Red sun rising

National Interest, The, Winter, 2004 by Herbert London

IN 2002 I stood almost alone among international observers of the Japanese economy in predicting that Japan's future was still bright--and that three percent economic growth was quite attainable over the next few years. Some, especially the prophets of a rapid Japanese meltdown, Argentina-style, mocked this prediction. Others were simply skeptical. But suffice it to say, the Japanese economy has now shown eight straight quarters of economic growth. Annual real growth in the third quarter of 2003 was at 3.3 percent--and an astonishing 7.5 percent in the last quarter-beyond my guardedly optimistic estimate. While Japan faces real problems-which have been discussed in these pages in past issues--they are far from permanent. And economic data have clearly shown that the pessimists are wrong. Japan is moving in the right direction, and growth is likely to be sustained for the next few years, barring an international convulsion.

Key to Japan's re-emergence is the fact that throughout Japanese history, determined leadership has arisen in response to crises, reshaping the nation's destiny. The impetus for change has brought about a turning point, allowing Japan to exit the counterproductive cycle of deflation, fiscal imbalance and public sector growth for structural economic reforms that will return Japan to an entrepreneurial society ready to reassert a leadership role in Asia and the world.

The institutional logjams affecting Japan both in the corporate and government sectors are well known. For now, though, it is clear that Japanese companies have begun to take the bitter medicine long prescribed by global investors. Firms have been buying back their own stock and some are consolidating through mergers or restructuring. Capital investments made, particularly in the manufacturing sector, are beginning to pay off.

Weltschmerz is rapidly disappearing from the Japanese worldview, and a dim fog seems to be lifting from the economy. For the second consecutive year, Japan will outperform U.S. and European markets. This is a modest achievement based on the postwar past, but a vast improvement over conditions in the 1990s. In most analyst surveys, Japan is the least popular region for investment relative to a benchmark global stock index. Skepticism is widespread, and as one Wall Street wag noted, "Japan is of no general importance except as a laboratory experiment for deflation."

This position is myopic. Unlike the herd of market analysts who only see the Japanese glass half empty, a new, more hopeful position is starting to emerge based on compelling evidence. For one thing, so-called cross-shareholder unwinding, that is, banks offering underwriting and clients taking stakes in banks, has peaked, thereby reducing the interlocking economic arrangements and the selling pressures in the market. Companies with large cash positions have been buying back their stock. Toyota Motor Corporation bought back 453 billion yen of its shares. Telecom provider KDDI Corporation bought 235 billion yen of its shares, while Matsushita Electric absorbed 99 billion yen of its stock.

Jim Rohwer, author of Remade In America: How Asia Will Change Because America Boomed (2001), makes the case that Asia's gargantuan pool of household savings--approximately $15 trillion, with the overwhelming portion of it in Japan-is beginning to stream into stocks. Rohwer notes that new issues drew $109 billion after the 1997 crash, marking the first time Asian companies raised more in the market than from banks. Rohwer contends that when Japan awakens from its economic slumber it will derive enormous benefits from the 90 percent of the Asian pension fund assets it already controls.

Japan has also seen a dramatic increase in merger and acquisition activity in 2003. Most industries have participated in this trend, which has helped productive firms gain market share. Seiko Epson Corporation, which produces the Colorio ink-jet printer and holds 50 percent of the Japanese consumer printer market, soared 35 percent in its debut on the Tokyo stock exchange, beating the 26 percent increase in the Nikkei after it hit its bottom in April 2003. Nippon Steel, which consistently fell short of targets in the 1990s, shows signs that restructuring efforts have begun to bear fruit. Company profitability rebounded significantly in the last quarter of 2002, with operating profit up 35 percent. Moreover, consolidation has given the company a larger market share than was previously the case.

The senior management of JGC Corporation--a Japanese oil services company--finally came to the surprising conclusion that if it discarded obscure and impenetrable accounting practices, it might secure foreign investment. This happened with Deutsche Bank's asset management arm. And JGC is not alone. A host of Japanese companies have adopted transparent accounting practices, in many instances overtaking their American counterparts in various disclosure statements, according to Standard & Poors.

Partly because of this openness, more foreign companies are taking controlling stakes in Japanese corporations--something unheard of until recently. Britain's Vodafone, for example, acquired 67 percent of Japan Telecom, and Renault has 44 percent of Nissan.