JapanÆs global companies thrive but economy withers

One-sided globalisation and a lack of investment opportunities for foreign capital make the Japanese economy vulnerable to a downturn.
An incongruous juxtaposition of events has arisen this week, with Japanese companies going on an international shopping spree on the one hand, and news that Japan has formally entered a recession on the other. Some commentators have assumed that the prowess of Japanese companies in acquiring foreign companies will mitigate the overall downturn at home. However, there is no logical link between the two.

The blame for this can be attributed partly to JapanÆs ambiguous relationship with globalisation. Japanese companies have successfully linked up with the outside world, but the Japanese economy is closed in the other direction. Inward foreign direct investment, imports and immigration all show little, or even negative, change over the years.

JapanÆs inward direct investment was $22 billion in 2007 (the same as AustraliaÆs and half the size of SwitzerlandÆs), while JapanÆs outbound investment came to a much larger $70 billion in 2007. The figures represent 1.1% of the world's total inward direct investment and 3.4% of outward direct investment, according to the Japan External Trade Organisation (Jetro). Further, JapanÆs strong export performance means that the country's income gains from net exports as a fraction of GDP are higher than at any time since the 1970s, according to Jetro.

So, while Japanese companies have increased their revenues by setting up in, and selling to, countries all around the world, there has been no counterbalancing growth effect by foreign companies and imports within Japan. A dearth of imports is the downside of the superficially impressive trade surplus. Some economic theories suggest that imports, as well as foreign companies producing in Japan, provide a tonic to the local economy by breaking up cartels and forcing down costs. On a macro level, a trade surplus also indicates a lack of domestic consumption, which makes the economy vulnerable to a slowdown in exports. In short, the trade balance should not be taken as a sign of overall economic strength. In fact, it merely reflects corporate prowess.

The stockmarket, a mechanism for creating domestic wealth in many other countries, does not have a similar function in Japan. This is again due to the one-sided nature of JapanÆs globalisation. Some 30% of the stockmarket is owned by foreigners, which means that 30% of dividends are paid out to non-Japanese shareholders. The higher the dividend payout and the tighter the cost controls on staff wages (traditionally not seen as a cost in Japan), the worse the outlook for Japanese employees. In the past, it was the employees who were first in the queue for extra profits, which they received as bonuses, but this is no longer the case. Japanese retail investors own just 19% of the market.Nor are Japanese investments in foreign assets compensating for reduced exposure in Japan. Data from the TSE shows net sales of Ñ59,000 billion in 2006 and Ñ51,000 billion in 2007 across stocks and bonds.

When it comes to capital expenditure, Japanese companies focus on the US, the UK, Korea and the high-growth economies of Latin America and China. The domestic market has zero attraction for them. According to one estimate by Barclays Capital, if the countryÆs population continues to decrease at its present rate, the Japanese people will be extinct in 300 years. Clearly, that has deflationary consequences which make it a deeply unattractive market for business. As a result, capital expenditure is done abroad, rather than in Japan.

ItÆs difficult to tell if the government foresees the seriousness of the situation. In one panel discussion at the recent MipimAsia real estate conference, the possibility of transforming Tokyo into an international financial centre along the lines of New York, London, Hong Kong and Singapore was debated. The officials and academics on the panel spent a good deal of their speaking time discussing how facilities have been set up for expats to get visas for their maids, and in emphasising the excellent Tokyo rail system. One investment banker on the panel pointed out that what would really attract foreign investors to Japan would be investment opportunities. Indeed, foreign businessmen have no problem spending a couple of years in hostile locations as long as they are compensated by good returns. However, the banker was ignored.

And thatÆs the nub of the matter. Even if the doors were flung wide open for foreign investors, itÆs not clear what they would do in Japan. As exports falter in 2008, deflation may be returning to Japan and if you define deflation as falling prices and an expectation that prices will fall even further, then it is already here. Share prices have declined brutally fast and, earlier this week, commercial rents were reported to have fallen in Tokyo for the first time in six years. With Japanese banks owning 15% of the sagging stockmarket û they have successfully trimmed their real estate exposure after the lessons of the bubble years û and the stockmarket heading south, they are likely to get more cautious about making loans. As usual, this won't affect JapanÆs blue-chips given their close relationships to the top banks. But it will affect JapanÆs non-manufacturing small business sector, which has hitherto survived on a thin diet of ultra cheap debt financing.

Small manufacturing businesses that supply parts to the multinationals have been squeezed on the one hand by rising commodity prices over the past year, and on the other by ruthless pressure from the blue-chips to keep their costs down. The latter is happening partly in response to Western standards of efficiency being imposed by international shareholders, foreign CEOs such as Howard Stringer at Sony, and foreign owners such as Renault, which is the controlling shareholder of Nissan.

In the old days, the blue-chips used to reluctantly subsidise the domestic part of the economy by paying higher than global prices for a wide range of products. These days, the fragmented, underperforming domestic economy is not even benefiting from that, since the blue-chips have either æoffshoredÆ or beaten down their suppliers. One of the first moves by Nissan after it was taken over by Renault, for example, was to reorganise its supply network.

It's a truism to say the situation is bleak in Japan. The real problem is the lack of faith that the country's leaders will come up with a solution.ÑÑÑÑÇÑ
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