Japan Inc faces up to need for fundamental reform
If wages are falling, consumption will fall too. But it also indicates firms are repairing profitability
Friday 11 June 1999
We are all familiar with the apparent perversity of the markets' response to bad corporate news. When the company announces that its profits are down and it is going to sack large numbers of its workers, the share price goes up. But this is not really so odd, because the fact that the company is adapting to its changed circumstances is seen as more important than the fact that the circumstances have changed - which everyone with any sense knew anyway. And so it is with Japan - but on a national rather than company scale.
Two particular pieces of bad news that have been emerging from Japan are shown in the charts. One is the level of capital investment in Japanese industry in real terms. As you can see, it has already fallen from its peak of 20 per cent of GDP in 1991. It may have fallen even further in the past couple of months to about 12 to 13 per cent of GDP.
Falling investment, you might think, is a sign of a still-weaker economy to come, but actually it means that at last Japanese firms are investing at a rate which is sustainable and does not result in vast overcapacity. In short, they are becoming more interested in trying to make profits than in going for loss-making growth.
The other bit of similarly "bad" news is what has been happening to wages. They are now clearly negative. Japanese workers achieved small gains in wages even through the worst of the 1990s recession. Now they are seeing real cuts. That, too, you might think was a negative sign. If wages are falling, workers will have even less to spend and consumption will fall even more. But it is also an indication that companies are at last starting to adjust their labour to their demand - they are restructuring to repair their profitability.
This process has a long way to go. Earlier this week I was talking with a senior Japanese official. He told me that the concealed unemployment - the numbers of workers still on company payrolls who were not needed - was larger than the actual tally of unemployed. So instead of there being 4.8 per cent of the workforce unemployed, as the official figures showed, it was about 10 per cent.
I think I must have looked shocked. "Lower," he said with a grin, "than in continental Europe."
How long will it take for companies to unload these workers, or whether they will indeed cut back as savagely as that, are both open questions.
But as it typically takes up to a couple of years for companies in Japan to move from decision in principle to implementing, the restructuring has a long way to run. The fact that they are making a start is encouraging, because it shows they are recognising that they cannot continue as they have been doing. If they do, many companies will go under, which is vastly worse than surviving in a slimmed-down form.
This recognition that corporate Japan is changing at last is probably one of the main factors behind the recent revival in share prices. That does not necessarily mean that the revival will be sustained, but eventually - maybe after another crisis of an unpredictable nature - corporate Japan will become vastly more competitive. It is at last recognising that there is a grave problem and that to fix it, Japanese companies must behave more like those of the US in their focus on shareholder value.
A rather different perspective on the structural changes taking place in corporate Japan was given last month at a London seminar organised by the Canadian publishing group, the Bank Credit Analyst. At it Shuhei Abe, president of Sparx Asset Management in Tokyo, argued that the regime that had run Japan really since 1940 had ended in 1985, and further collapsed after the bursting of the asset bubble in the early 1990s. The strategy of supporting strategic growth in key industries at the cost of less efficient industries and of consumer interests worked very well until about 1985 (and incidentally is still admired by some people here in the UK).
But this system, orchestrated by Japanese officialdom, had finally led to catastrophic investment decisions and had given way to rule by the market. The wave of mergers (including foreign takeovers) now starting to take place was one sign of this shift in the way decisions would be made. Meanwhile, the lifetime employment and seniority-based promotion systems were being abandoned.
Mr Abe's conclusion was that while the aggregate would remain flat for the foreseeable future, as families took yet another hit from rising unemployment and flat incomes, there would be increasing signs of buoyancy among the best companies, or at least the companies in the most promising sectors of the market. He thought that general recovery of the Japanese market was more than a year away and that a general economic recovery would not take place until the second half of next year. But meanwhile it was time to do some homework and seek out the promising companies whose shares were currently undervalued.
That must be broadly sensible. My own concern would be that there are still quite serious pitfalls ahead. One is politics. While companies may be committed to reform, it is not yet clear that the political system is ready to change.
There is a danger Japan will find itself in a similar trap to Germany, where companies run far ahead of government in the reform process. There is a danger, too, in carrying out such reforms at a time of deflation. This not only makes it harder to conceal cuts in real wages, but carries the danger of the "liquidity trap", where real interest rates cannot be cut sufficiently to stimulate growth because prices are falling even faster. If land prices continue to fall and the current stock market recovery falters, the indebtedness of many Japanese companies would threaten their existence. The banking problem seems to have been contained, but corporate indebtedness continues to be great concern. So there may be a further twist to the crisis later this year.
Nevertheless, the fact that companies are changing is enormously encouraging. All past experience of Japan would suggest that once a collective decision has been taken it will be implemented with thoroughness and determination. Corporate restructuring may be only one element of the changes that are needed, but it is an absolutely essential one for the whole region as well as for Japan itself.
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