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Japan's Fake Funk
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For a decade now, the western consensus has been that Japan is an economic basket case. But this is a dramatic misreading of a perennially secretive society. Indeed, it may come to be seen as one of the most significant misreadings in economic history.

The geopolitical implications of this misunderstanding go far beyond Japan or east Asia. The myth of Japan’s “collapse” has encouraged the west to imagine that the east Asian economic model (largely an extension of the Japanese model) is inherently flawed. Beyond a certain point, the argument runs, a nation must embrace the Anglo-American free-market model or flounder. Amongst other things, this view has fostered a dangerous degree of complacency towards the rise of the overtly authoritarian Chinese economic system. Incomes in China are still only a fraction of Japan’s but if ever China comes close to matching Japan’s success it will be bigger than the EU, the US and Japan combined.

Any summary of the case against the consensus must start by acknowledging that Japan has, of course, suffered serious financial strains in the last decade. But these strains have been largely confined to the financial sector and have done little, if any, damage to other areas of the economy. On the contrary, the wider Japanese economy has quietly thrived-so much so that, in many of the ways that matter to Japanese policy-makers, Japan has actually now surpassed the US to become the world’s leading economy. In particular, measured in terms of its ability to project economic power abroad, it is Japan, not the US, that is the world’s leading superpower.

As generally recounted, Japan’s story in the last 20 years is a morality tale of the perils of overarching ambition. It begins in the mid-1980s when Japan suddenly seemed to be sweeping all before it. But just as this new Sparta was on the verge of vanquishing the freedom-loving west, fate-in the form of the Tokyo stock market crash of 1990-intervened. The wheels came off the Japanese economic pantechnicon. Ever since, Japanese leaders have been engaged in increasingly comical efforts to get them back on.

This story has enormous appeal in the west-not least for the free-marketeers who edit the business pages on both sides of the Atlantic. But the key reason why this story has been so widely accepted is because various vested interests want it to be believed. The most important such vested interest is the Japanese economic establishment. For Japanese economic planners, the most obvious benefit of the basket case story has been its effect in cooling the west’s once dangerous anger over Japanese trade policies.

The truth is that dozens of facts contradict the gloomy consensus. Here are just a few.

1. Living standards increased markedly in Japan during the so-called “lost decade” of the 1990s, so much so that the Japanese people are now amongst the world’s richest consumers. (See box p39.)

2. Japan’s trade has continued to expand. Its current account surpluses totalled $987 billion in the “disastrous” 1990s. This was nearly 2.4 times the total recorded in the 1980s (when Japan was already seen as the “unstoppable juggernaut” of world trade).

3. Although you would expect the Japanese yen to have declined sharply against, for instance, the US dollar in recent years, the reverse is the case: the yen’s dollar value has increased 17 per cent since the beginning of the Tokyo financial crash.

4. At last count, the all-important Japanese savings rate, which has been the main driver of the country’s success, was 8.7 per cent of GDP. By comparison, the rate for the US was 5.7 per cent and for Britain only 4.5 per cent. In the 1990s, Japan routinely accounted for nearly 30 per cent of all new savings in the OECD group of rich nations. It is sometimes suggested that Japan’s high savings rate is a problem. If so, it is a problem that most of the world’s nations would be delighted to have. (To the extent that there are excess savings in Japan, these can be easily and-in national power terms-usefully deployed in buying foreign assets.)

5. Japan has continued to invest heavily in its industries and infrastructure. Investment per job in manufacturing, for instance, has consistently run at about twice the rate of the US over the last decade.

6. Although the eagerness with which Japanese investors snapped up foreign assets in the 1980s was a major reason why Japanese expansionism came to be eyed so suspiciously in the west, Japan’s net foreign assets have continued to mushroom. As measured by the IMF, they nearly quadrupled in the 11 years ended in 2000. How do we reconcile this with reports that the Japanese banks’ problems have been forcing a wholesale retreat by Japanese finance from foreign markets? The reports are nonsense. A nation’s ability to export capital is a function not of its banks’ financial health but rather of its trade performance: each dollar of current account surplus creates a dollar of capital exports. So long as Japan runs the world’s largest current account surpluses, it will remain the world’s largest capital exporter.

7. As a glance at Tokyo’s crane-filled skyline confirms, even in the hard-hit real estate sector the pace of investment has continued at an astonishing rate. An all-time record of more than 2.2m square metres of new office space will be completed in Tokyo next year. On the site of a disused railyard near the Ginza shopping area, no less than 12 major buildings and many smaller ones are being erected in one huge development which will create more space than was contained in the towers of the World Trade Centre.

ORDER IT NOW

8. Japan passed the US in the early 1990s to become the world’s largest foreign aid donor and, as of 1999, it was paying out 67 per cent more in aid than the US. The UN is only the most prominent of many international bodies that depend heavily on Japanese money. (Japan accounted for nearly 20 per cent of the UN’s budget in 2001.) Tokyo is reaping a rich reward in terms of rising influence in everything from the International Whaling Commission to Fifa.

9. Corporate Japan’s worldwide spending on sponsorship-from motor racing to universities-has grown by leaps and bounds. In the latter half of the 1990s, Japan’s sponsorship budget in the US alone increased by about 80 per cent. In Britain, an interesting instance of recent Japanese sponsorship is the Asahi Shimbun newspaper’s donation for the British Museum’s Great Court. It is hard to imagine, say, the Guardian, which is roughly the Asahi’s British counterpart, doing anything similar in Tokyo. In fact, the Guardian can’t afford a staff correspondent there. By contrast, on the strength of big increases in advertising in the last decade, not only can Japanese newspapers like the Asahi afford large bureaus in Britain but they can undertake extensive goodwill programmes.

Western analysts manage to overlook the above achievements, and tend to focus on various alleged crises for Japan that, in reality, are no such thing. First, consider the claim that Japan’s manufacturing industries are being driven to the wall by China. The mistake analysts make here is to assume that the Japanese economy is still highly labour-intensive. But Japan is probably the world’s most capital-intensive economy at present. Capital-intensive Japanese companies supply the sophisticated components, materials, and machines without which labour-intensive Chinese factories would have no exports. Japanese exports these days are not television sets and pocket calculators but rather machine tools, electricity-generating plants, railway rolling stock, broadcasting equipment, telephone switching equipment and internet routers.

Capital goods industries are invisible to the consumer and thus Japan’s dominance in many of them is easy to overlook. But capital goods are the ultimate fount of the world’s wealth and historically the nation that dominates their manufacture-Britain in the 19th century, America in the first 75 years of the 20th century-has been ipso facto the world’s leading economy. Capital goods industries are the toughest to break into because they require not only heavy investments of capital but large reservoirs of highly-sophisticated proprietary know-how-usually know-how that takes decades of learning-by-doing to acquire. It is no surprise that in many of the capital goods industries in which they are strong, Japanese companies face no significant competition from anywhere, let alone from third world nations like China.

Second, what about the claim that the Japanese economy is in the grip of a deflationary spiral? Actually, what Japan has been experiencing is similar to the persistent deflation the US experienced in the late 19th century. This was when the US went from rural backwater to the world’s most powerful economy.

In Japan today, as in the US then, monetary policy has been so effective in maintaining the currency’s domestic purchasing power that the economy’s rapid productivity improvements translate into a steadily falling price level. This is hardly a recipe for large profit margins. The result is a feel-bad feeling in corporate Japan. Similarly, as described by the historian Walter LaFeber, the productivity-induced deflation experienced in the US in the 25-year period to 1897 was “economic hell.” But it was thanks to US industry’s market-glutting productivity improvements in this period that the US succeeded Britain as the world’s greatest economy.

Third, it is claimed that Japan has been eclipsed in high technology by a resurgent US. This mantra of the 1990s has admittedly been less often heard in the wake of the bursting of the American internet stock bubble in 2000. But it was never true. All the evidence is that Japan has greatly lengthened its lead in the last decade. Take, for instance, the crucial area of supercomputers. Japan and the US ran neck and neck in this industry for many years, but Japan has now clearly broken ahead. At last count, the title of the world’s fastest computer was held by a weather-forecasting computer made by Tokyo-based NEC. By contrast, the fastest American supercomputer, an IBM-built machine used for designing nuclear weapons, is little more than one third as fast.

Japan’s lead in supercomputers is hardly surprising given its domination of most of the enabling technologies driving the global electronic revolution. The world now depends on Japan for virtually all of the many highly-purified materials needed to make computer chips. To make today’s ultra-powerful chips, you need ultra-pure silicon, for instance. US companies led the industry into the 1980s but they have long since fallen by the wayside. In the race to develop ever purer silicon, such unsung Japanese technology leaders as Shin-Etsu, Sumitomo Sitix and Mitsubishi Materials have now prevailed.

Japan leads the world also in the production of countless high-tech components such as laser diodes (the enabling components in the CD family of digital devices) as well as in the optical fibre networks that have transformed the communications industry. Meanwhile, Japan dominates in the supply of all nine major enabling components in mobile phones. A Deutsche Bank Securities study found that 29 out of 36 suppliers of these components were Japanese.

The story is similar in the advanced machinery used to make electronic components. Take so-called steppers-the minutely precise optical devices that print circuit lines on computer chips. Broadly speaking, a chip’s power is a function of how much circuitry can be packed onto it. So the technological imperative is to develop ever more precise steppers that print ever finer lines. American companies once dominated the stepper industry but Japanese companies like Nikon and Canon have now taken their place. The only other significant producer is ASM, a Netherlands-based company which sources its optical technology from Zeiss of Germany.

Japan’s high-technology dominance has been sealed by several key high-technology acquisitions in the US in recent years-acquisitions that would have created a political firestorm in Washington in the “Japan-bashing” 1980s. Take Furukawa Electric’s purchase last year of an advanced optical fibre business from financially distressed Lucent Technologies. At a stroke, this gave Japan clear control of a crucial industry formerly dominated by the US. (The optical fibre business has been in a slump for the last two years-but this is a short-term factor that hardly bothers Japanese corporate leaders.) Another example is Hitachi’s announcement earlier this year that it was buying IBM’s path-breaking disk drive business. The deal includes IBM’s Almaden Research Centre in California, which was described by the New York Times as one of America’s “science and technology jewels.”

Fourth, even the west’s understanding of Japan’s financial trauma has been wrong-headed. If the western press is to be believed, bad loan problems have threatened an uncontrollable wave of banking collapses. Yes, the Japanese banks have suffered huge bad debts from their ill-considered late-1980s lending binge. But there is no risk of a domino effect. And the banks’ problems peaked as far back as 1997-reflecting the fact that virtually all the problems are ultimately traceable to Japanese real estate and shares, whose prices have fallen little from their mid-1990s lows. Since then, the banks have been progressively restoring their balance sheet strength thanks to the generous “spreads” they enjoy between their lending and deposit rates.

Moreover, the financial malaise has not starved Japanese industry of investment capital. Far from it; faithful Japanese savers have continued to save, thereby producing the wherewithal for the financial system as a whole to maintain and indeed expand its financing of Japanese industry.

One of the most remarkable aspects of the basket case story is how it keeps mutating. As in a Harrison Ford movie, no sooner does Japan dispatch one problem than a more daunting one emerges from the deep. At first, the problem was the stock market collapse. Then it was the banks’ real estate loan problems. Then other problems swiftly followed: the banks’ accounting for the loan losses, a consumer spending funk, and a corporate investment strike.

The latest “disaster” is Japan’s allegedly out-of-control government spending. But Japan’s budget problems are grossly exaggerated. OECD figures show that in the first eight years of the 1990s, Japan actually ran large budget surpluses. Since then the government’s position has deteriorated somewhat but is still no worse than many other nations.

It is often pointed out that Japanese government debt supposedly represented 120 per cent of GNP in 2000. This does seem shockingly high-but, unbeknownst to most western observers, it is a gross figure that should properly be netted for the Japanese government’s huge and continually increasing financial assets. These include not only the world’s largest foreign exchange reserves, but extensive holdings of its own bonds. On a net basis, Japan’s national debt represents just 51 per cent of annual GDP-higher than the US’s 43 per cent but lower than that of most other developed countries.

As Adam Posen of the Institute for International Economics in Washington has pointed out, the Japanese debt scare is a storm in a teacup. “Savings, public and private in Japan, is a vast multiple of the government debt, so there is no solvency problem.” And, as Posen notes, when the Japanese government borrows, it borrows almost entirely from its own citizens-only 6 per cent of Japanese government debt is owed to foreigners. By contrast, the US depends heavily on foreigners, notably the Japanese, to fund its national debt.

Press suggestions that Japanese public spending is inordinately wasteful are equally unfounded. Typical of such suggestions is a now notorious comment by The Economist on the opening of the Akashi Kaikyo bridge in the mid-1990s. The Economist dismissed the new engineering marvel-at 2.4 miles long, it is the world’s longest suspension bridge-with the headline, “The bridge to nowhere in particular.” Thus began a media myth that much of Japan’s public spending is squandered on “bridges to nowhere.”

In reality, in ultra-densely populated Japan, it would take a truly perverse genius to build a bridge to nowhere. Some bridges, it is true, lead to what are (by Japanese standards) relatively underpopulated areas. But such projects are hardly wasted in a nation where so few citizens enjoy easy access to the countryside. In any case, the Akashi Kaikyo Bridge links the Osaka region to Awaji Island. Awaji’s 160,000 residents hardly think of themselves as living “nowhere.” For them, indeed, the bridge is their only road connection to the mainland. Perhaps more important in the long run is that the bridge promises to induce a more equitable distribution of population in the congested Osaka region.

No one would suggest that every yen of the Japanese budget is well spent. The point is that the abuses do not seem disproportionate in relation to the many badly needed projects that have been undertaken in recent years. In my own area in inner Tokyo, for instance, two new underground railway lines have opened in the last two years. The area has also been the recipient of, yes, a new bridge. The Rainbow suspension bridge has greatly eased traffic in central Tokyo. Further south is the new Aqua Line, which by dint of a 5.9-mile tunnel (the world’s longest sub-sea road tunnel) offers millions of cramped Tokyoites rapid access to recreation areas across Tokyo bay in Chiba for the first time. Another improvement in central Tokyo is in the sewage system, which has been transformed in the last decade. Each of these projects accounted for a large chunk of the national budget (construction work is expensive in no-immigration Japan, where even the least skilled male worker is paid a full breadwinner’s wage). But anyone who knows Tokyo would find it hard to argue that such improvements are unnecessary.

ORDER IT NOW

As the story of Japan’s alleged public spending profligacy indicates, much of the responsibility for the west’s misunderstandings must be put down to the western press. Relatively few correspondents speak or read Japanese. Moreover, they are blinded by western ideas that do not apply in Japan. They assume, for instance, that the stock market plays as prominent a role in Japanese finance as it does in British or American finance. When the Tokyo stock market crashed, this was seen as comparable to the Wall Street crash. In reality the stock market is regarded by the Japanese establishment as a rather dirty sideshow that can be neglected for years on end with impunity.

Similarly, westerners assume that Japan, in common with nations like Britain and the US, is avidly competing in some sort of financial beauty contest for the favours of the world’s investors. That this is nonsense should be apparent from the fact that for decades Tokyo fiercely resisted American requests for even a token opening of Japanese financial markets. In the end, whether or not foreign investors consider Japan an attractive place to invest is irrelevant because, in contrast with Britain and the US, Japan is a capital exporter, not a capital importer.

Whatever the western media’s responsibility, the lion’s share of the blame for the misunderstandings rests with the Japanese establishment. The impression of dysfunctional economic management in Tokyo is no more than grand kabuki-a thespian exercise in mock distress acted out by a Japanese elite that has always believed in cloaking its true agenda. Such theatrics are fundamental to Japan’s administrative culture-a culture whose father-knows-best ethos imposes no obligation on leaders to speak frankly to their own people, let alone to outsiders.

For example, official press packs distributed to visiting journalists routinely describe the economy as being in a “slump.” (The word connotes, among other things, very high levels of unemployment-several times anything Japan has suffered in the last decade.) In April 1998, Sony Corporation chairman Norio Ohga went on record saying, “The Japanese economy is on the verge of collapsing.” A few months later, Toyota president Hiroshi Okuda added that Japan’s problems could trigger a “worldwide financial crash.” When corporate chiefs talk like this, we might assume their comments reflect their own corporations’ experience. In fact, profits in 1998 for both corporations were much higher than in 1989, the last year of the Japanese boom. In Sony’s case, the growth relative to 1989 was 131 per cent; in Toyota’s 56 per cent. If the latter figure seems modest, it compares favourably with the performance of Ford and General Motors in the same period.

One thing is clear: given the country’s success in boosting both its consumers’ living standards and its exports, its economic growth numbers have clearly been understated in recent years. (Official statisticians can readily manipulate the figures by varying assumptions about, for instance, qualitative improvements in economic output.)

None of this subterfuge is new. Japanese leaders have a long tradition of artfully understating their country’s strengths. In the late 1930s, for instance, the Japanese military let it be known that Japanese soldiers couldn’t shoot straight and that Japanese planes were made of paper. In the event, Japan’s opening gambit in the second world war, the Pearl Harbor offensive, proved a military masterpiece.

Business leaders play the same game. When I arrived in Tokyo in 1985, the car industry conceded it was good at making small cars but it was somehow incapable of making anything the size of a Mercedes-Benz or a Cadillac. In the late 1980s, however, Japanese car makers launched the Lexus, the Infiniti and other superbly built top-of-the-line limousines.

Why would the world’s most proficient car makers affect such humility? In retrospect their motive is obvious: they were concerned to calm the fears of western competitors (who in the event proved all too willing to take Japanese false modesty at face value).

The basket case myth serves many propaganda purposes, of which trade diplomacy is merely the most obvious. The myth has also proved serviceable as an excuse for not compensating victims of Japan’s second world war atrocities and in batting down unsolicited requests from poor countries for development aid. (Japan’s aid programme favours east Asian nations; other nations are politely refused with an excuse about the state of the Japanese economy.)

Even foreigners in Japan have an interest in fostering the myth. Expatriate executives in Tokyo, for instance, find that sob stories about the Japanese “slump” are the perfect excuse for a sub-par business performance. And for foreign diplomats, who in the Japan-bashing climate of the 1980s had to spend most of their time trying to tear down Japan’s trade barriers, life is much easier. Now that the Japanese people have come to be universally seen as too poor or too scared to consume, western diplomats in Tokyo can go back to the status quo ante of exchanging elaborate pleasantries with top Japanese officials.

For foreign correspondents too, the basket case story is heaven sent. It not only guarantees them a frequent position on page one but, in a country where covering other forms of news is often very hard, it requires little effort: most of the sources are English-speaking analysts who, in sharp contrast with the extreme formality of normal Japanese practice, are happy to be interviewed by telephone.

All this might seem like merely an interesting sidelight on how different this “globalising” world still is, except that the geopolitical consequences are so important. Apart from the obvious point that the “collapsing Japan” myth has bought Tokyo’s trade bureaucrats a decade of undeserved peace, there is the larger point that it is clearly facilitating the transformation of China into a true superpower. Certainly, if westerners in general-and Americans in particular-had understood how well the Asian economic system has been doing in the last decade, they would have been far more wary about welcoming China into the world trading system.

But surely if Japan’s fake funk has facilitated the rise of an unpleasant new superpower on the east Asian continent, Japan would be the first to be concerned. After all, as portrayed in the western press at least, few nations are as wary of China as Japan-and vice versa. In reality, however, leaders of the two countries are far from daggers drawn. Although the public rhetoric on both sides is not always sweetness and light, they share much common ground-most obviously a centuries-old aspiration to rid east Asia of western influence. Although it is often assumed that America’s military bases in Japan are there to protect the Japanese from China, the truth is they signify Washington’s fears, not Tokyo’s.

As seen by Japanese leaders, the task of ridding east Asia of western influence is already half complete. By dint of decades of Japanese mercantilism, America’s once world-dominating export industries have been almost completely gutted-and with them America’s ability to project economic influence abroad. To put it at its most basic, whenever Washington wants to project economic power abroad these days, it must first phone Tokyo for the money.

Moreover, Japanese leaders are already planning for the day when China will take over as the world’s most powerful economy. Although when measured at market exchange rates China’s economy is today no more than one quarter the size of the Japanese economy, it is closing the gap rapidly. Given their uniquely clear-sighted insight into the wealth-creating potential of the east Asian economic system, the Japanese expect China to become the world’s largest economy in little more than 20 years. And with economic success will surely come commensurate military power.

The underlying warmth of the relationship is evident in trade matters. Although Japan has never had any compunction about erecting barriers to US exports, it has welcomed many of China’s exports with open arms (including exports of electronic goods which it generally does not accept from the US). Even more significantly, Japan has permitted its leading companies to transfer important technologies to China-something that it has usually opposed in the case of other nations, including the US.

But all this has to remain sub rosa for now if the Japanese-and of course the Chinese-are to retain privileged access to the US market. By promoting the myth of its economic collapse, Japan has pulled off the near impossible: it has retained good relations with the US, while tipping the global balance of power in China’s favour.

 
• Category: Economics • Tags: Japan 
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