Don't Forget Japan
from January/February 2008
by William J. Holstein
A funny thing happened on the way to the Pacific Century: Many top American executives and directors forgot about Japan, after the U.S. the world’s second-largest economy. CEOs and boards are obsessed with their China strategies and hold board meetings in Shanghai or Beijing, but many are bypassing Japan—mentally and physically—because its 2.2% growth rate pales in comparison with China’s feverish 9%-plus. So, of course, does its population, a shrinking 127.4 million versus a growing 1.3 billion. “People in the corporate community who are thinking about international issues are focused primarily on China,” says Steven K. Vogel, a professor at the University of California at Berkeley and author of the 2006 book Japan Remodeled: How Government and Industry Are Reforming Japanese Capitalism . “They may realize that the Chinese economy is smaller than Japan’s, but they also feel that China’s economy is where the biggest growth potential is. There’s not going to be a huge leap in Japan. China is seen as the more critical opportunity.”
Some American business leaders appear to think that Japan’s declining population is a critical indicator of economic gloom. In addition, companies like the auto manufacturers have virtually given up on expanding their footprints in Japan, not least because of the stranglehold Japanese carmakers have on local distribution. Other giants are finding it hard to buy their way in—witness Wal-Mart’s $1 billion investment in retailer Seiyu, which has yet to pay off. All of them seem transfixed by the conviction that China’s economy will one day overtake Japan’s in total size, which does indeed look inevitable. Says the CEO of a major U.S. technology company, who asked not to be identified: “I think Japan is finished.”
Whoa! Not yet it isn’t. The country seems to have insulated itself from both China’s litany of quality problems and the effects of the subprime lending crisis in the U.S. Japan also retains huge economic strengths, and even if the Chinese economy overtakes it in size, it is extremely unlikely that China can match Japan’s living standards or per capita income level for years or decades to come. Tokyo’s transportation infrastructure and the blossoming of new combined residential-office-shopping complexes such as Roppongi Hills in downtown Tokyo have helped it maintain a lead in living standards of at least 10 years over Beijing or Shanghai. And Canon and Nikon dominate crucial sections of the semiconductor-equipment industry, not some Chinese upstart. “In the 1980s, Japan probably had more attention than it deserved. We overestimated it,” says Vogel, whose father, Ezra Vogel, wrote Japan as Number One , a 1979 book that still holds the record as the all-time bestseller by a foreigner about the country. “Now we’re repeating that process with China, and we’re underestimating Japan. There’s an imbalance in the swings in opinion and attention.”
One of the participants in the great debate about Japan during the late 1980s was Clyde V. Prestowitz Jr., a former U.S. trade negotiator with Japan and now president of the Economic Strategy Institute, a Washington think tank. He sits on Intel Corp.’s policy advisory board. Intel clearly grasps that Japan is one of its largest markets, but when Prestowitz describes the country this way to other companies, he says, “I get a blank stare.”
In his view, U.S. corporate leaders have gone from Japan-bashing to “Japan-passing.” “I think Japan is the big sleeper,” says Prestowitz. “Everybody is talking about China’s Treasury holdings, which of course are huge. But Japan’s are huge too.” As the chart on the next page shows, Japan holds 28% of all foreign-held U.S. Treasury securities, versus 19% for China, according to the U.S. Treasury Department. At the same time, the carry trade, which is the practice by hedge funds and other major investors of borrowing yen at virtually no interest and reinvesting that money elsewhere in the world, keeps the yen very weak—a trade advantage that U.S. CEOs, including General Motors’ Rick Wagoner, view as far more of a challenge than China’s weak renminbi.
Prestowitz notes that Japan has a leading position in semiconductor equipment as well as audio and video technologies. And the Japan-passers, he says, “somehow overlook the fact that Toyota is the world’s largest auto company and the Japanese continue to eat Detroit’s lunch.”
Even though the population of Japan is shrinking, 2006’s average per capita income of $32,647 remained high by global standards, ranking No. 18 in the world. The U.S. was No. 4 with $43,444, China No. 87 with $7,598. “For many American companies, if you’ve got 4% or 5% of the Japanese market, that’s a hell of a lot more in sales than 20% or 25% of China or India,” Prestowitz argues.
Japan’s sheer wealth—$13.5 trillion in net liquid household assets, compared with a fraction of that in China—is impressive and is also attracting fresh attention from U.S. financial concerns eager to help the Japanese invest their money more profitably than they often do now. Some $3 trillion of those assets is currently invested in Japan’s low-interest postal savings system, and nearly $1 trillion more in a conservatively managed government pension investment fund, says Mark Mason, managing director of the TransPacific Capital Group in New York City, which makes private placements of Japanese money in U.S. private equity firms and hedge funds.
“They have enormous pools of liquid, misallocated capital,” says Mason, whose 1992 book, American Multinationals in Japan , remains a classic. Japan’s money “tends to be overly invested in domestic debt, and the money that is invested overseas tends to be largely invested in U.S. government debt. So they are not adequately diversified by geography or asset class. They haven’t been able to maximize their risk-return profile.”
Japan is debating whether to create a so-called sovereign wealth fund, which would be a mighty financial powerhouse much like Singapore’s two state funds, Temasek and the Government of Singapore Investment Corp. If that happened, says Mason, U.S. financial markets could feel the impact. “Few countries in the world have that kind of heft in terms of capital that they control,” he says. Temasek is buying strategic multibillion-dollar stakes in companies around the world, as in a recent move to help Singapore Airlines take control of China Eastern Airlines.
If a much larger Japanese sovereign investment fund were created, it would have to follow a similar global strategy, which could even end with its buying control of U.S. companies.
Unlike many U.S. business sectors, financial-services companies have recognized Japan’s continuing potential to play on the world stage. Insurers Aflac and AIG and investment banks including Goldman Sachs, Lehman Brothers, and Morgan Stanley have carved out big positions in Japan and hope to reap even more business as Japanese institutions and individuals start chasing higher returns abroad. “I think we’re witnessing the resurgence of Japan in many ways,” Mason says. “It took them longer to work their way out of the difficult postbubble period, but they’re back and they’re strong and they will remain a central feature in the global economy for the rest of our lives.”
David Meachin, chairman and CEO of the investment banking firm Cross Border Enterprises and a director of Lyondell Chemical Co. in Houston, who has lived in Tokyo, says he understands why many boards are preoccupied with China. “Japan is a one-off,” he says, meaning that the country does not have China’s large domestic market, so most products are made for export. But it’s a mistake, in his view, for boards to believe that they must make an either-or choice between the two countries. The reality, he says: “You have to be in both places.”
