So it was last week, when Prime Minister Junichiro Koizumi, responding to grim financial news, dumped his hands-off banking regulator and handed the brief to the most ardent reformist in his cabinet, Economics Minister Heizo Takenaka. Theoretically, the dual roles make Takenaka Japan’s first “economic czar,” with enough power to push through major reform. In practice, Takenaka has just six months to fix Japan’s financial system or risk losing his post when crisis talk erupts anew next March. At first blush, the onetime economics lecturer appears too mild and rumpled to pose a threat to Japan’s old financial order. Yet an endgame may truly be approaching this time, driven by a stunning role reversal in the economic balance of power in northeast Asia.
The dimmer Tokyo’s prospects get, it seems, the brighter Seoul’s grow. With robust consumers, surging foreign reserves and healthy terms of trade, the South Korean economy is set to expand by 6 percent in 2002, second only to China in the global growth race. Japan, Korea’s former colonial ruler and age-old rival, looks on in muted envy as the Koreans seem to grow ever more confident and united, from global boardrooms to the soccer pitch. Experts cite one key to Korea’s revival: after the financial crash of 1997, Seoul fixed its bad banks. The link is starting to register even in Japan, where the government looks set to attempt a banking rescue that–whether leaders admit it or not–will largely mimic South Korea’s.
Takenaka doesn’t hide that fact that he’s a student of Seoul’s banking reforms. When NEWSWEEK asked him last year whether Japan might follow Korea’s effort to liquidate debt-burdened corporations, his response was emphatic: “We can and we should.” Then he added, “But we need a mechanism,” which he defined as an aggressive Financial Services Agency–the banking watchdog he now heads. Takenaka has called nonperforming loans “the real sickness” in the Japanese economy, and is a chief proponent of both writing off bad loans and injecting public money into the financial sector. In a fresh NEWSWEEK interview, he hinted at a major industrial restructuring, including perhaps letting the worst deadbeat corporate borrowers go under. “In all market economies bad companies disappear,” he said. “I do not deny this basic principle.”
Takenaka embarks on his mission against a backdrop of slumping stocks and a business climate so negative that “the profitability of Japanese companies has largely been destroyed,” says bond-ratings expert Akio Mikuni. Japan Inc.’s long losing streak has shrunk the economy to its 1995 size and sent stocks plummeting to levels not seen since the mid-1980s. Property markets are in free fall. Bank lending declines by 2 percent each year, with most new credit going to so-called zombie companies–construction and retail failures kept alive with zero-interest loans.
But why are Japan and its former star pupil now headed in opposite directions? The roots of both banking systems trace back to 19th-century Japan, when banks rose up at the center of zaibatsu, industrial cliques run by wealthy clans with names like Sumitomo and Mitsui. The banks funneled household savings and government loans into sister companies whose exports sucked foreign exchange into the treasury, building a cash hoard that was jealously cultivated as symbolic of national strength. South Korea copied the blueprint for these banking and manufacturing conglomerates with chaebol like Hyundai and Samsung that turned the nation into a major global export power after the Korean War. The logic for both countries was not entirely economic. In a new book called “Japan’s Policy Trap,” Mikuni and coauthor R. Taggart Murphy write that “Japan’s decision-makers have run their country for well over a century now with three objectives: the independence of the country from foreign domination, their own survival as a ruling elite, and their continued control of key economic and political levers.”
In part because it was desperate to keep up with Japan, its old nemesis, Korea departed from the model in the 1980s and started borrowing heavily from abroad. As Japan became an increasingly large net lender, Korea began ringing up dangerously big debts. In 1997 the world’s 11th largest economy virtually imploded under the weight of red ink, forcing Seoul to accept a $58 billion IMF bailout. Out of this humiliation sprang the will to make radical changes. The government nationalized banks lacking the capital to cover their losses and forced others to dispose of bad loans, to can inept managers and to allow some of the largest chaebol to go bankrupt. Within just two years South Korea was once again one of the world’s fastest-growing economies. Japan has been able to put off such shock therapy because most of its deadbeat companies owe money to Japanese banks, not foreign ones. “The process [of reform] is quite simple, actually,” says Masaaki Kanno, head of economic policy research at JPMorgan in Tokyo. “The big difference between Japan and Korea is that we have the ability to waste time by living off our domestic savings.”
The Korean and Japanese versions of capitalism now bear increasingly little resemblance to one another. Since its own bubble economy burst in the late 1980s, Tokyo has refused to change. The government has tried to bail out the economy with massive public works, banks have refused to cut off old clients, corporations have kept on deadwood in senior management. Now banks are plagued by growing portfolios of bad loans to industries sinking under the weight of overcapacity and weak profits. In barely a decade, visionless leadership has transformed Japan from an export dynamo into what Jesper Koll, chief economist at Merrill Lynch in Tokyo, calls a “losers’ paradise.”
If Japan’s financial decline resembles a chronic illness, Korea’s struck like heart failure. Prompted by the IMF, Korean President Kim Dae Jung quickly moved to break the cozy ties between leading conglomerates and banks. He nationalized all six major banks and closed scores of smaller lenders; he slashed the industry’s work force by 40 percent and injected a total of $130 billion to shore up the balance sheets of those banks that remained. Fourteen of Korea’s 30 largest chaebol have been shuttered, including the third largest, Daewoo. “People believed they were too big to fail,” says Lee Kiho, special adviser to President Kim. “We have disproved that myth.”
The reforms have awakened market forces. Money traditionally channeled into export industry has begun to flow where it fetches the highest return. Smaller banks have pioneered venture, consumer and mortgage lending. Korean austerity has yielded to the thrill of credit-card shopping sprees. “The biggest single change in the Korean economy has been the end of government control over credit allocation and credit pricing,” says Sung-Keun Lim, representative director of Deutsche Bank Group in Seoul. “The ‘97 crisis was extremely beneficial because it allowed Korea to discard its excess baggage.”
Before the crisis, the work-and-save ethic of many Asians (including Koreans) was often traced to ancient Confucian values of restraint. Now that money circulates freely in South Korea, however, that myth has been dispelled. The old social mores discouraging conspicuous spending have easily surrendered to dreams of travel, cars and deluxe kimchi freezers. Korea’s savings rate has begun falling from highs above 30 percent, which were necessary when workers had to hoard cash in order to buy a house or a car. Now that home, auto and other consumer loans are widely available, and the Kim government is promoting the use of credit cards, Koreans don’t need nearly as much cash. These days, as one Korean fund manager puts it, “the average Kim on the street has four credit cards.” True, in theory the average Japanese consumer also has access to credit cards and low-interest mortgages–but in practice, most simply do not have the confidence to borrow, and banks are reluctant to lend to them.
Now they’re watching to see what Takenaka does. One fear is that he will tighten the definition of what it means to be a deadbeat. Japan now allows debtors who can at least pay interest to dodge classification as “nonperforming,” while Korea and the United States requires debtors to pay both the interest and the principal. By the stricter measure, dozens of big domestic companies are in danger of going under, and Japan could face the biggest industrial shakeout the world has ever seen. Japanese bankers also now live in fear of getting canned in favor of foreign professionals, as has happened in Korea. “When we visit Korean banks we typically meet at least one foreign manager, and they’re usually in charge of credit assessment,” says Takamasa Yamaoka of Standard & Poor’s in Tokyo. “That would be impossible in Japan today.”
It may be impossible tomorrow, too. There is huge resistance to reform in the bureaucracy and the long-ruling Liberal Democratic Party. Last week a senior official at a top Japanese ministry confided that “I personally don’t think we need to accelerate the disposal of nonperforming loans.” He said Japan was in better shape economically than either Germany or the United States, and suggested instead that Japan raise public spending–an approach it has been trying for the past decade, with no success. To many LDP leaders, the big news out of the prime minister’s office last week was Koizumi’s failure to consult them before reshuffling his cabinet. One hard-liner, faction boss Takami Eto, called his own party chief “a dictator, like Hitler.”
Takenaka’s disarming demeanor can’t mask the fact that he’s declared war on Japan’s major banks. Last Thursday he appointed a task force stacked with strident reformers, including Takeshi Kimura of KPMG Consulting, who believes Japan must rapidly shut down its 30 largest debtor companies to stem the bad-loan hemorrhage. Afterward, stocks in Tokyo plunged to 19-year lows, prompting the chairman of the powerful business federation Keidanren, former Toyota Motor Corp. president Hiroshi Okuda, to blame “the emergence of moves to dispose of bad loans.”
Implicit in his statement is the widely held view that Japan’s economy has grown too weak for major surgery. According to the senior government official, the Big Four banks don’t want an infusion of capital, because that would imply their in-house estimates of the bad-loans burden are too low. If Takenaka pushes an infusion anyway, the official predicted, “I’m sure [the banks] will challenge him in the courts over this, and he will lose.” Masaaki Kanno, of JPMorgan, says litigation is “just one example of the blackmail” opponents could deploy to stop reform.
Most observers give Tokyo six months to reform or lose its last shards of credibility in global financial circles. “There is great gaiatsu [foreign pressure] to solve the bad-loan problem, and there will be several large life insurers, general contractors and retailers that will be sacrificed,” says Takakazu Nakamori of Teikoku Databank in Tokyo. Many analysts have fixed their gazes on the end of the fiscal year next March; unless banks get serious about their bad debt by then, market pessimism could send Japanese shares into an even deeper trough and endanger not just Takenaka but his patron, Koizumi. They need to topple the old order before it topples them.
