Japan's GDP: agriculture: 2% industry: 41.5% services: 56.5% (1995)
Beginning in early 1997, Japan's dominant role among all Southeast Asian countries began to change. With Japan's economy sliding, its neighbors bought fewer imports. Countries like Thailand, Malaysia and Indonesia felt the impact in their own domestic economies. Japanese banks, which previously had provided aggressive financing for business projects throughout the region, abruptly pulled back. Mismanagement occurred in other countries, such as Indonesia. But Japan's actions contributed to the problem as well.
Overall, about 40 percent of U.S. agricultural exports are purchased by Southeast Asian and Pacific Rim countries. No other region of the world purchases as much. That's why American farmers and ranchers are interested in hopes of better times ahead in Asia, particularly in Japan. The yen's recent increase in value, from 147 yen to the U.S. dollar in August 1998, compared to 111 yen to the dollar early October 1997 is significant. It should make U.S. products more affordable, yet US export to Japan have not risen.
After a long internal political struggle, it now also appears the Japanese government is ready to provide additional capital to some commercial banks that had overextended themselves earlier. This will allow these banks to return to loaning money for business expansion, albeit with more stringent lending standards. This should help the Japanese economy and lead to more trade within the region.
The functions of the "keiretsu", or business group, and its impact on the present and futur strength of Japanese firms is unique and has been a model for some other Asian economies.
Before World War II several large industrial groups dominated Japanese economic activity. They were centrally owned and controlled with common interlocking directorships. After the war the United States forced Japan to dissolve these groups as they contravened anti-monopoly and anti-combine regulations. Since that time a number of major groups, or keiretsu, have reformed. Today each group is clustered together in voluntary association with a center bank at the core. An example of these powerfully related companies is the Mitsui Group, vying with Mitsubishi as one of the two largest keiretsu. Mitsui is representative of the key characteristics in these associations: Industry Range - The companies in the cluster are drawn from every industrial sector -- foods chemicals, metals, pulp and paper, finance, insurance, automobiles, etc. Ostensible Independence of Member Companies - Each company has its separate owners, shareholders, and board of directors. Central Role of a Major Bank - A major Japanese commercial bank is at the core of the group. The Mitsui Bank is at the centre of the web of approximately sixty companies with the Mitsui Trading Company and the Mitsui Real Estate Company also holding key positions. Nebulous Definition of Membership - There is no clear definition of members and non-members. Twenty or thirty members are very close and others are more loosely affiliated. Dynamic Nature of Relationships - The relationships of individual companies within the group can change with different degrees of affiliation. Toyota was traditionally closely associated with Mitsui but
now has cash balances of more than twelve billion dollars, is loaning money to banks, and is establishing its own group of companies. Mitsui Bank would view Toyota and Toshiba, with a similar relationship, as continuing to be very honored members of the group.
Four mechanisms emerge: cross-shareholding, commercial transactions, personnel movement, and strategic coordination:
Cross Ownership of Shares - Each company is likely to own small amounts of the shares of many of the other companies. A bank may own up to 5% and the other affiliated firms can also own share portfolios. In all cases, controlling shares are held "within the family" and are held for a long term. Shares actively traded on the stock exchange are limited to 20% to 40%. What happens to prices on the stock exchange is of little consequence as the majority of shares are held firmly and securely by other inside members.
Commercial Transactions - Most borrowing is through the Mitsui Bank. As much as fifty percent of sales volume within the family of firms is to others in the same group. Companies purchase supplies, raw materials, and equipment from each other.
Movement of Personnel - Cross movement of personnel, particularly senior personnel, makes it possible to transfer expertise when member firms move into new areas of operation. If a firm must phase out a product, staff can be absorbed into other firms. Certain technical people get together on a regular basis.
Strategic Coordination - The CEOs of the 25 most strategically important companies near the centre of Mitsui meet every second Thursday to plan and discuss their business strategies. They give assistance to each other when new products are launched or new markets are entered, and they are kept informed about projects which affect the whole group. Intercompany accounts can be stretched over a longer term to provide extra liquidity. In an informal sense all other
firms in the group can subsidize a company in an important strategic position. The Mitsui Bank will compensate by charging slightly higher costs for financing to the other companies while the member in the strategic position receives abundant financing at a slightly preferred cost of capital.
The role of the main bank which exists at the heart of each keiretsu is qualitatively different from the role of the Western commercial banks in which the bank lends money to a company in which it has no direct ownership, involvement, or commercial interaction. The Western bank's main concern is the security of its loan. In Japan the bank stands as a virtual guarantor of the long term liability of the companies within its own group, forming a long term supportive relationship that is rarely found in Western society.
Bank Support - If a company gets into financial difficulty and cannot meet its interest and principle repayments the bank will allow deferment of repayment and will continue making new loans to that company. Even when a company is no longer financially viable, the bank does not foreclose, but engineers a merger to draw the ailing company under the wing of one or more of the other members in the family. Physical assets are then incorporated into other operations and human resources are absorbed within the other companies. If there are losses to creditors the main bank will ensure that all creditors are paid off in full and will absorb the losses itself. The opposite situation exists when a Japanese company does not belong to a keiretsu and has no main bank relationship. Then there is no obligation at all on the part of the Japanese bank. Japanese lenders are wary of lending to such a company and therefore the company looks to foreign banks for most of its financing.
Bank Control - In return for long term security and support the bank at the centre of the keiretsu gets a great deal of control and influence. Traditionally many Japanese companies have been financed almost entirely by bank loans. The bank participates directly in corporate management decisions, and has implicit veto power.
Reverse "Debt" and "Equity" and Reverse "Creditor" and "Shareholder" - Debt and equity have almost opposite meanings in Japan and North America. When trying to understand the financial structure of a traditional large Japanese company, it is misleading to examine the balance sheet from an American point of view because the sheet indicates that the company has very little equity and a large percentage of debt, with 70% to 90% of borrowed capital in short term bank loans. A more realistic picture can be achieved by examining the balance sheet with the terms "equity" and "debt" reversed. Then the financial structure appears very similar to that of a typical American company, with the position of the Japanese bank seen as equivalent to that of the position of the American shareholder.
Bank as Risk Taker - In Japan the main bank at the centre of the group, the creditor, supplies most of the financing in the form of short term loans which are rolled over perpetually. Although the loans have fixed nominal rates of interest, the companies that borrow must keep substantial compensating balances on deposit at the bank. If the company does well, the balances get larger; if poorly, the balances can be drawn down to zero or negative. Therefore the real return to the bank fluctuates directly with the earnings of the company. The bank participates directly in the management decisions of the company and absorbs a great deal of the risk.
Shareholder as Creditor - In Japan the shareholder has a very secure position. The shareholder supplies only a small proportion of the financing and has a virtually no direct role in the management of the company. Dividends are usually based as a fixed percentage of the par issuing value of the stock and do not fluctuate with earnings.
Understanding the group relationships within the keiretsu makes it is possible to make sense of Japanese price/earnings and market value/book value ratios. Investors in large Japanese companies are really investing in a closed end mutual fund. This explains why Japanese Price/Earnings ratio is typically 40 to 50x and Market Value/Book Value runs around 500 to 700%.
Investment in a Japanese company actually means investment in the holdings of all the companies that function cooperatively in the keiretsu. The holdings and shares of these companies are recorded at their value at the time of purchase, a fraction of what these values may be today. Real estate holdings, for example, are listed at historical book value and may be worth hundreds of times that today. Investment in a Japanese company cannot be seen in terms of projecting current cash flows from the main operations of that company, but should be seen instead as a set of holdings in a diversified mutual fund with enormous amounts of hidden assets scattered throughout the whole network of companies.
Group linkages give enormous competitive strength which Western stand-alone firms would find almost impossible to duplicate. Important advantages for companies within a keiretsu include: Secure Financial Base - There is no threat from external takeover bids. Low Cost Financial Structure - There is lender monitoring and this quality of information translates to 1% lower cost of capital. Economic Diversification - Companies can undertake risky investment to develop new product lines with other keiretsu members providing subsidies, technological know-how, as well as captive markets. Fadeout Ability - Within the keiretsu there are great advantages when winding down inefficient operations. Resources can be freed up for new activities and human resources shifted to other companies with no overt bankruptcy or layoffs. Access to Technology - If Toshiba develops new technology for global communication or trading rooms, Mitsui Bank has immediate proprietary access, whereas in Canada banks must go out and shop for new technology on the open market. Economies of Scope - The keiretsu have the ability to link together different products and services while enabling each individual company to specialize in what it does best. Stable Internal Management Relationships - Employees can expect lifetime security. Their own long term objectives coincide with those of the company. These stable internal relationships are predicated largely on the stable external environment provided by the keiretsu group. Long-Term Planning and Profit Horizons - Japanese companies can engage in price competition for an extended time without generating profit until they eventually gain a desired market share. Strategically important companies can depend on the long-term support of related creditors, shareholders, suppliers and customers. An important question in comparative study is whether the qualities that make countries unique are unique.
William Lockwood's Gerschenkronian account, which claims that countries can dramatically improve their position in the international division of labor by making political and institutional adaptations, applies well to Japan. The state-firm system, by means of which Japan was able to exploit Gerschenkronian advantages to an extent that few others could, is what makes Japan unique. When the existing ruling blocs failed to resolve domestic and external problems, men of exceptional qualities (such as MITI men Yoshino Shinji, Kishi Nobusuke and Sahashi Shigeru) have emerged at critical moments to form new groups, and pursue their longer-term goals with great efficiency and minimal friction, and managed the conflicts which arise from the modern state's political and institutional expansion into areas of economic activity. The state organizes these areas, mobilizing private resources in order to secure political authority, and thereby provides new opportunities for and constraints upon private market actors. In these new markets, sometimes tension arises between the pursuit of political efficiency (that is, the state's capacity to reduce uncertainty about the political future) and economic efficiency (that is, the state's capacity to reduce transaction costs arising from market inefficiency or failure.)
In the case of petroleum, the state's pursuit of political efficiency has included artarkic industrial development, while the private sector has sought stable business conditions less vulnerable to the vagaries of the world system. The process of institutionalizing the power-sharing relationship between state and market has been consistently shaped by the state's efforts to take politically important (or sensitive) issues out of the political arena and into the administrative arena. By this means, institutional frameworks have been created which give free rein to competing private firms within confined agendas.
State and firms, therefore, seek different kinds of efficiencies in market intervention, and the political processes through which they interact are complex, presenting a picture of seams and cracks rather than of coherence and unity. In the 1980s Japan emerged as the world's largest net creditor country, and the Japanese yen has appreciated dramatically as a result. However, use of the yen as an international currency remains small both in comparison to other major currencies such as the US dollar and the deutsche mark and relative to the size of the Japanese economy. In other words, "yen internationalization" has been limited both in speed and scope. Japan's trade structure and the behavior of Japanese firms are such that traders have neither the market power nor any particular incentive to denominate their trade in yen. Specifically, (a) Japan's major export market is the United States, where the US dollar is the dominant invoicing currency; (b) A large part of Japan's imports consists of minerals, fuels, other raw materials, and basic commodities, in which global trade is generally dollar-denominated; (c) The bulk of Japan's exports and imports are handled by large trading companies (sougoushousha), which can manage exchange risks efficiently by pooling risks and marrying claims and liabilities in a foreign currency, at least until the late 1990s.
Money and capital markets, particularly those for treasury bills (TBs) and other short-term instruments, are not as well-developed in Japan as in New York or London. For example, the outstanding value of bankers' acceptances, introduced in June 1985 as a result of the bilateral Yen/Dollar agreement, has been zero since November 1989 due to high fees, high stamp duties and cumbersome procedures. The market for TBs lacks depth and liquidity, and many other financial transactions are taxed and subject to high fees. In addition, the Japanese financial system is governed by the nontransparent moral suasion and administrative guidance of the Ministry of Finance.
Postwar Japan developed, like other East Asian economies, within the domain of the US dollar's dominance. Japan received US aid during reconstruction, depended on the US market for its exports, and relied on US dollar short-term money markets to finance her trade and balance of payments. All these factors, plus Japan's postwar status as the only developed economy in East Asia, meant that her trade with the developing East Asian economies tended to be invoiced in US dollars.
Finally, the US dollar has continued to play a dominant role as an international currency, even though the shrinkage in the relative size of the US economy and the persistence of the American current account deficits have caused the value of the currency to fall. The US dollar's continued dominance can be attributed to economies of scale, hysteresis, and the public goods nature of the dollar. This suggests that it is difficult for a newly emerging currency to replace the dominant one without some fundamental change in the world economy. This may perhaps account for the limited role of the yen.
However, yen internationalization will proceed, albeit gradually, for the following reasons. Japanese money and capital markets are becoming more liberalized and accessible to both residents and non-residents. Japan's current account surpluses will continue to transfer large amounts of savings to the rest of the world. Japan's economic growth and net external asset position will inevitably increase international use of the yen. Japan's economic interdependence with East Asia will deepen via government and commercial loans, foreign direct investment, and intra-industry trade in manufactured products. This process will gradually increase the use of the yen as a lending and trade invoicing currency. The use of the yen as a nominal anchor will strengthen, due both to Japan's low and stable inflation and to the growing similarities in economic structure between the East Asian economies and Japan. The latter makes East Asian governments more willing to expand the role of the yen in their exchange rate policies. Finally, use of the US dollar as an international currency is bound to decline as US current account deficits continue and the value of the dollar plummets.
Hence the relative importance of the dollar as an international currency will erode and the yen's role will increase. This does not mean, however, that the yen will eventually replace the dollar in international, or even East Asian, trade and finance. The world is clearly headed towards a multiple-currency system in which the yen will play a significant part.
Of the changes that have occurred in the world economy during the 1990s following the end of the Cold War, it is possible to cite three that are especially major. First is the rapid progress of globalization, whereby factors of production other than goods, such as capital, move on a large scale unconfined by national boundaries. In the area of international trade as well, capital movements and service transactions have increased dramatically alongside conventional merchandise trade. Second, the launching of the euro at the beginning of 1999 marks a shift from the state to the region as the central concept, or in other words, a shift from nationalism to regionalism in thinking about economic affairs. Third, the information revolution has proceeded apace, providing the necessary technology for the actual functioning of a global economy. Statistical evidence of these changes is to be seen, for example, in the growth rate of trade, which is running at a faster pace than the world's economic growth rate, and also in the volume of cross-border financial transactions, such as buying and selling of foreign equities, the daily total of which is now a tremendous $1.5 trillion--an amount equivalent to one-third of Japan's annual gross domestic product.
Japan wants a new Japan-U.S. economic relationship. Given the major changes that have taken place in the economies of Japan and other countries, Japan thinks it is time now to review and update the economic relationship between Japan and the United States and the respective roles of the two countries. Japanese policy makers think it is anachronistic to attempt to measure economic affairs, whether globally or bilaterally, by looking primarily at merchandise trade and other forms of movement of goods, as Americans have emphasized. In terms of the bilateral merchandise trade balance between the two countries, Japan feels that the United States's deficit with Japan is continuing to rise because of the expanding demand being generated by its own booming economy. The merchandise trade deficit for 1998 was a record $ 231.1 billion, but the share of the deficit attributable to trade with Japan was 27.7 % for the year and 23.7 % for January 1999, less than half the share of 65.1 % recorded in 1991. Meanwhile, the share attributable to China has been rising slowly but steadily; the figure reached 24.8 % in January this year, making that country the largest single contributor to the deficit.
In the field of direct investment, as of 1997 investment in the United States accounted for 38 % of Japan's total direct investment overseas, the largest share by target country. Going in the other direction, U.S. direct investment in Japan represents 51 % of the total of inbound direct investment, making the United States by far the country's biggest foreign investor. As Japan moves forward with its Big Bang program of financial deregulation, American financial institutions have been aggressively moving into the Japanese market. When Yamaichi Securities, formerly one of Japan's top four brokerages, went out of business at the end of 1997, Merrill Lynch hired approximately 2,000 of its former employees. This is one indication of how human resources are being employed productively through movement between U.S. and Japanese corporations. Meanwhile, the lowering of corporate tax rates and decline in the price of land are making Japan a more attractive target for American investors. American purchases of Japanese stocks are also sharply on the rise. Going in the other direction, Japanese investors own 7.9% of the United States' Treasury notes, which is a sizeable share and about the same as that held by British investors. The relationship between Japan and the United States is thus growing ever closer in areas other than merchandise trade. And this increased closeness not only is essential for the two countries' macroeconomic stability but will also contribute to an Asian economic recovery. Even though Japan is running a huge deficit in its national budget--on the order of 7.8 % of GDP in fiscal 1999--it has announced plans for some $ 80 billion in assistance to other Asian countries, including $ 30 billion under the New Miyazawa Initiative, which is steadily being implemented. Asian countries want more, but it is clear that Japan will not increase its assistanc program unless Japan can have a greater voice, possibly at America's expense. The end of the long financial recession may be finally in sight, but the economy recovery is still elusive. In order to ensure a solid recovery, it will be necessary to banish the specter of moral hazard hanging over the financial sector. And moves are being made in that direction. Policy planner are aiming to build a Japan that can hold its own in global competition, primarily against the US in the near term and against China in the long term.
Henry C.K. Liu