News Analysis: West senses opportunity as Japan embarks on a painful revolution

Huge recovery potential is seen as Asia's business superpower begins an economic transformation
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The Independent Online
EVEN 10 years ago, it would have been unthinkable.

Japan, the country with the highest GDP growth of the world's major economies for three consecutive decades, is still struggling to climb out of the bottom of its deepest recession since the Second World War.

Last year the economy contracted 2.9 per cent and is forecast to produce negative GDP growth of 0.5 per cent both this year and next.

Finally this proud nation has accepted that it needs to carry out root- and-branch reform of its economy, spelling the end of its 50-year experiment in stakeholder capitalism and the adoption of the Anglo-Saxon model.

This will be more than a minor adjustment. It will be a revolution and one that economists believe will open up lucrative investment opportunities for the West.

Japan is slowly and reluctantly embarking on a painful restructuring that will trigger the most far-reaching transformation of its economic system since the Meiji restoration last century. Then, Japan decided to embrace foreign technologies and pull down its barriers to trade with the outside world.

This time it will have to import an alien version of capitalism that will herald the end of a number of features of economic life that the Japanese have taken for granted for decades - a job for life, cross-shareholder ownership of companies, a policy of pursuing market share ahead of profit growth.

What will replace it will be savage job-cutting, an acceptance of the need to continually strive for increased rates of returns and an appreciation in the share price.

"Japan will become a profoundly different country," said David Hale, Chicago-based chief global economist with Zurich Investment and an adviser to the city's Federal Reserve Bank.

"What we will see will be a new paradigm. But it is likely to take five years as there will be no simple way for Japan to revive its economy when it is confronted with so many challenges simultaneously."

Richard Batty, equity strategist at HSBC in London, said over a medium- to long-term view Japan could present some relative advantages compared with other markets once it had "returned to the fold".

"The problem is cultural. Moving to the idea of maximising profits rather than sales and employment, which was the previous model, requires a change in an economic, cultural and even a social sense," he said.

Mr Hale said Japan was suffering from four separate crises - each of which on their own would test the most battle-hardened policy maker. But taken together, they can only compel dramatic restructuring.

Corporate profitability has slumped, with returns on equity falling to 2 per cent last year compared with 9 per cent in the 1980s and 22 per cent in the US.

While Anglo-Saxon capitalism would dictate this lead to widespread mergers and the attached cost and job cuts, the cross-shareholding system - under which the banks own 25 per cent of equity - prevented that happening.

As a result, the monolithic banking sector found it was landed with trillions of yen in problem loans as a result of asset deflation and a severe recession that saw industrial production contract 7 per cent last year.

The lack of profitability also had a fall-out effect on corporate pensions, where low returns on assets have left a huge pile of unfunded pension liabilities.

Lastly, the fall in profitability and the crisis at the heart of the banking system have combined to create a public deficit nightmare as tax revenues plummet and state spending increased to stimulate growth.

The manifestations of these crises are becoming increasingly common.

On Friday NEC Corp, Japan's biggest semiconductor maker, unveiled its worst-ever earnings, posting a net loss of Y158bn (pounds 810m) in the year to 31 March. Hitachi followed with a record Y338bn loss, Kobe Steel lost Y38bn, Toshiba Y15bn and Matsushita's profits were halved to Y202.bn

Just two of the 100 largest global companies by market capitalisation are Japanese, compared with 43 a decade ago.

Last week commentators forecast the end of the culture of "jobs for life" for millions of salaried staff, after male unemployment surged to a post- war high of 5 per cent.

Analysts said firms have started cutting permanent jobs as part of a shift to temporary contracts and a more flexible labour market.

This manifested itself in falling unemployment among women, who are taking up these new temporary jobs. In total, the number of temporary workers is up 5 per cent.

The number of workers getting the sack exceeded those leaving voluntarily for the first time in 12 years.

The major banks have now set aside about Y10,000bn to wipe out bad loans while the government has injected Y7,500bn of public funds. A new Financial Services Agency expects 95 existing major banks to be merged into eight mega-institutions.

However, the weak link appears to be the Japanese government. A presidential election will take place in autumn, followed by a supplementary budget that may see another attempt at fiscal loosening - possibly as much as Y15,000bn - aimed at stemming the job cuts.

Economic and employment reform bills that were expected over the summer have been postponed because presidential candidates within the ruling LDP party do not want to be seen as responsible for tough reforms.

"Scrapping excess capacity entails much higher unemployment and this is the last thing politicians can tolerate before the election," said Shigenori Okazaki, of Warburg Dillon Read in Tokyo

Okazaki said plans to move away from unemployment subsidies towards a social safety net would be the right step, but added: "This is a difficult decision for politicians who have lived through the glorious days of lifetime employment."

The Bank of Japan has attempted to carry out both fiscal and monetary loosening, cutting rates to zero and announcing multi-trillion-yen expenditure programmes.

HSBC's Richard Batty said: "These have not worked and tax cuts have not worked and we are relying on companies to make the adjustment and that is occurring but that's a long and slow process."

He said managers who had previously shown a lack of initiative must now demonstrate a willingness to pursue profitability and carry out restructuring - including further job losses.

"Western investors will embrace the concept of companies trying to restructure and we have seen that with Sony and Toshiba. They have to return to the fold," he said.

Zurich's David Hale said Japan would be a "great stock market story" but predicted at least 18 months of pain preceding that.

"There are huge investment opportunities over the next two or three years," he said on a visit to London last week. "Despite the poor outlook for the economy in 1999, the case for a Tokyo bull market is increasingly compelling because of the structural changes now starting to occur in the corporate sector."

But one man's meat is another's poison. While all of this will go down very well on Wall Street and in the City, Japan's Mr Salary Men must be wondering where it all went wrong.

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