Japan Must Let Zombie Companies Die
Imagine that you’re a Japanese 26-year-old with big dreams. You graduated from Waseda University, an elite private school, with a degree in electrical engineering. You and your college buddies used to hang around your apartment, watching anime on your LCD television, which was made by Sharp Corp. -- the world’s 10th-largest LCD TV manufacturer. Even then, you had ideas about how to improve the product.
Now, after graduating and working for four years in the research division of an LCD manufacturer, you’re sure that you have figured out how to make LCD panels more cheaply, at higher quality. You also believe that you could market these TVs more effectively to young people with cool, fun designs. Instead of giving the idea to the higher-ups in your giant corporation -- which, knowing Japan, might get you little more than a pat on the head -- you decide to leave your job and start a business with your college buddies. You just know that you can beat lumbering, struggling incumbents like Sharp.
Everything goes well for the first couple of years. Your main rival, Sharp, is floundering so badly that it’s begging its own workers to buy its products. Meanwhile, you manage to secure venture-capital funding and even a bank loan. The interest rate is high, but with your rapid growth, you should be able to pay it back.
Then one day, in May 2015, you open your newspaper and see that Sharp has been bailed out by two of Japan’s largest banks, Mizuho Bank and Bank of Tokyo-Mitsubishi UFJ. These banks are themselves backed by government bailout guarantees, meaning that Sharp has been indirectly rescued by the government -- a prime example of the zombie-firm phenomenon that economists have been complaining about for decades. With those cheap bank loans, the ailing Japanese giant can afford to keep putting out TVs at fire sale prices, making no profit but squeezing your own margins.
But you soldier on. The bank bailout does nothing to improve Sharp’s corporate strategy -- the company’s managers are content to drag out the status quo for as long as possible. Eventually, you think, Sharp will quit, the market will become less crowded, and your innovative products and manufacturing processes will be rewarded with bigger profit margins.
Then, in January 2016, the Japanese government steps directly into the fray. The Innovation Network Corp. of Japan offers to bail out Sharp with an injection of 200 billion yen (about $1.7 billion). INCJ, which is funded by industrial giants but backed by government guarantees, will keep Sharp’s struggling LCD division alive and merge it with a rival, Japan Display Inc., itself a consortium of large corporations.
Faced with this kind of firepower, there is no way you can stay in the market. Nor can you expect a similar bailout -- you employ only 100 people, while Sharp employs 50,000. You fold your startup and move across the Pacific to Silicon Valley, following in the footsteps of other Japanese entrepreneurs.
The story of this young Japanese entrepreneur is fictitious, though there are some real-world parallels. But the part about the Sharp bailouts -- first by the banks and now by the government -- is all too true. Japan Inc. looks dead set on keeping the flailing electronics giant alive. That will keep the market flooded with artificially cheap Sharp products -- mobile phones, solar panels, air conditioners, printers, microwave ovens and a host of other items. Entrepreneurs looking to use the Japanese market as a launching pad for innovative products and processes will find themselves blocked by zombies. In reality, prospective Japanese entrepreneurs know this, and avoid taking the plunge in the first place.
Economists have been shouting about this problem for years now. Way back in 2003, Joe Peek and Eric Rosengren wrote a paper called “Unnatural Selection: Perverse Incentives and the Misallocation of Credit in Japan.” They found:
Japanese firms are far more likely to receive additional credit if they are in poor financial condition, and these firms continue to perform poorly after receiving additional bank financing. Troubled Japanese banks allocate credit to severely impaired borrowers primarily to avoid the realization of losses on their own balance sheets.
In 2008 -- before the global financial crisis had hit Japan -- Ricardo Caballero, Takeo Hoshi and Anil Kashyap published another paper, “Zombie Lending and Depressed Restructuring in Japan,” which declared:
Large Japanese banks often engage in sham loan restructurings that keep credit flowing to otherwise insolvent borrowers which we call zombies…The congestion created by the zombies reduces the profits for healthy firms, which discourages their entry and investment…Zombie-dominated industries exhibit more depressed job creation and destruction, and lower productivity.
A 2009 paper, by Mariassunta Giannetti and Andrei Simonov, found that the Japanese government’s bailouts of major banks made these problems worse.
These papers all came before the creation of the INCJ and other similar government bailout funds. The government hopes that the INCJ and its ilk will impose more stringent conditions on the companies it rescues, but the bailout funds obviously offer an incentive for bad behavior. Japan still just can’t let its bad companies die.
If Japan’s bailouts remind you of the U.S.'s rescue of its auto companies, you’re not alone. There is a strong argument that the auto bailouts only delayed the day when General Motors and Chrysler lose out to nimbler competitors like Tesla Motors. But there are also some important differences. The U.S. auto bailouts were undertaken in the middle of a deep recession, and are highly unlikely to be repeated. Japan’s bank- and government-led bailouts come all the time, repeatedly, during normal economic times. Additionally, U.S. startups such as Tesla can look to capital markets for funding, while Japanese finance is dominated by large government-backed banks that want to preserve the supremacy of their large zombie clients. So while the U.S. bailouts might have hurt productivity somewhat, the situation in Japan is just much, much worse.
If Japan wants to generate long-term growth, it needs to allow creative destruction. New companies can't grow when they are blocked by failing incumbents. The aspiring entrepreneur watching cartoons on his TV at Waseda University must be allowed to do his thing. Japan's cycle of bailouts must end.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
To contact the author of this story:
Noah Smith at email@example.com
To contact the editor responsible for this story:
James Greiff at firstname.lastname@example.org