I was invited by Yotaro Kobayashi, the chairman of Fuji-Xerox and the Keizaidoyukai to give a speech at the Trilateral Commission about reform in Japan. I didn't know what the Trilateral Commission was when Kobayashi-san called me. A quick google pulled up a lot of rumors about it being a secret society to control the world.

The Trilateral FAQ says:

Is the Trilateral Commission secret?

A. Not at all. Right from the beginning, the Commission痴 membership list and informational materials on its aims and activities have been available to all free of charge. Each of the Commission痴 task force reports is publicly available, as is the publication providing extensive coverage of each annual plenary meeting. Information on the Commission痴 funding and major contributors is also available. The agenda and a list of participants for each plenary meeting are regularly distributed. Press conferences are held during the meetings, and draft task force reports are customarily made available to the press. Only the discussions at the meetings are kept 登ff-the-record,・to encourage frankness and maximize the learning process for members.

The conference was a lot of fun and a great chance to get feedback from some influential people about my thoughts as well as hear frank comments from them about their own thoughts. We had to cross a anti-war picket line in front of the State Department on the way to dinner, but other than that there were no problems.

Following is the text of the speech I gave. The speech was later picked up by the Asian Wall Street Journal. Thanks to David Farber for distributing the speech for feedback on his mailing list before I gave it and thanks to all of the people who helped me edit it.

Japan Reform and Recovery
Panel Comment by Joichi Ito
April 7, 2002
Trilateral Commission Annual Meeting
Washington D.C.

Acknowledgements

On the bus on the way to dinner last night, I overheard someone say, "The panel tomorrow on reform and recovery in Japan should be a short one. Maybe I'll have time for a nap." Well, I don't know about the recovery side, but reform is certainly moving forward. The fact that you have a 35 year old college drop-out entrepreneur instead of a 70 year old banker telling you that Japan is OK is evidence of that.

I would like to briefly describe what I think is going to happen to Japan, where we are now in that process, and what do we do afterwards. I would like to qualify my remarks by saying that I am not an economist or a historian, but I will make up for in honesty what I lack in knowledge and experience.

I believe that the primary problems facing Japan today are a dysfunctional or absent free market, an aging population and an impaired national balance sheet due to excessive and persistent bad debts. I believe the bad debt issue is being thoroughly discussed and considering the fact that it is probably about 1/12th of the financial savings of Japan, I believe the solution is a procedural one. The intense sense of urgency necessary to move reform ahead quickly as it has moved in countries such as Korea is hindered by the cushion of high savings.

I believe Japan has the resilience to rebound from a hard landing if we do it before the aging of Japan makes it impossible. I believe that Japanese entrepreneurialism after WWII shows that, given the opportunity, Japanese can be entrepreneurial, focused and efficient.

One of the biggest differences between the current crisis and the post-war period is that in 1950 there were 12.2 working-aged Japanese for every retirement-aged Japanese (although many were still engaged in primary industries such as farming). In 1995 there were 4.8 and according to the 1998 UN population projection based on a no-immigration policy, Japan will have 2.2 working aged Japanese per retirement aged Japanese in 2025 and 1.7 in 2050. It will be very difficult to revive a country when over a third of the population is retired.

The problem that needs to be solved for Japan to have a true productivity and growth revival is that of building new businesses that it can be competitive globally considering the recent changes in the global markets. Japan can no longer be competitive in manufacturing long-term considering the emergence of China and other competitors in Asia. Although Japan is still weak in these areas, a shift towards IT, bio-tech and service businesses is the only alternative. For this reallocation of human and financial resources to occur, a major change is required in Japan. Japan has historically been prone to reforms based on central planning rather than allowing free market forces to develop new industries. A market-oriented shift is the most efficient and appropriate. It is important to realize that in Japan, industries that have developed without government interference have been the most successful. The automobile and consumer electronics industries have been quite successful, but the sector of the economy that has been the most tightly controlled, the financial industry, has failed.

Many people blame the illiquidity of the equity markets on the ignorance of the Japanese people or the tax structure causing Japanese to keep their assets primarily in savings rather than in equity. In fact, the figures are even worse for new businesses, studies showing that only 1% of the population invests in start-ups. I believe that the Japanese people are in fact quite intelligent, the figures reflecting a very well founded belief that the markets are rigged against them.

The Japanese stock market has been a rigged market geared towards large institutions and "insiders", cross shareholdings making it even more opaque. Fund returns (ROI) are terrible and companies difficult to understand due to inadequate financial disclosures.

This has caused foreign investors to be wary of Japan, foreign investment per capita in Japan being $97 in 1999 compared to $1034 in the US, $199 in Korea and $1793 in Singapore. Notwithstanding, it is interesting to note that foreign investment in the Japanese stock market exceeds investments by Japanese individuals, clear evidence of distrust.

Japan has developed an educational system that filters an elite group of obedient and intelligent people to populate the government agencies and the large companies who are consequently awarded with a career of low risk and high return. The not-so elite end up in small business or even worse, new businesses, forced to take the high risks for lower return. This has caused a society where it is socially disrespected to be an entrepreneur. The total entrepreneurial activity in Japan is less than 2% of the population according to Global Entrepreneurship Monitor, whereas the in the US it is around 13%.

The "elite" in Japan who have been mandated with guiding Japan's resource allocation and direction maintain their power through a tight network of relationships and social contracts. These contracts fueled much of the productivity early on, but now hinder greatly Japan's ability to change. The collusion between bureaucracy, politics and business which was hailed as Japanese great strength is now its enemy.

Most employees in Nissan knew what it would take to turn Nissan around, but top management was unable to execute these changes because of the social contracts in place. The current CEO, Carlos Ghosn, although he is a great leader, made his biggest contribution by defaulting on social contracts

These networks of relationships cause business in Japan to be more about relationships and less about running efficient companies in productive markets. A reset of this power structure will create a risk/return model which is the core of a healthy market and new business growth. It will allow young people like me to take risks and create new businesses instead of spending our lives trying to climb the ladders of power inside of large Japanese companies.

I am not a nihilist, but I am comfortable with a certain level of anarchy, and I believe that this is necessary to create the true bottom of the market which will be the platform of rebuilding Japan. A soft landing with a false bottom will not root out the entrenched corruption and will not set in motion a true open and free market. Japan missed the opportunity to create such a market after the war because the American military government, in order to fight communism, allowed the old Japanese power structure to remain in pace. The current crisis may be a very important next step in a restructuring process that started with the Meiji restoration.

I want Prime Minister Koizumi to destroy the system. Many people of my generation call him "Koizumi the Destroyer". "Scrap and build" has become a popular phrase in Japan, but I believe that when we use that phrase most Japanese tend to focus on the build side and not enough on the scrap side. I would like to make no escape routes and suggest that we not talk about building until we finish scrapping. Many of my elders call me irresponsible to talk about scrapping without a plan in place, but I have yet to see a plan that has worked out the way economists have predicted, for that matter, any other planners have predicted. I believe that unleashing the entrepreneurial spirit in Japan on to a free and open market has a much better chance of success than some methodical plan created by economists and bureaucrats based on today's assumptions.

The key is to do it quickly. I do believe that things are moving in the right direction. Although Prime Minister Koizumi's popularity is waning, he has made it possible and popular to talk about destroying the system and has made it possible for people like me to say things like this at places like this today. The financial crisis is imminent, the political system is destabilized and there is a consumer confidence crisis.

Because of the rigidities built into the system, necessary change will force many large companies to collapse and the basic fabric of Japanese trust will be damaged causing a continuing increase in the crime, unemployment and the suicide rate short term. (Suicide in Japan is 30,000 per year vs. traffic accidents which kill only 10,000 per year.) I believe that an increased role of women, immigration, a proper representative political system with an elected prime minister, financial literacy and self-esteem will be essential elements of rebuilding Japan into a globally integrated and productive country. Although many Japanese are trying to back-pedal on the commitment to implementing global best practices since Enron, I think that foreign investors such as Ripplewood and foreign CEO's such as Carlos Ghosn will help Japanese understand that companies can be competitive without being trapped within the fabric of traditional Japanese relationships. I believe that Japanese business has some great unique traits such as the hard working stick-to-it attitude of Japanese workers and the ideological flexibility that allows quick changes when necessary, but I believe these Japanese features will be of most value to Japanese business once we prove that we can manage a free and open market with global best practices.

9 Comments

About your speech: I liked it quite a lot, however,
>in practice I do not see how the relationship based
>practice of doing business can ever be overcome. It
>is so ingrained in the Japanese character. I would
>also have to agree with your detractors that a "scrap
>and rebuild" philosophy is inherently flawed without
>at least a minimal framework for the "rebuild" portion
>of the equasion. I do not agree that this framework
>needs to be comprehensive. A comprehensive framework
>would kill flexibility. I think flexibility is a
>necessary component for such a far reaching plan to be
>successful. I think the US Constitution is a good
>analogy. Simple in its conception with well defined
>goals and philosophy, but with broad flexibility to
>achieve its lofty goals. How long do you think it
>would take for such a program to be successful??? As
>with all revoutionary ideas, it is much simpler to
>tear down the status quo than it is to rebuild a new
>model that heals the sins of the former regime.

Thank you for your comments Paul. I think that relationship will aways be a part of business as it is often the basis of trust, which I think is necessary. The problem is, even gangsters USE their "relationships" to move practical business interests forward. The problem is that most Japanese business relationships have outlasted their value to anyone and much of the money and time spend isn't serving and social or business interest. Also, you can have "relationships" in a transparent way. People join each others boards, transact, back each other. What is very dangerous are undisclosed, non-commercial relationships...

So I guess I'm asking to purge our relationship balance sheets of these relationships to make room for more transparant and commercially viable relationships.

I agree that we need a blue print or a framework, but we have a consitution and business rules albeit a bit broken. I think that if we just forced people to follow the rules we have, we would be on the road to success. I'm just asking for standard clean business practice and the ability for the rule of law to govern. The Japanese judiciary has NO POWER right now and bureaucrats right the laws and select the judges. The politicans and bureaucrats are in cahoots and businesses regulated by these guys and in shambles.

I think it is quite clear what the rebuild plan is. Having said that, I've been asked to help come up with more of a "blue print" to present at the WEF Davos annual meeting next year so maybe you can help me. I guess I would agree we need something, but I think your point about flexibility is key and I've just seen SO many of these sorts of plans suddenly get riddles with irrelevant detail and get bogged down. These sorts of plans attract the bureaucrats and others who LOVE to plan. I think maybe we should call them RULES instead of a PLAN. Even that sounds dangerous to me. ;-)

I read your comment, and the first thing that popped
>into my brain was Teddy Roosevelt (the
>"Trust-Buster"). Perhaps a little research into how
>he brought archaic corporate systems to their knees is
>in order. It sounds to me that the problem is
>enforcement of the law. Who has the executive power
>to enforce laws in Japan?? Also, I did not know that
>judges are not elected officials in Japan. That seems
>like one hell of a problem. Rather disturbing, actually. Any chance in hell of
>changing that system? (probably not!)
>
>Another problem seems to be the lack of resources
>flowing into entrepeneurial enterprises. Is there a
>system of tax incentives in place (or that could be
>put into place) that might make it more desirable for
>people to venture out on their own?? There should be!
> If the risks were less risky, perhaps Japan's best
>and brightest could go persuaded to go into business
>for themselves. Let's face it, it is always about the
>cash. If the "safe" salary-man avenue is curtailed
>and the risks/costs of being self-employed are
>lessened, the smart people will go to where the most
>money can be made.

Totally agree Paul. In fact, if your parents were communists (for instance, subscribed to the communist newspaper) it is rumored that you can not become a public prosecutor, much less a judge. We do not have common law, so there is no jury and the judges are reviewed in a hierarchical structure. Judges are often "punished" for having opinions that are out of line with mainstream thought.

There was a survey by the Global Entrepreneurship monitor that showed that 60% of Japanese were afraid to start new business because of the risk of failure compared to 10%-20% in many countries. To the question of whether people respected entrepreneurs, 10%-30% in Japan said yes in 99 and 2000 vs. 80% in the US. Finally suicide rates amoung older men have gone up significantly since restructuring began and Japan is in the top 10. I think we have 10,000 car accident deaths vs over 30,000 suicides a year. This is obviously a result of a system where if you are smart and work hard, you get into a big company and take no risk. If you are starting a new company, you're obviously too stupid to get into a big company or have some other problem and don't deserve respect and will not get a return for your risk. If you are fired from a big company, better to die than to take the risk of failure and the shame of being in a startup... That's the current state. No wonder there are very few people willing to join or start new companies.

This will change though. It is changing. But we need to remember that a lot of it is a perception that feeds this loop, originally created by a government which created an educational system and social system to filter obedient, risk adverse, smart kids to populate the bureaucracies and big companies.

A great speech Joichi-san. It really encompasses every aspect of the problems that Japan is now facing. But it also depicts a rather gloomy perspective of the situation!!

You make a case that the collusion between bureaucracy, politics and business is responsible for a big part of the current mess. It is a common view that the Japanese economic crisis was primarily caused by a misallocation of resources, due to the collusion you mentioned above. But we have to ask ourselves: why did this collusion happen in the first place? Isn't it because the shareholders of these big firms let it happen? Isn't is because nobody dared take the stand and say 'stop this mess!!'?

I am not at all trying to express criticisms of how Japan handled the problem in the first place; I am just trying to understand. As a (French) foreigner in Japan, I am always surprised to see that Japanese people, in general, seem to be reluctant to 'shake the system', to take a stand, demonstrate, and publicly express their disbelief or anger. There seem to be a sort of shame in contestation. To me, the main cause of the current issues in Japan seems to be the fact that for years, the Japanese system was following a sort of 'collective', no-one-complains, everyone trusts the rulers, collectivity rules over individuality, approach. This system seemed efficient as long as the ‘big guys’ (i.e.: CEO’s, politicians…) were taking the right decisions. And for years they did, (global success of electronics manufacturers Sony, NEC, Matsushita…), and it took the world by storm. But as time passed, this “collective” approach allowed certain people to take advantage of the situation, and it generated collusion, opacity, misallocation of assets (and the bad debt problem that goes with it) etc…

Joichi, what you seem suggesting is for Japan to shift from this "collective"-minded society to an "individual"-minded society where individual successes are given more value, where entrepreneurship is fostered, and risk-takers rewarded accordingly. In short, it’s like Japan shifting to a more capitalistic liberal type of system, similar to that of the US. But the question is: how can you bring such changes to happen quickly, how can you push mentalities, shaped in years, to perform such a U-turn?? A gigantic task indeed!!

Olivier Jeudy
Sorry for the long posting!! Great site. And, by the way, on a different note, why did you stop writing for Japan Inc?

Thank you for your thoughtful comments Olivier. No doubt it is a daunting task. A few thoughts...

I think that ever since the Shogun took swords away from the people and gave Japan "peace" people have been given "peace" and low risk in exchange for obedience. Japan has never really been "free". The Meiji revolution was a great step forward, but I think that after the revolutionaries passed away, Japan slipped back into the "important guys rule the nation" mode. There was a great chance to reform Japan and free the people after the war, but the US chose to keep the bureaucrats in place because they were a convenient group to dictate orders to from the US and to fight communism. The French and the American's fought and won revolutions for freedom. This is a big difference.

If you look at the evolution of the Japanese judiciary, you can also see an interesting attitude. Historically, the prosecutor sat next to the judge facing the defendant! No jury, even today. Judges are appointed by bureaucrats. Over 90% of people prosecuted by the government are found guilty. People can not sue the government. Even though the supreme court of Japan has found that the current election ratios are unconstitutional, the politicians and the bureaucrats shrug it off... So, if you are an activist in Japan, you are either quickly written off as a communist or you are ejected from the community.

So why do I have hope? I think globalization will force Japan to open up and shift from the closed system to an open system that requires people to be individuals instead of "groups" in which trust can only function when closed. (See the link to Toshio Yamagishi's paper. http://joi.ito.com/archives/000127.html#000127 ) Also, if you read stuff written by Japanese during the Meiji period, you realize that in the right environment, Japanese are logical and direct. It is not "genetic". Like the crime rate in New York, my hope is that once we pass the "tipping point" things will move quickly...
(The book "Tipping Point" http://www.amazon.com/exec/obidos/ASIN/0316346624/qid=1026482847/sr=8-1/ref=sr_8_1/103-9779881-3119052 )

I may be wrong, but I hope I'm right.

As for Japan Inc. They told me they changed their editorial policy and were turning off all of the regular columns at the time. I don't know if that's true or not, but I believe it. Many people liked the column, but I also got comments that it was just a bunch of name dropping ( On name dropping http://joi.ito.com/archives/000129.html#000129 )and a bit annoying. ;-)

Vahh. Great!

The cobbler's wife is the worst shod.

Sir,
A great talk. I find your analysis about what is wrong with Japanese industry will apply equally to Indian big fat cats almost verbatim.
In India the success of SUZUKI motors and failure of SANYO (inspite of having one of the best products) should be a must read for all Japanese venture capitalists.

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