The Japanese Economy Takes a Darker Turn

In Part III, we will look at three cases covering a total of four innovative entrepreneurs who have been active during the period from the 1990s to the present day. During this period, Japan’s economy and its companies were forced into a prolonged slump, caught between breakthrough innovations in information and communications originating in developed countries and by “disruptive innovation” coming from latecomer nations that have rapidly caught up.

The 1990s is often referred to as a “Lost Decade” for the Japanese economy and Japanese companies. As seen so far, for more than three-quarters of a century since the 1910s, except for a brief period immediately after defeat in World War II, Japan’s economy enjoyed relatively high growth among capitalist countries. In the 1990s, however, Japan’s economy swiftly fell from “honor student” status to “failed student” in terms of economic growth among the developed countries participating in summit meetings.

In 1997–1998 (Heisei 9–10), the “Heisei Financial Panic” surfaced in the form of bankruptcies of Hokkaido Takushoku Bank, Yamaichi Securities, Long-Term Credit Bank of Japan, and Nippon Credit Bank. This was considered comparable to the “Showa financial crisis” of seventy years earlier in 1927 (Showa 2). In addition, at the end of the 1990s, Japan experienced its first full-scale deflation (a sustained fall in the general level of prices) in about half a century since the deflation triggered by the Dodge Line in 1949, a measure adopted after the country’s defeat in WWII.

The so-called Lehman Shock exacerbated Japan’s economic downturn. In September 2008, Lehman Brothers, a major investment bank in the United States, went bankrupt, sweeping the entire world into a recession. This simultaneous global recession dealt a serious blow to Japan’s economy as well.

Apart from the global recession triggered by the Lehman Shock, Japan experienced its own massive tragedy and dilemma: the Great East Japan Earthquake and the nuclear accident at the Fukushima Daiichi Nuclear Power Plant run by Tokyo Electric Power Company (TEPCO).

At 2:46 p.m. on March 11, 2011, the massive Great Tohoku Earthquake hit the Tohoku region, reaching 9.0 on the Richter scale. The earthquake and subsequent tsunami brought about the largest natural disaster in Japan’s postwar era, leaving nearly 20,000 people dead or missing.

The Great East Japan Earthquake was also significant in that it was accompanied by the Fukushima Daiichi Nuclear Power Plant accident, rated Level 7 (“serious accident”) on the International Nuclear Event Scale (INES) for evaluation of accidents and malfunctions of nuclear facilities. The level was on par with the 1986 Chernobyl Nuclear Power Plant accident in the former Soviet Union, considered the worst in history; the aftermath still prevents many residents from returning to the area to date.

Underlying the downturn of the Japanese economy and companies since the 1990s was an unprecedented and serious situation: the decline in the Japanese population after 2005. In December 2005, the Ministry of Health, Labor and Welfare (MHLW) released its “Vital Statistics” (annual estimates) for the year. According to the report, the number of births was 1,067,000, down 44,000 from the previous year, and the number of deaths 1,077,000, up 48,000 from the previous year, resulting in a “natural decrease” of 10,000 persons. For the first time on record since 1899 when such surveys began, the number of deaths exceeded the number of births.

A society with a declining population has advantages and disadvantages. Advantages include reduced consumption of energy, water, and other resources; reduced food consumption; reduced emission of carbon dioxide (CO2) that contributes to global warming; and increased availability of land for purchase. A significant disadvantage is that economic growth slows as the size of the market contracts, and opportunities and appetite for investment decrease. Other serious problems include the reduction in the number of social and cultural bearers as well as decline in the country’s global status. In sum, we conclude that a society with a declining population has more disadvantages than advantages.

Japanese-Style Management Turns Dysfunctional

In the mid-1980s, the country’s corporate system was viewed favorably by the international community, as it reflected the strong performance of the Japanese economy. However, as Japan’s economic bubble burst and the so-called Lost Decade began, criticism of the Japanese corporate system gained momentum.

The critiques were directed mainly at the Japanese management system. After the economic bubble burst in the early 1990s, Japanese-style management became less functional. It began losing esteem as the large, manager-centric companies, previously the main practitioners of Japanese-style management until the 1980s, lost confidence and came to prioritize shareholder- management systems.

To be clear, there is no problem in the large, manager-centric companies’ taking a shareholder-oriented approach in post-1990s Japan. The rapid expansion of Japan’s capital markets and financial globalization that began in the late 1980s required companies to raise funds from capital markets, and required companies to adopt a shareholder-oriented approach. The problem is that many manager-centric large corporations came to view shareholder-orientation as synonymous with pursuit of short-term profits, forgetting the long-term perspective that had been the strength of Japanese-style management.

Investment Restraint Mechanism

Often, companies equate a focus on shareholders with pursuit of short-term profits. In fact, from the 1960s to the 1980s, U.S. companies did likewise, failing to make necessary investments. This resulted in a “Japan-U.S. reversal” in some areas, causing U.S. companies to trail behind their Japanese counterparts. In the 1990s, however, U.S. companies began to invest aggressively with long-term vision while maintaining a shareholder-oriented stance, thereby moving ahead of their Japanese counterparts.

After the economic bubble burst, large manager-centric Japanese corporations actively pursued a shift to American-style management, emphasizing return on assets (ROA) and return on equity (ROE). In the United States, enjoying the “New Economy” in the 1990s, companies adopted a strategy of increasing ROA and ROE, investing aggressively to increase their A (assets) and E (equities), while at the same time increasing R (return) at a faster rate than A and E. By contrast, in Japan, many such companies tried to increase ROA and ROE by restraining investment and by reducing A and E.

Strictly speaking, the attempt to pare down inflated assets in Japan after the economic bubble burst was not in itself mistaken. If a company invests in assets to strengthen its competitiveness after such downsizing, it can revive its business. The problem was that many Japanese companies, despite having strengthened their fundamentals by downsizing their assets, did not make proper investments aligned with their growth strategies.

Although U.S. and Japanese companies generally shared the common goal of increasing ROA and ROE, companies took contrasting approaches to making investments. After the collapse of the bubble, what might be called an investment suppression mechanism became pervasive in Japan. In manager-centric Japanese firms where managers had lost confidence, companies did not undertake their essential function to make sufficient investments, and full-time employees actively cooperated with that strategy. The advantages of the Japanese management system, which featured long-term vision and concomitant necessary investments, faded away.

Part III will focus on four entrepreneurs: Kazuo Inamori, Toshifumi Suzuki, Tadashi Yanai and Masayoshi Son. Despite the general managerial malaise, these managers remained exceptionally innovative even in the difficult times of the 1990s and beyond.