The sun also rises (survey)

01.10.05 Publication:

The sun also rises

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Japan is at last ready to surprise the world by how well it does, not how badly, writes Bill Emmott, editor of The Economist

NO COUNTRY in modern history has moved so swiftly from worldwide adulation to dismissal or even contempt as did Japan, in a process that began more or less as the temple bells were tolling in the new year of 1990. In the 15 years that followed, amid crashing stock- and property markets, mountains of dud debt, scores of corruption scandals, vast government deficits and stagnant economic growth, Japan mutated from being a giver of lessons to a recipient of lectures, all of which offered recipes for its reform and revival. Those lectures, although received politely by a newly self-deprecatory Japanese elite, seemed to be ignored. Now, however, the time for lectures is over. Japan is back. It is being reformed. It is reviving.

Really? The very unJapanese event that took place on September 11th—a snap general election called on a policy issue and won in spectacular fashion by the reformist prime minister, Junichiro Koizumi—has changed perceptions of Japan as an irredeemable dud, but not much. After all, the case for cynicism is compelling.

There have been several false dawns during those 15 dismal years, most notably in 1996-98 when an incipient recovery turned into a fresh recession and produced both a banking crisis and an apparent enthusiasm for reform. Since then, Japan has suffered a price deflation that has still not come to an end. Since 2001 it has had a prime minister, that same Mr Koizumi, who has talked a lot about reform but whose real achievements remain rather hard to get your arms around. Moreover, the OECD recently rated Japan´s potential rate of GDP growth for the rest of this decade at a mere 1.3% a year, on the basis of poor productivity growth and a population that is shrinking and ageing. Politics didn´t even come into it.

But remember. During the 1980s, when adulation (or fear) of Japan was at its peak, many observers made the mistake of assuming that because some things in the country plainly worked extremely well, everything did, so everything must be worth emulating and the trend must be ever upwards. That is why your present author named a book he published in 1989 “The Sun Also Sets”. Japan´s sun does not only rise, the book argued; trends can also bring about their own downfall. Since 1990, the opposite mistake has been made: just because some things have gone badly wrong, so everything has been assumed to be wrong, in perpetuity or at least pending a revolution. Hence the somewhat self-indulgent title of this survey: the Japanese sun does not only set, either. It also rises, and looks likely to do so from now on.

For the case for greater optimism is also strong. It is not based on any notion that Mr Koizumi´s victory represents the start of radical change. Nor is it intended to suggest that privatisation of the postal savings system—the reform issue around which September´s election was fought—will somehow magically turn Japan from a sloth economy to a growth one, for it won´t. Rather, it is based on the view that Mr Koizumi´s victory is the culmination of a long period of incremental change, bringing welcome confirmation that that change is not likely to be reversed.

Even after his landslide win, it is not inevitable that Mr Koizumi will get his way, for his party´s rules stipulate that he will have merely a year as leader to exploit his new mandate. Still, there is a chance that the party will extend his term, but also a likelihood that any successor will follow the Koizumi script. This would mean that the size and role of the Japanese state will shrink, in a slow but remorseless process over the next decade or so. That will gradually help improve the public finances, which are in a mess; gradually help reduce the financial distortions that have arisen from the state´s role in banking; and gradually help reform politics, which had become dependent on state cash and power.

Gradually: that could be Japan´s watchword. The country has not had a revolution, nor has it gone through the “shock therapy” of reform that Margaret Thatcher deployed in Britain in the 1980s or that some central European countries tried in the 1990s, and it is not likely to go through that now. For this is not a country of revolutions, but rather one that tends to follow a course faithfully and steadily once it has been agreed upon and set.

For the past decade, although the main approach to the country´s immediate macroeconomic and financial woes has been one of muddling through and hoping for the best, there has been a gradual process of reform, of setting new courses and parameters for behaviour. This has consisted of an accumulation of many small changes—some in politics, but also in financial regulation, in corporate law, in public opinion, in capital markets, in corporate mores. The two big questions have been, first, whether that process will endure; and, second, whether the burdens of the past—debt, deflation, corruption, labour protection—will continue to overwhelm the benefits that come from those changes, or whether Japan might soon be in a position to grow and develop again as a normal country might.

September´s election answered the first question. But to answer that second question, it is no good speculating about politics, nor expecting the politicians to produce radical, invigorating reforms. They have neither the power nor the capability for that. The place to look is not in the fancy headlines of politics but deep in the fabric of Japan´s economy and society. And although there may not be one single reason to expect a transformation, there may well be one single field of data that currently holds the clue as to whether economic recovery is going to be sustainable in the longer term, as well as exemplifying some of the biggest changes that have taken place. That field is employment and wages.

The Japan of old was known as the country of “lifetime employment”, a somewhat exaggerated but still important notion that in return for loyalty and flexibility big employers typically offered a lifetime commitment to their workers, with associated company unions, generous fringe benefits and pay rising according to age and seniority. That also made for a fairly egalitarian society. Shock therapy would have shattered the lifetime notion, producing a big rise in unemployment. So it never happened: most big companies chose to maintain their commitment, asking workers to take pay cuts and waive bonuses rather than lose their jobs, but ceased to hire new graduates. Less than half as many new graduates were hired in 2003 as in 1997.

But also, helped by changes to employment law, firms found flexibility in another way: by hiring part-timers and others on temporary contracts, both at far lower cost than for regular workers. In 1990 such “non-regular” workers made up 18.8% of the labour force. Earlier this year, that figure reached 30%, which in Japan´s 65m-strong labour force means roughly 20m people. Those workers are predominantly women, the young and the fairly low-skilled. Since 2003, the law has allowed contracts to be counted as temporary, and thus cheap, for up to three years. The use of contract workers remains forbidden in some sectors that employ lots of people, including health care and construction, but has gradually become permitted almost everywhere else. Canon, for example, a successful electronics firm that still firmly maintains a lifetime commitment for its “core” workers, employs fully 70% of its Japanese factory staff on such “non-regular” terms, up from 50% five years ago and 10% a decade ago, according to Fujio Mitarai, Canon´s president.

This new labour flexibility has contributed to a boom in company profits and to the paying down of debt. In 1998 workers´ pay equalled about 73% of corporate earnings. By 2004 the proportion had dropped to 64%. Other factors helped too, most notably a big rise in exports to China in 2002-04, which revitalised manufacturers of all kinds, whether metal-bashers or precision engineers, and a series of bank nationalisations and mergers in 1998-2004 during which bad loans worth trillions of yen came good or were written off.

As a result, the gigantic pile of dud corporate debt for which Japan became notorious in the late 1990s is now a lot smaller: from a peak of more than ¥43 trillion in 2001, non-performing loans held by banks have more than halved to less than ¥20 trillion (see chart 2). The number is now also thought to be more or less accurate, whereas until 2001 or so official figures for non-performing loans were appallingly and deliberately underestimated.

Labour flexibility came at a price, however. Falling wages boosted profits but also weakened demand. In recent years, consumption has been sustained only by households choosing to save less of their incomes: the Japan that in the 1980s was reputed to be a nation of savers now has a household saving rate of merely 5% of disposable income, one-third of its level in 1990. New jobs have been created, but as 2005 began most were still part-time or on temporary contracts. Part-time workers in Japan get on average less than half the full-time hourly wage. The lowlier contract workers, such as shelf-stackers in convenience stores, can expect ¥600-800 per hour, which is well below the British legal minimum wage. Little wonder that an economic commentator, Takuro Morinaga, topped the bestseller charts in 2003-04 with a book on how to live on ¥3m a year. So much for the idea of Japan as a high-cost country.

As long as wages were falling and the new employment being created was the cheaper, less secure sort, there was little chance that economic growth could become truly sustainable. The cost-reduction and flexibility may have been a necessary condition of eventual recovery, but could not itself bring it about. Rather as in America during the Great Depression, declining demand has helped to neutralise improvements taking place elsewhere in the economy. Moreover, there are limits to what export-led growth, the great hope of 2002-04, can achieve, given Japan´s already large current-account surplus (3.6% of GDP), the chance that the yen will strengthen against the dollar and the danger of slower demand in Japan´s top foreign markets, China and America.

Since April, however, the employment data have shown something new and more promising: full-time employment is growing faster than the part-time sort for the first time in a decade, and although some of that growth is still in full-time contract work, regular employment is rising too. Wages are also rising, at their fastest rate since 1998 (which mainly means they are simply rising, at last), and bonuses are again being paid.

It is still early days—too early to tell how strong this rise in employment and incomes will prove to be. Probably, its effect will be gradual: people may try to rebuild their savings rather than spending all their gains, competition from low-cost China and India will help limit wage gains, and firms scarred by the past 15 years are unlikely to embark upon an investment and hiring binge. What this development does suggest, though, is that the last of the three excesses that have burdened the economy since 1990—excess corporate debt, excess capacity and excess labour—may now finally be on the point of elimination.


Learning to spend again

Elimination is probably too strong a word, for whether something is excessive is a subjective question. The ratio of debt to operating profits for large and medium-sized firms is down to levels typical in the 1980s, ie, less than 10%, compared with 15-20% at the peak in 1999. Smaller firms still hold debt of nearly 15% of operating profits, but that too is down from over 20% in 1999. Excess capacity is a particularly subjective matter: the capacity-utilisation rate reported by the Ministry of Economy, Trade and Industry is back up to 1992 levels, and businessmen´s perceptions, as reported in the Bank of Japan´s regular Tankan survey, are that excess capacity has largely disappeared.

The important issues now, though, revolve around risk, stability and incentives. During the 1990s, although Japan experienced only stagnation rather than collapse, there was always a risk that collapse might come. With corporate debt cleaned up and banks reformed, that risk has gone. Banks certainly think so: their lending has recently started to expand again for the first time since 1998. The alternative now seems to be either slow growth or faster growth, not growth or slump. Moreover, an economy that relies on increases in private spending, by households and by companies, is likely to follow a more stable path than one that depends solely on export demand or public spending. What matters most, though, is how that spending will be used. And that is a question of whether the incentives governing such spending have changed: the incentives for companies to waste the money or use it well, and the incentives for politicians and bureaucrats to abuse it, steal it or otherwise distort it.

That is where the many other small changes come in. A simple way to understand what happened to Japan in the 1980s and 1990s is that a country with many strengths, especially a high average level of education, formidable technology and powerful social co-ordination within companies, came to lose its basic disciplines and incentives, particularly in the late 1980s when it experienced one of the biggest asset booms in world history. Flushed with success and with seemingly costless capital, companies expanded and diversified recklessly. Banks lent regardless of risk or business viability. Bureaucrats and politicians resisted calls for deregulation that could have extended competition and encouraged innovation, because they did not think it was necessary. Interest groups anyway blocked change, chiefly by bribing politicians. The mass media were largely suborned by the political and corporate establishment.

The collapse of the stock- and property booms after 1990 and the ensuing recession might have been expected to shake all this up. It didn´t, for two main reasons. The first was that the principal economic response to the slump, ie, massive public-works spending, further enriched some pressure groups and many politicians, making them even more able to resist change, and an expansionary monetary policy deadened the price mechanism that ought to have imposed discipline. The second was that for a mixture of social and psychological reasons, neither bureaucrats nor companies chose to admit what was really happening.

Provincial cities and rural areas have suffered greatly, with shuttered-up streets and rising levels of poverty

A 15-year gradual work-off of the excesses inherited from the 1980s would not have been what most analysts would have recommended or even expected in 1990, whether they were rude foreign lecturers or polite Japanese. And it has been a more painful period than any visits limited to prosperous Tokyo would suggest. Provincial cities and rural areas have suffered greatly, with shuttered-up streets and rising levels of poverty. Suicides have soared, up more than 50% since 1990 to 34,500 in 2003. By Japan´s standards, crime has risen too, though it remains low in comparison with America and most of western Europe. Still, compared with what might have happened in most other developed countries had they gone through the same prolonged experience, Japanese society has remained remarkably stable.

Yet although society has been stable, the appearance of policy paralysis is misleading. Actually, bit by bit, step by step, a great deal has been changed, in what may come to look with hindsight like a sort of revolution by stealth. The changes are still continuing and being battled over, so it is too soon to judge whether that word will in the end be justified. But what this revolution-in-progress has already done is to alter many of the incentives surrounding political and corporate behaviour.

It needed to, because in 1985-95 Japanese companies proved incredibly bad at using their own money—or rather, their shareholders´ money. Neither commercial law nor the courts helped the shareholders´ cause very much. Banks supposedly provided the discipline in the system through their ability to intervene in their big customers´ affairs when things went wrong, but such interventions became rarer as the asset bubble inflated, and then rarer still once the banks got into at least as much trouble as their customers. Then, banks kept alive what became known as “zombie” companies for fear of acknowledging their bad loans, of creating unemployment or of upsetting the whole collective applecart.

This used to be called financial socialism, which was meant as a compliment. That time has long gone. Now, a joke is circulating in Tokyo about Chinese students on a course there. Someone asks them why they spend so much time with other Chinese rather than with Japanese students. Their answer: because we are afraid the Japanese might teach us communism. The way things are going, the joke might soon become obsolete.

Capitalism with Japanese characteristics

Suddenly, shareholders are beginning to matter

Rex Features
Rex Features

Mr Horie is a livewire too

TAKAFUMI HORIE is proof of the rewards of failure—and of “Livin´ on the edge”, which is what he called his company until he bought an internet portal called livedoor and adopted its name. This 32-year-old´s daring takeover bid earlier this year for the venerable media group Fujisankei Communications, via its radio subsidiary Nippon Broadcasting System, ended in defeat: Fuji found a white knight to hold a blocking slab of its shares and forced Mr Horie to retreat with only a small profit and a modest business deal between Fuji and livedoor. In July 2004 his bid for a baseball team, the Osaka Kintetsu Buffaloes, also failed. Yet the attendant publicity helped livedoor hugely: page views at its portal in June this year were more than six times higher than a year earlier, and the company has raised its advertising rates twice in less than six months. It remains a distant third in the internet portal business behind Yahoo! Japan and Rakuten, but its share price has stayed high despite stock dilution and the Fuji bid´s failure, and its earnings multiple is higher than that of Yahoo! Japan.

“The nail that sticks up”, runs a hoary Japanese saying, “gets hammered down.” Yet Mr Horie is an upstanding nail who has become famous as well as much admired, according to opinion polls, for his willingness to challenge old ways of doing things. He even ran (unsuccessfully) for the Diet in September´s elections. And he is not alone in breaking taboos. Hot on the heels of his bid, in July a young construction design firm, Yumeshin Holdings, launched a hostile tender offer for an older firm, Japan Engineering Consultants. And last year Sumitomo-Mitsui Financial Group, one of Japan´s biggest banks, barged its way into a friendly merger deal between two other mega-banks, Mitsubishi-Tokyo Financial Group (MTFG) and UFJ Holdings, offering to buy UFJ for a specified price. That may sound mundane, but to Japanese sensibilities it was shocking, because UFJ´s board had already accepted the merger proposal, even though no price had been set.

A related bank, Sumitomo Trust, weighed in too, seeking a court injunction to block the MTFG-UFJ merger on the ground that it violated a prior deal under which it was to buy a UFJ division. In the end, after a protracted battle in the courts and the capital markets, MTFG prevailed, but only at a cost: cash compensation for Sumitomo Trust, a big cash injection into UFJ to help it deal with its bad loans and a higher price for shareholders than it would otherwise have been paying.

The livedoor-Fuji battle, the Yumeshin bid and the mega-bank sumo-wrestling match illustrate three important developments. The first is a new willingness to use the courts as arbiters in corporate disputes, which reflects both changes in attitudes and changes in the law. Livedoor managed to get several of Fuji´s attempted defence manoeuvres struck down by the courts before Fuji´s white knight came along. Yumeshin failed to block Japan Engineering´s defences of a stock split and an equity warrant issue, but the Tokyo District Court laid down reassuring criteria for their use: that they must not simply be in the board´s self-interest, and that they are subject to shareholders´ approval.

Secondly, a change in the ownership pattern of publicly traded shares is making transactions and challenges easier. In 1992, according to the Ministry of Economy, Trade and Industry, 46% of all listed equities were held as cross-shareholdings by related companies, and only 6% by foreign investors. In 2004, cross-shareholdings accounted for merely 24% of shares whereas foreign ownership had risen to 22% of the total. However, that foreign slice is volatile, moving up and down along with investing institutions´ perception of the Japanese market. Cross-shareholdings first became prominent during a fright about hostile takeovers in the 1960s, so there is a chance that scared managements may now seek to rebuild them. Against that, though, new capital-adequacy rules due to take effect in 2006-07 will force Japanese banks to sell more of their holdings.

The third development is still small but is emerging steadily. It is the arrival on the scene of funds and partnerships willing to use their investments to challenge existing managements or to act as intermediaries to facilitate mergers and disposals. One example is M&A Consulting, a shareholder-activist fund that also profited from building a stake in Nippon Broadcasting System earlier this year, and which has specialised in pressing managements to use their cash piles to raise dividends and make share buybacks. Another is Privee Zurich Turnaround Group, a private-equity fund which despite its name is thoroughly Japanese, and which has also flirted with hostile bids. A third is Advantage Partners, a private-equity investor chiefly in the business of acquiring assets from companies being split up or turned around.

Alongside these new Japanese species there are the larger and more familiar foreign funds: Ripplewood Holdings, which with J.C. Flowers & Co made a fortune by buying Shinsei Bank, formerly Long-Term Credit Bank of Japan, from the government in 2000 and transforming it; Carlyle Group; Lone Star; Cerberus; and several others. By and large, though, it is the Japanese upstarts that are acting most aggressively, whereas the foreign funds try to stress how socially responsible they are.

Both make up only a small slice of market activity. But no matter: in any business, pressure on the margin can influence the rest. To some degree, indeed, these ginger groups have been encouraged by people in the Japanese establishment with just that thought in mind. Mr Horie may be an outsider, but plenty of the activist funds are run and staffed by well-connected former bureaucrats and by people in their 30s and 40s who lost their jobs or their loyalty during the banking meltdown of the 1990s. M&A Consulting, for example, is run by three partners, two of whom are former bureaucrats and the third used to work for Nomura Securities. An early investor in the firm, and a crucial provider of introductions, was Toshihiko Fukui, before he became governor of the Bank of Japan. Similarly, Ripplewood managed to recruit several senior Japanese to its board, including Minoru Makihara, then chairman of Mitsubishi Corporation, the trading and investment firm that epitomises the Japanese establishment.

The livedoor bid for Fuji illustrated another point about Japanese capitalism: that for a seemingly cosseted, conformist activity, it is strikingly unregulated. When almost everyone obeys unwritten rules, little attention needs to be paid to the written ones. So the supposedly heroic Mr Horie was able to mount his bid in ways that would be considered outrageous in London or New York: he built up his 35% stake in NBS in off-market trading, diluted his own investors´ shareholdings without consulting them and never offered a standard price to all NBS shareholders.

Part of the problem is that takeovers and other pressures from shareholders were long considered taboo or irrelevant. The protective role of main banks and cross-shareholdings was enough to regulate matters. Now that both of those protections are weakening, there is a fairly broad consensus that the law and the regulatory system need to be changed. But that change is happening slowly. An optimistic view is that the process is at roughly the halfway stage. Still, some important progress has already been made.

One of the worst corporate sins of the 1980s was the use of subsidiaries to hide problems, park surplus staff or disguise adventures: they did not have to be consolidated into profit-and-loss accounts. New holding-company and accounting laws in 1999-2001 changed that. A so-called “big bang” of financial reform in 1998 was in truth more like a slow drum roll, but it brought in a new regulatory body, the Financial Services Agency, with the job of supervising financial institutions and accounting practices.

One obstacle to firms selling divisions and subsidiaries to each other was a rule that required an appraisal of all the division´s assets by a court-appointed inspector. In 2000 a new law abolished that rule for “non-core” business units, defined as small, underperforming ones. That does not go far enough—firms ought to be free to sell what they like—but it has stimulated a lot of trading in distressed assets. Another new rule has reduced the capital requirement for new limited companies to just ¥1, down from ¥3m.

Virtually the whole of the Japanese commercial code is being overhauled along similar lines. Nevertheless, with politicians afraid of instability and especially foreign takeovers, and under pressure from big employers, many of the reforms so far have been as helpful to corporate defence as offence. Laws already passed have permitted companies to offer shares with differential voting rights, to grant stock acquisition rights through options and warrants, and to set up such provisions as a “poison pill” to be deployed in the event of a takeover bid.

On the other hand, the law has defined the proper purposes of such measures as well as the need for shareholder meetings to approve them. And it has made proxy votes against such measures easier. All that has helped boost the role of the courts. Earlier this year the Tokyo District Court rejected a crude poison pill proposed by Nireco, an instrument-maker.

The role of shareholders has been boosted too: at the spate of annual meetings on June 29th shareholders rejected poison-pill proposals at several big firms, including Tokyo Electron, Fanuc and Yokogawa Electric. Many other similar proposals passed, but significantly even some Japanese institutional investors took part in anti-management votes. Previously they had been quiescent.

One provision the Diet (parliament) considered too hot to handle was a reform to allow foreign firms to use their own shares as currency in acquisitions in Japan, whether hostile or friendly. This would bring the rules for foreigners into line with those already in place for Japanese companies. But in April the measure was postponed for a year. Unless there is a big controversial cross-border battle in the meantime, however, it stands a good chance of being passed in due course.

Another area of law that needs further refinement is the definition in corporate governance of outside directors: they have been given an enhanced role, especially in big firms that choose to adopt an American-style board committee system, but there is no requirement that they be wholly independent. Seibu, a railway and property giant whose autocratic boss, Yoshiaki Tsutsumi, was charged with fraud earlier this year, held no board meetings for seven years. It did have outside directors, but they all had business relationships with Mr Tsutsumi.

For all the fuss over hostile takeovers, however, such battles are rare even in America, which sees barely one each year. Even the theoretical possibility of such an event, though, helps put pressure on managements to improve their profits as well as to pay dividends to shareholders. Japanese corporate profits are at a record high mainly for other reasons, but market pressure has literally paid dividends: in the past seven years the dividend yield for firms listed in Tokyo has almost doubled (see chart 3).

Even so, the most important sort of transaction, in Japan as in America, is the friendly sort, whether involving whole firms or divisions of them. In the first eight months of this year, according to the Nihon Keizai financial daily, 1,735 M&A deals were completed, 28% up on a year earlier.

As James Abegglen, a veteran consultant and scholar in Tokyo, observes in his recent book, “Redesigning the Kaisha”, the consolidation of whole industries during the past decade has been impressive: from 14 oil companies to four; from seven big cement firms to three; from 14 pulp and paper companies to three; from seven industrial gas firms to three; from five big steel firms to four; from 15 big banks to just three. And big companies have traded or closed thousands of subsidiaries.

Neither the lawyers nor the financial advisers have been idle. Many of Japan´s biggest and most internationally famed firms are now more focused and efficient than before. Their scale and new concentration will make it easier for them to compete abroad. But for them, and even more for the huge array of domestic firms, there is another, more important question: is there enough competition at home to keep them all on their toes?

Deregulation during the 1990s, in fields such as telecoms, transport, energy, finance and retailing, benefited consumers to the tune of 4.6% of GDP in 2002, or so the Cabinet Office claims. This certainly helped, though the OECD reports that Japanese electricity and telecoms prices, for example, remain the highest among that organisation´s rich-country members. But perhaps the biggest issue now is whether Japanese anti-monopoly laws stand a chance of being enforced.

There is certainly some political will to do so. Amendments to antitrust law passed by the Diet in April and due to come into effect early in 2006 will bring four main changes: an increase in the penalties for breaking the law from 6% of affected sales for most large firms to 10%, with surcharges for repeat offenders; the introduction of a new incentive for cartel members to blow the whistle by offering discounted fines for those who come clean early; new powers for the Fair Trade Commission, Japan´s trust-buster, to make raids and seize documents; and new powers for the FTC to issue cease-and-desist orders before holding a hearing rather than waiting until afterwards.

That all sounds robust, and the new law was passed despite opposition to its first draft from big businesses. Yet those penalties remain lower than those used in the European Union and America. And in the past Japan has been none too assiduous in enforcing what legislation it had in this area. The OECD notes that there have been only 13 criminal antitrust cases in Japan since 1950, and that no one has ever gone to jail for breaking competition law.

Until 2002 the FTC was a small body with a low status, firmly under a ministry´s thumb. However, one of the less noticed moves of the prime minister, Mr Koizumi, was that he shifted the FTC so that it now reports directly to the Cabinet Office, and gave it a new boss and a bit more money. Whereas in 1995 the FTC had 220 investigators and a budget of ¥5.24 billion, last year it had 331 investigators and a budget of ¥7.82 billion.

There are some omens that bode well for stronger enforcement. Just as the courts have played a bigger role in securities disputes, so the Tokyo Stock Exchange acted decisively when Seibu´s frauds were disclosed, forcing the firm to delist in December last year. The FTC too has become more active. In March it fined six steel firms a total of ¥6.8 billion for price-fixing. Barely a week goes by without an FTC raid or an indictment of a construction company or a member of staff of the Japan Public Highway Corporation, a soon-to-be-privatised government agency, for rigging bids for bridge contracts. In May, the FTC filed a criminal prosecution of eight such companies.

It could be argued, though, that the TSE acted only once the game was up for Seibu. The bridge scandal too has been convenient for the government: Mr Koizumi wanted to show that privatisation will make a big difference, and to discredit the agency´s top bureaucrats sufficiently to ensure that they cannot scupper the plan. Yet if competition enforcement is simply a product of the political winds, what if the winds change?

New politics, old politicians

It will never be the same again. Well, not quite, anyway


One of them stands out

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IN SEPTEMBER 1998 the cover of The Economist carried the headline “Japan´s amazing ability to disappoint”, commenting on the government´s bungling of yet another bank-rescue plan. It attracted a petulant protest from the Japanese embassy in London. Motoo Shiina, a veteran Diet member, offered a more thoughtful dissent: the correct headline, he said, would have been “The Japanese people´s amazing ability not to be disappointed”. Not so snappy, perhaps, but he had a point: surely in no other democracy would the same party that had been running the country continuously since 1955—the Liberal Democrats—have been left in government following a financial crash and an economic slump to which they had found no solution. They did lose power for all of ten months in 1993-94, but then returned to government, albeit leading a series of coalitions. And they have just been returned to power once again in a landslide, giving them their biggest parliamentary majority since 1986, despite having presided over 15 years of stagnation.

That account, of course, leaves out Junichiro Koizumi, who since 2001 has led the LDP and served as prime minister, and whose early slogan was “change the LDP to change Japan”. His electoral genius at first looked as though it might be limited to his photogenic long wavy hair and clever marketing techniques, including his Lionheart e-mail magazine. The election result on September 11th, though, proved that there is rather more to him than that. By calling a snap general election over a single issue of economic reform, the privatisation of Japan Post, which had been opposed by rebels in the LDP but also, crucially, by the main opposition party, the Democratic Party of Japan, he managed the seemingly impossible: to cast the LDP, the ultimate guardian of the status quo, as the party of change. No, you might object, he cast himself as the bringer of change, not the LDP. Yes, but under the party´s rules Mr Koizumi has only one more year to serve as leader. Then, unless the rules are changed to extend his term, someone else will inherit the powerful position he has just built for his party. The long-term winner of the September 11th election was the LDP, not Mr Koizumi.

That raises a crucial question: might it all be just a mirage? That thought is raised, first, by how exceptional Mr Koizumi looks when you compare him with other LDP politicians. He has already lasted longer in office than any prime minister since Yasuhiro Nakasone (1982-87), who was himself the longest-serving since the postwar record-holder, Eisaku Sato (1964-72). Although Mr Koizumi has been a career party member and comes from a political family, in politics he is a loner. He is said to have no real party friends and no political support group. Once he is out of power, which could be in September 2006, or at the latest one or two years later, most people expect him to leave politics altogether.

The concern is reinforced if you examine Mr Koizumi´s record of pushing his supposedly bold reforms through the Diet in the past four years. To get his way against a lot of opposition from bureaucrats and from inside the party, he broke with tradition by using non-politicians to front his schemes: Naoki Inose, a historical writer, for the privatisation of the Japan Public Highway Corporation, the agency in charge of building roads and bridges that has been at the heart of the country´s corrupt and wasteful public-works schemes; Heizo Takenaka, an economics professor and, since 2001, his main economic-reform minister, for the privatisation of Japan Post. Their styles have been very different: while Mr Inose has shot from the lip in the effort to discredit his opponents, Mr Takenaka has beavered away more quietly. But the outcomes have been similar: such reform as has occurred has been heavily watered down. In the case of Japan Post it was even rejected—until Mr Koizumi won his landslide.

Now, Japan Post will indeed be reorganised and sold off—but over a period of more than a decade. This reform, like that of the highway agency, matters chiefly because the postal savings bank has been responsible for huge distortions in the allocation of funds, and with it a great deal of political corruption. It also matters because, after a decade of high public spending, the national gross public debt has reached 170% of GDP, just when the population is ageing rapidly, opening up the prospect of lower tax revenues and higher medical and pension costs.

Moreover, Japan Post, with subsidised deposits and insurance policies worth ¥330 trillion, taking 30% of all personal deposits and 40% of life insurance, has sat like an elephant in the middle of the financial-services business, skewing the market against the commercial banks and insurers and distorting the price mechanisms that would otherwise direct money flows to the best advantage. So Messrs Koizumi and Takenaka are reorganising the elephant into four separate parts arranged under a joint holding company, handling mail delivery, post offices, savings and insurance respectively. Each will have a profit-and-loss account, but all will remain publicly owned until at least 2017. Savings deposits have already lost their subsidies, though, and the banking and insurance divisions will now have to pay more attention to risk and returns.

Similarly, the highway agency has been split into six, with effect from October 1st, but will remain in public ownership for the time being. The main hope there, too, is that by giving the new roads agencies the obligation to service and repay an accumulated ¥40 trillion of debt, they can be made to act in a more businesslike and disciplined fashion.

The direction of policy under Mr Koizumi is thus clear: state lending and spending needs to be given new constraints and incentives, he thinks, and ultimately to be shrunk. Later this year, Mr Takenaka says, he will turn his attention to eight other state-owned banks. There was also talk in the LDP´s election manifesto of reforms to the public health-care system and to pensions, though few details were given.

Resistance to shrinking the state is stiff, however, not so much on ideological grounds as from interest groups: the construction industry, the bureaucrats, the medical profession, postal workers, all of whom have cultivated politicians to further their cause, particularly in the LDP. That is why Mr Koizumi and his front men from outside politics have struggled to make headway. But it also should prompt reflection on the paradoxical nature of the election result: that Mr Koizumi won his apparent mandate for change against an opposition party, the DPJ, whose manifesto actually proposed much more radical reforms, including a more rapid shrinking of the state. Yet the DPJ was crushed, losing one-third of its seats. Its dull but very worthy leader, Katsuya Okada, resigned.

That paradoxical result is testament both to Mr Koizumi´s tactical brilliance and to Mr Okada´s fatal mistake in getting his party to oppose postal privatisation in the Diet. He did that because the DPJ is an awkward collection, created only in 1996-98, of former LDP members, former socialists and young, genuinely liberal newcomers; the socialists among them retain close ties to the postal workers´ union.

For now, though, the DPJ´s defeat has destroyed the long-held dream of many political pundits: that Japan would develop a two-party system and have alternating governments. The LDP has regained its traditional dominance. If its coalition with a small Buddhist-backed party, New Komeito, survives, then the pair´s two-thirds majority in the Diet´s lower house will henceforth allow it to get its way on everything bar a revision to the constitution (which also requires a two-thirds majority in the upper house, where the LDP is weaker, and a simple majority in a national referendum).

But is it the same LDP, or has Mr Koizumi succeeded in changing it, as he promised? Essentially, he has changed it in three ways, none of which is guaranteed to survive his retirement but all of which stand a chance of doing so. The first is that he has severely disabled the system of factions which had long run the party. The factions existed primarily to raise money and to hand out jobs. The introduction of public funding for political parties in 1994 weakened the fund-raising function, as did an electoral reform at the same time that replaced multi-member constituencies (for which party factions therefore competed) with a mixture of single-member seats and proportional representation. Mr Koizumi demonstrated that the factions were weakening by winning the party´s leadership election in 2001 against a candidate from the richest and supposedly strongest faction, and rubbed in the lesson by ignoring the factions when appointing his cabinet. They still exist, but for the moment mainly as networking groups rather than power centres.

Mr Koizumi´s second change has been to concentrate power in the hands of the party´s secretary-general (who is appointed by him) and, within the government, in the prime minister´s office. Public funding for political parties had already added to the secretary-general´s role, because the money (a total of ¥30 billion a year for all parties) is channelled through each party headquarters. Since 2003 the same has been true for political funding supplied by Nippon Keidanren, the employers´ federation. That stronger party role was on display in August when Mr Koizumi ordered the expulsion of 37 LDP members of the lower house who had opposed his postal privatisation bills.

Under this new regime, advancement within the party depends on loyalty to the leadership more than to the factions. Within the government, too, the leadership has been strengthened. For decades, Japanese prime ministers have been fairly weak figures, with party power diffused by the factions and governmental power dominated by the ministries. That worked, you could argue, because informal co-ordination between the elites in the bureaucracy, the LDP and big business was strong, though that also led to corruption and a lack of accountability. As in other countries, a blend of economic and social change, scandals and public hostility has discredited that old-boy network (which in Japan was called the iron triangle), requiring its partial replacement by more formal, rule-based structures.

Under Mr Koizumi that process of replacement has been accelerated, with more money and staff for the prime minister´s office and a reorganisation of ministries to establish a new hierarchy. One main tool of that new control is the Council of Economic and Fiscal Policy, which is chaired by the prime minister and steered by his economics supremo, Mr Takenaka. In theory at least, that council can boss even the finance ministry about.

“In theory” is an important qualification, for much depends on how these new powers are used, and by whom. The third way in which Mr Koizumi has changed politics could determine that, although it is the most uncertain of all. What he seems to have shown is that the way to gain and hold power is by appealing to the public, by making gestures of leadership and by favouring change. Budding successors who would like to continue in that vein, either by choice or because that is the way to win elections, should thus be expected to follow Mr Koizumi´s lead in disabling party factions, centralising party power and strengthening the prime minister´s office. But will they? A two-thirds majority in the Diet, with an enfeebled opposition, could cause them to move the other way: if you feel untouchable, why bother with public opinion?

By continuing a policy begun in 1998 by an earlier prime minister, Ryutaro Hashimoto, of cutting public-works spending, and now reinforcing it through reforms to Japan Post and the highway agency, Mr Koizumi has probably put an end to pork-barrel politics. The demographic squeeze on public finances will make that almost impossible to reverse. The successors to Mr Koizumi most often mooted within the party—Shinzo Abe, a fairly right-wing former LDP secretary-general who is both youthful and telegenic, and Yasuo Fukuda, a respected former cabinet secretary—suggest that the old stuffed-shirt politics might also be in abeyance. But in a newly victorious party, personal support could shift rapidly. That makes it premature to make assumptions about the succession.

There are, though, more lasting signs that inspire some confidence about the direction and durability of change. The basic incentives surrounding politicians were altered not by the exceptional Mr Koizumi but by those electoral and campaign-finance reforms back in 1994. Political ethics laws from that same period have sought to crack down on corruption, as has a 1994 provision that made candidates legally responsible for illegal actions by their campaign supporters even if they have no direct knowledge of them. These changes have not eliminated corruption by any means, but they have constrained it.

Meanwhile, the voice of public opinion has been getting gently but steadily stronger. Disappointment with the old guard has long been coming through clearly in local elections for city mayors and prefectural governors, where all sorts of mavericks and outsiders have gained power. September´s vote demonstrated at least a desire for change at national level too. Also, though, it has become easier for non-party groups to influence policy outside the Diet. Until 1998, individuals could not readily form lobby groups or associations to promote their particular hobby-horses, because such non-profit organisations had no legal basis. Since then, more than 20,000 have been recognised under a new law. Crucially, they do not yet benefit from the sort of tax exemptions that help explain why America has more than 1.4m non-profits. But even this small vanguard is beginning to have an impact on policy debates, though mainly at local level, and to launch legal challenges to companies and to the government.

That public pressure is now more easily applied thanks to a freedom-of-information law which was passed in 2001, and to quite sweeping judicial reforms that became law in 2002-04. These have resulted in the opening of 68 new professional schools designed to double the number of qualified lawyers over the next decade or so; in the imposition of a two-year time limit on all first-instance trials of criminal and civil cases; in the creation of a new intellectual-property court; and in a new mechanism for involving citizens on judicial panels in criminal cases.

As Jeff Kingston, a professor at Temple University in Tokyo, writes in his excellent book “Japan´s Quiet Transformation”, what is happening is that the old system of “rule by law”, with wide administrative discretion and limited legal redress, is being replaced by something more akin to “rule of law”. It is the same trend as that evident in policy co-ordination by elites and the evolution of corporate law: old methods of discretionary power based on unwritten rules are fading away, with new structures and new written rules rising to take their place.

Not surprisingly, not everyone feels comfortable with this increase in the role and number of lawyers. But the increasing role for public opinion is causing some disquiet too. Being popular and campaigning publicly for change, as Mr Koizumi does, is all very fine and democratic, but alongside such virtues has also come a possible vice: anti-Chinese nationalism. Mr Koizumi is no sophisticate in foreign affairs, but in his four years in office he has achieved a steady expansion of Japan´s constitutionally limited military role, for example by sending troops to Iraq, and a steady deterioration in Japan´s relationship with two of its neighbours, China and South Korea. Until September´s election, those worried by such developments could comfort themselves with the hope that the opposition, the DPJ, which adopted a much less assertive, more diplomatic foreign stance, could either become the next government or else restrain the LDP. No longer. Like its old foes in China, Japan is now back to one-party rule.

New East Asia, old enmities

China´s growth has changed Japan´s region, but is also changing Japan´s politics


Unfriendly neighbours

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AMONG the forces pressing upon Japan, none has changed more since the country´s asset-bubble burst in 1990 than its own neighbourhood. Where 15 years ago China was merely a pariah with economic potential, having recently massacred protesters in Tiananmen Square, it now has a better international reputation and a much admired (and two and a half times larger) economy. Where the Soviet Union was then Japan´s principal military concern, as it had been for the previous four decades, that threat is no more. Where Japan was then a rarity as an East Asian democracy, with just the young Philippines democracy and the dictatorial sort in Malaysia and Singapore as company, now it has been joined by South Korea, Taiwan, Thailand and Indonesia. Where then Japan depended on exports to America and western Europe, now trade with other Asian countries makes up 45% of the country´s total. In both economic and political terms, Japan is no longer alone in Asia.

Yet it is not really together with its new friends either. For one thing has, if anything, got worse: Japan´s argument both with itself and, more painfully, with its neighbours about its 20th-century history. This year, there have been mass demonstrations in both communist China and democratic South Korea against Japan, accusing it of refusing to face up to its past. Japan´s efforts to gain a permanent seat on the United Nations Security Council if there is a broad reform of council membership have been set back.

Perhaps this doesn´t matter much, except to diplomats? Japan has lived with arguments about history ever since 1945, without suffering too much harm. Two factors, however, make that sanguine response look unwise. One is that there is a new threat in the region, or at least a more worrying old threat. That is North Korea, which gave Japan the jitters in 1998 when it tested a long-range missile by sending it flying over Japan; which caused great anguish and anger in 2002 when it admitted at last to having abducted Japanese citizens over several decades; and which now claims to have made several nuclear weapons. Japan is one of the five countries taking part in joint talks with North Korea about these issues (the others are China, Russia, America and South Korea), and stands shoulder to shoulder with its American ally in urging a tough line on the hermit kingdom. But Japan is in a weak position to convince China and South Korea to be tough too, because of its poor relationship with both countries.

The American alliance, first formalised in the US-Japan Security Treaty in 1960 and strengthened several times since, bolsters Japan´s confidence in the face both of North Korea and of those poor neighbourhood relationships. Participation in America´s missile-defence plan, while remaining under America´s nuclear umbrella, may well be Japan´s best form of insurance. Nevertheless, with public opinion sensitised by North Korean provocations, the government has exploited the situation to give itself a bit more autonomy in military and intelligence matters: it has launched its own spy satellites and has been shifting its defence spending away from tanks and towards advanced warships and submarine-detection technology. And in the longer term, North Korean collapse may be as much of a threat as the current regime´s sabre-rattling, for unification on the Korean peninsula would create a still-larger neighbour with whom Japan has rocky relations, and might force a rethink about America´s military deployments in Asia.

The second anti-sanguinity factor is China. It is not that China poses a big threat to Japan now, in military, political or economic terms. It is expanding its defence spending rapidly, by 12.6% in the past year, but its armed forces remain less advanced than Japan´s constitutionally constrained “self-defence forces”. The main threat China´s defence build-up currently poses is that it might get strong enough to confront Taiwan, which would give Japan an almighty headache. But in that case Japan would not be the only one reaching for the aspirin. In regional politics, moreover, other Asian countries are as suspicious of China as they are of Japan. They may like China´s market, but none is dependent on it: in 1999-2004, according to BNP Paribas, South Korea was the Asian country with the strongest trade links to China, but China still accounted for only 10% of its imports and 14% of its exports.

Nor does China represent an immediate economic danger for Japan. The two economies are strikingly complementary, with Japan hogging the sophisticated end of the electronics, engineering and vehicle industries and China occupying the cheaper end. Competition from South Korea for Japan´s top companies is much stiffer than that from China: Samsung in electronics, POSCO in steel, Hyundai in cars and ships have all given Japanese firms more pause for thought than have Chinese companies. That, alas, helps to explain why Chinese competition has not yet shocked Japan into economic reform. China is not as big a concern for high-tech Japan as it is, say, for mid-tech Italy.

The real worry is not about present threats at all; it is about a future that appears to be unfolding with disconcerting speed. If China´s economy, its regional clout and its defence spending all continue to grow at something like their current rates, then China threatens to overshadow the whole region and, more pertinently, Japan, during the next quarter-century or so. As that happens, other Asian countries might feel forced to swallow their distrust of the Chinese dragon and seek friendship with it for fear of something worse. And China could come to set the rules for regional deals, whether in trade, investment, the environment or even security.

That would injure Japan´s national pride but could also hurt its national interests. For Japan, too, would like to be the rule-setter, the top dog in the region. In that regard, what is in prospect is just a resumption of a natural historical rivalry that has lasted a thousand years or more. Like Britain in relation to France and Germany, Japan as an offshore island has always wanted to retain its independence from the continental power. But, also like Britain, it has an interest in gaining influence over trends in its neighbourhood, lest they become harmful to it. That wasn´t necessary for 45 years after 1945. Now, the same trends that are making such influence necessary are changing Japanese politics in ways that risk making it harder to attain.

The combination of North Korean provocations and Chinese bullying over history are pushing Japanese politics further to the right. Even the once slavishly pacifist left-wing daily paper, the Asahi Shimbun, has adopted a more strident line especially on North Korea but also on China´s recent anti-Japanese demonstrations. And a dispute over the rights to oil and gas in an area of the East China Sea claimed by both countries has provided a test-case of Japan´s determination: if Japan gives way to Chinese pressure over the Chunxiao gas field, it is said, then where will China´s expansionism end? The dragon is hungry for resources and will always push for more. Lines must be drawn.

The sort of nationalism being exhibited in Japan in response to such disputes is much milder and less worrying than that shown in either China or South Korea. Japanese nationalist fringe groups go around in loudspeaker vans touting their ideas, as they always have, but ordinary Japanese have not matched their neighbours by marching or rioting. And there is no consensus about how best to react: whereas LDP hawks want to deal with territorial disputes by sending drilling ships and risking confrontation, plenty of politicians would still prefer a quieter response.

What seems to be happening, though, is that in response to Chinese pressure Japan´s position is hardening. The annual visits made since 2001 by the prime minister to the Yasukuni shrine in Tokyo, long Japan´s principal memorial to its war dead, are a case in point. They have made many Japanese uncomfortable, especially businessmen wanting to sell their goods in China. Some debate has taken place about whether alternative memorials might be nurtured or created (see article), or how the history issue might otherwise be defused. But whereas similar Chinese and South Korean protests at official visits to the shrine in the 1980s by Yasuhiro Nakasone, Japan´s most recent openly nationalist prime minister, led speedily to a consensus that the visits should be stopped, the protests about the shrine and about the small number of Japanese history textbooks that whitewash the country´s war conduct now seem to strike more Japanese as unfair. Japan has apologised for the war on many occasions, runs the argument, but the neighbours will never be satisfied.

This new firmness in Japan´s foreign policy, or at least in its opinions about itself and its region, has coincided with a debate among diplomats and politicians about the right approach to East Asia. For many years, Japan has been leery of efforts to establish Asian regional institutions, for equal and opposite reasons: it has feared that its natural leadership of such entities, given its economic weight, would be resisted for historical reasons; and it has been concerned that as such entities develop they could come to limit its freedom of manoeuvre. Its most important Pacific alliance being with the United States, it has not wanted any commitments to evolve that could ever complicate that alliance or diminish America´s role in the region.

China´s rise has, however, changed the situation, and promises to do so even more in future. If any sort of East Asian community analogous to the European Union emerges, then Japan cannot afford to watch it becoming a platform for Chinese power. Moreover, the case for more regional co-operation and even integration is increasing with the rising interdependence of the region´s economies. So, at the same time as its politics and public opinion are becoming more assertive and more independence-minded, Japan is also becoming more interested in taking part in and (it hopes) leading regional institutions. The first East Asian Summit, bringing together government heads from South-East Asia, China, South Korea, Japan, India, Australia and New Zealand, will be held in Malaysia in December. It will also be the first big regional meeting in which America has not been a participant.

That fact makes many Japanese diplomats almost as nervous as the Americans. But nurturing regional institutions must surely be the right policy for Japan. If China´s economy continues to grow, there is no chance that Japan will be able to beat it in an outright contest for regional leadership—and any such contest would risk becoming destructive for both countries. A better strategy will be to use regional institutions and treaties to dilute China´s influence, establishing a framework of rules and procedures within which both countries will have to operate but which also offers the chance for Japan to build alliances with other Asian democracies.

When comparisons with the European Union are made, it is often assumed that the right analogue for Japan is Germany, since both were defeated in 1945. But that does not feel quite right. Japan´s situation is akin to Britain´s in many ways, being in Asia but not entirely of it, and having a closer relationship with the United States than with its neighbours. Yet during the next few decades, Japan´s ambition should arguably be to do what France once did successfully in Europe: to be the Asian country that aims to use regional institutions to give itself a greater voice in world affairs, and to prevent its hefty neighbour from pushing it around. Except, of course, that it will want to remain on friendly terms with the Americans.

The ambiguity of Yasukuni

Oct 6th 2005
From The Economist print edition

A private war shrine with imperial status


No ordinary shrine

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IF YOU visit the Yasukuni shrine in central Tokyo, as Junichiro Koizumi has insisted on doing once a year to loud protests in China and South Korea, it is hard at first to see why this memorial to Japan´s war dead is so controversial. Every country commemorates its military dead; this shrine dates back to 1869 and is dedicated to the 2.5m Japanese who have died in wars or civil wars since 1853. Its name, bestowed upon it by Emperor Meiji in 1879, means “peaceful country”. Only once you hear that among the spirits venerated at Yasukuni are 14 class A war criminals who were executed after the Tokyo war tribunal in 1948, and whose names were added to the roster at the shrine in 1978, do worries start to set in. But it is the shrine´s war museum, the Yushukan, which really sets foreign eyebrows rising: this is no mere place of prayer, but puts over a controversial view of Japanese history.

To concern expressed about the presence of those 14 spirits, the government´s response is that, yes, this is regrettable but Yasukuni has been a private religious entity since 1945 and Japan´s post-war, American-drafted constitution separates state and religion, so the government can do nothing about it. Besides, in the Shinto religion, the kami, or spirits, at a shrine are thought to be indivisible: the war criminals have been put among the 2.5m others rather like 14 drops of water might be put into an ocean.

The flaw in that claim of constitutionally mandated impotence is that Yasukuni retains a strong tie with the head of state himself, the emperor. No emperor has visited the shrine personally since 1975, but every year, during the two principal rites at the shrine in the spring and the autumn, an emissary from the emperor plays the central role. The archive at the shrine, which is where the names of the war dead are logged, was built with a private donation from Emperor Hirohito (now Showa) in 1972.

The museum has no such direct link to the emperor. But, as John Breen of London´s School of Oriental and African Studies wrote in June in “Yasukuni Shrine: Ritual and Memory”, an article for the Japan Focus website, the Yushukan is not like most other countries´ official war museums: it is a museum without mention of any enemies.

Its sole purpose is to glorify Japan´s dead, but in doing so it tells a clear story about Japan´s conquests in Korea, Taiwan and China and about the Pacific war in general: that they were heroic efforts to liberate Asia. And it features a large exhibit about the one judge at the Tokyo war-crimes tribunal, Radhabinod Pal from India, who considered the tribunal illegitimate. On the shrine´s website, when you click for the museum, a slogan appears: “The truth of modern Japanese history is now restored.”

Officially, that is not the government´s view. Japan accepted the verdict of the tribunal when it signed the San Francisco peace treaty in 1951, and insists that debate about the war is an inevitable part of being a democracy. But the fact that this debate is being conducted not just by extremists but by a shrine associated with the prime minister and many other LDP politicians as well as with the emperor makes this ambiguous, to say the least.

One obvious solution would be to have another official memorial. Yet one already exists: a war cemetery at Chidorigafuji in Tokyo. There is also a big ceremony on August 15th every year at the Nippon Budokan, Japan´s martial-arts centre, to commemorate the end of the second world war, which is attended by the emperor and the prime minister. The real problem lies at Yasukuni. For, private or not, it has a special status.

Visions of 2020

Japan´s next 15 years are likely to be a lot sunnier than the last 15


Rare and precious

EVERY so often, a slogan rings out: Welcome to the new Japan! It comes from any pundit or panjandrum wanting to claim that, in a country that to many seems so unchanging, some dramatic new trend can be seen. But it is usually misleading, or exaggerated, for Japan doesn´t do drama (and that is not a comment on Kabuki and Noh), except when it feels under threat of invasion, as in the 1860s, or suffers a wartime defeat, as in 1945. The stock- and property-market crashes that began in 1990 were dramatic for those caught up in them, and certainly produced a sharp change in perceptions of Japan in the world as well as in Japan´s perception of itself. But the social and political response was totally undramatic. The country muddled through, at first in denial but later with a host of incremental adjustments. Fifteen years on, the same party is in government with a big majority, society remains stable, and Toyota is the world´s best car company. Anyone know the Japanese for plus ça change, plus c´est la même chose?

As this survey has argued, however, that too is misleading. Those incremental adjustments, in politics, corporate law, capital markets, financial regulation, labour law and practices, and much else besides, have altered the incentives guiding society, the economy and politics. In part, the effect has been to reduce the distortions, misallocation of capital and indiscipline that have for about two decades neutralised Japan´s long-standing economic and social strengths: excellent education, co-operative relations inside companies and advanced technology. But also, over the longer term, such a gradual accumulation of many small reforms will lead the country in new directions, especially given the recent changes in East Asia and the world economy as a whole, and given its own changing demography. No one can really know where those directions might take Japan over, say, the next 15 years. But some guesses can be made.

The easiest place to start is with demography. With birth rates having plummeted since the baby-boom of the 1950s and life expectancy having lengthened every year, the trend is pretty much fixed for at least the next 15-20 years: the government thinks the total population may have begun to shrink in the first half of this year, and it is certain to do so from 2007 onwards. That shrinkage will be slow, but with fewer children already entering the labour force and more people retiring, the working-age population (ie, aged 15-64) will fall by about 0.7% a year, says the Ministry of Health, Labour and Welfare.

If you extrapolate current trends well beyond 2020, you get quite startling numbers. The health ministry´s central projection suggests Japan´s population could fall from nearly 128m now to about 100m in 2050. Peter Morgan, chief economist in Tokyo for HSBC bank, reckons the ministry is being over-optimistic about birth rates, given that more and more women are marrying later or not at all. He thinks that a prudent projection for 2050 is actually a drop to 86m people. As Mr Morgan knows, however, demography is not destiny beyond 15-20 years. France, Scandinavia and above all America have shown recently that falling fertility rates can start to rise again. That could happen in Japan too.

The trouble is that the possible policy responses to boost the workforce and revive population growth could end up contradicting one another. With the labour force shrinking and ageing, companies and the government are both likely to try much harder to bring more women into the labour force and to use them in skilled and responsible positions. But the more that effort succeeds, the fewer babies are likely to be born. If the government tries to encourage women to have more children, on the other hand, fewer will be in the workforce in their 20s and 30s.

The way to meet both of those objectives would be to spend a lot more public and corporate money on child-care facilities, which are currently in short supply. The old way was to use granny, but today´s and tomorrow´s grannies want to spend their retirements travelling the world, and young women are not keen on having them around the house in any case. So there is bound to be some increase in spending on child care.

Awkwardly, the pressure for that spending will come at the same time as the public finances are being tortured in other ways. Ideally, you would not want to start dealing with all these problems when the budget deficit is already at 6.4% of GDP and gross public debt is 170% of GDP, as they have been in 2004-05. That is why the trend that Mr Koizumi has been busy accelerating, namely cutting back state spending, especially in wasteful public-works schemes and subsidised lending, is bound to continue. Space needs to be made in the public purse for child care, pensions and medical costs.

A shrinking labour force, with efforts to give women a bigger role, also means that the great worry of the past five years—that the rise of part-time and contract workers was producing a two-tier workforce—is likely to fade. There may be some more trimming of the protections given to regular workers in order to keep things flexible, but with labour scarce the new shifting army of irregulars, now 30% of the total, will surely fall in numbers.

Another solution that is often mooted to deal with both low fertility and scarce labour is immigration, which in conformist, homogeneous Japan has so far been tiny, except to take up the nastiest of jobs. Most people´s chief candidate for a bigger immigrant workforce has been health care, where a government desperate to reduce state medical costs ought to welcome cheaper Filipina nurses with open arms. The medical profession, protective of its own pay, has blocked that up till now. Eventually, cost pressures combined with a stronger economy are likely to break that resistance. But beyond nursing, nobody should expect a big rise in immigration. The social and cultural fear of it shows no sign of changing.

The opening article of this survey cited the OECD´s recent estimate of Japan´s potential annual growth rate in 2004-10: just 1.3%. That number anyway looks low, as even during the country´s stagnant decade of 1993-2003 the annual average growth rate was 1.1%. What it reflects, though, is an arithmetical calculation based on two numbers: the shrinking labour force just described; and the slow annual growth in productivity in the 1990s of about 2%, a whole percentage point less than in the 1980s. But the OECD´s projection for productivity growth until 2010 is only a miserable 1.7% a year.

Here is a prediction, made with no arithmetic but much confidence: Japan´s growth rate for the rest of this decade, and quite possibly for much of the following decade too, will be a lot higher than 1.3% a year. The country saw its productivity growth drop during the 1990s because it misused huge amounts of capital, and at the same time many companies hoarded labour rather than laying off workers. Now, with public-works schemes slashed, bank bad-debt accounts honest, shareholders and other ginger groups pressing public companies to boost profits and dividends, and the over-diversification of big companies a thing of the past, capital is bound to be allocated more efficiently. There is much catching up to be done in capital investment in any case that should boost productivity, and a much tighter labour market will force companies to seek ways to boost it even more.

One way that is already being talked about at the bigger manufacturing companies is the use of robots. Japan has long gone further than other developed countries in replacing workers with machines. An alternative is to replace Japanese workers with Chinese ones by opening factories in China, and some of that has been done. But the big electronics firms, for instance, are leery of that and others may become so too: Chinese workers´ productivity is lower, they are harder for the Japanese to manage, there is a big risk of intellectual-property theft, and political relations between Japan and China are likely to remain scratchy. All this could well make robots and other machines increasingly attractive—especially if capital costs stay low.

No one can know, in an economy as large and diverse as Japan´s, which industries are going to grow the most during the next 15 years. The game of picking winners became obsolete long ago. It is safe, though, to say that technology will still play a big part in investment and output growth in Japan. The country has been spending 3.1% of GDP on research and development even during the stagnant years, compared with 2.8% in America and an average of 1.9% in the European Union. Much of that is in advanced electronics, a field in which Japanese firms still lead the world. In future, there will be plenty too in nanotechnology, which takes the Japanese skill in miniaturisation down to the molecular level. Big efforts will also be made in biotechnology, though Japanese firms have a meagre record in that field so far.

A serious problem in the past 15 years has been slow growth in services businesses, which have failed to provide enough jobs and income to make up for those lost in metal-bashing. Deregulation has improved matters, but costs for telecoms and electricity remain high relative to those in other countries and there is still too little competition. A prime example is the vast wholesale-supply business: Jesper Koll, chief economist at Merrill Lynch in Tokyo, points out that of Japan´s 380,000 wholesalers, two-thirds trade with each other rather than directly with a retailer or a producer. The squeeze on those middlemen has begun. Seven-Eleven, for example, recently cut soft-drink prices at its convenience stores by more than 20%, at the wholesalers´ expense.

Another services business that will need a kick up its bottom line is travel and tourism. All those pensioners are going to want to do more and more sightseeing, and rural areas are going to need the jobs that tourism brings. Although transport in Japan is top-notch, it remains pricey, however, and hotels are poor. An even bigger problem is that job-creation through public works has made so much of the countryside so ugly, thwarting job-creation through tourism. There are the beginnings of a movement among local authorities to tidy up their areas, dealing with what have become known as keikan mondai, or view problems. But there will have to be a lot more of that sort of thing if tourism is going to grow, especially from abroad.

If the government is to become serious about raising productivity growth, which it surely must, competition will have to be strengthened, whatever the objections. Still, even with stronger antitrust enforcement and fresh deregulation to encourage more entrepreneurs, Japan is not going to become an American-style, free-market economy. You can tell by listening to one of its leading venture-capitalists, Yoshitaka Kitao of Softbank Investment. Despite his brash braces and combative manner, Mr Kitao talks a lot about the social obligations of companies. He thinks that young entrepreneurs like livedoor´s Takafumi Horie, the notorious hostile bidder, are too greedy for money.

Over the next 10-15 years, Japan will have to begin to deal with the consequences of population decline. Faced with that burden, the country´s GDP growth will never again reach the dizzy heights of the 1960s, 1970s and 1980s, nor be anything like as exciting as China´s. But the more important measure is GDP per head, for that gauges living standards: if moderate GDP growth can be maintained alongside a slowly shrinking population, then GDP per head will rise quite nicely.

Just as neither the politics nor the economics of America after 1945 could sensibly be predicted on the basis of trends during the Great Depression of the 1930s, so the politics and economics of Japan ought not to be projected from its depressed past 15 years. With the important exception of the public debt, the excesses from that period now look to be gone. Politics and public policy will again face up to the demands of affluence, of labour shortages, of rising environmental concerns, of faltering universities and, above all, of a changing East Asian neighbourhood.

Given its huge electoral success on September 11th, much of that political debate can now be expected to take place within the Liberal Democratic Party, just as it has for the past half century, rather than between the twin poles of a two-party system. But it would take a brave man to predict that the LDP will still be in power in 2020. The lessons from Mr Koizumi, that electoral success requires charisma, a clear message and the promotion of change—rather than the old ingredients of money, a family name and a party machine—will not be lost on the younger generation in the opposition. Their time will come.

It might even come over the issue of foreign policy. The LDP´s hawkish response to Chinese bullying has stoked up some nationalist feelings in Japan, but this remains a pacifist nation at heart. A bigger role in peacekeeping and humanitarian operations can be expected in future, but short of a grave international crisis there is little likelihood of Japan revising its constitution to unshackle its armed forces, nor of the country going nuclear.

Hence a final prediction for the Japan of 2020. In 15 years´ time Japan will be a leading member of some sort of pan-Asian union, which will help it to keep China at bay. But it will still huddle closest to the United States, which will still have bases on Japanese soil. Some things never change.

Acknowledgments and sources

Oct 6th 2005
From The Economist print edition

The author would like to thank the many people who gave generously of their time and ideas for this survey. Particular thanks for hospitality and help with arrangements and introductions are owed to Minoru Makihara, Shintaro Hori, Thierry Porte, Martin Hatfull, Yoichi Funabashi, Skipp Orr, Yotaro Kobayashi, Alex Kerr, Keizo Takemi, Geoffrey Tudor, Jeff Kingston, Tadashi Nakamae and the Freshfields Tokyo office.

Abegglen, James, “Redesigning the Kaisha”, private publication in 2005 by CLSA Asia investment bank

Curtis, Gerald, “The Logic of Japanese Politics“, Columbia University Press 2000

Emmott, Bill, “The Sun Also Sets: the Limits to Japanese Power“, Touchstone 1991

Japan: Selected Issues“, IMF, August 2005

Kerr, Alex, “Dogs and Demons“, Penguin 2002

Kingston, Jeff, “Japan´s Quiet Transformation“, Routledge 2005

OECD Economic Surveys, “Japan – Volume 2005 Issue 3“, March 2005

Tett, Gillian, “Saving the Sun“, Collins 2004