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The Japanese Financial Crisis

Is there a way out?

By Ron Chepesiuk

Last month, President Bush met with Japanese Prime Minister Yoshiro Mori for two hours. Bush’s press office said the meeting had a full agenda that included discussions about North Korea and the sinking of the Japanese trawler, the Ehime Maru, by a U.S. submarine. In Japan, however, little attention was paid to the visit. Instead, the country was — and continues to be — focused on the big question: Who will succeed Mori as prime minister?

“The meeting was just a big ego trip for Mori,” Judith Lee, a lawyer with the Washington, D.C.-based law firm of Gibson, Dunn & Crutcher and an expert on Asian trade, said. “Mori’s got about a 95 percent disapproval rate, and everybody knows he will be out of office this month. So, he’s in no position to discuss the future of Japan.”

According to Balbina Hwang, an Asian specialist with Heritage Foundation, a think tank in Washington, D.C., President Bush “used the meeting to lay the groundwork for Mori’s successor … If Bush emphasized anything at that meeting, it was: ‘Mr. Mori, Japan has got to get its economic act together,’ ” she said.

Those comments by expert Japan watchers highlight the continuing concern about Japan’s political paralysis and the country’s inability to deal boldly with its serious and long-standing economic problems. Indeed, last month Finance Minister Kiichi Miyazawa told the Japanese parliament in blunt terms that Japan’s economic system was on the brink of disaster.

Japan’s Vital Statistics Population: 126, 549, 976 (July 2000 estimate) Population growth rate: 0.18 percent (2000 estimate) GDP: $2.95 trillion (1999 est.) GDP real growth rate: .3 percent (1999 est.) GDP per capita: $23,400 (1999 est.) GDP-composition by sector: • Agriculture: 2 percent • Industry: 35 percent • Service 63 percent (1999 est.) Inflation rate: -0.8 percent (1999 est.) Labor force: 67.6 million (Nov. 1999) Unemployment rate: 4.7 percent (1999 est.) Budget revenues: 463 billion Expenditures: $809 billion, including capital expenditures (public works only) of about $94 billion (fiscal year 2000-01). Industries: among the world’s largest and technologically advanced producer of motor vehicles, electronic equipment, machine tools, steel and nonferrous metals, ships, chemicals, textiles and processed foods Source: CIA Fact Book 2000

Reports out of Japan since the beginning of this year give credence to the finance minister’s words.

Last February, the Japan Department Stores Association announced that Tokyo department store sales in January fell .07 percent from a year earlier.

On Feb. 8, the Japanese government announced that the country’s economy contracted by an annualized rate of 2.4 percent during the July-September quarter of last year. The figure — the largest revision to the Japanese economy since 1978 — was a stunning reversal of the government’s previous estimate that Japan would have a 1 percent annual growth rate during that period.

The Japanese government also revised its figures on business investment, announcing that the country’s capital expenditures rose 1.5 percent compared with the previous quarter. Earlier, the government had predicted a stunning 7.8 percent investment business rate.

The figures are a blow to leaders, such as Taro Aso, Japan’s minister for the state of economic and fiscal policy, who had stated earlier that Japan’s economy was “out of its worst stage.”

Dark Days Not Over

“Some leading politicians have been reassuring the public that Japan has entered a period of recovery,” said Hans Belcsak, president of the S.J. Rundt and Associates, Inc., which conducts country risk assessments for multinational companies. “That’s nonsense. They’ve been saying that for two years, but massive public spending won’t create a recovery.”

According to policy analyst Gary Hufbauer, Japan could go back to its old formula, which is to export growth. But that wouldn’t lead to a long-term solution to the country’s economic woes. “Japan will need to reform its banking system for a recovery to happen,” Hufbauer said.

On Feb. 28, Japanese government figures showed that industrial production, considered the most reliable guide to Japan’s economic performance, fell 3.9 percent between December and January, the sharpest drop since 1993. On March 11, the Japanese stock market plunged to its lowest level since April 1985. A few days later, Fitch Inc., a credit rating agency, gave a negative rating to 19 Japanese banks, explaining that falling stock prices have added to the banks’ difficulty in maintaining capital and that government intervention might be needed.

There are other indications that Japan’s economy is in trouble. Last March, Japan’s current account posted a 249 billion yen surplus, falling for the second straight month and 59.7 percent for the year. Unemployment was at 4.8 percent at the end of March; the IMF has predicted that rate would top 5 percent in 2001. While the unemployment rate rises, the level of corporate restructuring has remained high, giving consumers no reason to feel confident about the economy. Meanwhile, wages have fallen the past decade because of severe deflationary pressure.

“Deflation has made the Japanese household risk-adverse and so consumer demand is down,” said Mohammed El-Erian, chief portfolio manager for emerging markets at Pimco, an investment management company based in Newport Beach, Calif. “But the more the government spends, the worse are the dynamics and the more worried consumers become. The Japanese need to increase their economy’s efficiency, and that’s where structural reform needs to come in.”

Fall from Grace

In assessing the current state of the troubled Japanese economy, it’s difficult to remember the time when the world regarded Japan as the model country for business and economics. Kent Kedl, executive director of the Hong Kong-based Technomic Asia, a marketing strategy consulting company, said Japan’s decline over the past two decades has been huge.

“Our business in Japan has tailed off,” Kedl said. “We used to do quite a few projects every year in Japan, but now we’re doing just a few. Japan isn’t growing and that’s what Technomic is all about. We look for companies in Asia that have growth potential.”

Chris Rush, president of Chris Rush and Associates, a White Plains, New York consulting firm, said Japan’s business philosophy is at the heart of many of its problems.

“Japan has a lot of old-timers in business leadership positions, who continue to do business the way they did in the ’60s and ’70s,” he said. “They still wield power in Japan, and that fact has stifled business creativity and the country’s ability to devise new and innovative business strategies.”

Rush added: “Remember the ad that had its motto, ‘It’s not your father’s car anymore.’ Well, the Japanese should have a motto that says, ‘It’s not your father’s economy anymore.’”

The Asian financial crisis of 1997-98 is a graphic example of Japan’s inability to change with the times. That crisis triggered reform in Korea, Taiwan and other Asian countries. There was little change in Japan, however, El-Erian said. “Today, the country is trying to make the necessary economic changes, but its leadership has been rather slow about it,” he said. “So, it seems as if Japan is standing still or going backward, but, in reality, the rest of the world has been moving a lot faster.”

Japan’s lack of economic imagination is evident in the approach it has used to extricate itself from its economic mess. In response to the flat-to-negative growth rate over the past decade, Japan has sought to pump-prime the economy by adopting stimulus packages — at least 10 of them — that have provided money for additional public works projects, small business loan guarantees, and similar government spending measures. Each fall, new legislation has been introduced to supplement the main budget with additional funds of $40-94 billion. The national debt now totals $5.5 trillion, the highest level of public debt of any industrialized nation.

“All the stimulus packages have done is create the real possibility that the Japanese economy could be crushed under the weight of its public debt,” El-Erian said. “What is really needed is wide and deep structural reform. Japan’s economic problems are so fundamental that its economy hasn’t been able to grow even with the injection of huge fiscal stimuli.”

Banking System Burdened, New Leadership Needed

Vital to economic recovery is the reform of the banking system, which since the early 1990s has been struggling with bad loans, the result of its poor lending decisions. In 1998, the government established the Financial Reconstruction Commission, an emergency agency that subsequently poured $80 billion into cash-strapped banks.

The government closed the agency on Jan. 6, but the banking crisis remains and is getting worse. According to a December, 2000 Wall Street Journal report, Japanese banks may have to come up with an additional $458 billion to cover bad loans, putting the total amount of debt on the lender books at more than a trillion dollars.

The banking crisis is being exacerbated by falling asset prices, Belczak said, especially property (urban land prices are down as much as 80 percent from the early 1990s) and a poorly performing stock market that has cut into the value of the banks’ share portfolios.

Most say Japan needs strong political leadership willing to make tough and bold decisions. Senior Liberal Democratic Party (LDP) officials have been meeting to see who can take over Mori’s job and lead the party in the crucial upcoming elections.

Said Hwang: “Japan has significant resources and a lot of things going for it, but without leadership, the country is going to continue stumbling along without an economy that can grow.”

Meanwhile, the Japanese have shown little confidence that the ruling LDP can provide the leadership needed. A survey released in March, conducted by Japanese broadcaster NHK, showed that only 8 percent of the respondents supported Mori’s government.

Mori’s style hasn’t helped him or his party. He has committed numerous blunders that contributed to record-low approval ratings. Among other gaffes, Mori has called Japan a “divine nation.” Moreover, upon hearing about the Feb. 9 submarine accident off the Hawaii coast that killed nine people, he reportedly continued playing golf.

Echoing Overseas

Japan’s economic woes have ramifications beyond its borders. Asia, in particular, has felt the effects. Japan was a huge investor in Asia during the 1980s and 1990s. Since then, direct investment has been down.

“Japan has been a major supplier of funds to Asia, but it’s now in a contracting mode,” Hufbauer pointed out. “Its banks are faltering and the economy sputtering, and that’s putting a squeeze on lending to Asia.”

Asian economies, moreover, have been hurt by slowing export sales to Japan. Meanwhile, the Japanese yen has weakened as its economic troubles have deepened, giving the country an advantage in trade.

Japan’s economic problems along with a slowing U.S. economy could have a global impact. “I’m optimistic about the economy and I don’t think it’s going into a recession,” Belczak said. “But if it does, the impact on Japan would be serious because the United States is its biggest market.”

Japan, no doubt, is at a critical juncture in its history and must begin to deal aggressively with its problems. It’s important not only for Japan, but also for the rest of the world. “Japan is at the crossroads,” Rush said. “What it does during the coming months is going to determine how strong or weak the economy will be in the long term.”