JEI's Spin on the News

Tuesday, October 10, 2000

Spin on the News Archive


Japan's Government Debt Raises New Concerns

Tuesday, October 10, 2000

The world's press has given enormous attention to the decision of Moody's Investors Services, Inc. to downgrade Japanese government debt. In fact, on September 11 it was the lead story in Britain's Financial Times. Even by the generous standards of popular journalism, the alarmist tone of some articles are off base. However, contrary to the assertions of some Japanese government officials, Moody's has identified a real problem. The downgrade decision seems to suggest that the Japanese economy, which has suffered through nearly a near decade of economic stagnation, is now on the verge of slipping another rung down the economic ladder to join the ranks of nations, most of them in the third world, that have chronic difficulties paying their debts. In some cases, these countries get caught in a downward spiral of surging debt and plummeting exchange rates, with adverse consequences for already weak economies. But such scenarios are extremely unlikely in Japan for a number of reasons.

Moody's downgrade decision was the second in less than two years. In November 1998, Japan lost the top Moody's ranking Aaa, moving down a notch to Aa2. The latest decision lowered it one further to Aa1. As such, Japan's rating is now lower than the United States or Canada. It is, of course, still far higher than many developing countries.

Importantly, Moody's decision relates only to yen-denominated securities. Since virtually all Japanese government bonds are sold domestically, yen securities preponderate, which would seem to suggest the importance of the decision. In fact, the opposite is true. If the Japanese government were to ever face a crisis that would threaten its obligations to pay interest and principal on its bonds, it could turn to the Bank of Japan for help. Although independent, the central bank would almost certainly help out in this instance by buying government securities as necessary to finance outstanding issues. BOJ would have no difficulty doing so since it could, in effect, print the money necessary for purchase.

If a third world country were to go this route it could face serious problems. The resultant surge in the money supply could fuel inflation. But Japan's problem is deflation, not inflation. A surge in the money supply might even be beneficial on its own terms by boosting aggregate demand. The worst that would happen is that prices might stabilize.

Economists have long recognized that government finance — and the risk of default — is different than that faced by individuals or corporations precisely because of the unique role of the central bank. Moreover, the holders of government bonds are in some respects the same as the issuers in the sense that Japanese taxpayers, who will in one form or another foot the bill of the debt, are also the holders of the bonds. In the unlikely event of a default, the bond holders lose, but taxpayers — relieved of liability — benefit to exactly the same degree. In this sense, the debt burden is zero and a default on the debt would similarly be without consequences in the aggregate.

Of course, in some situations the bondholders and taxpayers can be radically different, most obviously if the bonds are sold abroad. In this case, sales and interest payments affect exchange rates, as do central bank purchases of government securities. If the bonds are denominated in a foreign currency, fluctuations in exchange rates can increase the burden of the debt since funds to service the debt are in domestic currency. In particular, central bank purchases of government bonds to finance debt that is partially held in foreign currencies can be self-defeating if it leads to exchange rate depreciation that raises the burden of debt denominated in foreign securities.

But the foreign aspect to Japan's debt problem is largely hypothetical. Virtually all debt is held by Japanese citizens, so a default, which is unlikely in any event, would have few real effects. The exchange rate problems are minimal, especially since the debt is denominated in yen.

Taken together, these arguments would appear to suggest that Japanese debt is nothing to worry about. If so, Moody's should assign Japanese government securities the very highest ranking, reflecting the reality that Japan's exceptional savings rate provides the government with a uniquely large pool of purchasers of bonds in domestic currency, where the central bank's role makes default extraordinarily unlikely.

However, the prospects going forward are not so rosy. Over the next ten years, the conditions under which Japanese debt will be financed will become less favorable. The savings rate will probably fall as the population ages; older people may deplete their savings or at least slow the rate at which they increase savings. Moreover, Japanese citizens may be attracted by securities in venture capital firms or overseas companies that seem more appealing than government securities with their rock-bottom rates. One way or another, increasing government debt levels will be harder to finance. The problem will be even worse if the government borrows to pay interest, leading to spiraling deficits. Even under fairly optimistic scenarios regarding the deficit, Japan's outstanding government debt will soon overwhelm even that of the United States in its accumulated level.

Under this scenario, yields on Japanese securities are likely to rise. Americans, among others, might find the combination of current yield and possible currency appreciation hard to resist. Or perhaps they will insist on dollar-denominated bonds. Either way the issue of Japanese debt would become internationalized. A default would benefit Japanese taxpayers at the expense of foreign bondholders. Currency fluctuations could influence burdens. The Bank of Japan's ability to resolve the problem would become much more circumscribed.

Presumably it is this future scenario that Moody's has in mind in downgrading Japanese debt. The chance of default, although still low, would be somewhat higher in this case.

The task of the Japanese government is to head off continued movement toward this less favorable outcome. It has perhaps a couple of years before deficit and debt management becomes extraordinarily difficult.

Those analysts who see the hour as too late for Japan should remember some recent economic history. In the early 1990s, American officials repeatedly harped on what they regarded as the excessively large Japanese government surplus. Japanese officials complained that America needed to get its budgetary house in order. Indeed, most projections suggested out of control American deficits within a decade. Both the Japanese surplus and American deficit were gone by the end of the decade. Yet another role reversal, by say 2010, is not impossible.

"JEI's Spin on the News" are the opinions of one or more members of JEI's staff and do not necessarily represent the views of the organization.

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Firestone Firestorm A Blow To Bridgestone

August 31, 2000

When Japan's largest tire maker in 1990 took over Firestone, a company dating its origins to the earliest days of the automobile industry in this country, it was like a dream come true for Bridgestone Corp., whose founder had translated the two characters comprising his name and reversed their order to give his fledging concern a name similar to that of the American firm. In the early 1990s, Japanese companies seemed like members of a juggernaut, evoking fear among the overseas rivals of Japanese companies, but Bridgestone's purchase of Firestone generally was welcomed as a way of reviving a venerable American concern.

Bridgestone did not immediately fix Firestone, but — in contrast to numerous other Japanese companies that purchased American companies at the time — has stuck with its decision. Firms that gave up — such as Matsushita, which ventured into the entertainment industry — found that management of American companies was a good deal more complicated than they had thought. What worked in Japan was not necessarily as effective in the United States with its different workforce, relations between the public and private sector and the nature of the good or service being sold.

Now Bridgestone seems to be learning this lesson. Public relations — with its customers as well as with Washington — is one problem. On August 9, it announced a recall of 6.5 million tires installed on Ford Explorers because of the possibility that the tires could fail and lead to fatal accidents. In fact, at the time there had already been at least 46 deaths in this country. Such an emotional situation clearly suggested that Bridgestone treat Ford, the tire users and Washington very gently. Its statements at the time clearly suggested that the company thought it was going well beyond the call of duty in announcing the recall, but American public opinion — and partner Ford Motor Co. — apparently feel otherwise.

The contrasts with Ford's behavior was stark. Firestone clearly has much more at stake than Ford. The quality of the tire is much more the issue than that of the vehicle itself. Experts have hinted that the survival of the Firestone, but not the Explorer brand, may be at risk. Yet it was Ford chief executive Jacques Nasser who was visible on August 9, not the Nashville-based head of Bridgestone/Firestone chief executive Masatoshi Ono, let alone any of his bosses from Tokyo. Bridgestone appeared to feel that Ford, not the buyers of the Explorers, were its customers, even though of course Bridgestone/Firestone sells millions of tires directly to consumers in the replacement market each year. In fact, Bridgestone/Firestone representatives appeared to blame customers for the tire failures, which they implied resulted from a combination of under inflation, intense heat and high speed. This view, which the company continued to expound on its Japanese language website for at least three weeks after the initial recall, has been disputed by Ford, which has said it found no such pattern of failure.

Bridgestone/Firestone's apparently condescending attitude toward Explorer owners, possibly a consequence of the fact that in Japan car maintenance, even maintaining tire pressure, is likely to be left to professionals, has ended up hurting relations with Ford which, surprisingly, is its biggest customer, larger even than Japanese companies such as Toyota, Nissan and Honda.

Bridgestone, in contrast to Bridgestone/Firestone, slowly has become more involved, but even this involvement has brought problems. It is now shipping replacement Bridgestone tires from Japan at high cost, which may alleviate some customer concerns, but which also serves to highlight the Japanese ownership in a highly publicized environment. Given that Americans, like Japanese, are quicker to blame foreigners than natives for problems, Bridgestone could be doing itself long-term damage by such a move.

Behind Bridgestone/Firestone's crisis management other difficulties faced by Japanese companies have surfaced. It apparently failed to appreciate the critical role played by Washington in car safety, not understanding the extent to which National Highway Traffic Safety Administration could make its life miserable, for example. It may have assumed that government officials, as is often the case with their Japanese counterparts, serve mainly to make life comfortable for industrial concerns.

Japanese corporate executives may have believed that the recall was an American problem to be dealt with by their American subordinates, without any need for their involvement. Unfortunately, as Mitsubishi Motors and Sony Corp. discovered earlier, this hands-off style may mean that no one takes responsibility, especially if the American executives are responsible for the problem. In the Mitsubishi case, American managers failed to stop sexual harassment at its Illinois car plant; in Sony's case, American motion picture executives in effect rewarded themselves handsomely.

The case also illustrates the way in which information escapes American companies far more quickly than their Japanese counterparts. Mitsubishi Motors only in August of this year had to confront the fact that it had concealed for 30 years defects in its cars sold in Japan. Midsize companies in the smaller Japanese market may be able to keep secrets that long, but big companies like Bridgestone/Firestone, the world's largest tire maker operating in the world's largest tire market, cannot.

Finally, the Firestone case is a reminder that even at an operational level, the involvement of Japanese companies here can present problems. Ford has said the problem tires were produced at Bridgestone/Firestone's Decatur, Illinois plant at at time when the facility faced labor difficulties. Japanese manufacturers often have tried to avoid unions in this country by locating plants in locations where unions are weak. When they do have to face unions, the Japanese firms are likely to find them more militant than their Japanese counterparts.

In short, the Bridgestone/Firestone problem illustrates many of the problems facing Japanese manufacturers in this country. Not a few observers have suggested that Bridgestone's difficulties may go deeper than the immediate problem. Investors appear to agree. On August 7, before the issue surfaced in early August, Bridgestone stock opened at ¥2,325 on the first section of the Tokyo stock exchange. On August 29, it closed at ¥1,526, a 34 percent drop in just over three weeks.

This drop in price points to a mystery, however. The coverage of the Firestone recall has been much less extensive in the Japan than in the United States, even though the stakes appear higher than here. After all, a survival of a pillar of Japanese industry now may be at stake. Nihon Keizai Shimbun, the leading business daily, covered the story on page 1 the day it broke but has not had nearly as many follow-up stories as the Wall Street Journal, for example. (This relative lack of coverage may have served to maintain the complacency of Bridgestone/Firestone's Japanese executives, who naturally would respond more to press accounts in their own language and time zone.) On the basis of this coverage alone, Japanese investors would have had little reason to dump the stock. Either Japanese investors have other sources of information that are leading them to unload Bridgestone or else foreign investors, who are increasingly influential in the Japanese market, are decisive these days in pushing the stock down. If so, Bridgestone's internationalization may have been far more far-reachng than it has realized.

"JEI's Spin on the News" are the opinions of one or more members of JEI's staff and do not necessarily represent the views of the organization.

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Sogo II: Ramifications Continue

Wednesday, July 19, 2000

The bankruptcy of the Sogo Group companies continues to confuse analysts in Japan and abroad. Incredibly, a large number of respectable organizations, including Standard and Poors, seems to feel that the action points toward economic reform.

The basis for this conviction apparently is the incorrect argument that the government has signaled "no more bailouts." If this line of thinking were valid, then the government's debt burden would grow more slowly than otherwise, economic deadwood in the private sector would get hauled away, and the economy would grow faster over the long term, just for starters.

The "no more bailouts" argument misinterprets the Sogo case, however. The government never said it would bail out Sogo. What it said it would do under the abandoned plan was that it would bail out at least one large lender to Sogo, the Long-term Credit Bank (now Shinsei Bank). This is what governments do during a banking crisis, and Japan remains in a banking crisis. The United States bailed out financial institutions in spades during the savings and loan/ banking crisis in the late 1980s and early 1990s. An unwillingness to do so in Japan would undermine the premises of the deposit insurance system and break past specific promises to the new owners of Shinsei, among others.

The fact that the Japanese public and not a few Japanese politicians temporarily blocked the deposit insurance system from fulfilling its promises should not be taken as a sign that economic reform is on track and Japan is saying good-bye to the interventionist policies of the past. It suggests a degree of public hostility toward the banking system that could force the government into less transparent means of aiding the banks it has promised to help and needs to help if depositors' money is to be protected and the banking problem resolved.

This drift toward less transparency in the bank bailout process is already underway. Instead of a fairly obvious amount of help to Shinsei that the previous plan implied, the bankruptcy process means that the exact amount of the bailout will remain unclear for months while the various creditors jostle over assets of uncertain value. At the end of the day, it is not impossible that Sogo's assets will be so much larger than now thought so that everyone, Shinsei included, is paid in full. More likely, the losses will grow with the passage of time and close examination. Moreover, in order to avoid chain-reaction bankruptcies, the government may make various kinds of financial assistance available to Sogo suppliers, Sogo employees and other stakeholders.

The prospects under this scenario for the Japanese economy are dreary. Overall, intervention probably will be much greater than would have occurred under the rejected plan. Several sub rosa assistance programs will substitute for one transparent one, with the total cost probably being higher. The government will try to hide banking problems from the public for fear of an outcry. It tried this "crossed fingers" strategy with disastrous consequences for at least the first five years of the banking crisis, from around 1990 to 1995 or so. It covered up the problems at Sogo, and indirectly at Long-term Credit Bank, for almost as long. The costs rose with the passage of time. In the meantime, the banking system stayed broken and did not play its essential role in reviving economic activity.

What Japan needs to do is to combine aggressive government intervention to bail out, sell and close troubled banks — which will cost enormous amounts of money and require more government employees as well as a very hands-on attitude — with a clear statement that these actions are taken to clean up messes left over from the past and do not imply promises to fix problems that stem from today's actions. In putting assistance to Shinsei on hold, the government has obscured this message.

Unfortunately, the Sogo mess demonstrates that this policy of bailing banks out for past mistakes but not future ones is difficult to implement in the current political environment. The public appears to profoundly mistrust its leaders to the point where they will make it difficult for Tokyo to honor its commitments in a timely and transparent fashion. The abandoned plan for Sogo was rejected by the public apparently in large measure because the politicians came up with it, much the same way some members of the Republican Congress immediately reject any initiative associated with Bill Clinton. This lack of trust could make policymaking in Japan across a broad range of areas, including tax increases to stem the rising debt level or deregulation that leads directly to job losses, much more difficult.

In other words, the willingness to let Sogo declare bankruptcy was a mistake. The fact that it has been hailed as a sign of progress is telling and the most recent example of an ancient strategy. Tokyo for decades has made the same basic argument concerning its economic policy: it admitted that in the past it violated market principles in coming to the assistance of specific firms and industries, with negative consequences, but now it had learned its lesson. It would now follow the dictates of the market and let the chips fall where they may.

This argument has been persuasive to western analysts, who often are too new to the field to recognize a recycled argument when they hear one. Sometimes, the argument ends up being correct. Market-conforming reform in Japan does occur. In other instances, an action apparently in accord with market principles (such as a declaration of bankruptcy) ends up leading toward sustained intervention. That less fortunate outcome seems to where the Sogo case is heading.

"JEI's Spin on the News" are the opinions of one or more members of JEI's staff and do not necessarily represent the views of the organization.

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Sogo Bankruptcy Suggests Lessons Still To Be Learned

Friday, July 14, 2000

The July 12 bankruptcy petition of Sogo Department stores and 21 related companies is being hailed at home and abroad as a sign that the old ways of doing business in Japan are over. While there is something to that view, the bankruptcy and the events leading up to it also indicate that the electorate, politicians and business still have an immature view of what is involved in Japan's current economic difficulties. That stance could complicate the process of restructuring corporate Japan.

The bankruptcy followed loud opposition to a plan to restructure the department store chain along the lines of a workout. Under this plan, Sogo's major creditors were to take a major haircut. One major exception would have been Shinsei Bank, Sogo's second largest creditor. Under the terms under which the foreign-owners took control from the Japanese government earlier this year, the government would remain responsible for bad debts incurred by previous management. That meant that the Deposit Insurance Corp. would take a hit, just as most bankers did. The hope was that, by trimming its liabilities, Sogo would be able to survive.

Taxpayers sensed that Sogo was being bailed out at their expense and howled. Politicians argued that the scheme amounted to an encouragement of moral hazard, under which borrowers and lenders who invest profitably reap the benefits and those who do not can shift the burden elsewhere, thereby leaving excessively risky behavior unpunished and more profitable. In response to these criticisms, the DIC and related financial agencies withdrew their willingness to absorb a hit, forcing Sogo to court.

The taxpayer and politician arguments are both correct and, in that sense, represent an understanding of what is going on. However, both betray an ignorance of the consequences of the alternative. Compared to a workout, bankruptcy lifts Sogo's costs considerably, making its continued viability as a going concern more more questionable. The ultimate public sector burden almost certainly will be higher than under the workout alternative. Moreover, moral hazard arguments apply only to situations where lenders do not fully feel the riskiness of their actions. Because the workout option was less costly, it was only natural that lenders lose less under that option than under bankruptcy. In any event, moral hazard is a necessary, if undesirable, side effect of systems under which the government assumes the cost of financial institution failures. No side argues that the government should not have assumed these costs in connection with Long-Term Credit Bank, Shinsei's predecessor. Moral hazard is present with either the workout or the bankruptcy option.

More broadly, the negative reaction to the workout plan indicates the deep-seated hostility to banks among the Japanese population. This populist tendency generally is ignored by foreign observers who seem to believe that big business can get away with anything it wants in Japan. That is not true now and never has been. Thirty years ago, for example, big corporate polluters were called on the carpet through a popular outcry.

Today this profound lack of trust finds its obvious target in financial institutions, who have been badly mismanaged for a decade or more, have gotten trillions of yen in public money and now want further breaks. While such populist sentiments can lead to policies that improve economic performance, they also can also derail needed, if painful, measures to extricate Japan from its economic mess. Under the current circumstances, there really is no alternative to the use of public funds to straighten out the bad loan problem. Beliefs to the contrary, as apparently on view in the reaction to the Sogo workout plan, will serve to increase the cost of such cleanups.

"JEI's Spin on the News" are the opinions of one or more members of JEI's staff and do not necessarily represent the views of the organization.

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Plan To Introduce 401(k)-Style Pension Hits Potholes

Wednesday, June 21, 2000

The government's goal of adding a fixed-contribution option to public and private pension plans has encountered unexpected problems that most likely will push back the introduction of a 401(k)-style retirement system well into 2001. Tokyo had hoped to allow companies to begin offering their workers a fixed-contribution system as soon as January 10, 2001, with the government-run National Pension Fund Association to follow two months later (see JEI Report No. 4B, January 28, 2000). This schedule already represented a three- to six-month delay from the Liberal Democratic Party's original timetable — time needed to address the concerns of the LDP's coalition partners. With this year's ordinary Diet session already ended without action on this legislation, the LDP now plans to reintroduce the bill during this fall's expected extraordinary Diet session.

Three factors have combined to jeopardize this latest revised timetable for the start of Japanese-style 401(k) pensions:

Even if these factors all turn out in the LDP's favor, the Diet is not likely to see a pension reform bill on its agenda until the normal 2001 Diet session. If this is the case, it would be at least another six months before Japanese workers could begin to enjoy this new retirement planning option. This delay, in turn, will impact the business plans of the many domestic and foreign financial advisers that have been preparing for this new pension product.

"JEI's Spin on the News" are the opinions of one or more members of JEI's staff and do not necessarily represent the views of the organization.

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Drop In Unemployment Not Great News

Tuesday, June 6, 2000

Any incumbent politician welcomes a drop in the jobless rate just before an election. Japanese politicians, who face the voters June 25, were no doubt pleased that the Management and Coordination Agency announced May 30 that Japan's unemployment rate in April backed off the postwar record of 4.9 percent registered in February and March. (Both numbers are seasonally adjusted). Their pleasure should be tempered by the fact that a closer look at the numbers indicates that Japan's employment situation continues to deteriorate.

A comparison of the latest figures with those of exactly a year earlier shows this to be the case. Even though joblessness was 4.8 percent in both periods, last year's employment level was a quarter of a million people higher. Since the working age population grew by almost half a million and unemployment by 40,000 over this same period, the unescapable conclusion is that about 700,000 additional people opted out of even trying to get a job over the course of the past year. While many of these people had traditional reasons —marriage, child birth or retirement — for not participating in the job market, many others probably just got tired of looking for a job. Indeed the number of "discouraged job seekers" probably exceeds the 346,000 officially unemployed in April. One indication of this possibility is the labor force participation rate, the percentage of the working age population who are either working or looking for work. The participation ratio in April registered 62.7 percent, down from 63.2 percent a year earlier.

The labor force decline will matter in a different way when Japanese joblessness begins to drop significantly. In addition to discouraged workers, the decrease in the size of the labor force is being driven by ever smaller increases in the working age population. Indeed, Tokyo's monthly estimates of the rate of growth of the over 15 population are less than zero in some recent months. With few younger teenagers in the jobs pipeline, this trend will become even more pronounced in coming years. Once the potential labor force starts its long decline, the only way to increase overall employment will be through increases in the participation rate, which would be a reversal of recent trends.

"JEI's Spin on the News" are the opinions of one or more members of JEI's staff and do not necessarily represent the views of the organization.

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Low Participation By Women Limits Japan's Economy

Wednesday, April 5, 2000

While the Japanese economy showed some signs of life in early 2000, few analysts believe that its problems are behind it. Indeed, most policymakers believe that some combination of continued fiscal stimulus and structural reform will be necessary if the Asian nation is to keep pace with the United States and other industrial nations this decade. They tend to overlook one structural change that would improve economic performance enormously — increasing the role of women in the economy.

In the United States and Japan, the participation rate of men (the proportion of working age males who are working or looking for work) is very similar: between 75 and 76 percent in recent quarters. For women, however, the participation rate is very different: 60.4 percent in the United States versus 51.5 percent in Japan, according to the most recent data available for each country.

These numbers suggests at least one question: what if Japanese women were as likely to work outside the home as their male counterparts? In this case, an increase in the participation rate from 51.5 percent to 75.7 percent would imply a jump in economic output by a whopping 23 percent. This calculation assumes that the Japanese women added to the labor force would be just as productive as those men and women who are already in the labor force, an assumption that is too optimistic. Already employed workers have on-the-job training the new hires would have to acquire over time.

An alternative calculation makes use of the less drastic assumption that Japanese women participate in the labor force to the same degree as American women do. This would result in an increase in economic output of 10.3 percent, with the same caveat regarding productivity.

Of course, these numbers say nothing about economic welfare, only measured economic output (gross domestic product.) Economic welfare currently is poorly approximated by GDP because mothers provide a valuable service that is not reflected in the aggregate economic statistics. If mothers entered the labor force in greater numbers, GDP would go up, but economic welfare conceivably could fall.

Even with these qualifications, the impact of more women in the Japanese labor force could be significant. If the rate of participation grew to U.S. levels over ten years, the economy would get an annual boost of about 1 percent, enough to double the growth rate in some years such as 1999. This increase would also mean higher tax revenues, a smaller government deficit and less burden on public pension programs n coming years. These benefits notwithstanding, the consensus in Japan does not appear to favor such an effort. Japanese women are likely to remain outside the labor force far more than their male counterparts in Japan or women in this country.

"JEI's Spin on the News" are the opinions of one or more members of JEI's staff and do not necessarily represent the views of the organization.

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Bigger — Not Better — Banks

Wednesday, March 15, 2000

The process of consolidation in the top tier of the Japanese banking industry continues, as exemplified by a March 14 merger announcement involving three big banks. Since the late 1980s, Japan's large banks known as city banks have been combining in a process that now appears to be almost complete.

Arguably the first such merger involved Mitsui Bank, Ltd. and Taiyo Kobe Bank, Ltd., two of what were then 13 city banks and three long-term credit banks. The April 1, 1990 merger resulted in what is now Sakura Bank, Ltd.

The next big move came when Bank of Tokyo, Ltd. and Mitsubishi Bank, Ltd. merged in 1996. In addition, Asahi Bank resulted from the merger of two smaller city banks, Kyowa Bank, Ltd. and Saitama Bank, Ltd. and Hokkaido Takushoku Bank, Ltd. failed and was merged into smaller institutions. Two of the long-term credit banks failed, were nationalized and are now being privatized again.

That leaves the nine current city banks and one long-term credit bank. However, Dai-Ichi Kangyo Bank,Ltd. Fuji Bank, Ltd. and Industrial Bank of Japan, Ltd. (the lone remaining long-term credit bank) announced a slow-motion merger earlier, as did Sakura Bank, Ltd. and Sumitomo Bank, Ltd. Asahi and Tokai also announced they would be working together in 1998.

By early March of this year, that left only Sanwa Bank, Ltd. and Daiwa Bank, Ltd. without recent merger partners among the city banks. After the March 14 announcement linking Sanwa with Tokai and Asahi, Daiwa alone remains unattached. Americans may recall the Osaka-based institution as the bank that U.S. authorities ordered out of the United States in 1995 following alleged deception of Federal banking officials.

Once the mergers and other agreements are complete in a year or two, Japan will have four major banking groups — the Mizuho group arising from the DKB-Fuji-IBJ combination, Bank of Tokyo Mitsubishi, Sumitomo-Sakura and Tokai-Sanwa-Asahi. The two reprivatized long-term credit banks — LTCB, renamed Shinsei, and Nippon Credit Bank — as well as Daiwa will remain outside the big four, as will the half dozen trust banks, dozens of regional banks, credit associations, credit cooperatives and agricultural cooperatives. Daiwa and the long-term credit banks may become part of the merger frenzy, but otherwise additional mergers in the top tier seem unlikely.

In short, the commanding heights of Japanese banking is about to dominated by only four institutions in contrast to the 12 of less than a decade ago. Moreover, the consolidation is even greater than the mergers alone suggest since banks are working more closely than in the past with their keiretsu trust bank and insurance affiliates.

All this turmoil leaves unanswered a basic question: does it make any sense? The answer is probably no in most cases. Japanese companies in general, and banks in particular, are notoriously hard to integrate. The process can take years and leave the banks weaker than they were individually. Moreover, the recent mergers are not necessary on efficiency grounds. The banks all operate nationally and usually internationally already and are among the world's biggest institutions. Each one could easily afford investments in technology, for example, and is large enough to exploit the technology. What has been lacking is competence, something which is an unlikely consequence of merging institutions when it is not present in either partner.

Fundamentally, what is driving these mergers is fear of being left behind, both by mergers among their international rivals and their counterparts at home. Even though the link-ups promise few of the synergies possible from cross-industry mergers like Citicorp and Travelers, they are the best the Japanese banks can do.

Against debatable advantages must be weighed unquestioned costs. Fewer Japanese banks will mean less innovation since there are fewer innovators and a greater likelihood of continued government involvement if the banks totter since they will now certainly will be too big to fail.

Regardless of motivation, one result of the mergers will be a reshuffling of the keiretsu relationships among Japanese banks, their borrowers, and their sister financial institutions such as insurance companies. Economic power may become remarkably concentrated or more dispersed depending on how tightly the resultant organizations are integrated. This issue, along with similar changes involving nonfinancial companies such as carmakers, will be explored in more depth in a JEI Report available April 7.

"JEI's Spin on the News" are the opinions of one or more members of JEI's staff and do not necessarily represent the views of the organization.

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Carmkers Update Keiretsu Ties

Friday, March 10, 2000

Japanese corporate groups known as keiretsu long have been among the most interesting features of the Japanese economic landscape. Although generally descended from the prewar zaibatsu, they are much less centrally organized than were the zaibatsu. Moreover, recently some keiretsu companies have been weakening further their organizations by forming affiliations, not just with fellow keiretsu members, but with members of other keiretsu, nonaffiliated Japanese firms and even foreign companies. However, other organizations have been moving to bind affiliated companies more closely together.

The automobile industry exemplifies both these trends. Mazda now is effectively part of the worldwide Ford Motor Co. group, weakening dramatically the small carmakers traditional position inside the Sumitomo keiretsu, which arguably saved the company in the late 1970s and early 1980s. Similarly, Nissan, where Renault effectively is calling the shots, has announced that it will do business with a greatly reduced number of companies, weakening the ties both with the Nissan keiretsu and the broader Fuyo keiretsu of which the Nissan keiretsu forms a part. Mitsubishi Motors, a stalwart of the Mitsubishi keiretsu, reportedly is flirting with Daimler Chrysler, with what Mitsubishi group companies fear will be negative results for keiretsu solidarity.

Toyota, the biggest and arguably healthiest carmaker, however, is taking the opposite tack. Theoretically a member of the Mitsui keiretsu, the huge company long has more or less gone its own way. Its ties to its own keiretsu companies are much more important than its links to Mitsui companies such as Sakura Bank. It has made several moves to strengthen ties among the Toyota companies in recent months. It increased its shareholding of Daihatsu, a second-tier carmaker. In early March, it announced that it would buy 5 percent of Yamaha Motor Co., with which it has a 30-year relationship. Yamaha Corp. and Yamaha Motor will also buy shares in Toyota, creating a classic cross-shareholding arrangement at a time when many such ties are being eliminated. Moreover, the Nihon Keizai Shimbun, the leading economic daily, announced March 10 that Toyota was increasing its stake in truck maker Hino Motors, to 33.4 percent from 20 percent. In some cases, Toyota appears to be lending life support to faltering companies, while in other instances, it appears to want to strengthen ties to tap into the companies' expertise more fully. In most cases, its moves are partly defensive to keep what long have been considered Toyota companies from escaping the Toyota orbit.

In short, relations among keiretsu companies are in flux, with movement toward tighter and looser control both occurring. Conventional wisdom that the keiretsu are dismantling at rapid speed is surely incorrect. A JEI report available to subscribers April 7will explore the development of keiretsu and these recent divergent trends in much more depth.

"JEI's Spin on the News" are the opinions of one ormore members of JEI's staff and do not necessarily represent the views of the organization.

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Japanese Firms Mostly Missing Out On Korean Restructuring

Tuesday, February 15, 2000

When the South Korean economic crisis erupted in late 1987 and early 1998, the need for Korean companies to dramatically reinvent themselves became apparent. More than two years later, no one is yet sure where the restructuring efforts of Korean companies will end up, but evidence increasingly suggests that Japanese companies are not likely to be heavily involved, geography notwithstanding.

Banking and cars provide two examples. In the former, American and European financial institutions have picked up large, failed Korean banks, giving them entry into the Korean market. In the case of cars, de facto bankrupt Kia ended up as part of Hyundai, the leading Korean producer, in a move that probably avoided the second largest exporter of cars to the United States merging with General Motors, Ford or DaimlerChrysler. Samsung Motors, the newest Korean carmaker, which was just getting off the ground when the crisis hit, is expected to become part of Renault S.A., although some analysts remain skeptical. The Wall Street Journal reported February 14 that Daewoo Motor Co., part of the troubled Daewoo Group, is likely to be fought over by Ford, GM and maybe DaimlerChrysler.

The obvious question about these and other moves is: Where are the Japanese? In the case of banks, the answer might be that Japanese financial institutions have serious balance sheet problems of their own. Mergers among themselves are a major preoccupation at the moment and foreign markets are being abandoned. Despite the large amount of trade and travel between South Korea and Japan, Japanese banks do not apparently see their neighbor as essential to their global strategies.

Cars are another matter. Despite weakness at home, Japanese carmakers are doing fine in global competition, with the notable exception of Nissan. Their vehicles remain at or near the top in terms of product quality and consumer satisfaction in markets around the world. Moreover, in not a few instances they have provided key technology to Korean makers. Renault's probable affiliation with Samsung almost certainly has a lot to do with the fact that Samsung vehicles are based closely on those of Nissan, which Renault now effectively controls.

The reluctance to stay away from the Korean fire sale, with the partial exception of Nissan, probably reflects several factors. First, Japanese firms in general are not enthusiastic supporters of mergers, among themselves or with foreigners. The baggage is just too great according to the conventional wisdom, a view supported by some American studies which show that mergers mainly benefit stockholders of companies that sell out. Secondly, Korean firms do not fit as neatly in global plans of Japanese companies as they do in those of American or European ones. Mitsubishi Motors, to cite an example, does not need Koreans to build an Asian car for it; it already has one called Mitsubishi.

The most important reason that Japanese companies have not ventured into Korean merger waters, whether of banking or carmaking, is usually not mentioned — at least by Japanese analysts. The difficult history of the two countries' relationship, particularly the lengthy colonial period that lasted nearly half the twentieth century, has increased the sensitivity of what are sometimes called "marriages." Either Japanese companies have been invited to stay away or they have decided on their own to avoid ruffling feathers.

Although Japanese companies are increasingly active in direct investment in Japan, buying up a hgh profile Korean company may be a bit much still for either side to swallow. It is one thing to open a plant or sell a product in Korea, it is another to take over a struggling national champion, like carmakers and banks tend to be treated.

Whatever the reason, Japanese reluctance in automobiles, finance and other industries could affect the international competitiveness of the affected Japanese firms. One possibility is that they will not have to deal with messy merger problems, increasing their competitiveness. This view is stressed by those experts who feel mergers are consummated mostly done out of the vanity of the executives of the acquiring companies. The other possibility is that Japanese companies could end up outflanked, even in their Asian backyard, and diminish as global players. Stay tuned.

"JEI's Spin on the News" are the opinions of one or more members of JEI's staff and do not necessarily represent the views of the organization.

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New Doubts About Japanese Economic Recovery

Monday, February 7, 2000

Economic Planning Agency chief Taichi Sakaiya's pronouncement on February 6 that the Japanese gross domestic product probably shrank significantly in the last three months of 1999 has had wide ranging repercussions. For example, it has put the yen, which had been creeping upward, into a tailspin. The Japanese currency, which had been around ¥103=$1.00, has moved into the ¥107-108 range.

The psychological impact of the key official's announcement, however, is far greater. According to standard American ways of thinking, two consecutive quarters of shrinkage define a recession. Since preliminary data show that the Japanese economy registered negative economic growth in the July-September quarter, American analysts have interpreted Mr. Sakaiya to be saying that Japan again is in a recession only months after it seemed to have entered a recovery phase. The experience would be akin to that of a patient, released after a long hospital stay, who barely gets his bags unpacked before discovering symptoms that send him back to the hospital.

Mr. Sakaiya, who as head of the agency that compiles the GDP statistics, probably has access to unreleased data upon which he bases his prediction, but private sector forecasters feel much the same way even without those numbers. Most experts are predicting a quarter-to-quarter decline in GDP in the October-December period. Yet, all of them may be wrong. Last spring, Mr. Sakaiya expressed surprise at the strength of first quarter growth after the EPA released the GDP number in June. Similarly private sector forecasters had expected a modest pick-up at best, not the growth that approached double digit levels when measured on an annualized basis.

Even if preliminary numbers to be released in March show shrinkage, revised GDP figures released later this year may register an increase. Moreover, officially Japan uses a different set of criteria to determine the beginning and end of recessions and expansions than does this country. In any event, as in the United States, experts do not rely on those quantitative indicators alone in coming to a decision. For what they are worth, most of these criteria suggest that Japan is in the midst of a very modest recovery. In other words, assuming at this point on the basis of Mr. Sakaiya's announcement that Japan is in recession again is very premature.

"JEI's Spin on the News" are the opinions of one or more members of JEI's staff and do not necessarily represent the views of the organization.

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Reversal of Reform Efforts?

Thursday, January 20, 2000

Japan's long running policy of liberalizing its financial sector — and economy generally — may have stalled. This theme, which JEI surveyed last November (see JEI Report No. 43A, November 12, 1999) has received increased attention with Tokyo's year end decision to extend the life of unlimited deposit insurance (see JEI Report No. 2B, January 14, 2000).

Gillian Tett of Britain's Financial Times (http://www.ft.com/hippocampus/q322946.htm) now has picked up the theme, citing low-ranking bureaucrats who complain about the pace of change or who express fears that planned reforms may be scuttled completely. She also notes the growth of a group of anti-deregulation Liberal Democratic Party Diet members to around 100 people.

Officially, of course, Tokyo says reform remains on track. Some outside observers give the government some slack, noting that this year is an election year. Although the overall theme of economic reform remains popular, the details, which can involve real or perceived threats to job security, are not.

Coming months are likely to revealing. For example, will the opposition Democratic Party take up the cause of reform, repeating if necessary the arguments from overseas that the LDP has dropped the ball? If so, the LDP could be forced to make more of an effort to appear to be in support of reform, even if it is not. Will large business organizations such as Keidanren flex their muscles to reinvigorate the liberalization process?

The LDP and the government will have to show its hand in several upcoming decisions. Already, they appeared in mid-January to expand deposit insurance even beyond the level implied in the December reversal. If the LDP's apparent proposal is accepted, some types of deposits would be protected by unlimited deposit insurance even beyond the new, extended deadline of April 1, 2002.

The move toward a market-based Fiscal Investment and Loan Program could be another casualty of the new thinking. The government is expected to introduce a proposal this month that, among other reforms, would sever the obligation of the postal savings system to offer, and various semi-government agencies to accept, postal savings as means of financing their activities. Whether this proposal arrives on time will be critical, as will the details of what mechanisms replace the existing arrangement. For example, if bonds guaranteed by the government assume an important role, the increased market discipline on the agencies from the reforms would be minimal.

Actions to deal with the remaining sick financial institutions also will demonstrate Tokyo's commitment to reform. When will it find a buyer for Nippon Credit Bank ,which now has been on the block than the Long-term Credit Bank of Japan, which last September was handed over to Ripplewood Holdings LLC? (On LTCB see JEI Report No. 37B, October 1, 1999). If the government continues to delay, the partial nationalization of the banking sector could prove protracted.

What will Tokyo do about several small banks that failed in 1999? Will it use some of its trillions of yen already designated for bank recapitalization to breathe life back into the scores of credit cooperatives and credit associations that otherwise might go under? Such an initiative would be a departure because Tokyo has repeatedly stressed that, unlike the big banks that have gotten their government money already, these institutions are not too big to fail. If, as Tokyo says, the economy really is in a recovery phase, propping up these midgets would have even less rationale than it had a couple of years ago.

At this juncture, the LDP is likely to implement most of the described proposals that would rollback or delay reform. If the LDP does badly in the election, a new prime minister more committed to reform might take Mr. Obuchi's place. If the party does well, Mr. Obuchi would keep his job. Although some pundits predict he would then move boldly, he might read the returns as a validation of a go-slow policy. To judge by the growing numbers of legislators in the anti-reform group, he would have little difficulty selling a program of slow-to-nonexistent reform to the party's rank and file.

"JEI's Spin on the News" are the opinions of one or more members of JEI's staff and do not necessarily represent the views of the organization.

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