In this blog we will get know all about Japan’s Corporate, Banking and Government sectors post world war 2 and the challenges the country is facing today. So let’s dive into the topic right away.
Economic Situation in Japan – The lost decade
Japan in the Post World War 2 Era
Japan made an impressive economic recovery in the decades following world war. Japanese incomes grew rapidly and companies developed a significant presence in the major global industries like automobiles and consumer electronics. Unfortunately, in the 1990s Japanese economy sank when the economic bubble burst. This not only brought the economy down but also upset the people as it exposed the corruption in governance.
Key events leading to bubble burst
Japan and west Germany had huge trade surpluses with the US in the early 1980s. The US dollar was strong partly because of the high interest rates. In 1985, leading economic countries met inorder to reduce the huge trade deficit the US had with its major trading partners, by pushing the dollar down(called the Plaza accord). The logic was, by pushing the dollar down the Japanese yen would become stronger and the US exports would become more competitive in the international market compared to the Japanese exports. As a result of this accord, the US dollar fell sharply and the Japanese and the German exports became less competitive resulting in their respective economies getting hit massively. As a result of this, the GDP fell sharply.
In order to counter this, the Bank of Japan started giving loans with a reduced interest rate/discount rate. This resulted in expanding the credit in the economy. Many companies rushed to make use of this low interest credit by investing in stocks and real estate. The value of stocks and property prices rose exponentially. This fueled the economic bubble. Banks turned to the stock market to raise funds. The upward spiral of prices seemed out of control which worried the bank of japan who tightened the money supply by increasing the interest rate in 1989, effectively pricking the bubble.
Japan’s Corporate, Banking and Government Sectors – Post world war 2
Cross holding of stocks and lack of transparency
Once special aspect of company ownership in Japan is the Keiretsu, i.e, cross holding of stocks. This created a community of companies that looked out for each others interests. Banks held some of the stocks in their Keiretsu partners and vice versa. This cross holding was as high as 45% in some of the companies in the 90s. This connection between the companies was not always transparent, also banks were reluctant to ask for high interest rate with their Keiretsu partners even though their cost of obtaining funds from depositors was rising and squeezing their profit margins.
Banks tried to increase their returns through growth in assets whose value fell significantly once the bubble burst. The falling markets made it really difficult for the banks as the assets which they had taken as collateral for the loans they had given and also their assets, i.e,stock in others companies fell sharply. This made the banks less safe financially with the fall in value of assets.
To sum it up, Corporate governance had limited transparency which resulted in weakness and risks not readily apparent which would have been in-case of independent stock holders who would have demanded more information. This lack of transparency led companies to enter into commercial arrangements without any knowledge of full risks.
The bubble had created euphoria about market growth. To meet the market demand, companies invested a lot and hired more workers, finally when the bubble burst the demand vanished and companies realized that they had been misled and were now struck in maintaining underutilized factories and paying the surplus workforce. This had the ripple effect in slowing the economy hugely.
Another serious problem for companies manufacturing in japan was the increase in the value of Japanese yen. As the value of currency rises, the country’s product becomes more expensive in the global market. This had an effect on the competitiveness of Japanese products and also the economy.
Another significant factor was the wages to employees post war as the economy prospered the wages increased which resulted in the increase of Japanese product costs. As a result of this some of the companies moved manufacturing to other countries like Malaysia and China in-order to cut the labor cost, which had a negative impact on the economy as the jobs moved to other countries.
In the mid 90s the Yen retreated in value due to the softening of demand for Japan made products, which provided some relief for the companies manufacturing in japan. However, at the end of 90s due to the Asian financial crisis some of the countries like to South Korea and Thailand economies were severely affected in comparison to the Yen which wasn’t, resulting in their products coming into demand in the market thus reducing the competitiveness of the Japanese products again.
After the bubble burst, though companies tried to reduce cost, some of their own traditions were a hindrance like not firing lifetime workers who formed 25% of workforce. Also the Japanese weren’t individualistic as people of other countries like the US, also they lacked institutional arrangements which supported the formation and growth of new ventures. During the post war era, some of the factors of their culture like strong loyalty and group thinking were really beneficial but these very factors like loyalty between companies within keiretsu and group thinking backfired during the economic problem phase.
Role of Mafia in corporate governance
Stockholders had little stay in affairs of the companies.There was little discussion on important issues that may be controversial.
This brings us to one related problem in Corporate governance. Japanese managers were scared at the prospect open questioning at stock holder meetings. This made them vulnerable to extortion by mafia/sokaiya who had to be bribed to abstain from asking embarrassing questions. In-order to avoid sokaiyas, many Japanese companies used to arrange annual meetings on the same day. Over the years Japanese government tried to reduce the impact of sokaiyas by imposing strict regulations like arresting the executives who used to bribe them etc., which resulted in the reduction in numbers significantly. Gradually sokaiyas diversified into others areas like buying bad loans from banks and selling collateral property for a profit.
Role of politics in shaping the business environment
After world war 2, the US armed forces still present in Japan left the country in the early 1950s after which the Liberal Democratic Part(LDP) ruled the government for a long 40 years approximately. As corruption grew, it lost control in the 90s briefly to the opposition. The LDP had a number of factions that competed for influence, often the PM elected could not implement significant changes due to the influence of these factions. In case they tried to bring about changes, they would be forced to resign by these factions who were inturn answering to the Special interest groups or the farmers. In the 90s, Japan was in a political turmoil as 7 PMs resigned one after another mainly due to corruption charges.
Lets turn to another arm of government ,i.e, bureaucracy, mainly the powerful Ministry of Finance and METI(Ministry of Economic,Trade and Industries). A lot was said about METI which was hugely influential in bringing about changes in japan, in the post war era. These ministries mainly recruited talented graduates from the top universities who spent their whole career working there and were involved in drafting the policies of government. The bureaucracy provided continuity or stability in the midst of political turmoil in the 90s.However critics were of the opinion that, bureaucrats avoided risk which was evident in their slow response during the Kobe earthquake. Sadly, they were also increasingly implicated in corruption in 90s.
The bureaucrats and senior managers of industries had an interesting connection. Many had started out their careers at the same time after graduating together from top universities. They stayed in touch informally as their careers progressed in industries and government respectively. As they knew each other well, they could agree on strategies which would develop the country in the post war years. This also helped the companies a lot in globalization and also control the market from foreign intervention. However this connection had a negative side as well, as the companies with no close government connection were not given preference. Also this led to corruption and lack of transparency.
Recession in 1998 and Koizumi era
An economy can be called as being in recession when its GDP falls for 2 consecutive quarters. This recession happened in 1998 which resulted in increased unemployment. In the late 90s and early 2000s the economy was so depressed that the prices were falling year after year by a small amount. The deflation created a challenge for growth as people were putting off purchases with the falling prices and companies were under loss as they had lesser products to produce but had the burden of paying wages and maintaining factories.
In order to curtail this, the Japanese government introduced tax cuts so that people could spend more and fuel the economy. Also the government spending was increased to stimulate growth. These stimuli helped to soften the economic problems temporarily but failed to produce sustainable growth because the underlying structural problems didn’t go away and the government could not keep providing the stimuli. Due to these stimuli, the government ended up in huge budget deficits. These had to be compensated by huge borrowing.
In the late 90s as the economy was recovering with the stimulus provided, in order to check the huge budget deficits or debts the then PM removed the tax cuts and government spending which by then had improved the consumer demand without providing sustainable growth.The ill timed action, resulted in demand dropping which slowed down the economy and the government was forced to release a new stimulus to overcome this.
In 2001, LDP’s Koizumi came to power. Koizumi adopted the slogan “change the LDP to change Japan”, indicating the underlying factions,i.e, the special interest groups were the hindrance in implementing changes and drew power directly from the people. He used the Lion heart email magazine to communicate with the people. It is remarkable that he governed Japan for the full span of 5 years which none of his predecessors couldn’t complete.
The changes that were implemented during Koizumi’s tenure began to show results as the economy picked up. One of the main factor was increase in the imports to China as it replaced US as the main trade partner. By 2005, the Japanese recovery had blossomed into an expansion fueled by domestic demand, the stock index doubled since 2003, the banks raised the short term interest rates etc. However, Japan was becoming concerned about the aging population by then. The economy was expected to slow down again with the 2007 problem when the post war baby boomers began retiring and the shrinking workforce would reduce the output and increase the burden of supporting the retirees. To make matters worse, the country population started declining in 2005 owing to the falling fertility rate.
Corporate and banking sectors improved as well during Kozumi’s span. The non performing loans held by banks declined significantly by 2005. Furthermore, the ratio of corporate cross holding reduced from 45% in 1994 to 27% in 2002. Companies had gradually created a more flexible workforce, reducing dependency on lifetime employees through attrition and increased the intake of part time workers whose wages were much less compared to the full time employees.
Japan was deeply hurt by the global economic crisis of 2008. However, it began to recover pretty fast with the GDP rising in the coming years. In 2011, North-East Japan was hit by deadly earthquake and tsunami which killed thousands and brought about huge losses worth billions of dollars. Also people were forced to flee from the area to avoid the harmful radiation from fukushima nuclear reactor leakage.
All these disrupted the manufacturing supply chains, factories could not get critical parts and production came to a halt in the region and foreign countries which depended on the supplies from Japan. As funds flowed into Japan for reconstruction,this caused the yen to rise. As an effect of this the GDP turned slightly negative in 2011. Though it turned positive in the next couple of years it again slipped to the negative region in 2014 owing to sales tax hike. Another major challenge is very high public debt which is very high among developed countries. Abe’s reluctance to increase the sales tax is understandable as that would have increased the finances but would have risked slowing down the economy.
Abe’s current term
After Koizumi’s term got over and there was lot of work to be done and the PMs who followed him were not much effective. In 2008, the world was hit by the housing crisis in the US and the world economy was hit, from which Japan is still struggling to recover.The current PM Shinzo Abe assumed power in 2012, whose previous stint of one year was unremarkable.
When he came to power in 2012, he curbed the power of factions within LDP and gave greater power to the cabinet. He had focused to concentrate on important priorities rather than a larger more diffused set of objectives. This initiated an impressive economic turn around which led LDP to win majority in both the upper and lower houses of the parliament making it possible to legislate reforms for long term prosperity.Despite having such a strong mandate, Abe is being careful not to rush for changes that could be unpopular and eventually would remove him from power. After such a long term in power, people have become increasingly doubtful about Abe’s ability to bring about structural reforms.
Abe’s trademark strategy, Abenomics has three components referred to as the three arrows i.e., fiscal stimulus, monetary stimulus and structural reforms. Abe started out strong reviving the economy in 2013 with the first two of the three arrows as he got the parliament to approve an economic stimulus package. Inflation picked up and the urban property prices began rising. Since Abe assumed office the Yen depreciated significantly helping imports. The impact is limited as a lot of Japanese manufacturing companies moved abroad in the earlier years.A big challenge facing today is that the wages haven’t risen though the inflation is increasing causing hardship.
The structural reforms would belong to institutional changes section ,i.e., the third arrow of abenomics. For sustainable growth, Japan needs to remove impediments that hold back the economy and keep productivity low and discourage investment. The impediments are regulations which hinder business like creating rigidity in labor market by avoiding intake of women and foreigners.This results in scarcity of talent that is essential for making Japan globally competitive. Abe began to moved the Pension Investment funds to companies listed in the stock market so that he could improve the corporate governance through stock holders.He also announced reducing the very high corporate tax, the impact of which is still unclear as big companies are flushed with cash and don’t seem to invest unless there is demand picking up. On the other hand consumers have been hurt with rising consumption tax with no rise in wages.Also there is no progress on the Special economic zone creation promise. Progress on the Trans pacific partnership for trade has also been very slow, which is partly due to the US political situation.
Rise of China and Japan Diplomacy
Balance of power in the world is changing as China and India are emerging in the world market. The rise of China as both economic and military power is causing concerns to Japan, given its close proximity to the country and its strange relation with its neighbors. Both China and Korea have remained hostile and refuse to accept responsibility for their aggression in the first half of 20th century. Yasukuni Shrine is an example where the war heroes of Japan are buried who are classified as war criminals in China and Korea for their role in world war 2. PM Abe visited the shrine in 2013 which angered the neighbors and Abe has refrained visiting the Shrine since then.
Relations between Japan and China are also due to the territorial disputes over gas deposits near to the senkaku islands in the east China sea. China claim the islands as their own until it was annexed by Japan in the 1800s. But Japan say that it was not claimed by anyone until the 1800s and China started staking their claims after gas deposits were found. Japan’s territorial disputes with China can have serious economic impacts as there are boycotts over Japan’s products in China when tensions rise resulting in lower sales. Japan is trying to look for other trade markets by reducing China’s influence like taking part in the Trans-pacific partnership trade agreement. Japan was getting more interested in building relations with India whose trade is a mere 1% of its total trade.
The territorial disputes was leading to rising nationalism in the neighboring countries who were launching missiles to showcase their power. China launched one in late 2010. Abe is keen to enhance the military power and favors changing the constitution which was written during US occupation of Japan post ww2.The article in constitution renounces the use of force to settle international disputes. Overtime Japan has created a self defense force which is not meant for committing war but would defend the country from aggressors. Also new defense strategies were set up so that it could stand up to China and North Korea.
Given the way the balance of power is shifting, Japan is anxious not only to ensure US support but is also actively exploring collaboration with other countries like India and Australia to counter China’s rising power in the Indo-Pacific region.
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