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The sun also risesA survey of Japan l October 8th 2005

Japan is at last ready to surprise the world by how well it does, nothow badly, writes Bill Emmott, editor of The Economist

whose real achievements remain ratherhard to get your arms around. Moreover,the OECD recently rated Japan’s potentialrate of GDP growth for the rest of this de-cade at a mere 1.3% a year, on the basis ofpoor productivity growth and a popula-tion that is shrinking and ageing. Politicsdidn’t even come into it.

But remember. During the 1980s, whenadulation (or fear) of Japan was at its peak,many observers made the mistake of as-suming that because some things in thecountry plainly worked extremely well,everything did, so everything must beworth emulating and the trend must beever upwards. That is why your presentauthor named a book he published in 1989�The Sun Also Sets�. Japan’s sun does notonly rise, the book argued; trends can alsobring about their own downfall. Since1990, the opposite mistake has been made:just because some things have gone badlywrong, so everything has been assumed tobe wrong, in perpetuity or at least pendinga revolution. Hence the somewhat self-in-dulgent title of this survey: the Japanesesun does not only set, either. It also rises,and looks likely to do so from now on.

For the case for greater optimism is alsostrong. It is not based on any notion thatMr Koizumi’s victory represents the startof radical change. Nor is it intended to sug-gest that privatisation of the postal savingssystem�the reform issue around whichSeptember’s election was fought�willsomehow magically turn Japan from a

The Economist October 8th 2005 A survey of Japan 1

1

The sun also rises

NO COUNTRY in modern history hasmoved so swiftly from worldwide

adulation to dismissal or even contempt asdid Japan, in a process that began more orless as the temple bells were tolling in thenew year of 1990. In the 15 years that fol-lowed, amid crashing stock- and propertymarkets, mountains of dud debt, scores ofcorruption scandals, vast government def-icits and stagnant economic growth, Japanmutated from being a giver of lessons to arecipient of lectures, all of which o�eredrecipes for its reform and revival. Thoselectures, although received politely by anewly self-deprecatory Japanese elite,seemed to be ignored. Now, however, thetime for lectures is over. Japan is back. It isbeing reformed. It is reviving.

Really? The very unJapanese event thattook place on September 11th�a snap gen-eral election called on a policy issue andwon in spectacular fashion by the reform-ist prime minister, Junichiro Koizumi�haschanged perceptions of Japan as an irre-deemable dud, but not much. After all, thecase for cynicism is compelling.

There have been several false dawnsduring those 15 dismal years, most notablyin 1996-98 when an incipient recoveryturned into a fresh recession and producedboth a banking crisis and an apparent en-thusiasm for reform. Since then, Japan hassu�ered a price de�ation that has still notcome to an end. Since 2001 it has had aprime minister, that same Mr Koizumi,who has talked a lot about reform but

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Capitalism with JapanesecharacteristicsSuddenly, shareholders are beginning tomatter. Page 4

New politics, old politiciansIt will never be the same again. Well, notquite, anyway. Page 7

New East Asia, old enmitiesChina’s growth has changed Japan’s region,but is also changing Japan’s politics. Page 9

The ambiguity of YasukuniA private war shrine with imperial status.Page 11

Visions of 2020Japan’s next 15 years are likely to be a lot sunnier than the last 15. Page 12

AcknowledgmentsThe author would like to thank the many people who gavegenerously of their time and ideas for this survey. Particu-lar thanks for hospitality and help with arrangements andintroductions are owed to Minoru Makihara, Shintaro Hori,Thierry Porte, Martin Hatfull, Yoichi Funabashi, Skipp Orr,Yotaro Kobayashi, Alex Kerr, Keizo Takemi, Geo�rey Tudor,Je� Kingston, Tadashi Nakamae and the Fresh�elds Tokyoo�ce.

Exchange ratesYen, September 26th 2005

$1= 112 ¤1= 135 £1= 199

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2 A survey of Japan The Economist October 8th 2005

2 sloth economy to a growth one, for itwon’t. Rather, it is based on the view thatMr Koizumi’s victory is the culmination ofa long period of incremental change,bringing welcome con�rmation that thatchange is not likely to be reversed.

Even after his landslide win, it is not in-evitable that Mr Koizumi will get his way,for his party’s rules stipulate that he willhave merely a year as leader to exploit hisnew mandate. Still, there is a chance thatthe party will extend his term, but also alikelihood that any successor will followthe Koizumi script. This would mean thatthe size and role of the Japanese state willshrink, in a slow but remorseless processover the next decade or so. That will gradu-ally help improve the public �nances,which are in a mess; gradually help reducethe �nancial distortions that have arisenfrom the state’s role in banking; and gradu-ally help reform politics, which had be-come dependent on state cash and power.

Gradually: that could be Japan’s watch-word. The country has not had a revolu-tion, nor has it gone through the �shocktherapy� of reform that Margaret Thatcherdeployed in Britain in the 1980s or thatsome central European countries tried inthe 1990s, and it is not likely to go throughthat now. For this is not a country of revo-lutions, but rather one that tends to followa course faithfully and steadily once it hasbeen agreed upon and set.

For the past decade, although the mainapproach to the country’s immediatemacroeconomic and �nancial woes hasbeen one of muddling through and hop-ing for the best, there has been a gradualprocess of reform, of setting new coursesand parameters for behaviour. This hasconsisted of an accumulation of manysmall changes�some in politics, but alsoin �nancial regulation, in corporate law, inpublic opinion, in capital markets, in cor-porate mores. The two big questions havebeen, �rst, whether that process will en-dure; and, second, whether the burdens ofthe past�debt, de�ation, corruption, la-bour protection�will continue to over-whelm the bene�ts that come from thosechanges, or whether Japan might soon bein a position to grow and develop again asa normal country might.

September’s election answered the �rstquestion. But to answer that second ques-tion, it is no good speculating about poli-tics, nor expecting the politicians to pro-duce radical, invigorating reforms. Theyhave neither the power nor the capabilityfor that. The place to look is not in the fancyheadlines of politics but deep in the fabric

of Japan’s economy and society. And al-though there may not be one single reasonto expect a transformation, there may wellbe one single �eld of data that currentlyholds the clue as to whether economic re-covery is going to be sustainable in the lon-ger term, as well as exemplifying some ofthe biggest changes that have taken place.That �eld is employment and wages.

Lessons from the labour marketThe Japan of old was known as the coun-try of �lifetime employment�, a somewhatexaggerated but still important notion thatin return for loyalty and �exibility big em-ployers typically o�ered a lifetime com-mitment to their workers, with associatedcompany unions, generous fringe bene�tsand pay rising according to age and senior-ity. That also made for a fairly egalitariansociety. Shock therapy would have shat-tered the lifetime notion, producing a bigrise in unemployment. So it never hap-pened: most big companies chose to main-tain their commitment, asking workers totake pay cuts and waive bonuses ratherthan lose their jobs, but ceased to hire newgraduates. Less than half as many newgraduates were hired in 2003 as in 1997.

But also, helped by changes to employ-ment law, �rms found �exibility in an-other way: by hiring part-timers and oth-ers on temporary contracts, both at farlower cost than for regular workers. In1990 such �non-regular� workers made up18.8% of the labour force. Earlier this year,that �gure reached 30%, which in Japan’s65m-strong labour force means roughly20m people. Those workers are predomi-nantly women, the young and the fairlylow-skilled. Since 2003, the law has al-lowed contracts to be counted as tempo-rary, and thus cheap, for up to three years.The use of contract workers remains for-bidden in some sectors that employ lots of

people, including health care and con-struction, but has gradually become per-mitted almost everywhere else. Canon, forexample, a successful electronics �rm thatstill �rmly maintains a lifetime commit-ment for its �core� workers, employs fully70% of its Japanese factory sta� on such�non-regular� terms, up from 50% �veyears ago and 10% a decade ago, accordingto Fujio Mitarai, Canon’s president.

This new labour �exibility has contrib-uted to a boom in company pro�ts and tothe paying down of debt. In 1998 workers’pay equalled about 73% of corporate earn-ings. By 2004 the proportion had droppedto 64%. Other factors helped too, most no-tably a big rise in exports to China in2002-04, which revitalised manufacturersof all kinds, whether metal-bashers or pre-cision engineers, and a series of bank na-tionalisations and mergers in 1998-2004during which bad loans worth trillions ofyen came good or were written o�.

As a result, the gigantic pile of dud cor-porate debt for which Japan became no-torious in the late 1990s is now a lotsmaller: from a peak of more than ¥43 tril-lion in 2001, non-performing loans held bybanks have more than halved to less than¥20 trillion (see chart 2 on the next page).The number is now also thought to bemore or less accurate, whereas until 2001or so o�cial �gures for non-performingloans were appallingly and deliberatelyunderestimated.

Labour �exibility came at a price, how-ever. Falling wages boosted pro�ts but alsoweakened demand. In recent years, con-sumption has been sustained only byhouseholds choosing to save less of theirincomes: the Japan that in the 1980s wasreputed to be a nation of savers now has ahousehold saving rate of merely 5% of dis-posable income, one-third of its level in1990. New jobs have been created, but as2005 began most were still part-time or ontemporary contracts. Part-time workers inJapan get on average less than half the full-time hourly wage. The lowlier contractworkers, such as shelf-stackers in conve-nience stores, can expect ¥600-800 perhour, which is well below the British legalminimum wage. Little wonder that aneconomic commentator, Takuro Mori-naga, topped the bestseller charts in2003-04 with a book on how to live on¥3m a year. So much for the idea of Japanas a high-cost country.

As long as wages were falling and thenew employment being created was thecheaper, less secure sort, there was littlechance that economic growth could be-

1

*Annual average †Forecast

Return to form?Japan’s real GDP growth% increase on a year earlier

Sources: Thomson Datastream; Economist Intelligence Unit

2

0

2

4

6

–

+

1970s 1980s 90 92 94 96 98 2000 02 05†

*

*

1


2 come truly sustainable. The cost-reductionand �exibility may have been a necessarycondition of eventual recovery, but couldnot itself bring it about. Rather as in Amer-ica during the Great Depression, decliningdemand has helped to neutralise improve-ments taking place elsewhere in the econ-omy. Moreover, there are limits to what ex-port-led growth, the great hope of2002-04, can achieve, given Japan’s al-ready large current-account surplus (3.6%of GDP), the chance that the yen willstrengthen against the dollar and the dan-ger of slower demand in Japan’s top for-eign markets, China and America.

Since April, however, the employmentdata have shown something new andmore promising: full-time employment isgrowing faster than the part-time sort forthe �rst time in a decade, and althoughsome of that growth is still in full-time con-tract work, regular employment is risingtoo. Wages are also rising, at their fastestrate since 1998 (which mainly means theyare simply rising, at last), and bonuses areagain being paid.

It is still early days�too early to tell howstrong this rise in employment and in-comes will prove to be. Probably, its e�ectwill be gradual: people may try to rebuildtheir savings rather than spending all theirgains, competition from low-cost Chinaand India will help limit wage gains, and�rms scarred by the past 15 years are un-likely to embark upon an investment andhiring binge. What this development doessuggest, though, is that the last of the threeexcesses that have burdened the economysince 1990�excess corporate debt, excesscapacity and excess labour�may now �-nally be on the point of elimination.

Elimination is probably too strong aword, for whether something is excessiveis a subjective question. The ratio of debt

to operating pro�ts for large and medium-sized �rms is down to levels typical in the1980s, ie, less than 10%, compared with15-20% at the peak in 1999. Smaller �rmsstill hold debt of nearly 15% of operatingpro�ts, but that too is down from over 20%in 1999. Excess capacity is a particularlysubjective matter: the capacity-utilisationrate reported by the Ministry of Economy,Trade and Industry is back up to 1992 lev-els, and businessmen’s perceptions, as re-ported in the Bank of Japan’s regular Tan-kan survey, are that excess capacity haslargely disappeared.

The important issues now, though, re-volve around risk, stability and incentives.During the 1990s, although Japan experi-enced only stagnation rather than col-lapse, there was always a risk that collapsemight come. With corporate debt cleanedup and banks reformed, that risk has gone.Banks certainly think so: their lending hasrecently started to expand again for the�rst time since 1998. The alternative nowseems to be either slow growth or fastergrowth, not growth or slump. Moreover,an economy that relies on increases in

private spending, by households and bycompanies, is likely to follow a more stablepath than one that depends solely on ex-port demand or public spending. Whatmatters most, though, is how that spend-ing will be used. And that is a question ofwhether the incentives governing suchspending have changed: the incentives forcompanies to waste the money or use itwell, and the incentives for politicians andbureaucrats to abuse it, steal it or other-wise distort it.

A very stealthy revolutionThat is where the many other smallchanges come in. A simple way to under-stand what happened to Japan in the1980s and 1990s is that a country withmany strengths, especially a high averagelevel of education, formidable technologyand powerful social co-ordination withincompanies, came to lose its basic disci-plines and incentives, particularly in thelate 1980s when it experienced one of thebiggest asset booms in world history.Flushed with success and with seeminglycostless capital, companies expanded anddiversi�ed recklessly. Banks lent regard-less of risk or business viability. Bureau-crats and politicians resisted calls for de-regulation that could have extendedcompetition and encouraged innovation,because they did not think it was neces-sary. Interest groups anyway blockedchange, chie�y by bribing politicians. Themass media were largely suborned by thepolitical and corporate establishment.

The collapse of the stock- and propertybooms after 1990 and the ensuing reces-sion might have been expected to shake allthis up. It didn’t, for two main reasons. The�rst was that the principal economic re-sponse to the slump, ie, massive public-works spending, further enriched somepressure groups and many politicians,

The shape of better things to comeJapanese:

Sources: HSBC; Macquarie Research

banks’ non-performing loansFiscal years beginning April, ¥trn

employment% change on a year earlier

2

4

2

0

2

4

6

8

–

+

1995 96 97 98 99 2000 01 02 03 04 05

Full-time

Part-time

0

10

20

30

40

50

1995 96 97 98 99 2000 01 02 03 04

Learning to spend again

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2 making them even more able to resistchange, and an expansionary monetarypolicy deadened the price mechanism thatought to have imposed discipline. The sec-ond was that for a mixture of social andpsychological reasons, neither bureau-crats nor companies chose to admit whatwas really happening.

A 15-year gradual work-o� of the ex-cesses inherited from the 1980s would nothave been what most analysts would haverecommended or even expected in 1990,whether they were rude foreign lecturersor polite Japanese. And it has been a morepainful period than any visits limited toprosperous Tokyo would suggest. Provin-cial cities and rural areas have su�eredgreatly, with shuttered-up streets and ris-ing levels of poverty. Suicides have soared,up more than 50% since 1990 to 34,500 in2003. By Japan’s standards, crime has risentoo, though it remains low in comparisonwith America and most of western Eu-

rope. Still, compared with what mighthave happened in most other developedcountries had they gone through the sameprolonged experience, Japanese societyhas remained remarkably stable.

Yet although society has been stable,the appearance of policy paralysis is mis-leading. Actually, bit by bit, step by step, agreat deal has been changed, in what maycome to look with hindsight like a sort ofrevolution by stealth. The changes are stillcontinuing and being battled over, so it istoo soon to judge whether that word willin the end be justi�ed. But what this revo-lution-in-progress has already done is to al-ter many of the incentives surrounding po-litical and corporate behaviour.

It needed to, because in 1985-95 Japa-nese companies proved incredibly bad atusing their own money�or rather, theirshareholders’ money. Neither commerciallaw nor the courts helped the sharehold-ers’ cause very much. Banks supposedly

provided the discipline in the systemthrough their ability to intervene in theirbig customers’ a�airs when things wentwrong, but such interventions becamerarer as the asset bubble in�ated, and thenrarer still once the banks got into at least asmuch trouble as their customers. Then,banks kept alive what became known as�zombie� companies for fear of acknowl-edging their bad loans, of creating unem-ployment or of upsetting the whole collec-tive applecart.

This used to be called �nancial social-ism, which was meant as a compliment.That time has long gone. Now, a joke is cir-culating in Tokyo about Chinese studentson a course there. Someone asks themwhy they spend so much time with otherChinese rather than with Japanese stu-dents. Their answer: because we are afraidthe Japanese might teach us communism.The way things are going, the joke mightsoon become obsolete. 7

TAKAFUMI HORIE is proof of the re-wards of failure�and of �Livin’ on the

edge�, which is what he called his com-pany until he bought an internet portalcalled livedoor and adopted its name. This32-year-old’s daring takeover bid earlierthis year for the venerable media group Fu-jisankei Communications, via its radiosubsidiary Nippon Broadcasting System,ended in defeat: Fuji found a white knightto hold a blocking slab of its shares andforced Mr Horie to retreat with only a smallpro�t and a modest business deal betweenFuji and livedoor. In July 2004 his bid for abaseball team, the Osaka Kintetsu Bu�a-loes, also failed. Yet the attendant publicityhelped livedoor hugely: page views at itsportal in June this year were more than sixtimes higher than a year earlier, and thecompany has raised its advertising ratestwice in less than six months. It remains adistant third in the internet portal businessbehind Yahoo! Japan and Rakuten, but itsshare price has stayed high despite stockdilution and the Fuji bid’s failure, and itsearnings multiple is higher than that of Ya-hoo! Japan.

�The nail that sticks up�, runs a hoaryJapanese saying, �gets hammered down.�Yet Mr Horie is an upstanding nail who has

become famous as well as much admired,according to opinion polls, for his willing-ness to challenge old ways of doing things.He even ran (unsuccessfully) for the Diet inSeptember’s elections. And he is not alonein breaking taboos. Hot on the heels of hisbid, in July a young construction design�rm, Yumeshin Holdings, launched a hos-tile tender o�er for an older �rm, Japan En-gineering Consultants. And last year Sumi-tomo-Mitsui Financial Group, one ofJapan’s biggest banks, barged its way into afriendly merger deal between two othermega-banks, Mitsubishi-Tokyo FinancialGroup (MTFG) and UFJ Holdings, o�eringto buy UFJ for a speci�ed price. That maysound mundane, but to Japanese sensibil-ities it was shocking, because UFJ’s boardhad already accepted the merger proposal,even though no price had been set.

A related bank, Sumitomo Trust,weighed in too, seeking a court injunctionto block the MTFG-UFJ merger on theground that it violated a prior deal underwhich it was to buy a UFJ division. In theend, after a protracted battle in the courtsand the capital markets, MTFG prevailed,but only at a cost: cash compensation forSumitomo Trust, a big cash injection intoUFJ to help it deal with its bad loans and a

higher price for shareholders than itwould otherwise have been paying.

The livedoor-Fuji battle, the Yumeshinbid and the mega-bank sumo-wrestlingmatch illustrate three important develop-ments. The �rst is a new willingness to usethe courts as arbiters in corporate disputes,which re�ects both changes in attitudesand changes in the law. Livedoor managedto get several of Fuji’s attempted defencemanoeuvres struck down by the courts be-fore Fuji’s white knight came along. Yu-meshin failed to block Japan Engineering’sdefences of a stock split and an equity war-rant issue, but the Tokyo District Court laiddown reassuring criteria for their use: thatthey must not simply be in the board’s self-interest, and that they are subject to share-holders’ approval.

Secondly, a change in the ownershippattern of publicly traded shares is makingtransactions and challenges easier. In 1992,according to the Ministry of Economy,Trade and Industry, 46% of all listed equi-ties were held as cross-shareholdings byrelated companies, and only 6% by foreigninvestors. In 2004, cross-shareholdings ac-counted for merely 24% of shares whereasforeign ownership had risen to 22% of thetotal. However, that foreign slice is volatile,

Capitalism with Japanese characteristics

Suddenly, shareholders are beginning to matter

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2 moving up and down along with investinginstitutions’ perception of the Japanesemarket. Cross-shareholdings �rst becameprominent during a fright about hostiletakeovers in the 1960s, so there is a chancethat scared managements may now seekto rebuild them. Against that, though, newcapital-adequacy rules due to take e�ect in2006-07 will force Japanese banks to sellmore of their holdings.

The third development is still small butis emerging steadily. It is the arrival on thescene of funds and partnerships willing touse their investments to challenge existingmanagements or to act as intermediariesto facilitate mergers and disposals. One ex-ample is M&A Consulting, a shareholder-activist fund that also pro�ted from build-ing a stake in Nippon Broadcasting Systemearlier this year, and which has specialisedin pressing managements to use their cashpiles to raise dividends and make sharebuybacks. Another is Privee Zurich Turn-around Group, a private-equity fundwhich despite its name is thoroughly Japa-nese, and which has also �irted with hos-tile bids. A third is Advantage Partners, aprivate-equity investor chie�y in the busi-ness of acquiring assets from companiesbeing split up or turned around.

Alongside these new Japanese speciesthere are the larger and more familiar for-eign funds: Ripplewood Holdings, whichwith J.C. Flowers & Co made a fortune bybuying Shinsei Bank, formerly Long-TermCredit Bank of Japan, from the govern-ment in 2000 and transforming it; Carlyle

Group; Lone Star; Cerberus; and severalothers. By and large, though, it is the Japa-nese upstarts that are acting most aggres-sively, whereas the foreign funds try tostress how socially responsible they are.

Both make up only a small slice of mar-ket activity. But no matter: in any business,pressure on the margin can in�uence therest. To some degree, indeed, these gingergroups have been encouraged by people inthe Japanese establishment with just thatthought in mind. Mr Horie may be an out-sider, but plenty of the activist funds arerun and sta�ed by well-connected formerbureaucrats and by people in their 30s and40s who lost their jobs or their loyalty dur-ing the banking meltdown of the 1990s.M&A Consulting, for example, is run bythree partners, two of whom are formerbureaucrats and the third used to work forNomura Securities. An early investor in the�rm, and a crucial provider of introduc-tions, was Toshihiko Fukui, before he be-came governor of the Bank of Japan. Simi-larly, Ripplewood managed to recruitseveral senior Japanese to its board, in-cluding Minoru Makihara, then chairmanof Mitsubishi Corporation, the trading andinvestment �rm that epitomises the Japa-nese establishment.

The livedoor bid for Fuji illustrated an-other point about Japanese capitalism:that for a seemingly cosseted, conformistactivity, it is strikingly unregulated. Whenalmost everyone obeys unwritten rules,little attention needs to be paid to the writ-ten ones. So the supposedly heroic Mr Ho-

rie was able to mount his bid in ways thatwould be considered outrageous in Lon-don or New York: he built up his 35% stakein NBS in o�-market trading, diluted hisown investors’ shareholdings withoutconsulting them and never o�ered a stan-dard price to all NBS shareholders.

The wild west goes eastPart of the problem is that takeovers andother pressures from shareholders werelong considered taboo or irrelevant. Theprotective role of main banks and cross-shareholdings was enough to regulatematters. Now that both of those protec-tions are weakening, there is a fairly broadconsensus that the law and the regulatorysystem need to be changed. But thatchange is happening slowly. An optimisticview is that the process is at roughly thehalfway stage. Still, some important pro-gress has already been made.

One of the worst corporate sins of the1980s was the use of subsidiaries to hideproblems, park surplus sta� or disguise ad-ventures: they did not have to be consoli-dated into pro�t-and-loss accounts. Newholding-company and accounting laws in1999-2001 changed that. A so-called �bigbang� of �nancial reform in 1998 was intruth more like a slow drum roll, but itbrought in a new regulatory body, the Fi-nancial Services Agency, with the job ofsupervising �nancial institutions and ac-counting practices.

One obstacle to �rms selling divisionsand subsidiaries to each other was a rulethat required an appraisal of all the divi-sion’s assets by a court-appointed inspec-tor. In 2000 a new law abolished that rulefor �non-core� business units, de�ned assmall, underperforming ones. That doesnot go far enough��rms ought to be free tosell what they like�but it has stimulated alot of trading in distressed assets. Anothernew rule has reduced the capital require-ment for new limited companies to just ¥1,down from ¥3m.

Virtually the whole of the Japanesecommercial code is being overhauledalong similar lines. Nevertheless, withpoliticians afraid of instability and espe-cially foreign takeovers, and under pres-sure from big employers, many of the re-forms so far have been as helpful tocorporate defence as o�ence. Laws alreadypassed have permitted companies to o�ershares with di�erential voting rights, togrant stock acquisition rights through op-tions and warrants, and to set up such pro-visions as a �poison pill� to be deployed inthe event of a takeover bid. Mr Horie is a livewire too


2 On the other hand, the law has de�nedthe proper purposes of such measures aswell as the need for shareholder meetingsto approve them. And it has made proxyvotes against such measures easier. Allthat has helped boost the role of the courts.Earlier this year the Tokyo District Court re-jected a crude poison pill proposed by Ni-reco, an instrument-maker.

The role of shareholders has beenboosted too: at the spate of annual meet-ings on June 29th shareholders rejectedpoison-pill proposals at several big �rms,including Tokyo Electron, Fanuc and Yoko-gawa Electric. Many other similar propos-als passed, but signi�cantly even someJapanese institutional investors took partin anti-management votes. Previouslythey had been quiescent.

One provision the Diet (parliament)considered too hot to handle was a reformto allow foreign �rms to use their ownshares as currency in acquisitions in Japan,whether hostile or friendly. This wouldbring the rules for foreigners into line withthose already in place for Japanese compa-nies. But in April the measure was post-poned for a year. Unless there is a bigcontroversial cross-border battle in themeantime, however, it stands a goodchance of being passed in due course.

Another area of law that needs furtherre�nement is the de�nition in corporategovernance of outside directors: they havebeen given an enhanced role, especially inbig �rms that choose to adopt an Ameri-can-style board committee system, butthere is no requirement that they bewholly independent. Seibu, a railway andproperty giant whose autocratic boss,Yoshiaki Tsutsumi, was charged with fraudearlier this year, held no board meetingsfor seven years. It did have outside direc-tors, but they all had business relation-ships with Mr Tsutsumi.

For all the fuss over hostile takeovers,however, such battles are rare even inAmerica, which sees barely one each year.Even the theoretical possibility of such anevent, though, helps put pressure on man-agements to improve their pro�ts as wellas to pay dividends to shareholders. Japa-nese corporate pro�ts are at a record highmainly for other reasons, but market pres-sure has literally paid dividends: in thepast seven years the dividend yield for�rms listed in Tokyo has almost doubled(see chart 3).

Even so, the most important sort oftransaction, in Japan as in America, is thefriendly sort, whether involving whole�rms or divisions of them. In the �rst eight

months of this year, according to the Ni-hon Keizai �nancial daily, 1,735 M&A dealswere completed, 28% up on a year earlier.

As James Abegglen, a veteran consul-tant and scholar in Tokyo, observes in hisrecent book, �Redesigning the Kaisha�, theconsolidation of whole industries duringthe past decade has been impressive: from14 oil companies to four; from seven big ce-ment �rms to three; from 14 pulp and pa-per companies to three; from seven indus-trial gas �rms to three; from �ve big steel�rms to four; from 15 big banks to justthree. And big companies have traded orclosed thousands of subsidiaries.

More competition, pleaseNeither the lawyers nor the �nancial ad-visers have been idle. Many of Japan’s big-gest and most internationally famed �rmsare now more focused and e�cient thanbefore. Their scale and new concentrationwill make it easier for them to competeabroad. But for them, and even more forthe huge array of domestic �rms, there isanother, more important question: is thereenough competition at home to keep themall on their toes?

Deregulation during the 1990s, in �eldssuch as telecoms, transport, energy, �-nance and retailing, bene�ted consumersto the tune of 4.6% of GDP in 2002, or sothe Cabinet O�ce claims. This certainlyhelped, though the OECD reports that Jap-anese electricity and telecoms prices, forexample, remain the highest among thatorganisation’s rich-country members. Butperhaps the biggest issue now is whetherJapanese anti-monopoly laws stand achance of being enforced.

There is certainly some political will todo so. Amendments to antitrust lawpassed by the Diet in April and due tocome into e�ect early in 2006 will bringfour main changes: an increase in the pen-

alties for breaking the law from 6% of af-fected sales for most large �rms to 10%,with surcharges for repeat o�enders; theintroduction of a new incentive for cartelmembers to blow the whistle by o�eringdiscounted �nes for those who come cleanearly; new powers for the Fair Trade Com-mission, Japan’s trust-buster, to make raidsand seize documents; and new powers forthe FTC to issue cease-and-desist ordersbefore holding a hearing rather than wait-ing until afterwards.

That all sounds robust, and the newlaw was passed despite opposition to its�rst draft from big businesses. Yet thosepenalties remain lower than those used inthe European Union and America. And inthe past Japan has been none too assidu-ous in enforcing what legislation it had inthis area. The OECD notes that there havebeen only 13 criminal antitrust cases in Ja-pan since 1950, and that no one has evergone to jail for breaking competition law.

Until 2002 the FTC was a small bodywith a low status, �rmly under a minis-try’s thumb. However, one of the less no-ticed moves of the prime minister, Mr Koi-zumi, was that he shifted the FTC so that itnow reports directly to the Cabinet O�ce,and gave it a new boss and a bit moremoney. Whereas in 1995 the FTC had 220investigators and a budget of ¥5.24 billion,last year it had 331 investigators and a bud-get of ¥7.82 billion.

There are some omens that bode wellfor stronger enforcement. Just as the courtshave played a bigger role in securities dis-putes, so the Tokyo Stock Exchange acteddecisively when Seibu’s frauds were dis-closed, forcing the �rm to delist in Decem-ber last year. The FTC too has becomemore active. In March it �ned six steel�rms a total of ¥6.8 billion for price-�xing.Barely a week goes by without an FTC raidor an indictment of a construction com-pany or a member of sta� of the JapanPublic Highway Corporation, a soon-to-be-privatised government agency, for rig-ging bids for bridge contracts. In May, theFTC �led a criminal prosecution of eightsuch companies.

It could be argued, though, that the TSE

acted only once the game was up for Seibu.The bridge scandal too has been conve-nient for the government: Mr Koizumiwanted to show that privatisation willmake a big di�erence, and to discredit theagency’s top bureaucrats su�ciently to en-sure that they cannot scupper the plan. Yetif competition enforcement is simply aproduct of the political winds, what if thewinds change? 7

3

*Forecast

Up, from a low baseAverage dividend yield for Japanese non-financial

listed companies, fiscal years beginning April, %

Source: Goldman Sachs

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1998 99 2000 01 02 03 04 05* 06*

1


IN SEPTEMBER 1998 the cover of TheEconomist carried the headline �Japan’s

amazing ability to disappoint�, comment-ing on the government’s bungling of yetanother bank-rescue plan. It attracted apetulant protest from the Japanese em-bassy in London. Motoo Shiina, a veteranDiet member, o�ered a more thoughtfuldissent: the correct headline, he said,would have been �The Japanese people’samazing ability not to be disappointed�.Not so snappy, perhaps, but he had apoint: surely in no other democracy wouldthe same party that had been running thecountry continuously since 1955�the Lib-eral Democrats�have been left in govern-ment following a �nancial crash and aneconomic slump to which they had foundno solution. They did lose power for all often months in 1993-94, but then returnedto government, albeit leading a series ofcoalitions. And they have just been re-turned to power once again in a landslide,giving them their biggest parliamentarymajority since 1986, despite having pre-sided over 15 years of stagnation.

That account, of course, leaves out Jun-ichiro Koizumi, who since 2001 has led theLDP and served as prime minister, andwhose early slogan was �change the LDP

to change Japan�. His electoral genius at�rst looked as though it might be limited tohis photogenic long wavy hair and clevermarketing techniques, including his Lion-heart e-mail magazine. The election resulton September 11th, though, proved thatthere is rather more to him than that. Bycalling a snap general election over a singleissue of economic reform, the privatisa-tion of Japan Post, which had been op-posed by rebels in the LDP but also, cru-cially, by the main opposition party, theDemocratic Party of Japan, he managedthe seemingly impossible: to cast the LDP,the ultimate guardian of the status quo, asthe party of change. No, you might object,he cast himself as the bringer of change,not the LDP. Yes, but under the party’srules Mr Koizumi has only one more yearto serve as leader. Then, unless the rulesare changed to extend his term, someoneelse will inherit the powerful position hehas just built for his party. The long-termwinner of the September 11th election was

the LDP, not Mr Koizumi.That raises a crucial question: might it

all be just a mirage? That thought is raised,�rst, by how exceptional Mr Koizumi lookswhen you compare him with other LDP

politicians. He has already lasted longer ino�ce than any prime minister since Yasu-hiro Nakasone (1982-87), who was himselfthe longest-serving since the postwar re-cord-holder, Eisaku Sato (1964-72). Al-though Mr Koizumi has been a careerparty member and comes from a politicalfamily, in politics he is a loner. He is said tohave no real party friends and no politicalsupport group. Once he is out of power,which could be in September 2006, or atthe latest one or two years later, most peo-ple expect him to leave politics altogether.

The concern is reinforced if you exam-ine Mr Koizumi’s record of pushing hissupposedly bold reforms through the Dietin the past four years. To get his wayagainst a lot of opposition from bureau-crats and from inside the party, he brokewith tradition by using non-politicians tofront his schemes: Naoki Inose, a historicalwriter, for the privatisation of the JapanPublic Highway Corporation, the agencyin charge of building roads and bridgesthat has been at the heart of the country’scorrupt and wasteful public-worksschemes; Heizo Takenaka, an economicsprofessor and, since 2001, his main econ-omic-reform minister, for the privatisationof Japan Post. Their styles have been verydi�erent: while Mr Inose has shot from thelip in the e�ort to discredit his opponents,

Mr Takenaka has beavered away morequietly. But the outcomes have been simi-lar: such reform as has occurred has beenheavily watered down. In the case of JapanPost it was even rejected�until Mr Koizumiwon his landslide.

No rushNow, Japan Post will indeed be reorgan-ised and sold o��but over a period ofmore than a decade. This reform, like thatof the highway agency, matters chie�y be-cause the postal savings bank has beenresponsible for huge distortions in the allo-cation of funds, and with it a great deal ofpolitical corruption. It also matters be-cause, after a decade of high public spend-ing, the national gross public debt hasreached 170% of GDP, just when the popu-lation is ageing rapidly, opening up theprospect of lower tax revenues and highermedical and pension costs.

Moreover, Japan Post, with subsidiseddeposits and insurance policies worth¥330 trillion, taking 30% of all personal de-posits and 40% of life insurance, has satlike an elephant in the middle of the �nan-cial-services business, skewing the marketagainst the commercial banks and insurersand distorting the price mechanisms thatwould otherwise direct money �ows tothe best advantage. So Messrs Koizumi andTakenaka are reorganising the elephantinto four separate parts arranged under ajoint holding company, handling mail de-livery, post o�ces, savings and insurancerespectively. Each will have a pro�t-and-loss account, but all will remain publiclyowned until at least 2017. Savings depositshave already lost their subsidies, though,and the banking and insurance divisionswill now have to pay more attention to riskand returns.

Similarly, the highway agency hasbeen split into six, with e�ect from Octo-ber 1st, but will remain in public owner-ship for the time being. The main hopethere, too, is that by giving the new roadsagencies the obligation to service and re-pay an accumulated ¥40 trillion of debt,they can be made to act in a more business-like and disciplined fashion.

The direction of policy under Mr Koi-zumi is thus clear: state lending and spend-

New politics, old politicians

It will never be the same again. Well, not quite, anyway

4Back in frontJapanese parliamentary election resultsMain parties’ share of vote, %

Sources: Centre on Democratic Performance, Binghamton

University; Gerald Curtis; electionguide.org; electionworld.org

0

10

20

30

40

50

1986 88 90 92 94 96 98 2000 02 05

Liberal Democratic Party

Largest opposition party

1


2 ing needs to be given new constraints andincentives, he thinks, and ultimately to beshrunk. Later this year, Mr Takenaka says,he will turn his attention to eight otherstate-owned banks. There was also talk inthe LDP’s election manifesto of reforms tothe public health-care system and to pen-sions, though few details were given.

Resistance to shrinking the state is sti�,however, not so much on ideologicalgrounds as from interest groups: the con-struction industry, the bureaucrats, themedical profession, postal workers, all ofwhom have cultivated politicians to fur-ther their cause, particularly in the LDP.That is why Mr Koizumi and his front menfrom outside politics have struggled tomake headway. But it also should promptre�ection on the paradoxical nature of theelection result: that Mr Koizumi won hisapparent mandate for change against anopposition party, the DPJ, whose mani-festo actually proposed much more radicalreforms, including a more rapid shrinkingof the state. Yet the DPJ was crushed, losingone-third of its seats. Its dull but very wor-thy leader, Katsuya Okada, resigned.

In the Lionheart’s lairThat paradoxical result is testament bothto Mr Koizumi’s tactical brilliance and toMr Okada’s fatal mistake in getting hisparty to oppose postal privatisation in theDiet. He did that because the DPJ is an awk-ward collection, created only in 1996-98, offormer LDP members, former socialistsand young, genuinely liberal newcomers;the socialists among them retain close tiesto the postal workers’ union.

For now, though, the DPJ’s defeat hasdestroyed the long-held dream of manypolitical pundits: that Japan would de-velop a two-party system and have alter-nating governments. The LDP has regainedits traditional dominance. If its coalitionwith a small Buddhist-backed party, NewKomeito, survives, then the pair’s two-thirds majority in the Diet’s lower housewill henceforth allow it to get its way oneverything bar a revision to the constitu-tion (which also requires a two-thirds ma-jority in the upper house, where the LDP isweaker, and a simple majority in a na-tional referendum).

But is it the same LDP, or has Mr Koi-zumi succeeded in changing it, as he prom-ised? Essentially, he has changed it in threeways, none of which is guaranteed to sur-vive his retirement but all of which stand achance of doing so. The �rst is that he hasseverely disabled the system of factionswhich had long run the party. The factionsexisted primarily to raise money and tohand out jobs. The introduction of publicfunding for political parties in 1994 weak-ened the fund-raising function, as did anelectoral reform at the same time that re-placed multi-member constituencies (forwhich party factions therefore competed)with a mixture of single-member seatsand proportional representation. Mr Koi-zumi demonstrated that the factions wereweakening by winning the party’s leader-ship election in 2001 against a candidatefrom the richest and supposedly strongestfaction, and rubbed in the lesson by ignor-ing the factions when appointing his cabi-net. They still exist, but for the moment

mainly as networking groups rather thanpower centres.

Mr Koizumi’s second change has beento concentrate power in the hands of theparty’s secretary-general (who is ap-pointed by him) and, within the govern-ment, in the prime minister’s o�ce. Publicfunding for political parties had alreadyadded to the secretary-general’s role, be-cause the money (a total of ¥30 billion ayear for all parties) is channelled througheach party headquarters. Since 2003 thesame has been true for political fundingsupplied by Nippon Keidanren, the em-ployers’ federation. That stronger partyrole was on display in August when MrKoizumi ordered the expulsion of 37 LDP

members of the lower house who had op-posed his postal privatisation bills.

Under this new regime, advancementwithin the party depends on loyalty to theleadership more than to the factions. With-in the government, too, the leadership hasbeen strengthened. For decades, Japaneseprime ministers have been fairly weak �g-ures, with party power di�used by the fac-tions and governmental power dominatedby the ministries. That worked, you couldargue, because informal co-ordination be-tween the elites in the bureaucracy, theLDP and big business was strong, thoughthat also led to corruption and a lack ofaccountability. As in other countries, ablend of economic and social change,scandals and public hostility has discred-ited that old-boy network (which in Japanwas called the iron triangle), requiring itspartial replacement by more formal, rule-based structures.

Under Mr Koizumi that process of re-placement has been accelerated, withmore money and sta� for the prime minis-ter’s o�ce and a reorganisation of minis-tries to establish a new hierarchy. Onemain tool of that new control is the Coun-cil of Economic and Fiscal Policy, which ischaired by the prime minister and steeredby his economics supremo, Mr Takenaka.In theory at least, that council can bosseven the �nance ministry about.

�In theory� is an important quali�ca-tion, for much depends on how these newpowers are used, and by whom. The thirdway in which Mr Koizumi has changedpolitics could determine that, although it isthe most uncertain of all. What he seemsto have shown is that the way to gain andhold power is by appealing to the public,by making gestures of leadership and byfavouring change. Budding successorswho would like to continue in that vein, ei-ther by choice or because that is the way to

One of them stands out

1


2 win elections, should thus be expected tofollow Mr Koizumi’s lead in disablingparty factions, centralising party powerand strengthening the prime minister’s of-�ce. But will they? A two-thirds majority inthe Diet, with an enfeebled opposition,could cause them to move the other way: ifyou feel untouchable, why bother withpublic opinion?

Voice of the people, voice of lawBy continuing a policy begun in 1998 by anearlier prime minister, Ryutaro Hashi-moto, of cutting public-works spending,and now reinforcing it through reforms toJapan Post and the highway agency, MrKoizumi has probably put an end to pork-barrel politics. The demographic squeezeon public �nances will make that almostimpossible to reverse. The successors to MrKoizumi most often mooted within theparty�Shinzo Abe, a fairly right-wing for-mer LDP secretary-general who is bothyouthful and telegenic, and Yasuo Fukuda,a respected former cabinet secretary�sug-gest that the old stu�ed-shirt politics mightalso be in abeyance. But in a newly victo-rious party, personal support could shiftrapidly. That makes it premature to makeassumptions about the succession.

There are, though, more lasting signsthat inspire some con�dence about the di-rection and durability of change. The basicincentives surrounding politicians werealtered not by the exceptional Mr Koizumibut by those electoral and campaign-�-nance reforms back in 1994. Political ethicslaws from that same period have sought tocrack down on corruption, as has a 1994provision that made candidates legallyresponsible for illegal actions by their cam-

paign supporters even if they have no di-rect knowledge of them. These changeshave not eliminated corruption by anymeans, but they have constrained it.

Meanwhile, the voice of public opinionhas been getting gently but steadily stron-ger. Disappointment with the old guardhas long been coming through clearly inlocal elections for city mayors and prefec-tural governors, where all sorts of maver-icks and outsiders have gained power. Sep-tember’s vote demonstrated at least adesire for change at national level too.Also, though, it has become easier for non-party groups to in�uence policy outsidethe Diet. Until 1998, individuals could notreadily form lobby groups or associationsto promote their particular hobby-horses,because such non-pro�t organisations hadno legal basis. Since then, more than20,000 have been recognised under a newlaw. Crucially, they do not yet bene�t fromthe sort of tax exemptions that help ex-plain why America has more than 1.4mnon-pro�ts. But even this small vanguardis beginning to have an impact on policydebates, though mainly at local level, andto launch legal challenges to companiesand to the government.

That public pressure is now more easilyapplied thanks to a freedom-of-informa-tion law which was passed in 2001, and toquite sweeping judicial reforms that be-came law in 2002-04. These have resultedin the opening of 68 new professionalschools designed to double the number ofquali�ed lawyers over the next decade orso; in the imposition of a two-year timelimit on all �rst-instance trials of criminaland civil cases; in the creation of a newintellectual-property court; and in a new

mechanism for involving citizens on judi-cial panels in criminal cases.

As Je� Kingston, a professor at TempleUniversity in Tokyo, writes in his excellentbook �Japan’s Quiet Transformation�,what is happening is that the old system of�rule by law�, with wide administrativediscretion and limited legal redress, is be-ing replaced by something more akin to�rule of law�. It is the same trend as that ev-ident in policy co-ordination by elites andthe evolution of corporate law: old meth-ods of discretionary power based on un-written rules are fading away, with newstructures and new written rules rising totake their place.

Not surprisingly, not everyone feelscomfortable with this increase in the roleand number of lawyers. But the increasingrole for public opinion is causing some dis-quiet too. Being popular and campaigningpublicly for change, as Mr Koizumi does, isall very �ne and democratic, but alongsidesuch virtues has also come a possible vice:anti-Chinese nationalism. Mr Koizumi isno sophisticate in foreign a�airs, but in hisfour years in o�ce he has achieved asteady expansion of Japan’s constitu-tionally limited military role, for exampleby sending troops to Iraq, and a steady de-terioration in Japan’s relationship withtwo of its neighbours, China and SouthKorea. Until September’s election, thoseworried by such developments couldcomfort themselves with the hope that theopposition, the DPJ, which adopted amuch less assertive, more diplomatic for-eign stance, could either become the nextgovernment or else restrain the LDP. Nolonger. Like its old foes in China, Japan isnow back to one-party rule. 7

AMONG the forces pressing upon Japan,none has changed more since the

country’s asset-bubble burst in 1990 thanits own neighbourhood. Where 15 yearsago China was merely a pariah with econ-omic potential, having recently massacredprotesters in Tiananmen Square, it nowhas a better international reputation and amuch admired (and two and a half timeslarger) economy. Where the Soviet Unionwas then Japan’s principal military con-cern, as it had been for the previous four

decades, that threat is no more. Where Ja-pan was then a rarity as an East Asian de-mocracy, with just the young Philippinesdemocracy and the dictatorial sort in Ma-laysia and Singapore as company, now ithas been joined by South Korea, Taiwan,Thailand and Indonesia. Where then Ja-pan depended on exports to America andwestern Europe, now trade with otherAsian countries makes up 45% of the coun-try’s total. In both economic and politicalterms, Japan is no longer alone in Asia.

Yet it is not really together with its newfriends either. For one thing has, if any-thing, got worse: Japan’s argument bothwith itself and, more painfully, with itsneighbours about its 20th-century history.This year, there have been mass demon-strations in both communist China anddemocratic South Korea against Japan, ac-cusing it of refusing to face up to its past. Ja-pan’s e�orts to gain a permanent seat onthe United Nations Security Council ifthere is a broad reform of council member-

New East Asia, old enmities

China’s growth has changed Japan’s region, but is also changing Japan’s politics

1


2 ship have been set back.Perhaps this doesn’t matter much, ex-

cept to diplomats? Japan has lived with ar-guments about history ever since 1945,without su�ering too much harm. Two fac-tors, however, make that sanguine re-sponse look unwise. One is that there is anew threat in the region, or at least a moreworrying old threat. That is North Korea,which gave Japan the jitters in 1998 when ittested a long-range missile by sending it�ying over Japan; which caused great an-guish and anger in 2002 when it admittedat last to having abducted Japanese citi-zens over several decades; and which nowclaims to have made several nuclear weap-ons. Japan is one of the �ve countries tak-ing part in joint talks with North Koreaabout these issues (the others are China,Russia, America and South Korea), andstands shoulder to shoulder with its Amer-ican ally in urging a tough line on the her-mit kingdom. But Japan is in a weak posi-tion to convince China and South Korea tobe tough too, because of its poor relation-ship with both countries.

The American alliance, �rst formalisedin the US-Japan Security Treaty in 1960 andstrengthened several times since, bolstersJapan’s con�dence in the face both ofNorth Korea and of those poor neighbour-hood relationships. Participation in Amer-ica’s missile-defence plan, while remain-ing under America’s nuclear umbrella,may well be Japan’s best form of insur-ance. Nevertheless, with public opinionsensitised by North Korean provocations,the government has exploited the situa-tion to give itself a bit more autonomy inmilitary and intelligence matters: it haslaunched its own spy satellites and hasbeen shifting its defence spending awayfrom tanks and towards advanced war-ships and submarine-detection techno-logy. And in the longer term, North Koreancollapse may be as much of a threat as thecurrent regime’s sabre-rattling, for uni�ca-tion on the Korean peninsula would createa still-larger neighbour with whom Japanhas rocky relations, and might force a re-think about America’s military deploy-ments in Asia.

The second anti-sanguinity factor isChina. It is not that China poses a big threatto Japan now, in military, political or econ-omic terms. It is expanding its defencespending rapidly, by 12.6% in the past year,but its armed forces remain less advancedthan Japan’s constitutionally constrained�self-defence forces�. The main threatChina’s defence build-up currently posesis that it might get strong enough to con-

front Taiwan, which would give Japan analmighty headache. But in that case Japanwould not be the only one reaching for theaspirin. In regional politics, moreover,other Asian countries are as suspicious ofChina as they are of Japan. They may likeChina’s market, but none is dependent onit: in 1999-2004, according to BNP Paribas,South Korea was the Asian country withthe strongest trade links to China, butChina still accounted for only 10% of its im-ports and 14% of its exports.

Nor does China represent an immedi-ate economic danger for Japan. The twoeconomies are strikingly complementary,with Japan hogging the sophisticated endof the electronics, engineering and vehicleindustries and China occupying thecheaper end. Competition from South Ko-rea for Japan’s top companies is muchsti�er than that from China: Samsung inelectronics, POSCO in steel, Hyundai incars and ships have all given Japanese�rms more pause for thought than haveChinese companies. That, alas, helps to ex-plain why Chinese competition has notyet shocked Japan into economic reform.China is not as big a concern for high-techJapan as it is, say, for mid-tech Italy.

The real worry is not about presentthreats at all; it is about a future that ap-pears to be unfolding with disconcertingspeed. If China’s economy, its regionalclout and its defence spending all continueto grow at something like their currentrates, then China threatens to overshadowthe whole region and, more pertinently, Ja-pan, during the next quarter-century or so.As that happens, other Asian countriesmight feel forced to swallow their distrustof the Chinese dragon and seek friendshipwith it for fear of something worse. AndChina could come to set the rules for re-gional deals, whether in trade, investment,the environment or even security.

That would injure Japan’s nationalpride but could also hurt its national inter-ests. For Japan, too, would like to be therule-setter, the top dog in the region. In thatregard, what is in prospect is just a resump-tion of a natural historical rivalry that haslasted a thousand years or more. Like Brit-ain in relation to France and Germany, Ja-pan as an o�shore island has alwayswanted to retain its independence fromthe continental power. But, also like Brit-ain, it has an interest in gaining in�uenceover trends in its neighbourhood, lest theybecome harmful to it. That wasn’t neces-sary for 45 years after 1945. Now, the sametrends that are making such in�uence nec-essary are changing Japanese politics inways that risk making it harder to attain.

Soft nationalism or hard?The combination of North Korean prov-ocations and Chinese bullying over his-tory are pushing Japanese politics furtherto the right. Even the once slavishly paci�stleft-wing daily paper, the Asahi Shimbun,has adopted a more strident line especiallyon North Korea but also on China’s recentanti-Japanese demonstrations. And a dis-pute over the rights to oil and gas in an areaof the East China Sea claimed by bothcountries has provided a test-case of Ja-pan’s determination: if Japan gives way toChinese pressure over the Chunxiao gas�eld, it is said, then where will China’s ex-pansionism end? The dragon is hungry forresources and will always push for more.Lines must be drawn.

The sort of nationalism being exhibitedin Japan in response to such disputes ismuch milder and less worrying than thatshown in either China or South Korea. Jap-anese nationalist fringe groups go aroundin loudspeaker vans touting their ideas, asthey always have, but ordinary Japanesehave not matched their neighbours by

C H I N A

Tokyo

P A C I F I C

O C E A N

P A C I F I C

O C E A N

S e a o f

J a p a n

( E a s t S e a )

Y e l l o w

S e a

E a s t

C h i n a

S e a

NORTHKOREA

SOUTHKOREA

TAIWAN

Seoul

Taipei

Pyongyang

Beijing

Okinawa

Hokkaido

Kyushu

Shikoku

Honshu

J A P A N

RUSSIA

Osaka

Sendai

Sapporo

NagoyaKyoto

Hiroshima

Nagasaki

750 km

5IntegratingJapan’s merchandise trade with Asiaas % of total Japanese merchandise trade

Source: IMF

30

35

40

45

50

1990 92 94 96 98 2000 02 04

1


2 marching or rioting. And there is no con-sensus about how best to react: whereasLDP hawks want to deal with territorialdisputes by sending drilling ships and risk-ing confrontation, plenty of politicianswould still prefer a quieter response.

What seems to be happening, though,is that in response to Chinese pressure Ja-pan’s position is hardening. The annualvisits made since 2001 by the prime minis-ter to the Yasukuni shrine in Tokyo, long Ja-pan’s principal memorial to its war dead,are a case in point. They have made many

Japanese uncomfortable, especially busi-nessmen wanting to sell their goods inChina. Some debate has taken place aboutwhether alternative memorials might benurtured or created (see box), or how thehistory issue might otherwise be defused.But whereas similar Chinese and SouthKorean protests at o�cial visits to theshrine in the 1980s by Yasuhiro Nakasone,Japan’s most recent openly nationalistprime minister, led speedily to a consen-sus that the visits should be stopped, theprotests about the shrine and about the

small number of Japanese history text-books that whitewash the country’s warconduct now seem to strike more Japaneseas unfair. Japan has apologised for the waron many occasions, runs the argument,but the neighbours will never be satis�ed.

This new �rmness in Japan’s foreignpolicy, or at least in its opinions about it-self and its region, has coincided with a de-bate among diplomats and politiciansabout the right approach to East Asia. Formany years, Japan has been leery of e�ortsto establish Asian regional institutions, for

IF YOU visit the Yasukuni shrine in cen-tral Tokyo, as Junichiro Koizumi has in-

sisted on doing once a year to loudprotests in China and South Korea, it ishard at �rst to see why this memorial toJapan’s war dead is so controversial. Ev-ery country commemorates its militarydead; this shrine dates back to 1869 and isdedicated to the 2.5m Japanese who havedied in wars or civil wars since 1853. Itsname, bestowed upon it by EmperorMeiji in 1879, means �peaceful country�.Only once you hear that among the spir-its venerated at Yasukuni are 14 class Awar criminals who were executed afterthe Tokyo war tribunal in 1948, andwhose names were added to the roster atthe shrine in 1978, do worries start to setin. But it is the shrine’s war museum, theYushukan, which really sets foreign eye-brows rising: this is no mere place ofprayer, but puts over a controversial viewof Japanese history.

To concern expressed about the pres-ence of those 14 spirits, the government’sresponse is that, yes, this is regrettable butYasukuni has been a private religious en-tity since 1945 and Japan’s post-war,American-drafted constitution separatesstate and religion, so the government cando nothing about it. Besides, in the Shintoreligion, the kami, or spirits, at a shrine arethought to be indivisible: the war crimi-nals have been put among the 2.5m oth-ers rather like 14 drops of water might beput into an ocean.

The �aw in that claim of constitu-tionally mandated impotence is that Ya-sukuni retains a strong tie with the head

of state himself, the emperor. No em-peror has visited the shrine personallysince 1975, but every year, during the twoprincipal rites at the shrine in the springand the autumn, an emissary from theemperor plays the central role. The ar-chive at the shrine, which is where thenames of the war dead are logged, wasbuilt with a private donation from Em-peror Hirohito (now Showa) in 1972.

The museum has no such direct link tothe emperor. But, as John Breen of Lon-don’s School of Oriental and AfricanStudies wrote in June in �YasukuniShrine: Ritual and Memory�, an article for

the Japan Focus website, the Yushukan isnot like most other countries’ o�cial warmuseums: it is a museum without men-tion of any enemies.

Its sole purpose is to glorify Japan’sdead, but in doing so it tells a clear storyabout Japan’s conquests in Korea, Taiwanand China and about the Paci�c war ingeneral: that they were heroic e�orts toliberate Asia. And it features a large ex-hibit about the one judge at the Tokyowar-crimes tribunal, Radhabinod Palfrom India, who considered the tribunalillegitimate. On the shrine’s website,when you click for the museum, a sloganappears: �The truth of modern Japanesehistory is now restored.�

O�cially, that is not the government’sview. Japan accepted the verdict of the tri-bunal when it signed the San Franciscopeace treaty in 1951, and insists that de-bate about the war is an inevitable part ofbeing a democracy. But the fact that thisdebate is being conducted not just by ex-tremists but by a shrine associated withthe prime minister and many other LDP

politicians as well as with the emperormakes this ambiguous, to say the least.

One obvious solution would be tohave another o�cial memorial. Yet onealready exists: a war cemetery at Chidori-gafuji in Tokyo. There is also a big cere-mony on August 15th every year at theNippon Budokan, Japan’s martial-artscentre, to commemorate the end of thesecond world war, which is attended bythe emperor and the prime minister. Thereal problem lies at Yasukuni. For, privateor not, it has a special status.

A private war shrine withimperial statusThe ambiguity of Yasukuni

No ordinary shrine

1


2 equal and opposite reasons: it has fearedthat its natural leadership of such entities,given its economic weight, would be re-sisted for historical reasons; and it hasbeen concerned that as such entities de-velop they could come to limit its freedomof manoeuvre. Its most important Paci�calliance being with the United States, it hasnot wanted any commitments to evolvethat could ever complicate that alliance ordiminish America’s role in the region.

China’s rise has, however, changed thesituation, and promises to do so even morein future. If any sort of East Asian commu-nity analogous to the European Unionemerges, then Japan cannot a�ord towatch it becoming a platform for Chinesepower. Moreover, the case for more re-gional co-operation and even integrationis increasing with the rising interdepen-dence of the region’s economies. So, at thesame time as its politics and public opin-ion are becoming more assertive and moreindependence-minded, Japan is also be-coming more interested in taking part inand (it hopes) leading regional institu-tions. The �rst East Asian Summit, bring-ing together government heads fromSouth-East Asia, China, South Korea, Ja-pan, India, Australia and New Zealand,

will be held in Malaysia in December. Itwill also be the �rst big regional meeting inwhich America has not been a participant.

That fact makes many Japanese dip-lomats almost as nervous as the Ameri-cans. But nurturing regional institutionsmust surely be the right policy for Japan. If

China’s economy continues to grow, thereis no chance that Japan will be able to beatit in an outright contest for regional leader-ship�and any such contest would risk be-coming destructive for both countries. Abetter strategy will be to use regional insti-tutions and treaties to dilute China’s in�u-ence, establishing a framework of rulesand procedures within which both coun-tries will have to operate but which also of-fers the chance for Japan to build allianceswith other Asian democracies.

When comparisons with the EuropeanUnion are made, it is often assumed thatthe right analogue for Japan is Germany,since both were defeated in 1945. But thatdoes not feel quite right. Japan’s situationis akin to Britain’s in many ways, being inAsia but not entirely of it, and having acloser relationship with the United Statesthan with its neighbours. Yet during thenext few decades, Japan’s ambitionshould arguably be to do what France oncedid successfully in Europe: to be the Asiancountry that aims to use regional institu-tions to give itself a greater voice in worlda�airs, and to prevent its hefty neighbourfrom pushing it around. Except, of course,that it will want to remain on friendlyterms with the Americans. 7

Unfriendly neighbours

EVERY so often, a slogan rings out: Wel-come to the new Japan! It comes from

any pundit or panjandrum wanting toclaim that, in a country that to many seemsso unchanging, some dramatic new trendcan be seen. But it is usually misleading, orexaggerated, for Japan doesn’t do drama(and that is not a comment on Kabuki andNoh), except when it feels under threat ofinvasion, as in the 1860s, or su�ers a war-time defeat, as in 1945. The stock- and prop-erty-market crashes that began in 1990were dramatic for those caught up in them,and certainly produced a sharp change inperceptions of Japan in the world as wellas in Japan’s perception of itself. But thesocial and political response was totallyundramatic. The country muddledthrough, at �rst in denial but later with ahost of incremental adjustments. Fifteenyears on, the same party is in governmentwith a big majority, society remains sta-ble, and Toyota is the world’s best car com-

pany. Anyone know the Japanese for plusça change, plus c’est la même chose?

As this survey has argued, however,that too is misleading. Those incrementaladjustments, in politics, corporate law,capital markets, �nancial regulation, la-bour law and practices, and much else be-sides, have altered the incentives guidingsociety, the economy and politics. In part,the e�ect has been to reduce the distor-tions, misallocation of capital and indisci-pline that have for about two decades neu-tralised Japan’s long-standing economicand social strengths: excellent education,co-operative relations inside companiesand advanced technology. But also, overthe longer term, such a gradual accumula-tion of many small reforms will lead thecountry in new directions, especiallygiven the recent changes in East Asia andthe world economy as a whole, and givenits own changing demography. No one canreally know where those directions might

take Japan over, say, the next 15 years. Butsome guesses can be made.

The easiest place to start is with demog-raphy. With birth rates having plummetedsince the baby-boom of the 1950s and lifeexpectancy having lengthened every year,the trend is pretty much �xed for at leastthe next 15-20 years: the governmentthinks the total population may have be-gun to shrink in the �rst half of this year,and it is certain to do so from 2007 on-wards. That shrinkage will be slow, butwith fewer children already entering thelabour force and more people retiring, theworking-age population (ie, aged 15-64)will fall by about 0.7% a year, says the Min-istry of Health, Labour and Welfare.

If you extrapolate current trends wellbeyond 2020, you get quite startling num-bers. The health ministry’s central projec-tion suggests Japan’s population could fallfrom nearly 128m now to about 100m in2050. Peter Morgan, chief economist in To-

Visions of 2020

Japan’s next 15 years are likely to be a lot sunnier than the last 15

1


2 kyo for HSBC bank, reckons the ministry isbeing over-optimistic about birth rates,given that more and more women are mar-rying later or not at all. He thinks that aprudent projection for 2050 is actually adrop to 86m people. As Mr Morgan knows,however, demography is not destiny be-yond 15-20 years. France, Scandinavia andabove all America have shown recentlythat falling fertility rates can start to riseagain. That could happen in Japan too.

The trouble is that the possible policyresponses to boost the workforce and re-vive population growth could end upcontradicting one another. With the la-bour force shrinking and ageing, compa-nies and the government are both likely totry much harder to bring more womeninto the labour force and to use them inskilled and responsible positions. But themore that e�ort succeeds, the fewer babiesare likely to be born. If the governmenttries to encourage women to have morechildren, on the other hand, fewer will bein the workforce in their 20s and 30s.

The way to meet both of those objec-tives would be to spend a lot more publicand corporate money on child-care facili-ties, which are currently in short supply.The old way was to use granny, but today’sand tomorrow’s grannies want to spendtheir retirements travelling the world, andyoung women are not keen on havingthem around the house in any case. Sothere is bound to be some increase inspending on child care.

Awkwardly, the pressure for thatspending will come at the same time as thepublic �nances are being tortured in otherways. Ideally, you would not want to startdealing with all these problems when thebudget de�cit is already at 6.4% of GDP

and gross public debt is 170% of GDP, asthey have been in 2004-05. That is why thetrend that Mr Koizumi has been busy ac-celerating, namely cutting back statespending, especially in wasteful public-works schemes and subsidised lending, isbound to continue. Space needs to bemade in the public purse for child care,pensions and medical costs.

A shrinking labour force, with e�orts togive women a bigger role, also means thatthe great worry of the past �ve years�thatthe rise of part-time and contract workerswas producing a two-tier workforce�islikely to fade. There may be some moretrimming of the protections given to regu-lar workers in order to keep things �exible,but with labour scarce the new shiftingarmy of irregulars, now 30% of the total,will surely fall in numbers.

Another solution that is often mootedto deal with both low fertility and scarcelabour is immigration, which in conform-ist, homogeneous Japan has so far beentiny, except to take up the nastiest of jobs.Most people’s chief candidate for a biggerimmigrant workforce has been healthcare, where a government desperate to re-duce state medical costs ought to welcomecheaper Filipina nurses with open arms.The medical profession, protective of itsown pay, has blocked that up till now.Eventually, cost pressures combined witha stronger economy are likely to break thatresistance. But beyond nursing, nobodyshould expect a big rise in immigration.The social and cultural fear of it shows nosign of changing.

The potential of robotsThe opening article of this survey cited theOECD’s recent estimate of Japan’s poten-tial annual growth rate in 2004-10: just1.3%. That number anyway looks low, aseven during the country’s stagnant decadeof 1993-2003 the annual average growthrate was 1.1%. What it re�ects, though, is anarithmetical calculation based on twonumbers: the shrinking labour force justdescribed; and the slow annual growth inproductivity in the 1990s of about 2%, awhole percentage point less than in the1980s. But the OECD’s projection for pro-ductivity growth until 2010 is only a miser-able 1.7% a year.

Here is a prediction, made with noarithmetic but much con�dence: Japan’sgrowth rate for the rest of this decade, andquite possibly for much of the followingdecade too, will be a lot higher than 1.3% ayear. The country saw its productivitygrowth drop during the 1990s because itmisused huge amounts of capital, and at

the same time many companies hoardedlabour rather than laying o� workers.Now, with public-works schemes slashed,bank bad-debt accounts honest, share-holders and other ginger groups pressingpublic companies to boost pro�ts and divi-dends, and the over-diversi�cation of bigcompanies a thing of the past, capital isbound to be allocated more e�ciently.There is much catching up to be done incapital investment in any case that shouldboost productivity, and a much tighter la-bour market will force companies to seekways to boost it even more.

One way that is already being talkedabout at the bigger manufacturing compa-nies is the use of robots. Japan has longgone further than other developed coun-tries in replacing workers with machines.An alternative is to replace Japanese work-ers with Chinese ones by opening fac-tories in China, and some of that has beendone. But the big electronics �rms, for in-stance, are leery of that and others may be-come so too: Chinese workers’ productiv-ity is lower, they are harder for theJapanese to manage, there is a big risk ofintellectual-property theft, and political re-lations between Japan and China arelikely to remain scratchy. All this couldwell make robots and other machinesincreasingly attractive�especially if capi-tal costs stay low.

No one can know, in an economy aslarge and diverse as Japan’s, which indus-tries are going to grow the most during thenext 15 years. The game of picking winnersbecame obsolete long ago. It is safe,though, to say that technology will stillplay a big part in investment and outputgrowth in Japan. The country has beenspending 3.1% of GDP on research and de-velopment even during the stagnant years,compared with 2.8% in America and an av-erage of 1.9% in the European Union. Muchof that is in advanced electronics, a �eld inwhich Japanese �rms still lead the world.In future, there will be plenty too in nano-technology, which takes the Japanese skillin miniaturisation down to the molecularlevel. Big e�orts will also be made in bio-technology, though Japanese �rms have ameagre record in that �eld so far.

A serious problem in the past 15 yearshas been slow growth in services busi-nesses, which have failed to provideenough jobs and income to make up forthose lost in metal-bashing. Deregulationhas improved matters, but costs for tele-coms and electricity remain high relativeto those in other countries and there is stilltoo little competition. A prime example is

6

*Children per woman †15-64

Demographic destinyJapanese:

Source: Lehman Brothers

0

0.4

0.8

1.2

0

40

80

120

1.6

2.0

2.4

160

200

240

1960 80 2000 4030109070 20 50

total population, m

working-age† population, m fertility rate*

FORECAST

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the vast wholesale-supply business: JesperKoll, chief economist at Merrill Lynch inTokyo, points out that of Japan’s 380,000wholesalers, two-thirds trade with eachother rather than directly with a retailer ora producer. The squeeze on those middle-men has begun. Seven-Eleven, for exam-ple, recently cut soft-drink prices at its con-venience stores by more than 20%, at thewholesalers’ expense.

Another services business that willneed a kick up its bottom line is travel andtourism. All those pensioners are going towant to do more and more sightseeing,and rural areas are going to need the jobsthat tourism brings. Although transport inJapan is top-notch, it remains pricey, how-ever, and hotels are poor. An even biggerproblem is that job-creation through pub-lic works has made so much of the coun-tryside so ugly, thwarting job-creationthrough tourism. There are the beginningsof a movement among local authorities totidy up their areas, dealing with what havebecome known as keikan mondai, or viewproblems. But there will have to be a lotmore of that sort of thing if tourism is go-ing to grow, especially from abroad.

Back to the politics of a�uenceIf the government is to become seriousabout raising productivity growth, whichit surely must, competition will have to bestrengthened, whatever the objections.Still, even with stronger antitrust enforce-ment and fresh deregulation to encouragemore entrepreneurs, Japan is not going tobecome an American-style, free-marketeconomy. You can tell by listening to oneof its leading venture-capitalists, YoshitakaKitao of Softbank Investment. Despite hisbrash braces and combative manner, MrKitao talks a lot about the social obliga-

tions of companies. He thinks that youngentrepreneurs like livedoor’s TakafumiHorie, the notorious hostile bidder, are toogreedy for money.

Over the next 10-15 years, Japan willhave to begin to deal with the conse-quences of population decline. Faced withthat burden, the country’s GDP growthwill never again reach the dizzy heights ofthe 1960s, 1970s and 1980s, nor be any-thing like as exciting as China’s. But themore important measure is GDP per head,for that gauges living standards: if moder-ate GDP growth can be maintained along-side a slowly shrinking population, thenGDP per head will rise quite nicely.

Just as neither the politics nor the eco-nomics of America after 1945 could sensi-bly be predicted on the basis of trends dur-ing the Great Depression of the 1930s, sothe politics and economics of Japan oughtnot to be projected from its depressed past

15 years. With the important exception ofthe public debt, the excesses from that per-iod now look to be gone. Politics and pub-lic policy will again face up to the demandsof a�uence, of labour shortages, of risingenvironmental concerns, of faltering uni-versities and, above all, of a changing EastAsian neighbourhood.

Given its huge electoral success on Sep-tember 11th, much of that political debatecan now be expected to take place withinthe Liberal Democratic Party, just as it hasfor the past half century, rather than be-tween the twin poles of a two-party sys-tem. But it would take a brave man to pred-ict that the LDP will still be in power in2020. The lessons from Mr Koizumi, thatelectoral success requires charisma, a clearmessage and the promotion of change�rather than the old ingredients of money, afamily name and a party machine�willnot be lost on the younger generation inthe opposition. Their time will come.

It might even come over the issue of for-eign policy. The LDP’s hawkish responseto Chinese bullying has stoked up somenationalist feelings in Japan, but this re-mains a paci�st nation at heart. A biggerrole in peacekeeping and humanitarianoperations can be expected in future, butshort of a grave international crisis there islittle likelihood of Japan revising its con-stitution to unshackle its armed forces, norof the country going nuclear.

Hence a �nal prediction for the Japan of2020. In 15 years’ time Japan will be a lead-ing member of some sort of pan-Asian un-ion, which will help it to keep China at bay.But it will still huddle closest to the UnitedStates, which will still have bases on Japa-nese soil. Some things never change. 7

Rare and precious

Future surveys

Countries and regionsCanada November 19thItaly November 26thSaudi Arabia December 17th

Business, �nance, economics and ideasIntellectual property October 22ndMicro�nance November 5thThe evolution of man December 24th

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