By Jesper Koll
Although Japan’s post-bubble era financial structure isn’t something to look up to, its industry developments may be the answer.
In mid-November, world leaders gathered in Washington to start the process of re-designing global finance. Clearly the so-called new-financial architecture built on throughout the 1990s had failed and now it is time to start afresh and build a system that prevents a boom from turning into a bust.
What will Japan bring to the table when the world leaders discuss re-designing the global economic system? Unfortunately, in the realm of finance and financial regulation, Japan has little constructive input to offer. If anything, Japan’s banking and financial companies serve as a negative example. Why? Because its dependence on cross-shareholding is still significant. The facts speak for themselves—when the Nikkei stock index dropped below 8,000 in October, Japan’s major banks faced hidden losses from cross-shareholdings that were almost as large as the subprime-related losses the US banks faced so far.
Japan remains the only country in the world that allows banks to hold significant equity stakes in the companies they do business with. This creates a dangerous double-gearing effect: in good times, banks benefit from better credit, loans and rising stock prices. But in bad times, they get hit on all fronts. In other words, high times make banks feel richer, encouraging more lending but in down-cycles, they call in loans, and the credit crunch gets worse very fast—just when companies need access to credit the most. Good regulation should try to encourage exactly the opposite—put a break on credit creation before a boom turns into a bubble, and encourage credit creation and risk taking during a business cycle downturn.
Despite all this, Japan’s banks will probably continue to lobby for the exceptional nature of their capital structure. After all, cross-shareholding is still considered important to cement business relationships, although the contribution to the macro-economy and its corporate governance implications are clearly questionable, if not outright negative. Privately, many bankers and regulators are prepared to admit as much, but the public policy stance remains muddled.
But while Japanese banking and finance remains a negative example, Japanese policy-making does have one very strong point to offer—industrial policy. Defining future growth industries, supporting them through special tax measures and depreciation allowances, building public infrastructure to support future growth—all things Japan has a good record of doing.
During Japan’s struggle with deflation in the 1990s, all the major economic stimulus packages offered clearly defined visions for the sectors and industries the government was going to sponsor. Prime Minister Mori, for example, brought with him the great IT initiative, which quickly propelled Japan from being the broadband underdog of the world to the broadband superpower. Others focused on biotechnology, nanotechnology, health care, call-centers, logistic centers, taxis and so on.
Of course, these initiatives were not always successful and there are many examples of Japan’s industrial policy catering to special interests rather than serving the public at large. However, the almost relentless focus of Japan’s government to actually try to promote new growth industries is something the US and the world can learn from. As the global crisis deepens, trust and confidence is in increasingly short supply. It is the one thing strong government leaders and true statesmen can do—instill trust and confidence. By clearly outlining what industries and sectors will be sponsored and supported, global leaders can bring back to the private sector what entrepreneurs, a risk takers and employees need the most right now—confidence in a brighter future.
What will those new global boom areas be? Common sense suggests four areas: food and agriculture, health care, infrastructure, and fossil-fuel independence. The sooner we get clarity on where governments will sponsor new growth and new investments, the end of the current misery will come into sight. Re-designing global finance is, of course, important. But the next up-cycle—or dare I say boom—will start only when we all know where to invest in for future growth.
Jesper Koll is the CEO of independent investment advisory company, Tantallon Research Japan.