Japan: How Bad?Robert Neff
Is Japan tanking? That's the seemingly inescapable conclusion as torrents of nasty news wash over the Japanese economy. During the past 13 weeks, the Nikkei index has crashed by 19% in the wake of plunging corporate profits, a liquidity squeeze, and frustration with a government that seems incapable of doing anything to correct Japan's sagging economy. On Dec. 1, the index closed at 17,125 yen.
The market's fall is further jeopardizing fragile banks and insurance companies, dependent as they are on their stock portfolios for financial health. Banks recently reported profit drops for the first half of the fiscal year and a growing number of problem loans. Department-store sales in October fell for the 20th straight month. In a recent survey, Japanese companies said their capital investment would decline in 1994 for the third straight year, by 3.5%. Unemployment is rising, business and consumer confidence are touching alarming lows, and even long-sanguine government officials admit they see no light at the end of the tunnel. "There's no prospect for improvement," says Yasuko Niimura, a deputy director-general at the Economic Planning Agency.
NO RESCUE. What makes the Japanese quagmire so worrisome is that it is vastly different from previous recessions. The "oil shocks" of 1973 and 1978--which were externally generated--just briefly interrupted Japan's march toward economic might. Last year, after a similar market plunge, government intervention lifted the Nikkei and helped paper over the problems. But this time, the coalition government of Prime Minister Morihiro Hosokawa has been slow in taking action.
That's helping to expose the economy's deep structural problems, which throw into doubt Japan's long-term competitiveness even as the leading edge in technology moves away from traditional Japanese strengths (table). Some analysts wonder if Japan is on its way to becoming another Germany--an increasingly hobbled high-cost producer, lagging in leading-edge technologies and saddled with redundant workers. "Can Japan move from excellence in hardware and boxes to excellence in software and systems?" asks James C. Abegglen, chairman of Gemini Consulting (Japan). "The question remains open."
Few analysts expected the latest Nikkei plunge. As recently as last spring, even prominent bears foresaw an upturn by now. But the yen's unforeseen surge and a cold summer that depressed consumption and devastated the rice harvest undercut all hope. What's more, most analysts didn't take full account of the structural problems that have since come to light.
Now that these problems are exposed, Japan's officials are hoping the current turmoil will help them reshape Japan Inc. for the next century. Key ministry officials know that corporations and banks must be modernized to cope with a slower-growth future and tougher global competition. They want more market-opening measures and deregulatory steps, as evidenced by Hosokawa's compromise on importing foreign rice. Where appropriate, the government is also using its fragile position to fend off trade pressures and plead for relief from the high yen.
One of the biggest problems facing Corporate Japan is its bloated work force. Saddled with 6% redundant workers, companies are starting to take drastic measures. They are moving production overseas, slashing the number of contract workers, and shutting down production lines. While many people in corporate circles insist that there will be no mass layoffs, the unemployment rate could almost double within three years to about 5%, says Paul Summerville, director of Asian research at Lehman Brothers Japan Inc.
Meanwhile, Japanese "salarymen" are finding themselves forced into demeaning early retirement or transfers to lower-status jobs at their companies' subsidiaries. College students, long used to lavish attention from prospective employers, now find chilly receptions.
EARLY RETIREMENT. All this is generating a crisis of confidence worse than anything in the postwar era. "I don't know how I'm going to get through the first quarter of next year," confides a Japanese publishing executive. The strong yen is giving managers fits. "It gets to the point where all the work we do is aimed at nothing but making up for the rising yen," says Tsuzo Murase, an executive vice-president at Matsushita Electric Industrial Co.
The situation could hardly be more explosive for Hosokawa, who took office in August at the top of a fractious, seven-party coalition government. Since then, he has concentrated on enacting the political reform that he was elected to accomplish. Hosokawa is making progress, and his public-support ratings are the highest in recent history. But as the government balks at acting on the economy until political reform is pushed through, many in the business community are growing restless. "There's a feeling that there's no one up there," says Geoffrey Barker, chief economist at Baring Securities (Japan) Ltd. in Tokyo.
In Japan's plants and labs, technology managers reflect similar concern. It's much tougher to pursue a copycat strategy in the new worlds of software and superhighways, where Japan now lags. "In the past, we always had somebody we could look to for ideas," says Koji Hase, a senior manager at Toshiba Corp.'s Advanced Media Dept. "We could catch up." But in the coming four to five years that will be difficult, he says. Hase frets that Japan's stultifying educational system "kills" the kind of creative thinking that's required to move into the digital, multimedia
Worse yet, in their scramble to cut costs, Japan's beleaguered manufacturers are scrutinizing research and development programs they once regarded as lifelines to the future. Over 42% of companies responding to a poll taken last summer by Japan's leading business daily, the Nihon Keizai Shimbun, said they intend to reduce the number of research themes they pursue this year. Only 16% planned to expand such programs. For the fiscal year ending next March, Hitachi Ltd. is plowing 6% less money than last year into next-generation chip designs, computer systems, and telecommunications. Toshiba's R&D budget is down 2%, and Fujitsu Ltd.'s by about 14%.
Many of these electronics companies sit awestruck at the speed with which multimedia information highways are coalescing in the U.S. Although Japan for years has been planning an optical-fiber network that would serve a similar purpose, investment has been delayed. Meanwhile, government regulation has stymied the proliferation of everything from pocket phones and computer networks to cable and satellite broadcasting. Local suppliers of such products are therefore at a global disadvantage.
With the world's next big high-tech push coming in the integration of telecom, information, cable TV, and entertainment, U.S. companies from Bell Atlantic to QVC Network Inc. seem to be in the driver's seat--just as the Japanese were in the 1980s revolution in miniaturization, automation, and quality. If the U.S. controls ideas, software, and systems, the Japanese could be little more than second-tier hardware suppliers. On another front, incursions by low-priced U.S. personal-computer makers into Japan have thrown pricey Japanese competitors for a loop. Desktop PCs from Japan haven't made a dent in overseas markets, and they're heavily dependent on American software.
LITTLE TO DO. While U.S. exporters such as Compaq Computer Corp. and Dell Computer Corp. are reaping the benefits of endaka, or the high yen, it is saddling Japanese exporters with high labor costs. As working hours contract and the work force ages, unit labor costs in Japan have been spiraling. Last year, they rose by 8%, according to the Organization for Economic Cooperation & Development. Lower-cost competitors such as South Korea, Taiwan, and even the U.S. are snapping at the heels of Japanese makers of semiconductors, autos, and steel. "Mass producing things cheaply isn't enough to assure our survival," says Shojiro Asai, general manager of Hitachi Ltd.'s Advanced Research Laboratory. "Japanese companies aren't the only ones who know how to manufacture."
Although Japan's official jobless rate of 2.7% remains far below those in the West, the scope of "hidden" unemployment is becoming more visible every day as companies announce major work-force trimmings. Japan's unofficial lifetime employment system prevents wholesale layoffs. So superfluous workers are being shunted off to affiliates, where they often have little to do, in order to remove their labor costs from the parent company's bottom line. In recent months, 20 major companies have announced plans to shed 74,000 employees during the next two to three years through attrition, reduced hiring, and outplacement. That represents 10% of their current payrolls.
Still, Joseph L. Raudabaugh, vice-president at A.T. Kearney Inc. consultants in Tokyo, estimates that more than 4 million "underemployed" workers may be embedded in the system. Virtually all of these are in the white-collar ranks, dragging down productivity and fueling labor costs. While overall productivity in Japan is almost 25% lower than in the U.S., Japanese labor costs are 14% higher than those in America. Already, companies such as Sanyo, Honda, and Nippon Steel have begun restructurings. They are reorganizing in a host of ways to define authority and responsibility more sharply, shift staff workers to line jobs, consolidate headquarters functions, and move even more production abroad.
On top of all this distress, other recent events have contributed to an erosion of confidence among ordinary Japanese. Reduction in overtime and bonuses cut growth in total compensation per employee to 2% last year, against more than 4% in 1991, according to the OECD. This year looks to be worse. The result: Consumers are saving, not spending. "When I'm out with my friends, the talk is always about gloomy things," says Atsushi Ohsaka, a general manager at Asahi Bank. "They all wonder whether their own firm can turn around."
Making many Japanese feel yet more vulnerable is the bureaucrats' failure to address the current crisis as adroitly as they have in the past. "The Finance Ministry doesn't seem sufficiently aware of this country's economic problems," says Yukiteru Azukizawa, a general manager at the Japan Department Stores Assn.
CUTTING TAXES? The government is finally responding. On Nov. 30, Finance Minister Hiroshi Fujii and Trade & Industry Minister Hiroshi Kumagai met under intense publicity to emerge with largely vague but promising talk of rescue measures. This was enough to propel the Nikkei index up 6% in two days. Among the good news was their call for a reduction of capital-gains taxes on property sales and other measures to perk up the moribund real estate market. The two ministers also agreed that next year's budget should include further stimulus measures.
At the same time, the Hosokawa gov- ernment appears to be moving toward cutting steeply progressive income taxes. The system's current top rate is 50%. Until recently, a $46 billion cut, or about 18.5% overall, was expected. But Asahi Bank says such a reduction would boost gross national product by only 0.6%, barely enough to hold growth at zero next year. The conventional wisdom is that it would take $93 billion to jolt consumers out of their battened-down mentality. But now $65 billion to $74 billion seems more likely. Economist Takashi Oshio at Morgan Guaranty Trust Co. in Tokyo says that would help underwrite a pallid 1% gain in GNP next year.
Tax cutting is only a start, of course. The Bank of Japan in coming weeks is likely to cut Japan's record-low 1.75% Official Discount Rate by 0.5% or so. This should ease pressure against the yen and stimulate bank lending. The Finance Ministry is also discussing a plan to let banks securitize their bad debts and sell them to investors, as the U.S. did in the face of its late-1980s banking crisis. And Finance still has at least $9.3 billion left from last year's stock-market "price-keeping operation" to prop up the Nikkei index, says Baring's Barker.
Once Hosokawa gets political reform under his belt and attacks the economic downturn with short-term measures, he's bent on enacting sweeping deregulation on everything from airfares and breweries to the financial system and land policy. This won't be easy, of course. Hosokawa hopes that he can open up many sectors of the Japanese economy to more foreign competition despite opposition from vested interests. In the long run, that should help modernize an economy hobbled by inefficient barriers and rules. Yet it also will almost guarantee more pain, as bankruptcies, shrinking profit margins, and concerns about the future continue to increase.
TIME TO REBUILD. When does it all end? It's important to remember that the current upheaval isn't destroying the country's economic base. But it could wipe out obsolete practices such as over-regulation, legal cartels, seniority-based pay scales, and counterproductive land policies. Ultimately, that could help rally Japan to rebuild on its core strengths, including its highly educated workers, state-of-the-art plants, high savings rates, and government-business cooperation.
In technology, Japanese companies also remain key players at almost every level of the U.S. information superhighway. While bemoaning America's lead in telecommunications, Japanese companies quietly exported $15 billion worth of telephone and radio equipment last year. Included were high-speed digital switches that will be the backbone of the U.S. information superhighway. And the Japanese will be major "content" suppliers through Sony Pictures and Matsushita-owned MCA Inc.'s Universal Studios.
At the same time, companies have begun addressing their labor costs, mainly by shifting production overseas with breathtaking speed. At home, they're reducing part-time workers and cutting wage increases to the bone. As a result, growth in unit labor costs in manufacturing has declined to 2%, according to the OECD, and continues to fall.
Companies also have a government-supplied cushion to fall back on while they restructure. The state now pays a part of redundant workers' salaries to keep them on the payroll. Last year, the government spent $30 million on subsidies for underemployed workers, but this year the budgeted amount has soared to about $700 million. Currently, 4.2 million workers are covered by the program. Thanks to the still-intact cross-shareholding system, companies remain less exposed to profit demands from shareholders and can more easily absorb the costs of redundant employees.
Finally, Japan's business and government leaders are skilled crisis managers. Overstating Japan's problems to foreigners buys time on festering trade issues. A head-knocking shock that scares the daylights out of Japanese workers and injects a new sobriety into corporate Japan is exactly what younger bureaucrats and politicians want to rally the nation for the next stage of rebuilding.
There's no doubt, though, that the days when almost all Japanese could enjoy a piece of the economy's gravy train are over. Instead, the gap between winners and losers will grow larger. There will be shakeouts in the auto and cable industries. Low-tier suppliers will be wiped out as manufacturers diversify supply channels and import more parts and materials from lower-cost countries. "Japan will become an importing superpower," predicts Lehman Brothers' Summerville. Deregulation will gradually break down rigidities and open the economy up to newcomers. Markets will force companies to accelerate their restructuring.
While this will all engender pain, the efficiencies it brings will enhance Japan's competitiveness. And foreigners needn't worry that Japan will disappear as a source of liquidity for the world. While its current-account surpluses and savings rate look bound to decline, they will remain high by world standards.
Just as fears of Japanese economic predominance in the '80s were exaggerated, so too is any notion that Japan is now in danger of collapsing. The younger bureaucrats and politicians coming into power are facing up to Japan's structural problems. If they prevail, the special brand of capitalism that propelled Japan in the postwar era will be modernized, not abandoned. This ability to manage difficult transitions will make Japan a force to reckon with for years to come.
JAPAN'S TROUBLES ARE MOUNTING... LABOR High wages and large numbers of redundant workers are raising costs to corporations TECHNOLOGY Japan Inc. lags in many strategic industries that are likely to be key in the 1990s, such as information highways, software, and systems integration COMPETITIVENESS The high yen is hurting exporters such as Honda and Nissan, and low-priced imports such as Compaq and Dell PCs are challenging local giants such as NEC NIKKEI The Nikkei stock index has dropped 19% since September, placing even more pressure on banks CONFIDENCE A poor rice harvest, political uncertainties, and falling incomes are adding to pessimism about the nation's future... BUT UNDERLYING STRENGTHS REMAIN LABOR The work force is well-educated, disciplined, and highly skilled SAVINGS Consumers are still saving at a rate of 15%, consumer debt is low, and the central government's budget deficit is tiny MANUFACTURING Japan's manufacturers maintain their tremendous skills in miniaturization, automation, and quality control COMPETITIVENESS Despite cutbacks, spending on research and development remains high TRADE Surpluses with the fast-growing economies of East Asia are growing 23%, helping the overall trade surplus climb to $120 billion DATA: BUSINESS WEEK