Nippon Steel is just one of many Japanese companies that, after years of disappointing results, have started to burn brightly again. For the past few quarters, the perennially sick Japanese economy has been growing at a pace few thought possible. In the last three months of 2003, Japan's real GDP increased at an annualized rate of 6.4%, surpassing the U.S. rate of 4.1% over the same period and marking Japan's best quarterly performance in 13 years. In the 12 months prior to March 31, Japanese stocks posted their best annual performance in 31 years, with the Nikkei-225 Stock Average surging 47%. The country's employment outlook is more promising than it has been in a decade. Even ratings agency Standard & Poor's, which incurred the wrath of the government with a series of high-profile downgrades that left Japan with a bond rating comparable to some Third World countries', recently raised its credit outlook for Japan from negative to stable. And the yen hit a four-year high against the dollar last week, fueled by mounting optimism over the Japanese economy.
Japan's long-suffering citizens are at last allowing themselves a degree of optimism after years of borderline despair. "There were times I thought I'd have to hang myself," says Dai Tajima, a 49-year-old construction worker from Tokyo who a few years ago struggled to support his family. He says work is steadier these days and that he fears the future less than he used to. "It's nothing like the bubble years," he says, "but things are improving."
Can the good cheer last? Since the bursting of its 1980s asset bubble, Japan has experienced three aborted rebounds, all of which fizzled due to governmental bungling and an overreliance on exports to bail out the nation's anemic domestic economy. However, even some of Japan's most skeptical analysts have come to view the current recovery as real, braced by an improving global economy, new demand from China, and economic reform at home. "Many of the pieces that will spur a broad-based recovery are finally in place," says Jesper Koll, Merrill Lynch's chief Japan analyst. Failed recoveries in the 1990s were often underwritten by wasteful public-works projects, such as unnecessary bridges or dams, which provided a quick adrenaline shot but minimal lasting economic value. Not this time. Public-works spending has fallen an average of 6 percentage points a year since Prime Minister Junichiro Koizumi took office in 2001, and the recently approved 2003-04 budget features an additional 3.5% cut. "Sentiment is different this time," says Shuhei Abe, president and CEO of Tokyo-based investment firm Sparx Asset Management. "People have much more confidence. They may not yet believe that everything is optimum, but they do believe that the worst is past, that we hit bottom a while ago."
For years now, late March has been a time of wide-scale panic as banks struggled desperately to avoid an end-of-the-financial-year meltdown triggered by gory revelations of their ever-worsening balance sheets. But this time around, top Japanese bankers reported to parliament that they were on track to meet the demands of Financial Services Agency Minister Heizo Takenaka, who mandated 18 months ago that bad-loan portfolios be halved by 2005. Bad loans at Japan's seven largest banking groups totaled $132 billion on Sept. 30, down 13% in a six-month period. Furthermore, the government's competent handling of a bailout of Resona Holdings (Japan's fifth largest bank) and nationalization of regional lender Ashikaga Bank last year have reduced fears of an outright collapse by one of the country's worst basket cases.
Many major Japanese companies are also completing comprehensive restructuring programs that are leaving them leaner than ever before. After much resistance, they are finally firing unnecessary workers, outsourcing noncore operations, cleaning up their balance sheets and scrapping excess capacity. According to Merrill Lynch, big Japanese companies disposed of nearly $50 billion in inefficient tangible assets in 2003, or just over 1% of GDP. Such streamlining helped Japan's largest companies report operating profits last year that were almost 20% higher than the previous peak year of 1990. And according to a survey by newspaper Nihon Keizei Shimbun, corporate Japan expects to report new record profits for the fiscal year that ended on March 31.
To regain profitability, Hajime Sawabe, CEO of electronic-components manufacturer TDK, says in the past two years he has closed 10 factories worldwide, laid off 8,000 workers and reduced inventory almost by half. "We realized we could not return to the break-even point the way we were headed," he explains. "We did what needed to be done." Over the past three years, Matsushita president Kunio Nakamura has shuttered dozens of factories and cut the company's domestic work force by 20%. Similar programs are under way at a variety of Japan's other well-known companies such as Sony, Toshiba, Fujitsu, Komatsu and Nippon Steel. With TDK now back in the black, generating $100 million in profits last year, Sawabe says he is ready to invest in new product lines and more R. and D. And he is not alone. Corporate capital investment accounted for approximately half of Japan's GDP growth last quarter as its companies retooled to meet increased international competition. The business community's complacency of the 1990s has gone, says Sawabe: "We all realize now that reform and restructuring is a continuous process."
Positive as these developments are, they pale in comparison to the impact on Japan of China's epic economic rise. Japanese vendors can barely keep pace with the mainland's insatiable appetite for basic materials, construction equipment and commodities. In recent years, exports have supplied half of Japan's total GDP growthand 80% of Japan's export growth over the past 12 months came from China alone. Just two years ago, Japan exported nearly twice as much to the U.S. as it did to China, Taiwan and Hong Kong combined. Last year, exports to greater China exceeded those to the U.S., traditionally Japan's largest trading partner. Masahiro Sakane, CEO of heavy-construction-equipment maker Komatsu, says his company's annual growth in exports to China has ranged between 50% and 100% over the past three years. He expects Komatsu's sales to the mainland to continue growing by at least 20% a year, topping $1 billion12% of total salesby 2005. "And that's the conservative estimate," he says with a gleeful chuckle.
Indeed, 2003 may well go down as "The Year Japan Learned to Stop Worrying and Love China." A few years ago, fear of the dragon dominated Japanese business discourse: a sense of resentment and persecution accompanied talk of the "hollowing out" of Japan's industrial base as many of its manufacturing jobs left for the mainland and a flood of cheap Chinese exports contributed to Japanese deflation. Now, the downsides of China's ascendance seem outweighed by the lure of its 1.3 billion people as a major new export marketespecially since long-term growth in Japanese domestic consumption is likely to be relatively sedate.
Combi, a Tokyo-based maker of baby clothing, children's toys and adult exercise equipment, has successfully operated factories in China since 1992. "Chinese factories have become so proficient that we are now considering moving our most complex products like car seats and exercise bikes to China as well," says Shoji Shibata, vice president in charge of international operations at Combi. But the real prize, he maintains, is not the continued exploitation of China as a low-cost source of labor and raw materialsCombi could set up more factories in Indonesia and Vietnam if that were the bottom line. No, the true allure of China lies in its fast-rising standard of living, especially in coastal cities like Shanghai. "There are only 1.1 million babies born in Japan every year, and even that number is declining. But there are 17 million babies born in China," Shibata says. "We are prepared to wait many years, but when a critical percentage of new Chinese parents have a high enough income to afford our upscale products, this will be a huge market for us."
Some say the psychological shift in Japanese attitudes toward China goes beyond mere business opportunism. "For more than 2,000 years, China was the parent state and Japan was the satellite," says Yoshihiro Sakai, managing director of investment banking at Nomura Securities. In the past century, he continues, Japan thought it could reverse that relationshipmilitarily before World War II, and economically after it. Japan today is the world's second largest economy. But as China gradually gains an edge economically, demographically, in diplomatic clout and in military might, Japanese are beginning to accept the idea that the past century may have been an exception, not the rule. Says Sakai: "More people now believe that the best course for the future of Japan is to figure out how to maximize its relationships with the two real global powers: China and the U.S."
Even with the profound economic impact of China, there is little chance that Japan's fortunes would have changed so quickly were it not for a surprising new spirit of dynamism among policymakers in Tokyo. After becoming Bank of Japan governor just over a year ago, Toshihiko Fukui took unprecedented measures to fight the country's chronic struggle with deflation. He embarked on a radical monetary easing policy (by buying assets such as corporate bonds and company stock) in order to flood the system with cash. And so far, the policy seems to be having an effect because, by many measures, the rate of deflation is slowing.
The Ministry of Finance, meanwhile, has been conducting an experiment of its own: since the start of this year, the Japanese government has spent a boggling $90 billion buying dollars on international currency markets to keep the yen weak. (A weak yen aids Japan's export industries by lowering the price of Japanese goods abroad.) That is almost half the amount spent in all of 2003, itself a record year. Critics have long called this policy anticompetitive and unsustainable. But with a lasting recovery looking increasingly likely, the ministry may have achieved its goal, enabling it to scale back its interventions in recent weeks.
While Japan Inc. may be pulling in the right direction for the first time in years, this recovery might still prove vulnerable. With a national debt that's 160% of GDP (compared with 24% on average for developed nations) and a budget deficit of 8% of GDP, Japan's national balance sheet is the worst in the developed world. Moreover, the country's recent economic growth stems overwhelmingly from just two sources: corporate spending and exports. What's still missing from the mix is a convincing improvement in domestic consumer spending. "Unless the household sector recovers, real growth will sputter out all over again," says Shuji Shirota, a Tokyo-based economist at investment bank Dresdner Kleinwort Wasserstein.
Tightfisted Japanese, who continue to worry about deflation, shrinking pensions and eroding home values, have stuffed almost $400 billion in bank vaults or beneath futon mattresses. Unlock even a percentage of that money, and Japan's elusive domestic rebound will commence. And there are heartening signs that a consumer-led recovery is already under way. Household spending has increased every month for the past four months. Average monthly income, meanwhile, jumped 4.1% and retail sales rose 0.9% in February. Merrill Lynch's Koll says recent employment statistics suggest this upturn in wages and spending will continue or even accelerate. Meanwhile, the unemployment rate has fallen to 5.0% from last year's postwar peak of 5.5%, and companies in Japan are currently looking to fill a hefty 679,000 new positions, almost 30,000 more vacancies than the previous high in 1991. "Everybody is talking about jobless recoveries in the U.S. and Europe," Koll says, "but Japan is enjoying a job-rich recovery. There are more companies looking for more workers right now than at any time in Japan's history." He also notes that 41% of new jobs are in the service industries (up from 20% in 1990), while manufacturing and construction jobs now represent just 16% of posts available, compared with 35% in 1990. Taken together, the changes suggest that Japan's long-overdue transformation from a fully developed industrial economy to a postindustrial service economy is finally taking place. "The probability for a successful transition from an export-led expansion to a consumer-led one is higher now than it has ever been," Koll says.
And what of structural reform, that overhaul of Japan's business culture so often cited by politicians and economists as essential for the nation's return to economic health? There is growing unease that the China boom and the government's success at fighting deflation have enabled Koizumi to abandon some of his reform initiatives. Despite the great strides in efficiency and productivity made by its export manufacturers, Japan's more backward sectorsnotably agriculture, distribution, construction and retailingstumble along as lamely as ever, overburdened with excess capacity, excess debt and excess labor. "Small and medium-size companies still need to go through the restructuring that have been so painful for big businesses lately," says Komatsu's Sakane, who recently finished a two-year round of streamlining that cut his firm's overhead expenses by 4 percentage points to 20% of sales, bringing it more in line with U.S. nemesis Caterpillar. Until such reforms catch on more widely, many doubters insist that Japan's recovery may still prove fleeting. But after so many years of being dismissed as an economic lost cause, the nation has at last earned the right to walk with a little swagger in its step.