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The Floodgates of Reform Are Poised to Open



The yen dwindles in value, but there is more important news from here, and it illustrates why Japan will never be the same.

The purchase by Travelers Group of half of Nikko Securities, following Merrill Lynch's expansion in Tokyo, signals that Japan's closed financial and economic system--despite skepticism around the world--is going to open up dramatically in the next few years.

As outsiders wring their hands over Japan's seeming obliviousness to demands for reform, big changes are in fact occurring beneath the calm surface.

"There is a legal and official undercurrent that people don't notice. In corporate finance, we are going to become more like the United States," says T. Yoshitami "Tom" Arai, a consultant who years ago was in on the ground floor of Sony's dramatic success.

"The administrative and legal system is going to change very rapidly because the government is going to require more disclosure by publicly owned corporations," Arai says.

Forty years ago, Arai helped Akio Morita open Sony's first warehouse and distribution center in New York. He was part of Japan's decades-long rise to industrial eminence as its well-made cars, appliances, television equipment and industrial machinery swept to world leadership.

A renowned corporate-government system carried Japan to that eminence. Exports were prized, foreign competition and investment in Japan were tightly controlled, and financing was plentiful from Japan's banks under the tutelage of the Ministry of Finance. It was a system praised for long-term views of investment and capital.

But glaring flaws in the system have been showing up in this current economic crisis.

Lulled by easy finance, Japanese industry has built vast overcapacity to supply markets that are no longer buying. They expanded overseas and liberally financed product development. But under a system that put priority on increasing exports and keeping the work force employed, many Japanese companies never put a priority on profits.

Japanese businessmen routinely admit that half the country's major companies are unprofitable by international accounting standards. And Akio Mikuni, founder of Mikuni & Co., Japan's first credit-rating agency, puts the credit-worthiness of 60% of Japan's major companies at junk bond levels.

The bills are now coming due on all that easy capital. Japan's banks are loaded with $800 billion to $1 trillion in bad loans, some dating to real estate speculation in the 1980s, others to Southeast Asian ventures. To meet international banking standards, they can no longer simply roll over unpaid company loans. They must write them off or collect.

More worrisome is that inattention to profit has left Japan's pension funds seriously underfunded, with only 60% of the money they will need to pay retiree benefits. The pension funds, in turn, have performed dismally, earning an inadequate 1.5% a year by investing almost totally in Japanese government bonds.


Pension inadequacy, along with doubts about the banks, has aroused anxieties among the Japanese people, who are demanding higher-yielding investments. That's why the Japanese government is inviting Travelers and Merrill, Goldman Sachs and Morgan Stanley to offer mutual funds and other investment products to Japan's household savers.

That's a huge potential market: Japanese households have piled up an incredible $10 trillion in savings in post office and bank accounts.

It's extraordinary and unprecedented for Japan's government to open such opportunities to foreign concerns. That it's doing so is testimony to how seriously the government views the political and financial problems.

Other revolutions are to come with demands from international investors and the Japanese government that companies adopt international accounting standards. Traditional Japanese accounting has favored fiction over fact. The method, expressly approved by the Finance Ministry, blithely refuses to acknowledge bad news, such as losses in business operations, explains Iwao Tomita, 74-year-old founder of Deloitte Touche Tohmatsu, a leading Tokyo accounting firm, and a longtime campaigner for Japan to adopt international accounting standards.

For years, false accounting has made Japanese companies look more successful than they are, says Tomita, who holds an MBA from University of Pennsylvania's Wharton School. The aim, he says, was to "keep financial order--by cheating shareholders."

But now, with pension reform, shareholders will count. And an overhaul of Japanese industry is inevitable, similar to what American business went through in recent decades as pension fund managers demanded that U.S. companies be restructured to produce higher returns on retirement savings.

For Japanese companies, the model is clear. "Japanese companies need to become as efficient in using capital as they are at producing automobiles," says Kenneth Courtis, Tokyo-based chief Asia economist for Deutsche Bank.

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