Japan in 2002: Mired in a long dark tunnel, or riding a 20 year take off?

Back to Contents of Issue: April 2002

by Assaad Razzouk

Scenarios are food for thought, used by major global corporations and decision makers around the world in setting strategy frameworks and in taking investment decisions affecting billions of dollars of foreign direct investment, and thousands of jobs. In this article, I attempt to sketch two contrasting scenarios addressing the question of exactly which Japan could emerge in 2022. The creation and destruction of fantastic wealth and the livelihood of millions will be affected by the answer.

The author

March 2020, Intercontinental Hotel, Tokyo Bay, 11pm

Yotaro 'Ken' Tanaka, Hiroshi Amano and Jason Lotov were lounging at the 6th floor bar, gazing at the imposing Rainbow Bridge. There was a perceptible tension in the air, and after a period of uncomfortable silence at the table, Hiroshi asked Yotaro the question he really wanted to ask: "Tanaka-san, why is a talented man like you, who could contribute more to the country of his ancestors, living in Hawaii, maintaining secondary homes in New York, Paris, London and Bangkok, investing globally, except in Japan, and employing as his right-hand man a rude foreigner from Singapore who does not speak Japanese and takes too many holidays? Why do you avoid visits to Tokyo except when you have to? You were young in the 1980s, but Japan then was a model for the rest of the world. Yet you've made your fortune elsewhere and show no sign of wanting to come back. Why?"

Yotaro paused for a moment. Then the quiet billionaire began: "I will tell you why: In my view, Japan is mired in a long and dark tunnel. Do you remember how lethargic our Japan was in the late 1990s? More than 50 percent of us did not bother to vote in national elections. Interest rates were at a record low, yet the economy was going nowhere. Bank after bank was being rescued because the government thought it was saving Japan from global shame. Today, we know that the banks were sitting then on more than JPY250,000 billion of bad debts. Superficial deregulation in finance, telecommunications, distribution, electricity, transportation, and in the retail industry, led, as far as I can remember, to the emergence of more large-scale supermarkets around the country, and that's about it. I am still waiting for real changes in corporate governance, the tax system, deregulation aggressive enough to encourage young entrepreneurs to start up more new businesses, institutionalized measures to allow women to take their fair share of the job market, sweeping changes to the pension system, and an independent telecoms regulator, and where are these, Amano-san?

Do you remember that unemployment was at 16 percent in 2007, while our politicians were still in denial? Corporate Japan adjusted to the uncomfortable environment reluctantly, slowly, one small step at a time. You needed a hearing aid to notice the 'Big Bang', the reforms intended to open up and introduce transparency into the financial system. Even today, 20 years later, Japanese companies abuse accounting rules and compliance and corporate governance principles.

"Improvements in health care solidified the aging population trend, and we were not preparing for it. Most companies kept honoring commitments to tenured workers such as lifetime employment and pay-by-seniority systems, at the expense of corporate financial stability. The result was a two-tiered labor force, divided by age: older workers protected by past agreements in inefficient firms, and younger workers who found themselves in temporary jobs, working part-time. The younger generation became alienated and started resenting the older generation, and so moved out: Instead of setting up businesses in Shinjuku and Harajuku, they went to India, London and California. Those that stayed vented their frustrations in bizarre music, disturbing movies, comic books, increasingly violent cartoons, and my favorite, TV shows featuring cockroach eating contests. In the meantime, look at the resurgence of the extreme right in Japan, and tell me how one can be optimistic about the future.

"From 2010, if you remember, even the most prestigious Japanese corporations started finding young domestic talent hard to find, and that's not surprising: They should have been recruiting bright Japanese in California. Schools started closing because of the combination of the brain drain and the aging population. So, some of the most successful Japanese companies left too or were acquired by foreign companies. Would you have believed 20 years ago that Fiat would acquire Toyota? Or that seven of our most competitive companies would move their headquarters to London, four to Los Angeles, and three to Singapore? Japan's leading companies are growing overseas, where they can find competitive and open economies, flexible labor policies and an educated and creative workforce, and you can't blame them. In the meantime, you are still hard pressed to find one foreigner on the board of a major Japanese company, and this insularity is incomprehensible to me in this day and age.

"Japan's slide was gradual, and we were pushed down a long and dark tunnel by the financial cancer at the core of our economy. The troubled markets of the late 1990s and the banking crisis of July 2002 were a time for true moral and strategic decisions. Our political leadership was probably not paying enough attention and continued with business as usual, and so 20 years on, the Nikkei is at 3,000, our country is broken and becoming a bit more irrelevant every year. We're like a rabbit caught in the headlights of a car, frozen with fear. The bright and ambitious will always settle elsewhere, that's why we are stuck in a long and dark tunnel."

Hiroshi Amano stood up and left, without a word.

Urawa, Saitama Prefecture, Near Tokyo, July 2022

Good evening, this is Afrit Smart, reporting live from Urawa, a wealthy Tokyo suburb and home of the Urawa Reds, the soccer team that contributed eight players to Japan's dramatic 3-2 win yesterday over Germany in Casablanca in the 2022 World Cup. Tonight, we hope you will stay with us for this CNN special report, "Japan 2022 - The Twenty Year Takeoff Story."

Let's go back first to July 2002, and to the first few tense days of Japan's banking crisis. The financial system was then on its knees; the equity of some of the largest banks, life insurance companies and asset management firms was worthless; the banks had over JPY250 trillion of bad loans and could no longer raise funds from the capital markets. Instead, they had relied on affiliated companies such as asset management firms and life insurance companies to raise capital. This in turn exacerbated a wealth-destruction spiral in which the banks lent money to life insurance companies which in turn bought their securities. Depositors were queuing outside banks to withdraw their funds, a fresh round of bankruptcies was around the corner, and it threatened to close down Japan's financial system.

The Japanese government moved in decisively on July 19, when it ordered all banks, securities firms, asset management firms, post offices, and the capital markets to close on Friday and for all of the following week, an unprecedented event for an industrialized economy. Police were deployed nationwide to control angry crowds. The yen took a dive, and markets around the world saw heavy selloffs. Midday on Friday, the prime minister went live on television to announce that an emergency finance, tax and administrative reform bill cleared the Diet, code-named Operation Takeoff.

The financial component of Operation Takeoff was:

- All financial institutions, post offices and the capital markets were to re-open on August 5.

- All banks, without exception, were nationalized.

- Special auditors would ensure that all government corporations, as well as the banks, published genuine balance sheets and wrote off all their bad loans.

- The government would re-capitalize the banks as appropriate.

- The government guaranteed all deposits 100 percent.

- To fund the rescue package, 35 percent of all bank deposits and postal savings were converted, with immediate effect, into 15-year government-guaranteed zero coupon 'Solidarity Bonds.'

Social, tax and administration measures simultaneously announced by the prime minister were:

- 35 percent of all bank employees were to be made redundant within a month.

- All bank directors were to resign with immediate effect.

- The corporation tax was being cut to 10 percent, retroactive to April 2002.

- Combined local and national income taxes were cut to 10-20 percent, and the land tax system was being reformed to re-liquefy the real estate market.

- New startup companies would receive a 10-year exemption from all corporate taxes.

- All industries were to be deregulated.

- Parliament was dissolved, and elections were called for September, in new electoral boundaries reflecting the true weight of the urban vote.

The Japanese public, numbed by a recession which was entering its 12th year, and desperately seeking change, overwhelmingly backed the prime minister in opinion polls, and this was later confirmed by the 80 percent turnout at the September elections (up from less than 50 percent at the previous elections) a clear popular mandate to aggressively implement fundamental reforms.

Operation Takeoff was a success. The banks, re-capitalized and strong again, emerged from their lethargic state and started lending. The tax cuts encouraged entrepreneurs to establish new businesses, and the healthy banking sector helped finance them. Deregulation led to the gradual closure of inefficient companies, and a level playing field for established and new companies alike. The shift from an industrial economy to a service economy accelerated, and Japan entered a new productivity boom. Its famously two-tiered economy characterized by strong export-oriented companies and weak insular ones, started converging, and the 12-year recession was finally over in 2005, with the economy exhibiting a healthy 5-6 percent growth rate for the next decade. Unemployment fell from a peak of 14 percent in 2004 to 6 percent by 2010. From 2005 to 2007, the Government felt confident that the economy had turned the corner and privatized the post office and the banks it had nationalized four years earlier, making sure they all had a majority of non-executives on their boards, and at least two respected foreigners as well. This privatization contributed to a resurgence of the capital markets with the Nikkei breaking through 30,000 in 2007, and 50,000 in 2012. With the proceeds from the privatizations, the government was also able to announce that it will lessen the population's pain by paying a 3 percent interest rate on its Solidarity Bonds.

The Japanese cabinet, by then with an average age of 38 and 14 women ministers, increasingly began focusing on social reforms and on encouraging more women to join the workforce. To the surprise of everyone except demographers, more working women led to higher fertility rates, and these rose again and reached a replacement rate of 2.1 by 2012. With fewer people of working age, and an improving work environment, women started to reach higher positions within Japanese corporations, and to achieve equal pay, culminating in the nomination of Ayumi Takano at the head of the prestigious Keidanren, the federation of Japanese business and industry, in 2010.

The hiring practices of smaller, entrepreneurial companies changed gradually, and they increasingly turned to overseas universities, such as Berkeley and Columbia, looking for overseas-educated Japanese, widely viewed to be more creative and flexible than graduates of Japanese schools and universities. In the infotainment age, where these skills were highly prized, smaller companies started outperforming the traditional large Japanese corporations, increasing the pressure on schools and universities in Japan to reform. Japanese schools started modifying their curriculum to graduate more creative and international students. Labor shortages in turn continued to put pressure on Japan to significantly raise productivity, and the country re-emerged as one of the world leaders in the info-technology economy, with thriving virtual reality entertainment, industrial biotech, fourth-generation robotics and nanotech sectors powering it forward.

With this let me turn to an old friend, Claudia Alagolesh, who is now established as Chairwoman of one the most prestigious think tanks in Japan, the Kaze foundation. Claudia, where does all this lead us?

Alagolesh: In my view, Japan's economic turnaround also meant that the Japanese today have much more self-confidence and are more comfortable with who they are than they were in the dark 1990s period. Women are playing a far more visible and prominent role in society. The relationship between corporations and individuals has also changed dramatically and workers are no longer as constrained by the companies they work for, and they no longer need to give up their personal lives in order to keep their jobs. A sense of entrepreneurship pervades, among the young and the old, and world leading companies, especially in the service sector, are being established at a regular rate.

On the world stage, Japan has emerged as an increasingly respected leader and with its consistent innovation track record, its anti-war values, and its wealth, has clearly taken a position of leadership in the twenty-first century.

Smart: Thank you Claudia. And with that perspective we end this special look back at Japan, a nation which engineered an economic miracle after World War II, manifested in part in the success of the 1964 Olympics and the inauguration of the shinkansen, and again fifty years later, this time with a win at the World Cup to boot. From Urawa, this is Afrit Smart, reporting for CNN. Thank you and good night. ii

Assaad Razzouk is Deputy Head, Global Corporate Finance Group, at Nomura International in London. He holds a BA from Syracuse University and an MBA from Columbia University. The views and opinions expressed in this article are those of the author alone.

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