Hidden JapanRobert Neff and Ted Holden and Karen Lowry Miller
For months, Japan's top financial reporters had been nosing around giant Nomura Securities Co., hoping to follow a money trail they suspected might lead to the country's power brokers. But only when disgruntled middle-level bureaucrats at the National Tax Agency began to talk did the scandal break wide open. Soon, newspaper headlines were screaming that Nomura and its three big competitors were making paybacks to clients and funneling millions of dollars to one of Japan's most notorious gangsters.
So began one of the worst scandals to rock Japan in recent years. As the revelations are uncovered, a veil is being lifted on the hidden Japan. The scandals are exposing, as never before, how politicians, bureaucrats, big business, and sometimes even gangsters work hand in glove to keep the economic engine primed.
To outsiders, Japan may seem corrupt. But what would amount to scandal in the West is often business-as-usual in Japan. Japan-watchers call it "structural" or "institutional corruption" that helps grease the wheels of the nation's amazing economic machine. "The danger in calling it corruption is projecting onto Japan our own values and legal assumptions," says Chalmers Johnson, a leading Japan scholar at the University of California at San Diego. "What's been revealed is the way business has been done for years in Japan. It's not necessarily bad."
RIPPLE EFFECT. That would be all right if Japan were a third-rate economy. But with Japan's growing piece of the global pie, the scandals are reverberating far beyond Tokyo. Foreigners wanting to do business in Japan are getting a good look at the collusive network they're up against. And those stung by Japanese competition back home are now glimpsing what underlies Japanese corporate prowess. The scandals are again raising the troublesome question: Is Japan's economic system compatible with the rest of the world's?
It's now clear that Japanese and American companies are not on an equal footing. Hitachi Ltd.'s stock market investments, for example, were all but insured by Nomura. As the scandals have now exposed, the broker forked out $16 million to cover Hitachi's losses over the last couple of years. General Electric Co., by contrast, has no such safety net. No foreign investors were offered paybacks by Japan's Big Four brokers for losses. In fact, several are now mapping lawsuits against the Big Four.
Perhaps most eye-opening is the realization that the Japanese system is based on personal relationships rather than the dispassionate enforcement of laws. Bureaucrats play a confusing role as both coddlers and regulators of industry. Even everyday life is full of rituals that to an American might smack of conflict of interest. Twice a year, at midsummer and yearend, an army of delivery trucks bears such gifts as food, liquor, and soap to people who should be thanked--clients, employers, teachers, landlords. Hiroshi Takaku, an executive at a nonprofit organization, recently spent about $1,000 on gifts of candy, beer, and canned crabmeat for two dozen people, including his boss, his sons' rugby coaches, and the professor who served as matchmaker for his marriage. To neglect such tribute would be a breach that could sour relations. "It doesn't feel strange at all, it's just social courtesy," Takaku says. "I don't expect anything special."
Nowhere are interests more intertwined than in politics. Indeed, the Japanese have refined back-room dealing to an art. One expression of this is the zoku--informal "tribes" of Diet members from the ruling Liberal Democratic Party (LDP) who watch out for different interest groups and intercede deftly when necessary (page 42 20 ). In turn, the related industries lavish money on the politicians on a scale rarely seen elsewhere. Japanese experts say it's a rule of thumb, for example, that 2.8% of all construction revenues are funneled to the LDP through its construction zoku.
With its enormous clout, the LDP signs off on nearly every penny of the $3 trillion that Tokyo is spending on public works. And the pork barrel projects are for the power brokers' to dispense. A $2.6 billion contract for a high-tech magnetic levitation train went to a small corner of the Yamanashi prefecture near Mt. Fuji--the district represented by Shin Ianemaru, chairman of the LDP's dominant faction.
NO FOREIGNERS. As the recent scandals show, collusion is common in Japan. Nowhere is this clearer than in construction bidding. Before the formal bids are submitted for a job, the Japanese contractors meet to decide whose turn it is and what the price should be. One way of quietly signaling bids to others is to write them down on the back of business cards that are exchanged during greetings. Everyone except the pre-agreed winner bids higher. Foreign contractors are not invited to these meetings.
The zoku can make or break a foreigner's success in Japan. Washington has been banging on Japan's door for years, complaining that U. S. contractors don't have a fair shot at most big projects. Take Motorola Inc. For years the company had pressed to get a piece of Japan's booming cellular phone market, to no avail. When Washington threatened sanctions, the issue became a flashpoint in U. S.-Japanese trade relations, and Tokyo relented. Yet the person dispatched to negotiate with the Americans was a telecommunications zoku leader, Ichiro Ozawa. He flew to Washington, checked into a suite at the Watergate hotel, and held a series of grueling meetings with U. S. trade representatives. Using his clout with the industry, Ozawa was able to cut a deal.
NEW HEIGHTS. It's the same web of interests that underlies the Nomura scandal. After the Plaza Accord of 1985 revalued the world's currencies, Japanese policymakers cast about for ways to preserve competitiveness as the yen began rising sharply. With their hands on every lever of the economy, the bureaucrats were able to set about retooling the system. In short order, excess liquidity was helping to propel Japan's stock and property prices to unimagined heights. The Bank of Japan, for example, pumped money into the banking system and held interest rates artificially low. Japanese industry was able to raise vast sums of capital cheaply. Economist Kenneth S. Courtis of Deutsche Bank in Tokyo estimates that in the late 1980s, Japanese companies raised $630 billion on the markets for almost nothing. One result: In 1990 Japanese corporations spent $660 billion on plant and equipment, speeding past their U. S. competitors, who invested only $510 billion.
Suddenly, Japan's long-belittled Big Four brokers were star players in their nation's economic plan. Their profits soared, thanks to high fixed commissions sanctioned by the Finance Ministry. The ministry also tolerated eigyo tokkin, huge funds that brokers were managing for Japan's blue chips to take advantage of the go-go climate. Since the scandal, the funds have been banned to cool speculation. When the market crashed in 1990, the brokers felt obligated to cover the losses of their best clients, who helped generate hundreds of millions in profits.
No one challenged the moral soundness of the paybacks. The trouble came because Nomura and others were reporting the payments as tax-deductible entertainment expenses. That rankled the Finance Ministry, whose tax inspectors hit the brokers with big bills and penalties. Intoxicated with their newfound status, the brokers resisted and threatened to use their connections with the politicians to beat back the bureaucrats.
Securities heavies often pump up prices of shares held by LDP politicians. Thanks to these hefty "donations," they assumed they had the clout to fend off the ministry. One estimate is that brokers account for half of all LDP funding.
In the past, the Big Four could certainly count on throwing their weight around. When Salomon Brothers Asia Ltd. in Tokyo became the first foreign broker to introduce a spiffy Wall Street-type bond issue for two Japanese clients, Nomura hit the roof. A Nomura official even charged that Salomon's use of imported financial techniques exposed the Tokyo market to the financial equivalent of AIDS. Salomon, now embroiled in its own scandal, watched its two clients back out.
SKELETONS. But in the battle with the tax agency, Nomura overstepped its bounds. Appalled at the broker's arrogance, tax officials threw open the door, exposing closets full of skeletons. No one in Japan could have imagined how vast the scandal would become. Many observers think the loss compensation scheme would have blown over had it not been for revelations of Nomura's links with the yakuza, Japan's Mafia.
Now the trail is leading to the banks. On Aug. 13, Tokyo was rocked by its biggest bank scandal ever. Some of Japan's most prestigious financial institutions, including giant Industrial Bank of Japan Ltd., were linked to a scheme involving a staggering $2.5 billion in fraudulently obtained loans. An Osaka restaurateur borrowed the money after putting up phony certificates of deposit as collateral.
The Finance Ministry and the Bank of Japan seem determined to press ahead. Aiming to squeeze out the excesses caused by land and stock speculation, officials are cracking down on all kinds of fast-money schemes, from phony certificates of deposit to art speculation. The moves are swift, taking down high-fliers and even brushing Finance Minister Ryutaro Hashimoto. It shows the sweeping power the ministry has to shape Japan's economy.In postwar Japan, the Finance Ministry's primary role was to funnel cheap funds to important industries. That was done by keeping interest rates for consumer bank deposits remarkably low, notes Akio Mikuni, who runs his own credit-rating firm. To keep Japan's savings rate high, the ministry levied no taxes on the interest paid to depositors in Japan's massive postal-savings system. "These tax advantages increased the pool of savings and lowered the cost of investment," says economist Jesper J. Koll at S. G. Warburg Securities (Japan) Inc.
The Finance Ministry's powers reach much further than those of the U. S. Treasury. Pulling the strings in securities, banking, insurance, and other key industries, the ministry has many of the same functions as the Securities & Exchange Commission, the Federal Reserve, and state banking and insurance regulators combined. The ministry wields more power over Japan's National Tax Agency than Treasury does over the Internal Revenue Service. And it's the Finance Ministry, not an Office of Management & Budget, that drafts Japan's annual budget.
Enhancing their grip, ministry officials have strictly limited the number of banks and brokers operating in Japan. In the 1950s, the ministry also seized partial control over the central bank. While the U. S. Fed is completely independent, the Bank of Japan reports to the Finance Ministry.
With so many fiefdoms to run, the ministry exerts its powers idiosyncratically. Its elite corps of officials, almost all of them graduates of Japan's top-ranked Tokyo University, purposely keeps rules vague, forcing bankers and brokers to make frequent visits to its dreary, gray stone headquarters for clarification. In dimly lit corridors and uncarpeted rooms, they wait to be received by one of the 2,000 ministry officials. Control is exercised indirectly, through hints and suggestion, not by American-style regulation. "The fact that the Ministry of Finance can control markets by picking up the phone is an important factor," says Charles S. Stevens, who runs the Tokyo office of the law firm Coudert Brothers.
DOUBLE AGENTS. To stay plugged into the ministry, most banks and brokers offer finance officials senior jobs upon retirement. It's dubbed amakudari, or descent from heaven. A recent survey by Shukan Bunshun magazine lists 31 former ministry officials in senior spots at securities companies. To a degree, they serve as double agents: They convey their employers' wishes to top Finance Ministry officials and at the same time keep the bureaucrats informed about their company's activities.
This informal control gives the ministry unparalleled clout over the industries it oversees. It is widely accepted that the ministry twisted brokers' arms to prop up the market after Wall Street's Bloody Monday in 1987. Well-informed sources say the ministry pressed institutional investors to continue buying U. S. Treasury bonds despite huge losses. Companies that don't go along know that they'll somehow be penalized later. By prohibiting price competition and new kinds of policies by insurance companies, for example, the ministry thwarts entry by foreign carriers. And the ministry orchestrated a complex scheme, with brokers' help, to privatize telecommunications giant Nippon Telegraph & Telephone Corp. (table, page 36).
Professor Ivan Hall of Gakushuin University in Tokyo sees historical antecedents in the ministry's far-reaching authority. He believes that the legacy of the Tokugawa Era, which ended with the Meiji Restoration of 1868, was that Japan failed to produce a merchant class with political self-confidence to take over, as it did in Western nations (table). Today's bureaucracy is like the old political class in a new guise, the perpetual domination of appointed officials. "It's a Confucian view--leadership by an intelligent elite with the moral obligation to guide the people," Hall says.
CROSSROADS. History might suggest that the ruling power blocs in Japan will never give up ground. But Japan may be at a crossroads as its economy globalizes with a big shift to offshore production. It's no wonder that the organization of the largest companies, the Federation of Economic Organizations, is irate at the brokers for sullying Japan's global image. Gaishi Hiraiwa, the chairman of Keidanren, the big business association, was unusually quick to censure the brokers and to dismiss fired Nomura Chairman Setsuya Tabuchi as vice-chairman of Keidanren. Hiraiwa has also organized a task force on reform.
Indeed, cracks are beginning to show in the "collusive group" running Japan, says Yoshi Tsurumi, professor of international business at Bernard M. Baruch College in New York. As Japanese companies become "borderless," they are eager to move beyond a relationship in which the bureaucrats and politicians operate so cozily. To expand internationally, they have to play by global rules, which increasingly puts them at odds with their own system back home. "The balance is permanently upset," says Tsurumi. "This is the beginning of the end of this cozy tripartite balance."
By most accounts, that's an optimistic view. The scandals have inspired dozens of proposals to chip away at the Finance Ministry's power and to bring the hidden Japan out of the shadows. Some politicians, including Prime Minister Toshiki Kaifu, are calling for a U. S.-style oversight agency. But few reforms are likely to go far. In Tokyo's power corridors the talk is why let an embarrassing episode ruin a formula that works overall?
In the end, there has been only one arrest. Few laws were broken. Those hurt most are Japanese consumers, who wind up paying higher prices for stocks without any safety nets and have little say in what bureaucrats and businessmen decide behind rice-paper screens. But some say the consumers' own attitudes are the problem. Indeed, some Japanese seem almost inured to the kind of under-the-table favors whose disclosure sparked the latest scandals. "It's so much a part of Japanese culture and tradition that the people don't think they're doing anything wrong," says Toshiko Yamamoto, a 34-year-old chemist who watched her stock portfolio plunge by 60% and received no compensation.
Besides, consumers aren't as riled up by this scandal as they were over a 3% consumption tax that passed in spite of unheard-of protests across the country. But as the scandals continue to roil Japan, the world will be learning more and more about what drives the country's success.
A LONG TRADITION OF FAVORS AND BRIBES
THE SHOGUN ERA The Shogun and his samurai despised the merchant class, but needed them to run the economy. To protect themselves, the merchants showered favors on the officials
THE OCCUPATION After World War II, U.S. occupation forces tried to break up the collusion of Japanese politics and big business. They diluted the monopolistic industry groups, organized trade unions, and divvied up landholdings of powerful aristocrats. They even set up a U.S.-type securities oversight agency, which was dismantled when the Americans left
1950s To rebuild the economy, the bureaucrats funneled money into certain industries. New businesses sought political allies, and Diet members coveted their cash. In one case, bribes by shipbuilders to attract the best government loans and contracts ensnared both politicians and bureaucrats in a scandal, including future Prime Minister Eisaku Sato
1970s AND 1980s Desperate for cash to fund expensive elections, LDP politicians accepted bribes and mysterious campaign donations. Exposure toppled Prime Minister Kakuei Tanaka, later arrested for taking bribes from aircraft maker Lockheed. Political reform measures launched by his successor turned out to be toothless. In 1988, the Recruit insider trading scandal implicated nearly the entire ruling party elite
1991 SCANDALS The latest spate of scandals erupted when the bureaucrats took aim at real estate and stock speculators who thrived in the 1980s. To cool Japan's worrisome asset inflation, the bureaucrats turned the screws but with no intention of altering the basic system