Japan: From Kamikaze Capitalism to Smartpower Dynamism

May 29, 2009

Speaker:
Jesper Koll, President & CEO, Tantallon Research Japan KK

Presider:
Alicia Ogawa, Adjunct Associate Professor, Columbia University School of International Affairs; Senior Advisor, Center on Japanese Economy and Business, Columbia Business School

Jesper Koll of Tantallon Research shared his views on Japan's strengths in the context of the global economic crisis.

Mr. Koll moved to Japan in 1986 and spent 20 years as an economist and strategist at several bulge bracket investment banks. "It was wonderful," he said. "Japan was a real-life textbook. I lived a liquidity trap, saw banks collapse, land prices crash and policy makers increasingly desperate." Two years ago, he moved to hedge fund Tantallon to focus on individual companies. "And of course the moment I handed in my resignation to Merrill Lynch we had the biggest macro event in the world" as the collapse of the U.S. subprime market ushered in a worldwide financial downturn.

Are the U.S. and the world now going through the same thing Japan did during the 1990s? "The U.S. is not Japan," Mr. Koll said. Japan's credit boom came mostly in the form of bank loans by domestic banks--simple stuff. In the U.S., by contrast, "traditional loan books did not really expand that much. U.S. leverage was built up through more complex and innovative financial structures, the so-called shadow banking system. And, unlike Japan, much of the ultimate credit came from foreign investors. So today's crisis is a "global problem, very international, and a lot of complex finance."

"Is that good? Is that bad? It's irrelevant, but I just want to highlight that you can't really compare the Japanese experience. Japan was a "Zen bubble"--very focused and inward looking. America was a "Hollywood bubble"--lots of bells and whistles that seduced the entire world."

"The impact on the real world, however, is very similar. Excessive financial leverage--whether simple or complex--forces mitsu no kajo--three excesses: excess debt, excess employment and excess capital stock," Mr. Koll continued. "I recently visited China and there we have almost three and a half years of global demand of refrigerators sitting in inventory. So, I really urge you not to go into the refrigerator business, because the competition there is going to get very, very intense. It may not be quite as bad in the global car industry or the steel industry, but basically excess capacity--and with it excess employment--abounds. The great liquidation of many of these assets is still to come. During the boom, producers around the world prepared to supply for 4.5-5 percent global demand growth. In reality, we'll be lucky to get 3 percent or 3.5 percent on a sustained basis over the next decade."

For Japan, the good news is that the so-called lost decade in Japan wasn't really lost, he said. First of all, the banks actually became better banks. There were mergers, there was deregulation, there was better oversight, and there was the postal savings system moving out of many businesses to help create new profit centers for private banks. Bank operating margins, which had been close to zero even during the boom years of the 1980s, "actually began to expand very nicely." Moreover, "Japan globalized its economy." Allowing in cheaper imports, from kiwifruit and cherries to construction material, "actually boosted the purchasing power of the Japanese people." By contrast, in the U.S. currently "the focus seems to be on buy American, which tends to be inflationary and inefficient rather than disinflationary and efficiency enhancing."

There is no doubt that Japanese policy was often "too little, too late" throughout the 1990s. But they actually learned their lesson and the Japanese policy response to the current global downturn has been "actually quite creative, very pragmatic and fast," he said. A case in point is the cut in the gift tax: "If my father or my grandfather gives me a gift and I use that money to purchase land or buy an apartment, that becomes tax free for both sides. That is very good policy given that we have a balance-sheet and asset-deflation downturn."

"Right now, a string cyclical recovery is underway," he added. "Japan over the next six months is easily going to generate economic growth rates on the order of between 3 and 4 percent," enough to get unemployment down to a more normal 3.5 percent within the next two years. Of course, most of this growth will be export-led. Indeed, many corporations have sharpened their competitive edge considerably.

Japan has great strengths in R&D, Mr. Koll pointed out. "Throughout the 1990s, while the banks were bankrupt, while politics was a disaster, you see that corporate Japan continued to invest." R&D spending amounted to 3.4 percent of GDP, "way above what you have in the U.S., way above what you have in Germany."

In the U.S., the private sector accounts for only half of R&D, with the balance carried out by the American military and military contractors. In Japan, the private sector share is 80 percent, so there's more new technology getting out into the broader marketplace, from the Toyota hybrid to cellphones: "If you have an Apple iPhone, you find that about 62 percent of the components are made by Japanese companies and can only be made by Japanese companies."

Japanese firms are entrepreneurial in a way that German companies are not, Mr. Koll said, Germany being his country of origin. By way of illustration he recounted a late-night conversation five years ago with the CEO of BMW. At one point Mr. Koll asked whether Japanese cars were better than German ones. No, was the emphatic reply. At Toyota, "'they cut a lot of corners. Our hybrid system at BMW is so much more beautiful and technologically efficient. The engineering is clean. It is professional.' So, I said, Mein Herr, tomorrow morning when we roll out of this bar, with cash, I will buy your BMW hybrid.' And the only reply was, 'Oh, Jesper, I'm terribly sorry; you're going to have to wait another 10 years.'"

Simply put, Toyota has had the fortitude not to let the perfect be the enemy of the good. "Japanese companies are never shy about actually bringing new technology to the market. It may not be the most profitable thing to do at that moment, in the very quarter, but they are out there. They want to create the cutting edge, because they actually do want to bring the best cars in the world to consumers."

Reflecting these strengths, Japan ranks second only to the U.S. in patent filings. In the four-year period ending in 2008, patent applications by Chinese companies rose from 1,700 to 6,000, but Japan's rose from 20,000 to 29,000. And Japan has much more depth of bench: the five biggest Japanese patent filers--Panasonic, Toyota, Fujitsu, NEC and Sharp--have more patents than all of China, whereas a third of China's patents are controlled by a single company, Huawei Technologies.

It's true that 28 percent of Japan's exports compete head-to-head with products that can be made in China, up from 8 percent a decade ago, Mr. Koll said. But this is minor compared with Korea, where the figure is over 50 percent, and the rest of Asia, where it's over 70 percent.

Even where Japan and China do compete directly, the cool-Japan factor gives Japan the edge, he declared. "In Hong Kong, which is the most discerning and competitive consumer market in the world," Sony's made-in-Japan DVD player commands a premium of 12 to 15 percent over the company's identical player made in China.

Between 2002 and 2007, Japanese GDP rose, but so did the country's export dependency, Mr. Koll said. "Toyota loses money on every car that they are selling in the domestic economy. You make all your money by producing or selling to the rest of the world. And this is why the Japanese share market got hammered so dramatically" in the global downturn.

It is natural that Japanese companies began to invest ever more aggressively overseas. "Corporate Japan is incredibly rational," he said. "You go to where the margins are. You go to where the profits are." This is happening not just in the industries where Japan has been active abroad for many years--cars, car parts, electronics and electrical machinery--but also in the food sector, software, movies and even financial services. "The global footprint of corporate Japan is going to be changing very dramatically."

How does Japan improve domestic margins? "This is the exciting story on Japan," he said. Over the last 15 years, the U.S. experienced a "productivity miracle" due mostly to better merchandising, distribution and supply chain management, and Japan has a lot of room for improvement in just these areas.

Of the 350,000 wholesalers in Japan, two-thirds buy from other wholesalers and sell to other wholesalers. "It's a Byzantine, clustered, multilayer distribution system, and it is why Japan is not very profitable. Here, the good news is being unleashed by the current recession. We are seeing massive, unprecedented restructuring of the supply chain, of logistics, of merchandising."

Sony has pledged to cut its suppliers by half in the next 12 months; Toyota has said it will buy steel from a Korean company rather than a Japanese firm. Mergers in the last two years have reduced the number of department-store chains from eight to four.

Health care spending in Japan is "remarkably low," and the industry is ripe for growth, Mr. Koll indicated. Another promising area is housing: "when you look at the expenditure levels, still there is a lot of room to actually increase creature comforts there."

Budget deficits remain a burdensome fiscal reality, but "the saddest point about Japan" is not the deficit levels, in Mr. Koll's view, but the lack of tax efficiency. The tax multiplier tells the story: "If national income grows by one unit, how much do public revenues grow? A fair allocation would be 1 for 1." The U.S. is 1, Germany is 0.9; Japan is 0.4.

"One in three households in Japan doesn't pay national income tax. There is no tax number system. If you really wanted to improve the efficiency here, in my opinion you would be best served not by increasing the consumption tax, but by actually issuing a tax number system so that everybody actually gets taxed on an equitable and equal basis."

Yet tax system improvements won't help without economic growth. "A clearly spelled out pro-growth policy I think is the most important thing to actually entice animal spirits" in domestic and international investors alike, Mr. Koll said.

Finally, he concluded, the government ought to go beyond the borders of Japan, just as corporate Japan has done. "My suggestion is very simple. Have an Asian Airbus. Have the Koreans build the wing, the Chinese the cabin and the Japanese the engine. You actually pull the three major economies in Asia together. You've got economic policy that goes beyond your border, and as a result of that, you not only have integration, but you actually have a much better shot at having stable economic relations, stable diplomatic and political relations."

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Presider Alicia Ogawa of Columbia University asked the first question.

What about the need to stimulate domestic demand? How would Japan go about this?

"In the 21st century, to think categorically in terms of domestic demand versus global demand I think is very dangerous. It's a return to mercantilism," replied Mr. Koll.

"Japan should be the lifestyle superpower of the old," but there's actually a shortage of homes for the elderly in Japan, he added. Why? Excessive rules and regulations, like the rule that mandates one dining room for every 10 residents. It's nice to have small dining rooms, but it makes the economics of operating a retirement home impossible. Do away with excessive regulation in health care and in housing, and these two sectors can start to realize their potential as engines for growth.

The audience joined in the Q&A.

The pro-growth strategy that you spoke of doesn't seem to be there at the moment, even with the electorate. Where is it going to come from?

For tax policy, regulatory policy, monetary and fiscal policy, "the interface here has to come with the business community," Mr. Koll answered. For too long, business people haven't gotten involved politically. The head of Keidanren used to be "the prime minister of the business community," but that's been lost. The "iron triangle" of politics, technocrats and business has broken down because the business leaders are focused on only their own companies, not the national policy. Once business starts to become more pro-active and involved in politics again, a pro-growth strategy may start to merge. Recently, there have been one or two cases--Yoshimi Watanabe has broken away from the LDP and is actually sponsored by some of the leaders of the Keizai Doyukai," the Association of Corporate Executives, but "this is the first time that I see the business community actually saying we're stepping out of the box" to sponsor a politician. If business and politics do not work closer together, technocrats, by default, will get stronger and stronger.

What about compensation? Don't these systems need to change to create incentives for performance?

Pay-for-performance systems are being put in place in most of the listed companies, Mr. Koll said. They've been very successful, for example, at Yamada Denki, an electronics retailer that went from being a mom-and-pop store to having an 18 percent market share, which is a bigger slice of Japan's electronics retail market than Walmart has of the American consumer electronics market.

"Has the lack of pay-for-performance incentivization in Japan stifled innovation? No. Not at all," he concluded. Isn't it interesting that during the high-growth, high-performance period of Japan in the 1980s, Japan's corporations had basically nothing but seniority-based pay and incentive structures? Clearly there are other factors more important than simple pecuniary incentives. That's why management--like economics and strategy--is an art, not a science.

--Katherine Hyde