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  Officially it wants to increase the return on
  Japan's $13 trillion in savings, which now earn a
  meager 0.25% in a postal savings account



  July 21, 1997

  The Bottom Line on Japan

  No, it's not moribund. Nor is it going to turn back
  into a global powerhouse
  anytime soon. But little by little, Japan is
  opening up its economy.

  Edward W. Desmond
  Reporter Associates Cindy Kano, Andrea Prochniak

  Plus: How Goldman Won

  udging from newspaper headlines these days,
  there are at least two Japans, one ready for the
  obituaries and one readying to conquer the
  world. The Japan with the deathly pallor has
  reportedly been done in by crushing bad-debt
  problems, wishy-washy deregulation, and bizarre
  economic management. How bizarre? Prime Minister
  Ryutaro Hashimoto has mandated a major tax
  hike and a cut in government spending, well before
  the economy is out of the woods.

  Then there is
  Japan Inc., back from the dead. Though not
  quite the
  globe-striding colossus of the late 1980s, Japan's
  top performers,
  companies like Toyota and Sony, are
  fiercer then
  ever, earning near record profits and market
  share abroad.
  Japan's growth in the past fiscal year was a
  very respectable
  3%, and, contrary to the obituaries,
  Japan is
  deregulating, here and there. Just look at the
  growth in telecommunications and Prime
  Hashimoto's promise of a "Big Bang" reform in
  Tokyo's hidebound
  financial markets. "I think the
  weakness of Japan is emphasized too much," says
  Eisuke Sakakibara, director-general of the
  International Finance Bureau at the Ministry of
  Finance. "I would call it irrational pessimism. Japan is
  neither a miracle nor about to collapse. We're
  aiming at a mature, stable 2% to 3% growth."

  Somehow, neither idea fully convinces. Japan isn't
  moribund, yet the Japanese have a lot to do before
  they can coast along on momentum--or until their
  economy's strength matches that of the U.S. In fact,
  like the Americans who studied Japanese concepts
  like "just-in-time inventory" a decade ago, Japanese
  business wonks today are looking for the secret of
  America's success. Their answer: deregulation, as
  launched by President Ronald Reagan in the 1980s.
  Says Makoto Utsumi, a retired former vice finance
  minister: "I know a U.S. Congressman who opposed
  Reagan when unemployment in his state was
  something like 21%. Now it's 5%. Now he says Reagan
  was right. And Reagan was right."

  Hashimoto has a lot to prove before anyone calls
  him Japan's Reagan, especially considering the
  reluctance of Japan's powerful bureaucrats to admit
  that their "miracle" economy has seen its day. Yet
  time is running out on the tried and true methods
  of Japan Inc. From 1992 to 1994, Japan staggered
  along with practically no growth. Recovery since
  then has been erratic, marked by one-time,
  government-led tactics such as heavy public works
  spending, record-low interest rates, and an
  export-stimulating weak yen policy. In fact,
  Hashimoto underscored Japan's dependency on the weak
  yen on his trip to New York last month when he said
  Japan might "succumb to the temptation" to sell
  off U.S. Treasuries if Washington did not cooperate
  in stabilizing exchange rates--a comment that
  threw the Dow into an unnerving dive. It's on the
  strength of that weakened yen that Japan's blue-chip
  manufacturers have recovered, but for the first
  time they have not brought the rest of the economy
  along too--the financial sector, small industry,
  construction and real estate, and so on.

  It's no wonder that Japanese frequently ask in
  popular newspaper and magazine commentary: "If the
  economy is recovering as well as the government
  claims, then why don't we feel better?" Japan is on its
  fifth Prime Minister in five years, and the
  nation's bureaucrats, once the most esteemed group in the
  country, are regarded with contempt. The situation
  is ripe for change, as long as some kamikaze (divine
  wind), like a further weakening of the yen, does
  not intervene to save the old system. More pain, more
  gain--at least from the reformist point of view.

  Will the reformists prevail? They'll have to, at
  least in certain fields, like finance and information
  technology, where Japan must compete globally to
  survive. Hashimoto claims that he will stake his
  political future on change, but the question is how
  much, how fast. Six years into the hard lessons of
  Japan's economic setback, that question is still
  unanswerable. Says Minoru Makihara, president of
  Mitsubishi Corp.: "I think Japan will get there,
  but it all depends on timing. If Japan takes too long to
  deregulate, it will lose competitiveness. If in the
  financial sector, for example, people are really confident
  that it will open by 2001, there will be lots of
  business pouring into Japan. But if people believe it will
  take until 2020, there will be a problem."

  The Hashimoto government retorts that the economy is
  coming along very well, thank you. Technically
  it has been recovering for some time. Corporate
  have risen more than 50%, from their lows in 1993 and
  1994. Growth in the first quarter of this year was
  which annualized would come out to a ripsnorting

  So what's the problem? Simply put, no current
  source of
  growth is here to stay. A significant part of that
  spike in
  the first quarter, for example, was due to a 4.6%
  surge in
  consumer spending--the strongest in 37 years--in
  anticipation of an April rise in sales tax from 3% to

  Exports contributed nearly 25% of net growth in the
  past three quarters. Top-tier exporters have cut
  costs dramatically, strengthened their balance
  sheets by borrowing at Japan's lowest interest rates in
  postwar history, and moved significant portions of
  their production chain overseas. Best of all, the yen
  steadily weakened in the past 23 months, reaching a
  52-month low of 127.46 to the dollar on May 1.
  "Companies like Canon, Matsushita, Honda, and
  Toyota look like GE five years ago," says Kenneth
  Courtis, chief economist at Deutsche Bank. "They
  have tremendous momentum. They spent the
  recession cutting costs--Toyota by as much as
  38%--and the results are nothing less than

  That's a bummer if you happen to be Detroit or IBM,
  but it does not mean that Japan is back on its
  feet. "We've had very good growth of exports
  relative to everything else," says Ronald Bevacqua,
  economist at Merrill Lynch in Tokyo, "but it's an
  environment where the Nikkei is going nowhere, bank
  loans are not growing, and small firms are not
  doing well. Japan is like a four-cylinder engine with only
  one cylinder working." And that one cylinder could
  easily blow out if Japan's partners in the G-7,
  unhappy about Japan Inc.'s export windfall, have
  their way.

  No one is warier of the export issue than Robert
  Rubin, U.S. Secretary of the Treasury, now the most
  prominent player in U.S.-Japan relations. Japan's
  export blitz puts Rubin on the spot because, ironically
  enough, the U.S. Treasury made it possible in a
  backhanded way. In late 1995, just as then-U.S.
  Trade Representative Mickey Kantor declared a
  dubious victory in trade talks with Japan, Rubin
  reached an informal, nonpublic understanding with
  the Finance Ministry's Sakakibara to help weaken
  the yen to put Japan's economy back on its feet.
  Tokyo's side of the bargain was to encourage capital
  flows into U.S. securities, which contributed in a
  big way to the health of U.S. markets and Clinton's
  reelection last year. Tokyo also agreed to two
  conditions: first, to push domestic-demand-led growth;
  second, to keep the trade surplus under control.
  Tokyo, however, let Rubin down on both counts.

  When the yen got weaker, Japanese manufacturers did
  what comes naturally: export like hell. As a
  share of GDP, exports had declined from 3.1% in
  1993 to 1.4% early this year, but that ratio is now
  mounting fast. In May alone, Japan's merchandise
  trade surplus jumped 222.2% from a year earlier,
  and exports jumped 20.5%, led by a 43.3% rise in
  car exports. In the first five months of this year, for
  example, U.S. sales of Toyota's popular 4Runner
  were up 37%. It was no surprise when the G-7
  Summit in Denver last month pointed a finger at
  Japan, insisting that Tokyo do more to create more
  growth at home.

  But Japan has already embarked on a risky course
  domestically. Hashimoto's government in May
  agreed to a dramatic fiscal contraction plan that
  flies in the face of Tokyo's pledges to strengthen
  domestic growth. From Washington's point of view
  the plan is madness: Why would Japan want to
  raise taxes the equivalent of 2.4% of GDP and
  reduce overall government spending 0.5%, including a
  10% cut in public works, at a time when the
  domestic economy is still unsteady? Says one U.S. official:
  "Hashimoto's macro policy is a train wreck waiting
  to happen."

  At the Ministry of Finance, the argument in favor
  of deficit reduction is simple if unconvincing. As a
  result of five massive supplementary budgets and
  tax cuts, Japan's budget deficit is now nearly 7% of
  GDP. That's on par with Italy's--a shocking
  development to a nation of proud penny pinchers. What is
  more, goes the argument, the rapid aging of Japan's
  population means that social welfare payouts will
  escalate sharply in the years ahead and the tax
  base will shrink, a recipe for still more fiscal trouble.
  Better to mop it up now. Those arguments have taken
  a profound hold not only in Hashimoto's
  government but in the press and with the public as

  U.S. officials believe that the plan puts the
  recovery needlessly at risk. With a third of the world's
  savings in its banks and virtually no demand for
  capital at home, Japan can afford to lend to itself. And
  interest rates are at an all-time low, so borrowing
  is cheap. Richard Koo, a senior economist at the
  Nomura Research Institute, argues that the
  ministry's move makes sense only as a way to restore its
  battered prestige and recapture the moral high
  ground after a series of unprecedented scandals in the
  past few years. Says Koo: "The Ministry of Finance
  is willing to punish the rest of Japan in order to

  The result is a standoff between Washington and
  Tokyo, but a standoff that's largely behind the screen.
  To some extent, Sakakibara is trying to head off a
  conflict. This spring the Ministry of Finance quietly
  engineered a strengthening of the yen. The yen fell
  15%, from 127 on May 1 to 110 on June 11, a
  rapid drop that angered Japanese manufacturers.
  Treasury officials, however, are still repeating their
  mantra that Japan must show domestic-led growth and
  contain the trade surplus. Look for a move of
  the yen to 100 before year-end.

  If exports slow, where will Japan's growth come
  from? Hashimoto has opted to raise taxes and cut
  spending, so there is no hope for government pump
  priming. Consumers? Part of the government's
  current policy centers on talking up the economy to
  loosen pocketbooks, but so far it hasn't worked:
  Japanese savings rates are near all-time highs.

  What's left is deregulation, the structural reform
  of the
  economy. Despite all the enthusiasm for Reagan-era
  reforms, though, there will not be any sweeping
  moves. Japan's regulatory scene is heavily
  Ministries control their own turf, and few are
  eager to
  give up the power and influence that comes from the
  more than 10,000 regulations that govern Japan's
  business scene. The idea of the traditionally passive
  Diet taking matters into its own hands is almost
  inconceivable, and in any case, deregulation across
  board would have disastrous consequences because
  so many sectors have far too many employees. "No
  one is stupid enough to really want deregulation in
  every industry," says Jesper Koll, chief of
  economic research at J.P. Morgan Securities Asia. "There
  would be nothing left."

  But increasingly Tokyo really is willing to open up
  key industries, all of which share one element: a fear
  of falling behind. Right now there is a lot of
  anxiety in Japan about the U.S. edge in information
  technology and finance--two sectors that have
  recently started to deregulate.

  In telecommunications, for example, the Ministry of
  Posts and Telecommunications has ended NTT's
  monopoly in many areas, including local phone
  service, and also pushed through a plan to break up the
  telecom giant. The result is a boom in businesses
  like portable phones. Prices have fallen to almost
  nothing for Personal Handiphone System phones, a
  sort of poor man's cellular. Basic PHS service is
  only about $20 per month, plus a few cents for each
  minute, no matter the distance. Virtually every
  college student now has a PHS, and there is serious
  discussion that they will soon make public phones
  extinct. Both usage and revenue for the PHS
  companies, which include NTT Personal, DDI Pocket,
  and Astel, more than doubled in the past year. PHS
  is Japan's first major telecommunications system
  export--to Hong Kong. Overall, the
  telecommunications sector grew 19% last year.

  "Usually we think of deregulation as a paper tiger
  in Japan," says Richard Kaye, a telecommunications
  analyst at Merrill Lynch in Tokyo. "But in
  telecommunications we have to give them the benefit of the
  doubt. All the walls are coming down, and actual
  beneficial effects are visible in the economy." One
  example of the benefits for foreign companies: In
  March, Motorola won a $2 billion contract to build
  infrastructure for a new digital cellular phone

  But when it comes to deregulation the real headline
  grabber is Hashimoto's declaration in November
  that he would set free Japan's financial markets by
  the year 2001. In fact, gradual deregulation has been
  going on for years, and foreign financial
  institutions like Goldman Sachs, Merrill Lynch, and Fidelity are
  already making big plays (see box). But Hashimoto,
  at the Finance Ministry's prodding, is determined
  to go much further. Next April, foreign-exchange
  controls will be lifted completely, and legislation is in
  the works that should--if it lives up to its
  promise--throw wide open the banking, trading, and insurance

  The Finance Ministry also insists that it will end
  its dominating, behind-the-scenes micromanagement of
  the financial sector. Foreign bankers are drooling
  at the prospect of an open field in Tokyo. Virtually
  every major foreign bank is increasing its staff to
  handle new business in areas like mutual funds and
  future business such as securitizing troubled loan
  portfolios. Bankers Trust's announcement in April that
  it would assist Nippon Credit, a major but ailing
  bank, was motivated partly by eagerness to play in
  securitization, where Japanese banks are clueless.

  Why did the Finance Ministry have such a change of
  heart? Officially it wants to increase the return on
  Japan's $13 trillion in savings, which now earn a
  meager 0.25% in a postal savings account, the most
  common place for savers to put their cash. That's
  undoubtedly a part of the story, but the ministry is
  also eager to ensure the safety of the industry. So
  far, 16 banks and related financial institutions have
  closed, and many other banks and life insurance
  companies are at risk due to bad-debt problems. The
  ministry closed Nissan Life, a $16 billion company,
  in April, the first insurance company to collapse
  since the war. The arrival of foreign banks will
  mean not only more competition but also more capital
  and know-how to extend a bigger safety net under
  the ailing financial institutions.

  If the bureaucrats in the ministry's banking
  division have learned one lesson in the 1990s, it is that they
  cannot begin to supervise the detailed operations
  of banks with trillions in assets and global operations.
  "They now feel that telling the banks what to do
  got out of hand," says Noboru Sakata, a senior adviser
  at Nippon Credit Bank, "and if they continue to do
  it, Japanese banks will be left behind."

  Tokyo also wants its markets to become world-class
  and the financial center for Asia. Officials say that
  the turning point for Hashimoto was the G-7 meeting
  in Lyon last year, where he realized that the euro
  might overshadow the yen unless Japanese banks
  became more competitive. The question is whether
  the Hashimoto government can really face up to the
  closures, consolidations, and huge personnel cuts
  that everyone agrees are an inevitable part of a
  real Big Bang. "I doubt that Hashimoto really
  understands the significant pain that will result
  from Big Bang," says Shinji Okabe, a bank analyst at
  Moody's Japan. "But if the Japanese banking system
  does not change, many banks will die anyway."

  Japan's economic managers tried to avoid the main
  lesson from the blowout of the early 1990s--that
  the country needed a fundamental overhaul of its
  economic system--for as long as possible, but now
  the message is seeping through. Big Bang, if it
  really comes to pass, is exhibit A, and other fitful
  deregulatory efforts also point to progress. But
  Japan has just started down a long road. Change is
  going to come in fits and starts, following the
  imperatives of Japan's bureaucratic landscape. "We have
  to make changes in the system that led to Japan's
  success," says Akio Mikuni, president of Mikuni &
  Co., a credit-rating agency in Tokyo, "and that's
  not easy." Japan has made radical changes before, but
  they've always unfolded frustratingly slowly. It
  will take years, not months, before its economy is hitting
  on all cylinders again.


  The Japanese like to say that when Japan finally
  changes, it's usually abrupt and decisive. Don Mulvihill,
  president of Goldman Sachs Asset Management Japan
  Ltd., would sign on to that. From 1992 to 1995
  he spent much of his time lobbying Japanese
  officials to make Japan's trillions in pension and mutual
  fund accounts more open to foreign investment
  management companies. Suddenly, it happened. Last
  year Goldman Sachs sold $4 billion worth of shares
  in five new mutual funds and took on management
  of $1.5 billion in pension funds from a government
  fund and big corporations like Honda, Toyota, and

  So far, foreign firms have only
  minuscule percentages of the $1.3 trillion
  pension fund and mutual fund
  businesses. But the potential is intoxicating.
  Japanese savers have stashed away
  $13 trillion, the majority in low-yield
  savings accounts. With Japanese
  interest rates at record lows, the stock market
  in a seven-year funk, and many
  big insurance companies barely solvent, returns
  have dwindled. That, along with
  pressure from the U.S. Treasury, helped
  launch Goldman's business, as
  well as that of 15 or so non-Japanese
  competitors. "The system,"
  Mulvihill says, "is up for grabs here."

  When the insurance companies cut
  their guaranteed returns to 2.5% in April
  last year, pension managers
  rebelled. Last year Nenpuku, the national
  employee insurance system, took
  the lead by withdrawing $50 billion from
  insurance companies' funds and depositing part of
  it with investment management firms, including
  Goldman. Many corporations followed suit.

  The Ministry of Finance helped by relaxing some
  onerous requirements for foreign mutual funds last
  year. But marketing was a challenge. Japanese
  housewives do most of the investing for their families,
  and Mulvihill's marketing folks told him that they
  expect something, well, sort of jazzy, not the usual
  somber Goldman image. The result: colorful posters
  for funds named Da Vinci, Marco Polo, and so on.
  "Our people in New York," says Mulvihill, "were
  mystified by this sort of marketing." But hey, it



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