earning a return for pension funds have contributed to the change in corporate attitude.

But Japan’s companies were never merely creatures of cheap finance and favorable government policies. Their more-lasting assets were disciplined, innovative manufacturing, a focus on product development and often long-term vision.

Many companies are on top of their industries worldwide, Myers says. He cites little-known specialty companies such as Disco Corp., Murata Manufacturing and Advantest, all makers of electronic equipment, and better known firms such as Canon Inc. and Ricoh Co. and Kyocera Corp. as examples of continued excellence in Japanese industry.

Kyocera, a ceramics company founded in 1959, has become a global maker of semiconductor materials, mobile telephones, computer parts and solar energy cells.

Founder Kazuo Inamori boasts of Kyocera’s ventures in China, where it has three factories and is forming a joint venture with China Zhenhua Science Group to produce and sell telephones that use the code division multiple access, or CDMA, a technology devised by Qualcomm Corp. of San Diego.

Kyocera, which gets 60% of its $10 billion in sales outside Japan, has made itself into a multinational company.

“Many Japanese managements have been lax and lazy,� Inamori says. “But today we have new opportunities in China and other countries.�

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Plenty of Strength in Nation’s Industries

No one doubts the abilities of Japan’s auto and consumer electronics giants Toyota Motor Corp., Honda Motor Co., Sony Corp. and Matsushita Electric Industrial Co., which have spread their operations to every continent. And in the last two years, Nissan Motor Co. has demonstrated how quickly a Japanese giant can turn around.

Japan’s management, labor and government establishment allowed Renault of France to make a controlling investment in Nissan in 1999 and then allowed Renault’s Carlos Ghosn to change operations, reduce staff and turn record profits after years of losses.

Now, Nissan is bringing out new models and expanding output in the United States, where all Japanese car makers are increasing production.

A new sense of global competitiveness among most Japanese companies won’t happen overnight, but they are pursuing it with determination. Takashi Kiuchi, a senior executive of Mitsubishi Group, founded a consulting firm in Tokyo a year ago to help 18 large and small companies develop an understanding of new technology and global alliances.

“We target the year 2010, trying to position our clients in our society eight years from now,� says Kiuchi, who led Mitsubishi Electronics in Southern California for many years.

Japanese universities from Osaka and Tokyo are joining other universities in Asia and the Americas--including USC and UC Santa Barbara--in exploring such U.S.-style concepts as technology transfer from college laboratories to entrepreneurial companies.

Japanese researchers will join specialists from UCLA, USC and local companies in a nano-technology conference Friday in Torrance.

It all adds up to a new energy and openness by Japanese industry. In this decade, we can expect to see Japanese firms behaving like U.S. and European multinationals, attuned to global investment markets, building up operations in many countries while turning to management and service industries in Japan.

“Japanese investment could be a big factor in China becoming a manufacturing superpower,� says Kenneth Courtis, head of Asian research for Goldman Sachs.

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Politics, Economy Pose Immediate Problems

Yet the outlook for energetic companies does not answer today’s question of whether Japan can reform its political system and rejuvenate its economy.

The evidence is not promising. Prime Minister Junichiro Koizumi, who was hailed as a reformer when he took office two years ago, has fired his foreign minister because she angered powerful interests in the ruling Liberal Democratic Party.

“That shows he can’t buck the special interests and there will be no real reform in Japan at this time,� says Frank Gibney, head of the Pacific Basin Institute at Pomona College and a veteran of decades of doing business in Japan.

In fact, an alternative to reform that is openly talked about in Japan is “comfortable decline�--a concept of a wealthy nation with an aging population living on the capital it built up in years of greater industrial dynamism.

Mitsubishi Chairman Minoru Makihara acknowledged the concept in an interview, saying, “Japan would withdraw into itself and people would be comfortable for a time. But I fear that pressures from the outside would make it unpleasant before long.�

In fact, pressures are building inside and outside Japan. That is why there is such concern about the latest recession and banking crisis. Inside the economy, there is the rising pressure of pensions, with the number of retirees expected to grow as companies restructure and downsize their work force, says economist Adam Posen of the Institute for International Economics in Washington. Japan’s problem is acute because its pension funds have earned returns of only 1% to 2% on investments in Japanese government bonds in recent decades.

And outside pressures could come from developments in Asia, which Japan has led economically and technologically for well over a century.

“The rise of China, uncertainty concerning reunification of the Korean peninsula and its relations with the United States pose major questions for Japan,� wrote former U.S. Ambassador to Japan Michael Armacost and Kenneth Pyle of the University of Washington in a report for the Seattle-based National Bureau of Asian Research.

China particularly is critical because its rising economic and military power could “eclipse Japan in the Asian region,� says Charles Wolf, senior advisor at Rand Corp. Recognition of their country’s declining position could so shock the Japanese that the society would see an upheaval recalling the Meiji restoration in the 19th century.

Wolf is referring to a central event in Japanese history, when the nation in the 1870s recognized how far Western technology had moved ahead of it. The nation committed itself to modernization and began the long march to industrial, technological and military leadership of Asia and economic preeminence in the world.

Bush will get no quick answers during his visit this week to Japan, which will be followed by stops in South Korea and China. But even in the questions about Japan’s crisis, he will learn about rapidly moving currents that will affect every economy and nation on Earth.

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James Flanigan can be reached at [email protected].