TTHEHE OORIENTALRIENTAL EECONOMISTCONOMIST REPORT

VOLUME 83, NO.10 PUBLISHED BY JAPAN WATCHERS LLC October 2015

‘One-way-street’ definition of free trade TPP: Ball is in GOP court n a surprising development, it is Congressional Republicans and a That distrust adds a highly-charged emotion to the GOP resistance. few of their business allies who now pose the biggest threat to the The hope among TPP proponents, including many in the busi- I Trans-Pacific Partnership (TPP), a trade agreement among 12 ness world, is that the frustration and resentment will blow over, and countries with 40% of the world’s GDP. When, after five years of that the deal’s detractors will recognize that half a loaf is better than talks, an agreement was finally announced on October 5, neither a none at all. Some of the disgruntled business sectors, and their GOP single Republican leader in Congress, nor any broad business feder- allies, have convinced themselves that they can force a renegotiation, ation could be found to support it. With a few exceptions, the either under Obama, or his successor, if the latter is a Republican. Democrats were always a lost cause for proponents of TPP. They point to the Korea-US Free Trade Agreement, where the US However, the Republican majority in both Houses led most went back three times for changes after the initial signing. But Korea observers to think they would try to ratify it. was just one country. Eleven countries will not tolerate such antics. So, now the ball is in their court and ratification is not just a The Washington business source considered the notion of renegotia- question of “when,” but also “if.” “Without the ardent efforts of GOP tion a complete fantasy. What incentive would other countries have leaders to move some of their reticent rank-and- to make even more concessions to the US? “This file, the TPP cannot be ratified,” said a Washington was absolutely the best deal the US could get given player who has been lobbying Capitol Hill the bargaining situation,” said our business source. Republicans for years. Froman says that the pact will eliminate 18,000 Legally, Congress cannot even vote until tariffs and quotas other countries have imposed on February at the very earliest and, in an election year, ratification will US exports and the United States will eliminate 6,000 of its own. be very difficult even with the support of GOP leaders. Without it, Those trade changes, estimated the Peterson Institute for 2017 may be the earliest chance. Either way, Republicans are indis- International Economics (PIIE), mean that, 12-15 years from now, pensable since most Congressional Democrats oppose TPP, Hillary American exports would be 4.4% higher than otherwise, imports Clinton has just come out against it, and candidates like Donald would be 3.7% higher and GDP a negligible 0.2% higher. Trump denounce it. If Clinton were to win in November and/or the A Wall Street Journal editorial concluded: “The question is GOP lose the Senate, then TPP would be dead. Derek Scissors, a whether this TPP is the best the U.S. can do.” We’ve got our own trade expert at the conservative American Enterprise Institute, called problems with TPP (www.foreignaffairs.com/articles/asia/2015-05- waiting for 2017 “a very bad bet.” 12/trade-trials), but now it’s either this TPP or no TPP at all. The real TPP comes into force when ratified by at least six nations with question is whether the benefits of this TPP outweigh its flaws, and at least 85% of TPP-wide GDP, which effectively means the US, whether rejection now would lead to better pact later. Japan, and four others. All politics is special interests Hope that negativity is just temporary As many as a couple dozen Republicans who voted for the Trade Optimists argue that much of the immediate reaction is temporary, Promotion Authority (TPA) that empowers Obama and his successor the result of a misplaced view by some business sectors, like phar- to conduct negotiations now strongly resist voting for what they dis- maceuticals, that the Obama administration “sold us out” in order to miss as “Obamatrade.” The level of distrust is so high that a few get a quick deal that could be ratified during his term, which meant among this group contend that Obama is somehow going to use TPP early in 2016. But in reality, as a clued-in Washington-based busi- to impose gun control on the US. ness source pointed out, “Reaching agreement was a case of now or With the vote so close—TPA would have failed if just six mem- never. The other countries were adamant that this had to be the last bers of the House had changed sides—it doesn’t take much to tip the ministerial meeting.” Japanese sources told us the same. balance. In an election year, what Republican House member wants Nonetheless, according to several sources, many in the GOP a primary opponent accusing him of supporting Obama’s policies? feel that US Trade Representative (USTR) Michael Froman made The resignation of House Speaker John Boehner—resulting from the deal, not because it was “now or never,” but in order to make sure accusations of insufficient combativeness toward Obama—does not Obama got credit for the achievement. These GOPers feel the US bode well for TPP. could have gotten a better deal if only Obama had taken more time. Anti-Obama emotions are only a small part of the problem. The 2 more important background context is the Committee would be the point man on TPP ture Chairman Mike Conaway had been long-term erosion of the post-WWII free passage. He lamented, “While the details are pressing negotiators last week to protect trade consensus on both sides of the political still emerging, unfortunately I am afraid this dairy and sugar producers. aisle. Even more pivotal at this particular deal appears to fall woefully short.” That Unlike the beef and pork lobbies that moment is the immense veto power over harsh language doesn’t leave a lot of wiggle are supporting TPP because it opens more Congress of assorted well-connected and room. export markets, the dairy lobby has been well-heeled special interests, from tobacco Hatch is upset because the US pharma- more focused on limiting imports. A week to pharmaceuticals to dairy to sugar. If Tip ceutical industry did not get its demand that before the agreement was reached, The O’Neil famously said, “All politics is local,” all TPP countries agree to the US standard of National Milk Producers Federation and US now he’d have to say, “All politics is special 12 years of “data exclusivity” for biologics, Dairy Export Council sent a letter to [interests].” In the indispensable balance a class of drugs based on living organic tis- Congress, saying that they had “grave con- between the national interest and legitimate sue rather than chemicals. Instead, in order cerns” about a possible deal that would give special interests, the pendulum has swung to conclude the deal, Froman had to compro- New Zealand more access to the US market too far toward the latter on both sides of the mise with Australia and others who wanted but not adequately open Canada’s market. aisle. no more than five years, in order to make “We are deeply concerned that the…USTR While the majority of Congressional drug prices affordable. Some countries have intends to reach an agreement that the US Democrats are openly critical of free trade, zero years. According to the Wall Street dairy industry may not be able to support.” too many of those in both parties calling Journal, the eventual compromise was that, After the deal was concluded, both organiza- themselves “free traders” use the term to “Countries can offer either eight years or five tions said that they will “carefully review the mean, not a two-way street in which the US years with a ‘plus up’ of three extra years if agreement's dairy provisions in the coming helps promote the prosperity of itself by pro- drug makers make certain price and access days.” moting that of its partners, but a one-way commitments. The US will be allowed to street in which others open their markets to maintain 12 years of protection.” It’s unclear Tobacco favored US business sectors, while the US to us how much of a change, if any, that will The USTR agreed that tobacco products does not sufficiently reciprocate. Lack of mean for US biologics producers. In any would be exempted from a dispute-resolu- reciprocity by Washington was a chronic case, Hatch had warned for months that fail- tion mechanism, called ISDS, that lets multi- complaint among many of the other 11 TPP ure to have everyone go to 12 years could be nationals sue countries before arbitration countries. (In some cases, even though the a deal-killer. Will he really let the entire deal panels dominated by lawyers who represent charge had some validity, the countries fail over this one issue? corporations in other cases. The poster child involved used it as a pretext to continue their While “big pharma” claims that twelve for abuse of this process was a series of suits own protectionism.) years of protection are necessary to promote by Philip Morris and R.J. Reynolds against innovation, a 2009 report by the US Fair countries for insisting on plain packaging in Biologics Trade Commission found that biologics are order to make cigarettes less enticing. For Consider Senator Orrin Hatch (R-UT), who so expensive and difficult to emulate that some countries, refusal to exempt tobacco as the chair of the Senate Finance producers don’t need any years of data was a deal-killer. exclusivity to avoid a flood of cheap gener- Senate Majority Leader Mitch TTHEHE OORIENTALRIENTAL EECONOMISTCONOMIST ics. Ordinary patents are enough. McConnell, who hails from the tobacco state of Kentucky, has suggested several times REPORT Dairy that exempting tobacco could be a deal-killer Editor Richard Katz Even more disappointing to the pro-TPP for him. After the agreement was reached, he Chief Correspondent Takao Toshikawa Washington Chris Nelson crowd was what one Washington trade stated, “Serious concerns have been raised Contributing Editor Yoshisuke Iinuma expert called “the surprising neutrality” of on a number of key issues,” without specify-

Design December Design, Inc. Paul Ryan (R-WI), chair of the Ways and ing what they were. House Agriculture Means Committee and point man in the Chairman Mike Conaway also objects to the The Oriental Economist Report is published House. Ryan could not come up with a sin- tobacco carve-out, while Senator Thom monthly by Japan Watchers LLC 450 Seventh Ave., Suite 2000 New York, NY 10123 gle positive word. Instead, he lamely com- Tillis (R-NC), who voted for TPA, says he Chairman: Takao Toshikawa mented, “I am reserving judgment. I hope will actively fight against TPP over this Editorial information: Tel: (212) 868-4380 Fax: (212) 868-4392 that Ambassador Froman and the White issue. Hatch commented, “I hate tobacco, e-mail: [email protected] House have produced an agreement that the but I still realize what's important to get the House can support.” votes, and I'm very concerned about that.” Annual subscription price is $100 in all countries for e-mail delivery in PDF format Since Ryan is regarded as an ardent free Cal Cohen, president of the Emergency trader, one expert speculated that he may not Committee for American Trade, a member Subscription information: have wanted to get too far ahead of his GOP of the pro-TPP business coalition, declared (US) 212-868-4380 (Japan) (03) 3263-0419 colleagues. But it is worth noting that he that the tobacco settlement, “would be coun- e-mail: [email protected] hails from the dairy state of Wisconsin, and terproductive in that it would open the way http://www.orientaleconomist.com the dairy lobby has threatened not to support for other exemptions for other rules to be put Copyright ©Japan Watchers LLC. All rights reserved. Reproduction by any means without the deal if it opens the US market to too in place.” permission is strictly prohibited. many imports. Reportedly, House Agricul- Imagine a deal being touted as a key to

THE ORIENTAL ECONOMIST OCTOBER 2015 3

21st century growth and national security process of consulting their membership. owned by US citizens, and crewed by US cit- being lost over plain packaging of cigarettes. izens and permanent residents; the protec- Given the division within the business One-way street ‘free trade’ tionist “yarn forward” rule in textiles that community—some support this deal and What is most concerning is the “one-way particularly hurts poor countries like others oppose it—not a single one of the street” attitude of many of those who call Vietnam or Mexico; the high import barriers major business federations could come up themselves “free traders.” Some in business on sugar (where the US will allow more with a positive statement of support. and Congress contend that America is imports from Australia by cutting those from One would have expected fulsome already so open that there is little left to do. Mexico) and dairy (the latter particularly praise from the Trade Benefits America That’s, at best, a self-consoling illusion, one upsetting to New Zealand since dairy com- Coalition, an alliance of 275 business associ- that causes intense resentment among prises a third of its exports and it is the ations and important firms whose whole rai- America’s trading partners. world’s largest dairy exporter); and tariffs on son d’être was to promote TPP. Instead, it The latter point to a host of issues, some Japanese trucks (25%), cars (2.5%), and issued a blandly neutral statement: “We look of which the US did not even allow to be dis- parts (mostly 6-10%) that will not be lifted forward to reviewing the details of today's cussed in the “gold standard” TPP talks. under TPP for 30, 25 and up to 15 years, agreement and continuing to work with Some were GOP issues and some were respectively (and yet Ford Motor still oppos- Congress and the Administration on the Democratic issues, but all of the following es TPP). TPP.” The US Chamber of Commerce and examples are, in our opinion, “special inter- American leadership rests on others’ the National Association of Manufacturers, est” issues: “Buy America” provisions of perception that it is a “benign hegemon.” By both members of the coalition, issued similar many state procurement laws (limiting undermining that perception, one-way- remarks. Most knowledgeable observers access to a $1.4 trillion market); the Jones street notions of free trade post a far greater expect that these federations will end up Act, which requires that all goods transport- threat to national security than any Free energetically lobbying for TPP, but they can- ed by water between US ports be carried on Trade Agreement that China could create in not do so without first going through the ships constructed in the United States, Asia. (RK) TPP and Japanese growth

Prime Minister Shinzo Abe has repeatedly pointed to the Trans- growth rate by 0.18 of a point. He comments, “This increase is signif- Pacific Partnership (TPP) as a key catalyst of “third arrow” reforms icant given the nearly 0.8% [annual] growth rate in Japan’s real GDP aimed at boosting growth. The claim is that TPP will promote reform per capita over the past 20 years.” of backward sectors like farming, while giving Japanese multination- Both Petri and Todo make heroic assumptions for TPP’s benefits als a boost vis-à-vis competitors regarding both exports and over- on the assumption that it will massively raise the level of Foreign seas investments. Despite purported economic gains, many in the Direct Investment (FDI) into Japan. Todo estimates that this, plus out- Liberal Democratic Party (LDP) fear the deal will hurt the party in the ward FDI, will raise annual growth by another 1.3 points beyond the July 2016 Upper House elections, and, according to Nikkei, “want trade effects. So, TPP would take an economy growing 0.8% per year ratification postponed until after the election.” and make it grow 2.3% a year, a rate above Prime Minister Shinzo Abe’s 2% target. This seems rather fanciful. How much additional growth? We certainly agree that Japan is better off with TPP than without it, How much reform? but believe the benefits are being oversold. The Abe Cabinet Office’s Expanded trade and FDI make better growth possible, but they do not own 2013 study said that TPP would in a decade or so make the level guarantee it. It all depends on how much expanded trade and FDI of GDP just 0.66% higher than it would otherwise be. A 2012 study by lead to fiercer competition and therefore better productivity growth the Washington-based Peterson Institute for International in laggard sectors, from farming to assorted manufacturing and serv- Economics (PIIE) predicted that, after 12-15 years, Japan’s level of ice sectors. There is no guarantee that Abe and/or his successors exports would be 14% higher with TPP than without it, and that will use TPP to catalyze broad-based structural reform even though imports would be 14.3% higher. If that forecast is correct, PIIE esti- many officials at the Ministry of Economy, Trade and Industry (METI) mates that the expanded volume of trade would make GDP a measly hope and/or expect that they will. 0.2% higher, while boosting the income of people plus firms by a If, for example, Japan increases imports from Japanese affiliates more substantial 1.4%. overseas, that boosts productivity by much less than an increase in Both of these studies make the conservative assumption that imports from companies like Samsung, a process that pressures the expanded trade creates a one-shot improvement in the level of GDP. Japanese firms to improve or die. Farming is the poster child for how In reality, a higher ratio of trade to GDP tends to stimulate a higher TPP will supposedly catalyze reform. However, Kazuhito Yamashita, growth rate on an ongoing basis, but Peter Petri, one of the PIIE a former Ministry of Agriculture official who is now a Research authors, said that was hard to estimate. director at the Canon Institute for Global Studies in Tokyo, told the Professor Yasuyuki Todo of Waseda University tried to make that Financial Times that, “This [TPP] deal may not affect Japanese agri- estimation. He cited a cross-country study showing that an increase culture much at all.” He pointed out that the reduction in tariffs was in the ratio of trade to GDP by 1 percentage point will increase the limited and slow, while the government would continue to buy up rice growth rate of GDP per capita by 0.027 of a point. If the PIIE is right to support domestic prices. Yamashita had previously argued that about how much TPP will expand Japan’s trade, then Todo says that, Abe’s reform of Zenchu (Japan Agriculture) would somewhat weak- after a decade or so, TPP would increase Japan’s per capita GDP en the power of that lobby, but not really change farming itself.

OCTOBER 2015 THE ORIENTAL ECONOMIST 4

LDP-Komeito coalition, and ride that TOKYO momentum in a lower house race. We oppo- sition parties will be able to triple or quadru- INSIDELINE ple our numbers if we join forces. There are by Takao Toshikawa a number of ways that the alliance could run JCP willing ally with others to defeat LDP in UH poll in the election. I plan to work toward a group capable of sweeping all 32 of the single-seat upper house districts.” Security bills hurt Abe Ironically, the JCP in Osaka is going to endorse the LDP candidate for mayor in the qualitative transformation of Japanese JCP gambit and the UH election upcoming Nov. 22 election. That candidate is security policy has occurred with the The Japan Communist Party (JCP) is consid- Akira Yanagimoto, the secretary-general of A passage of Prime Minister Shinzo ering a major change of policy that could the Osaka chapter of the LDP. That chapter is Abe’s security legislation by the Upper seriously hurt the LDP in next summer’s fairly independent of the central party. The House, and hence the Diet as a whole, early Upper House election. Thirty-two single- JCP apparently considers the LDP a lesser on the morning of September 19. seat, mostly rural districts have proved the evil than the even more nationalist party of Cries that the bills were “unconstitu- swing factor in recent UH elections. As long former Osaka Mayor Toru Hashimoto, the tional legislation” and “war bills” came from as the opposition parties remain divided, it is Osaka Restoration Party. The local LDP is the opposition parties, as well as some media fairly easy for the LDP to win. But now the very strongly opposed to Hashimoto whereas outlets, constitutional scholars and other JCP appears to have decided that, instead of Abe is trying to reach a deal with Hashimoto intellectuals, young people such as Students running its own candidates in every district, to help amend the Constitution after the 2016 Emergency Action for Liberal Democracy as it always does, it will seek to have a uni- Upper House elections. As the saying goes, (SEALDs), young mothers, and Japanese fied slate of all the opposition parties, so that, in Osaka, the JCP and LDP “sleep in the baby boomers who had experienced the 1970 in each district, there is only one candidate same bed, but dream different dreams.” Japan-US Security Treaty protests back in opposing the LDP. their own student days. The JCP has never done this in its entire Suppressing Noda’s election effort After their voices were exhausted and history as a legal party after World War II. It As expected, Abe’s reelection was a relative- they had despaired of defeating the legisla- is doing so now because it says there is a ly minor affair with most of the major play- tion, the protests outside the Diet Building need to protect the Constitution, including ers kept in place. The most interesting new turned to chants of “Let’s have an election!” Article 9, from Abe and the LDP. In order to feature is that LDP Policy Research Council and “Vote them out!” This issue will protect the Constitution, the JCP feels the Chairwoman Tomomi Inada was reappointed inevitably arise as an important one in next need to bring down the LDP and is willing to to her post as head of the LDP Policy Affairs summer’s Upper House election. resort to any means to do so, including sup- Council. For reasons we’ll investigate, she Regarding the constitutionality of the porting a unified slate of candidates from all failed to be named to a high-level Cabinet legislation, a movement to form a 10,000- opposition parties. Post, such as Minister for Economy, Trade strong group of plaintiffs, led by constitu- I have received inside information that and Industry, a typical pathway on the road tional scholars, to bring a lawsuit against this this change was promoted via a secret agree- to higher things. It is well known that Abe legislation has begun. ment between former JCP chief Tetsuzo has talked about her as his successor; if that To Abe, it was the achievement of a Fuwa, an octogenarian still seen as a “god” occurred, she would become Japan’s first cherished desire, so he seems not to care by the rank-and-file, and none other than female Prime Minister. about the national criticism. Even so, if the Ichiro Ozawa. On September 8, Abe won his third term Liberal Democratic Party (LDP) is soundly Hints of the change were given by the as Liberal Democratic Party (LDP) presi- defeated in the Upper House election, it is current JCP President, Kazuo Shii, in an dent, without the need for a vote (LDP rules possible Abe could resign in order to take exclusive October 3 interview with Nikkei. do not allow another term when this one ends responsibility, signaling the end of the road In that interview, Shii talked of realizing a in September 2018). Former LDP General for his long Government. list of unified candidates among opposition Council Chairwoman Seiko Noda had indi- Public opinion polls since passage of forces to overturn the recently passed collec- cated interest in running until just before the the legislation have not all come out yet. In tive security legislation. “I was there protest- election, but abandoned the attempt when an Asahi poll taken on the 19th and 20th, ing in front of the Diet when the bills were pressure from LDP leaders made it impossi- 30% approved of the new security laws, and under debate. There was an immense desire ble for her to gather the required 20 endorse- 50% opposed them. A survey by a TV Asahi to see that war legislation stopped and the ments from other Diet members. Noda com- news program (September 19-20) found a current government knocked out of power. plained, “It’s inexplicable, but there were support rate for the Abe Cabinet of 37.1% Citizens want to see the opposition band people who tried to stop my candidacy.” (down 2.7 points from the last poll) and a together into a single force to achieve those On September 2, there was a story con- non-support rate of 45.4% (up 6.7 points). goals, and we must answer their call. We veyed to the Kantei (Prime Minister’s The prevailing view among political experts need to change how we do things, too. Official Office) and the LDP leadership that is that the next polls could find the Cabinet During next summer's upper house election, the Noda camp had asked the party presiden- support rate down by close to 10 points. the opposition needs to unite, sweep out the cy election managing committee if the “list

THE ORIENTAL ECONOMIST OCTOBER 2015 5 of recommenders” could be turned in before the following to me. “I have met and talked year’s nominal GDP was 491 trillion yen, the campaign opened. Fear grew that the with a large number of foreign investors. and the highest ever was 521 trillion in FY Noda camp already had the 20 needed rec- Rather than just talking about Abenomics, 1997. Criticism that these numbers are only ommenders. On the 5th, a story made the they’re now interested in Japanese politics in good for empty slogans swiftly arose in the rounds of Nagatacho (Japan’s political dis- general.” Investors who hedge against risk media. trict) that Noda had told former Upper House must gather all kinds of information. Even In any case, the Abe Kantei is undoubt- Vice-Chairman Hidehisa Otsuji, who was getting official government opinions first- edly devoted to stock prices breaking free being cited as one of Noda’s recommenders, hand does not generally go beyond what is from their current stagnation. Before labor- “We have 18 people so far.” This story blew already known, and so may be of little help management negotiations on raising base up into former LDP Secretary General for investors. pay begin next February, Abe aims to: 1) fire Makoto Koga backing Noda, along with for- A friend who is a reporter for the Nikkei a surprise “Kuroda Bazooka III” at the Bank mer Chief Cabinet Secretary Hiromu Shimbun makes the following bold predic- of Japan policy meeting on October 7; 2) Nonaka, and former Secretary General Taku tion. If the Nikkei Average is not back above pass a large supplemental budget of 4-5 tril- Yamasaki, with Chief Cabinet Secretary 20,000 by the end of the year, the landscape lion yen during the fall extraordinary Diet Mikio Aoki joining in to use Noda’s candi- will change starting at the beginning of 2016. meeting; and 3) accelerate the planned cut in dacy to manipulate the autumn political Fears will rise inside the LDP about the the corporate tax in December. Setting aside agenda (so as to get rid of Abe). Upper House election in July and the theory whether or not these will work as revival that Abe will bow out after hosting the May measures, for now Abe has no choice but to Factions and machinations 2016 Group of Seven summit in Ise-Shima, concentrate on the economy. The Abe Kantei had long hoped for an unop- Japan will look more realistic. Abe may be posed reelection. If another candidate had left with no options to escape from that situ- Foreign efforts don’t lift approval entered, Abe would have had to tour the ation, except going all in on a double Upper The anticipated rise in Abe’s support rate country on an election campaign up to the House and Lower House election next sum- through foreign policy successes did not voting on September 20. That would have mer. occur as hoped. Japan’s foreign policy con- affected debate and passage of the security cerns are relations with China, Russia, and legislation. A busy foreign policy schedule Abe’s press conference North Korea. Difficulties with China contin- awaited at the end of September. Those close On September 24, Abe held a press confer- ue because of the latter’s claims of sover- to the Prime Minister also wanted to avoid a ence regarding his reelection as party eignty over the Japan-held Senkaku Islands vote because of Abe’s less-than-perfect President. Discussing how he will govern in the South China Sea. With Russia, there is health. from now on, Abe emphasized his thinking still the signing of a peace treaty for WWII The Noda camp narrowed its aim to the on bringing economic recovery and and the return of the “Northern Territories” LDP’s dovish faction led by Foreign improved social security to the fore, saying (four small islands) to pursue. With North Minister Fumio Kishida, as a place to find that, “The economy will be my highest pri- Korea, there is achieving the return of the prospective recommenders. Flustered ority. We have to put the brakes on the low abduction victims. Kishida faction leaders fanned out to make birthrate and aging population.” A “Deep Throat” source inside the sure that the younger Diet members in the Abenomics is to “enter stage 2” soon, Foreign Ministry informed me that Prime faction remained under control. This was with the “new three arrows” of a strong econ- Minister Abe personally instructed them to successful, and in the end, there were report- omy, support for child-rearing, and social concentrate on a Japan-China-South Korea edly only six or seven Noda recommenders. security. Specific goals are: 1) nominal GDP summit and Japan-Russia relations. My Ultimately, it was all just a tempest in a reaching ¥600 trillion, a 20% increase from source said, “The Prime Minister is thinking teapot. today’s level; 2) achieving a hoped-for fertil- so hard about the Japan and Russia relation- ity rate of 1.8, up from today’s 1.4, but still ship. He is determined to accomplish a peace Abenomics no longer popular below the 2.07 needed just to keep the popu- treaty and the return of the Northern The Abe government’s only road to a long- lation from falling; and 3) no one being Territories while he is in office. He believes lasting tenure is a rising economy, specifical- forced to quit working in order to provide that it will be impossible to achieve this ly, an economy characterized by rising stock family medical care. Additionally, he has unless he negotiates directly with Putin.” Abe prices. Stock prices, however, must be left up firmly committed to raising the consumption strongly desires a state visit to Japan by Putin to the market. Clumsy government interven- tax to 10% in April 2017: “In order to main- before the end of the year. He met with Putin tion could lead to a repeat of the Shanghai tain the trust of the international community, on the 28th in New York as the prelude to Stock Exchange debacle. we will implement it as planned, barring the that. The reputation of Abenomics in Japan occurrence of another event like the Lehman Japan-North Korea relations are also on and abroad has certainly fallen back to Earth. Shock.” the rocks. As I have reported more than once, The Nikkei Stock Average, which was above Because the eyes of the public have North Korea’s reinvestigation report differs 20,000 at one point, fell below the supposed been focused on the unpopular security leg- little from what was previously said. The ball psychological line of 18,000 for a few islation, the Abe Kantei was enthusiastic is in Japan’s court as to whether or not to weeks, but has now recovered into the low about their campaign to turn the public’s accept it. Will Abe still be able to use a con- 18,000s. Amidst a joking conversation, gaze once more to economic policy. While fident foreign policy to come up with results Deputy Chief Cabinet Secretary Seko said there are no clear numerical targets, last that will gain the public’s support?

OCTOBER 2015 THE ORIENTAL ECONOMIST 6

cial experts to employ complicated tech- niques to try to hide losses. Toshiba’s top TOSHIBA management continuously applied pressure to increase profit figures beginning in by Yoshisuke Iinuma President Atsutoshi Nishida’s tenure (2005- Broader implications for corporate governance 09), and various business departments coop- erated in response to that pressure. The group mentality of Japanese corporate cul- Toshiba scandal ture became the breeding ground for accounting fraud. Even when there were no oshiba, the huge electrical manufacturer Won’t end here specific orders, employees inferred the top that deals in everything from semicon- Toshiba’s attempt to draw a line under the management’s intent and manipulated the T ductors to nuclear power plants, has scandal will likely be frustrated. First, out- numbers. The manipulation itself took the been rocked by scandal: it “cooked the side observers say Toshiba’s balance sheet form of extremely common methods such as books” to inflate its reported profits. This is may still not be accurate. Second, because making costs appear lower by putting losses shocking for a company that has produced Toshiba has used US accounting standards, on orders off to the future, or by booking numerous chairmen of the Keidanren busi- and published its results in English-language excessive inventory, or manipulating the ness federation and the Japan Chamber of annual reports, the company may be exposed price of parts transactions. This view holds Commerce and Industry. Having discovered to a more stringent investigation and harsher that this is exactly the usual type of account- the fabrication this February, the company penalties from the American SEC than from ing scandal that occurs under the collectivist took until September 7 to reveal it had over- the Japanese authorities. The results of any mentality in the Japanese business culture. stated its profits by ¥224.8 billion ($1.9 bil- SEC investigation could implicate not only Some minimize the seriousness of the of- lion) over the past seven years. Toshiba, but also Ernst & Young ShinNihon fense by saying it is no worse than typical. Toshiba had initially planned to an- (which audited Toshiba’s books) and even In a case like Olympus, in which the nounce its results at the end of August, but it the state of market regulation in Japan. illegal activities were led by top executives, was forced to postpone further because inter- Two issues have been raised in regard to removing them resolves the problem. How- nal reports of improper accounting kept the first point. The first is the possible over- ever, if manipulation of accounts has become coming in, even after the July release of the valuation of Westinghouse, which Toshiba habitual throughout the organization, simply results of an investigation by a third-party acquired for roughly ¥600 billion ($5 bil.) in lopping off some heads won’t uproot the committee of attorneys and accountants. The 2006. Orders for nuclear power plants have syndrome. In the Olympus case, seven peo- amount of overstated profits ballooned from fallen precipitously since the Fukushima dis- ple were arrested. The three who went to the ¥156.2 billion ($1.3 bil.) reported by the aster. Quite a few accounting experts believe trial and pled guilty were given suspended third-party committee in July. that Toshiba’s valuation of Westinghouse is sentences, as is typical in such cases. Things On September 30, Toshiba submitted its no longer realistic since it was based on bull- have not progressed that far with Toshiba revised accounts to an extraordinary share- ish expectations for nuclear power at the yet, in part because the specific actions of holders’ meeting, together with nominations time of its acquisition. Consequently, individuals are still being investigated. for seven outside directors (including three Toshiba needs to book an impairment loss of A very different view is held by Yuji noted business people, an attorney, two cer- several hundred billion yen from the West- Hosono, a certified public accountant. In the tified public accountants, and a management inghouse book value. Secondly, reserves September issue of Sekai magazine, Hosono scholar) and four internal directors. Except allocated for future retirement payments to wrote that Toshiba first began falsifying its for one outside director and two internal employees may be short by around ¥200 bil- accounts under President Nishida during the directors, the other nominees will be new to lion ($1.6 bil.); more on this below. fiscal year that ended in March 2009 because the board. Toshiba also established a com- it had fallen deeply into the red following the mittee made up of three outside attorneys to Toshiba scandal or Japan scandal? collapse of Lehman Brothers, and the com- look into the responsibility of current and There are two ways of looking at the nature pany was in a life-or-death situation. former officers. The most recent three presi- of Toshiba’s accounting scandal. Financial institutions, he contends, might dents of Toshiba have already resigned for The first view, which was outlined in have demanded that it repay its entire debt in causing the falsification of accounts by the third-party committee report and has bulk. The window dressing was intended to pushing for unrealistic profit targets, but an been adopted by most media outlets, is that help Toshiba receive a ¥500 billion ($4.2 outside investigative committee has been Toshiba’s overstatement of profits was the bil.) capital increase to avoid such a crisis. created to probe their specific responsibili- run-of-the-mill window dressing that could Because it had to improve its balance sheet ties as well as that of other officers. The be seen in many Japanese companies. From to qualify for the capital increase, Toshiba Securities and Exchange Surveillance this perspective, the Toshiba case is not the reduced the apparent “present value” of its Commission (SESC), Japan’s equivalent of same type of scandal as the Olympus case of retirement payment obligations. It disguised the American SEC (Securities and Exchange 2011, where the decision to cook the books ¥230 billion ($1.9 bil.) in obligations by rais- Commission), has launched a full-fledged was made by a clear order of top manage- ing the expected return on investments used investigation. Toshiba has also set aside ¥8.4 ment and a small number of accounting to fund those obligations. billion ($70 million) in anticipation of fines. executives, who colluded with outside finan- Hosono sees this as the genesis of

THE ORIENTAL ECONOMIST OCTOBER 2015 7

Toshiba’s accounting scandal. Once top their knowledge of finance and accounting what kind of materials Toshiba submitted to management took that path to meet the cri- was insufficient, and they also had no sup- the audit company.” Gohara is a former pros- sis, then the entire company became contin- port staff versed in accounting. Thus, the ecutor who has taken the lead in speaking uously involved in falsifying accounts to actual form of the accounting manipulation out against compliance problems, including push back reported costs over the following was concealed from the outside directors. his service on the third-party committee that six-year period. Toshiba had an internal “whistleblowing” investigated the Olympus scandal. system, but that also did not function well. The fact that ShinNihon could not see Failure of governance reform Ultimately, after a number of years, the fraud through the methods Toshiba used to win- Regardless of the origin of Toshiba’s malfea- was finally discovered due to an insider’s dow-dress its accounts, despite those meth- sance, this fraud will have an enormous report to the Securities and Exchange ods being incredibly common, means that impact on the Japanese capital market in that Surveillance Commission. this same type of fraud could occur any- it will raise serious questions about the cor- As part of the corporate governance where, which could greatly undermine con- porate governance reform movement now reform movement that is currently under- fidence in accounting audits. The Certified being widely touted (see article on pg. 8). way, listed companies are now required to Public Accountants and Auditing Oversight Toshiba had been seen as a paragon of install two or more outside directors. Board, which falls under the umbrella of the corporate governance reform. It had installed However, the Toshiba scandal proves that Financial Services Agency, and the Japanese outside directors ahead of other companies, simply adopting these reforms is no guaran- Institute of Certified Public Accountants and in 2003 it built a seemingly cutting-edge tee that they will have the desired effect. have both launched inspections of Ernst & corporate governance system consisting of a Over the past 10 years, Japan has strength- Young ShinNihon. It is still unclear what the nominating committee (to nominate the next ened its regulations that compel companies results of those inspections will be and what top management candidates), compensation to effectuate a number of systems to ensure kind of punishments, if any, will be handed committee (to decide officer compensation), compliance with laws and regulations. down. and audit committee dominated by those Accordingly, compliance-related costs have In 2006, ChuoAoyama Audit Corp. (an outside directors. also risen many times over. affiliate of PricewaterhouseCoopers and one None of this prevented Toshiba from Nevertheless, as the Toshiba scandal of the four major audit companies at the continuously manipulating accounting fig- demonstrates, adopting a certain form of time) received a disposition from the Finan- ures in disregard of compliance rules. governance does not necessarily guarantee cial Services Agency (FSA) suspending its Moreover, another aim of corporate gover- its effectiveness. That requires reliable business for two months, which ultimately nance reform—to increase growth—was enforcement of internal control rules in indi- drove the company to dissolve. In 2005, completely unsuccessful. Toshiba has been vidual companies. However, in a Japanese three of ChuoAoyama’s certified public incredibly reluctant to divest itself of divi- corporate world that still sees very few accountants who were working with Kanebo sions, like laptops, that bleed red ink. This is employees changing jobs between compa- led the falsification of accounts that caused also evident from a comparison with former nies, the influences of a particular corporate that company’s scandal. The following year rivals Hitachi and Mitsubishi Electric, which culture can easily win out over the normative ChuoAoyama was also involved in the fraud were much quicker in the restructuring of power of compliance rules in the wider busi- at Livedoor. Since these were only some in a their business lines. ness culture. In order for compliance to long history of problems at ChuoAoyama, Although a nominating committee’s spread throughout a company, it is necessary an exceptional punishment was given to a function is to select the most appropriate for top management to be resolutely ethical major auditing firm in Japan. CEO, at Toshiba it simply approved the per- in business, but that was lacking at Toshiba. Ernst & Young ShinNihon also handled son chosen by the old boys’ club of former It can hardly be said that this lack of ethics is audits at Japan Airlines, IHI, and Olympus, company presidents who still retain the most limited to Toshiba. all of which used some window dressing to internal influence. Outside directors were cover fraudulent accounting. A list to which unable to resolve the feud between Atsutoshi Where were the auditors? we can now add Toshiba. The most impor- Nishida, the third most recent president, and In Toshiba’s case, outside financial auditors tant developments to watch for now are the Norio Sasaki, the second most recent presi- say that they were unable to penetrate the FSA report from its inspection, and what dent, a feud that prevented flexible decision- window dressing. ShinNihon, the Ernst & kind of reforms the FSA will bring about in making. Until their joint resignation in July, Young affiliate that carried out the audits, the character and methods of accounting Nishida and Sasaki wielded their remaining contends that it could not find improprieties audits in Japan. influence at Toshiba as an advisor and vice- in those books that were accessible to out- With the direction of the Securities and chairman, respectively. siders. Even when they asked questions, they Exchange Surveillance Commission’s inves- Although the personal computer and could not get accurate answers because tigation into Toshiba and the FSA’s investi- television divisions had been generating underlying data was so falsified. gation into Ernst & Young ShinNihon re- huge losses, Nishida, who had, in the past, However, attorney Nobuo Gohara has maining unclear, the kind of action the US nurtured Toshiba’s laptops into being among questioned whether that was really the case. SEC takes or does not take in response may the best in the world, blocked the company “The core of the accounting fraud has not yet also have a major impact. The Toshiba scan- from scaling back or retreating from the PC been completely uncovered,” he says. “We dal runs the risk of growing into a bombshell business. Although outside directors held a don’t know whether the audit company was that will rock corporate culture, capital mar- majority of seats on the audit committee, really fooled or just overlooked the fraud, or kets, and the state of regulation in Japan.

OCTOBER 2015 THE ORIENTAL ECONOMIST 8

and lower the amount of equity. In that case, CORPORATE your ROE number may look good, even though your productivity as measured by STRATEGY return on assets may not have improved at all. Nicholas Benes: Benes: You can only pull that trick so many times before investors wake up to it.

‘Governance a big deal’ TOE: How are all these innovations actually going to improve corporate performance? You mentioned earlier the resistance of the Nicholas Benes is Representative Director of The Board Director Training Institute of industrial community. Japan, which trains directors as a government-certified “public interest” nonprofit. Benes: In regard to resistance, I am referring Since 2010, he has chaired the Growth Strategy Task Force of the American Chamber particularly to the Keidanren [the chief busi- of Commerce in Japan. ness federation]. The business community itself has actually become much more frag- he Japanese government and the Tokyo decades, to discuss their impact. mented and diverse on these issues than 10- Stock Exchange have taken a number of 15 years ago. Keidanren tends to reflect the T steps aimed at improving corporate TOE: How important are these governance lowest common denominator. Keidanren is governance on the assumption that this will innovations? sort of a club of people with great seniority not only improve returns for shareholders, Benes: The most important thing is that the who don’t want to offend other senior people but also improve corporate efficiency and government has made it very clear that pro- too much. growth prospects. ductivity and profitability matters, and that it Within many firms, the reaction has The Japan Company Law was amended believes that corporate governance is impor- been quite positive. There has been a strong so that firms were urged to add at least one tant for achieving that. The government is level of interest at middle management lev- outside director to their boards under a basically saying, “We need to make sure els, where we do some training. Many of “comply or explain” rule, as is used in many your pension fund is worth what it’s sup- these people want to take advantage of these countries, such as the UK. These outsiders posed to be in 30 years.” That’s a very dif- governance changes in order to accelerate had to be true outsiders, not people currently ferent message than the government has ever the company reforms that they wanted for a working at affiliates or allied firms. sent out in the last few decades. while. It’s elevated the internal discussion A Stewardship Code for investors, also Taken together the two Codes will mark that is very important in Japanese compa- using the “comply or explain” procedure, the beginning of the end for cross-sharehold- nies. The top guys often will not take leader- was promulgated by the Financial Services ings and similar “stable (i.e., “silent”) share- ship on these issues, but if it bubbles up from Agency (FSA). Investors who choose to sign holdings.” Over the past 5-10 years, such below enough, they won’t say no. up need to explain things like their policies holdings have come down very significantly. for engaging with firm management, as well But now, after the new Codes, the banks are TOE: You had written previously that, up to as their policies for voting their proxies at reducing their shareholdings in companies in now, most of the “outside directors” were the shareholders annual meetings; they can- accelerated fashion. “friendly cocker spaniels, instead of not continue to just turn over blank proxies Dobermans.” How will outside directors to management and let the latter vote for TOE: Will “comply or explain” be effective have real impact if senior management real- them. or will it let firms get away with just “talking ly doesn’t want to listen to them? The Tokyo Stock Exchange then creat- the talk”? Benes: I borrowed that expression from ed a Corporate Governance Code, once Benes: Most countries use a “comply or Warren Buffett, who was talking about US again based on the “comply of explain” prin- explain” approach. The US is an outlier in directors. At very few firms will outside ciple, according to which firms are recom- taking a mandatory approach. By forcing directors become Dobermans, no matter the mended to follow global best practices in companies to either comply or explain, you country. What you want is cocker spaniels governance, but are free to work out the give investors a lot of detailed disclosure that who bark when necessary. details. In theory, firms that don’t follow the reflects each company’s situation. It is then And you want at least three of them. If “comply or explain” rule could be delisted up to investors how much they actually there is just one, it’s very difficult for him or from the exchange. engage in dialogue with the companies to her to say anything which runs against the Finally, an advisory committee to the nudge them forward, and praise those who thinking of ten other people. But if that one Ministry of Economy, Trade and Industry show progress while criticizing the laggards person on the board says, “We ought to think (METI) urged that firms target a Return-on- publicly. A certain level of public shaming or harder about XYZ,” and if the person next to Equity ratio (i.e., the ratio of profits to the praising leads to change. him says, “Yes, he’s got a point,” and the value of all the shares held in the firm) of at person next to him says, “Yes,” that’s really least 8%. TOE: ROE has got a numerator and a all you need to start a meaningful discussion. We asked Nicholas Benes, who has denominator. So, even if your profits stay the So firms’ concerns with their reputation can been pushing for these kinds of reforms for same, you can buy back a bunch of shares, lead to the kind of board that companies

THE ORIENTAL ECONOMIST OCTOBER 2015 9 should want to have. Growth Strategy Task Force that I led in back-and-forth with management. 2010 which had proposed many features of I think we’ll see a lot of changes over TOE: Will outside directors have an impor- the “third arrow,” especially the urgent need the coming five years. tant say on issues like compensation of exec- to raise productivity. So, it’s not odd. What’s utives and nomination of new directors? odd is that there are not more Japanese peo- TOE: Back in 2006, you had written that Benes: Not necessarily, and that’s a prob- ple who see it as in the interests of their own Japan was at a tipping point in terms of cor- lem. You need the outside directors to take country to make detailed proposals. porate governance. Not that much has hap- the lead in helping to make decisions where pened since then. Why will this time be dif- the interests of executives might conflict TOE: A friend of mine, who is not Japanese, ferent? with the best interests of the company. has been an outside director for a few Benes: I disagree with your premise. I think months. His impression is that outside direc- a lot has happened since 2006, and it is pre- TOE: What was your involvement in all this tors only make a difference if management cisely those changes that enabled me to pro- besides your role in training directors? genuinely welcomes an outsider, because he pose the governance code and other meas- Benes: I proposed that a Corporate can offer a different perspective from those ures to get it approved. “Tipping point” Governance Code be part of the govern- inside the firm. If management doesn’t real- doesn’t mean everything is going to happen ment’s growth strategy in conversations with ly want that input, they may go through the at once. It means a point beyond which there Diet member Yasuhisa Shiozaki, who was a motions, but, in substance, they’ll ignore is no return, and the next stage will definite- key leader of the growth committee of the him. He thought that, out of the 1,600 com- ly unfold. A lot of the changes since 2006 Liberal Democratic Party (LDP). This was panies in the First Section of the TSE, per- were under the radar and slower. An increas- back in late 2013 and early 2014. At first, haps 100 really wanted to take advantage of ing number of leading companies started to Mr. Shiozaki hoped to get a mandatory outside directors. Over time, he felt this self-improve their governance in order to requirement for one outside director put into would grow and become tremendously survive in a competitive environment. We the company law. My advice was that it important. saw more disparities among companies in would be better to legitimize the concept of Benes: I’m not going to argue whether it’s terms of governance and corporate strate- “comply or explain” in that law so that we 100 vs. 300, but the number of digits is right, gies, more corporate restructurings. Most of could build something with much more as opposed to 1,000 or 1,200. But I think that all, society here now sees the necessity for impact—a governance code—on that foun- would be true in any country. These changes reform, which was not the case 10 years ago. dation. There had been arguments about the always take time. outside director rule for almost four years TOE: Japanese companies are now so flush and I felt that sticking to a mandatory TOE: So what will be the driver for outside with cash they don’t really need to raise a lot requirement would just result in years of fur- directors having a real impact? of equity to fund investments. They can fund ther argument, since Keidanren refused to Benes: In any country, it largely depends on them internally. Can the shareholders really accept it. Shiozaki readily understood the shareholders. Shareholders have a lot of have power over management when the benefits of this approach. He grabbed the rights in Japan, under the company law, company does not need their money? ball and ran with it and convinced the FSA to more than in the US. If they raise their voic- Benes: This is the key question in Japan. start this process. And he pushed it ahead to es—as they are expected now to do under the What made Japanese corporate governance its conclusion. Stewardship Code—that can change things. effective in the past was that they had to go I then immediately took the FSA’s point Management likes to get high shareholder back to the banks for capital. Still, the gov- man on this—Motoyuki Yufu [Director of approval ratios at their annual meetings. ernment has made a very, very strong public the Corporate Accounting and Disclosure Beyond that, the Corporate Governance message that shareholders have authority. Division]—to dinner and gave him a memo Code includes the concept of director train- In the past, if a shareholder went to with my ideas of what should be in the gov- ing, one of the things I most wanted to XYZ company, and talked about the dormant ernance code. He had spent time at the include. Most companies don’t have any cash lying around—and asked whether the OECD and was familiar with governance meaningful director training program for all firm had plans to invest it productively or to issues, but he had never sat on a board. He those inside directors. Perhaps 500-600 do give it back to the shareholders as divi- appreciated that the advice that I was giving engage in some sort of meaningful training, dends—he risked being labeled as an him was based on my years of experience on but it’s all internal. It’s kind of like the stu- “activist” and maybe avoided. Companies various boards. And learning about practices dent writing his own test and then taking it. would avoid meeting with investors who in other countries was one of the things most You will not come up with new practices that talked that way too much. useful to Mr. Yufu. the President might not like. The more train- But nobody can label you an “activist” ing that occurs, the more that directors now, because the new Corporate Governance TOE: Did you find it striking that a top understand what is expected of them. People Code talks about using capital efficiently and member of the Diet and a top official were here tend to act according to what is expect- you can point to the Stewardship Code and willing to take advice from a member of the ed by society. say, “I am sorry to have to ask these ques- foreign business community? Creating boards that are not just rubber tions, but I am required to do so by the Benes: I have been here for 30 years, and stamps requires getting the important strate- Stewardship Code.” have been doing nothing but working on this gic topics to the board sooner so there is a Praising and shaming have a big effect issue for the last six years. It was the ACCJ’s real chance to meaningfully engage in a here. There will be articles in Japanese mag-

OCTOBER 2015 THE ORIENTAL ECONOMIST 10 azines about firms with low ROEs or poor and structures that made this possible are have been much earlier discussions at that governance structures, or the firms most quite common. People do not have a flexible committee. But, even in that case, it proba- highly-rated by foreign investors. This kind labor market so that, if the corporate culture bly would have been extremely difficult to of peer pressure—how do we stack up stinks at one firm, managers cannot go to have a very healthy discussion if she was the against our archrivals?—is going to be an another firm that acts more honestly. The only one with that sort of background (see extremely strong motivator. hierarchical structure can go in a good direc- pg. 6). tion if you have a rigorous, excellent leader TOE: Corporate governance may end up as is the case with Kyocera. Or, it can some- TOE: Do you think the situation in Japan is being better for shareholders in terms of times go in a bad direction like Toshiba, worse than what we saw at Enron, higher ROE or higher dividends. But to what because people obey orders almost as if it MCI/WorldCom, etc.? In the Olympus case, degree does corporate governance translate were a military organization. I saw no evidence that directors who were into better management or better strategy? At Toshiba, there were nine members of stealing from the stockholders put a single At least by American standards, Canon’s the board who were insiders in the firm. yen in their own pockets. corporate governance was not good, but it Many of them must have known that a lot of Benes: That’s right. It certainly is not worse has been a superb firm mainly, in my view, the stuff was going on, or sensed it, or heard in that sense. because 70% of its sales were overseas and things from friends over drinks at night. But so competition disciplined the firm and kept they didn’t report it to the board and didn’t TOE: Do you think it’s harder to be a it focused on core competencies. We’ll have report it to independent members of the audit whistleblower in Japan than in the US? to see how it deals with the smartphone chal- committee, as far as I know. These directors Benes: I think the tendency of directors not lenge. On the other hand, Toshiba had four had a legal duty to report any information to be sufficiently aware enough of their own outside directors. that might result in large damage to the com- legal duties and not to act on them is worse Benes: I think you are right. Competition is pany to the audit committee, and to the board in Japan. When they get promoted to the one of the best forms of medicine. Good as well. What prevented them from doing board, they’re still really thinking of them- governance doesn’t always translate directly that? Hierarchy. selves as executives in a hierarchy, where the into good management. There are hundreds When I do compliance training with the President is their boss. of other factors which affect the success of middle-level people, I ask them: Could you That is a different issue from whistle- your management strategy. We cannot meas- report anything that you find ethically wrong blowing in the general case. Former ure the contribution of governance in the or potentially harmful to the company? They Olympus President Michael Woodford, who overall success of a firm. But it is also true, all say: I could probably report it to my was ousted when he tried to investigate the that rigor in one area, such as governance, immediate boss because I know him person- accounting fraud, often says that Japan lacks often leads to rigor in other areas. Also, bet- ally and can trust him. But above him, prob- a whistleblower culture. But Olympus was a ter governance assures investors that moni- ably not. I don’t personally know those peo- case where a whistleblower actually went to toring of management is taking place, so that ple. They might go directly to the president somebody, in that case FACTA magazine. a manager might not be promoted if he is and I might suffer some kind of retaliation. Toshiba was a case where the revelations mediocre. Without that, we tend to get what came about because a whistleblower went to we had in the last couple decades, i.e., peo- TOE: Toshiba also had outside directors, the SESC [Securities and Exchange Sur- ple climbing the ladder in lockstep. That pro- and it was listed on the JPX 400 exchange, veillance Commission], the equivalent of the moted a bureaucratic risk-averse attitude one of whose criteria is good governance. American SEC [Securities and Exchange where managers avoided sticking their necks What does that tell us? Commission]. And there are statistics show- out and firms just sat on cash. Benes: It tells us that director backgrounds, ing an increase in the number of whistle- Across the world, corporations are at a skill-sets, competency, and training matter. blowers who go directly to the authorities very primitive stage regarding governance At Toshiba, the former Chief Financial because they don’t trust their own hierarchi- practices and structures. Notions of gover- Officer (CFO) chaired the audit committee. cal structure not to retaliate, and because nance only came into discussion about 50 If he doesn’t want to give information to the they have enough conscience to report the years ago. others, it’s not going to flow to the outside problem. directors very easily. Another member of the So, here in Japan there is an ethical base TOE: There was the scandal at Olympus audit committee was the former head of which I think is at least as good as in the US. over cooking the books and much of the Toshiba’s legal department, and such people What we don’t have in Japan is something Western press talked about it, not as a scan- don’t usually know much about finance or that was put into the 2009 Dodd-Frank bank- dal at Olympus, but as a scandal of corporate accounting. Two of the outside directors on ing bill in the US. That law prescribes not Japan. The same is true regarding the that audit committee were former diplomats. only a prohibition on retaliation, but also that Toshiba scandal. By contrast, people don’t The only outsider who had much knowledge whistleblowers will get a reward if any fines talk about the much worse scandal at about finance was Kiyomi Saito. She used to result from their whistleblowing. The fact Volkswagen as a German problem. Are the work at Morgan Stanley, had gone to that Toshiba whistleblowers went to the Olympus and Toshiba scandals typical or Harvard Business School, and runs her own SCSC—despite the lack of either protection untypical of Japanese firms? company, which is a listed company. I think or a reward in that case—speaks to the good Benes: I don’t think it is typical in the sense that, had she known about doubts about the ethics at the middle levels of Japanese com- of accounting fraud, but I think the habits accounting treatment, there would certainly panies.

THE ORIENTAL ECONOMIST OCTOBER 2015 11

dropped from 86% in 2001 to 71% in 2009, marking a shift to competitive resource allo- E D U C A T I O N cation that favors universities that meet MEXT performance criteria. In 2014 the by Jeff Kingston OECD found that Japan’s public expendi- tures on higher education amounted to 0.5% Japanese universities blunting attacks of GDP, lowest in the OECD, compared to an average of 1.1% among member nations. Liberal arts at risk Meanwhile, the number of 18-year-olds has plunged from 2 million in 1990 to 1.5 million in 2000 and 1.2 million in 2010. In Jeff Kingston is Director of Asian Studies at Temple University Japan, and author of addition, only half of Japan’s high school Asian Nationalisms Since 1945 (2016), and editor of Press Freedom in Japan (2016). He graduates enter universities (excluding jun- is a Contributing Editor to the Asia-Pacific Journal, from which this is excerpted; see ior colleges), well below the OECD average http://japanfocus.org/-Jeff-Kingston/4381/article.html of 62% and far below Australia where more than 90% do so and South Korea where the n June 8 the Ministry of Education, The latest QS World University university enrollment rate for high school Culture, Sports, Science and Technol- Rankings rank just five Japanese universities graduates is 82%. There is an oversupply of O ogy (MEXT) sent a directive to all 86 in the top 100: Kyoto University (38), universities in Japan with 86 national univer- national universities in Japan, apparently University of Tokyo (39), Tokyo Institute of sities, 90 universities run by prefectures or calling on them to abolish or reorganize their Technology (56), Osaka University (58) and municipalities, and 606 private institutions, humanities and social sciences (HSS) Tohoku University (74). By contrast, so consolidation is inevitable. departments. I use the word “apparently” Singapore boasts two universities in the top Private universities complain that they because the letter is ambiguous. 15, while China and Hong Kong each have enroll roughly 80% of freshmen undergradu- Nonetheless, the Yomiuri reports that 26 four and South Korea has three in the top ates while national universities get nearly of 60 public universities operating HSS 100. Prime Minister Shinzo Abe has targeted 80% of government funding. This disparity departments have agreed to stop accepting getting 10 Japanese universities into the is the source of vigorous lobbying by private students into these programs or reduce rele- world’s top 100 by 2025. However, he has universities to spread the funding more equi- vant electives. By contrast, top national uni- been better at setting unrealistically ambi- tably and to downsize national universities, a versities, e.g., the University of Tokyo and tious targets than actually doing what is nec- pitch that plays well with a conservative Kyoto University, are not shutting down essary to achieve them. Moreover, this anti- government eager to cut budgets and rely HSS, demonstrating that powerful institu- intellectual salvo from Abe’s government fits more on the private sector. tions with sufficient funding are not behold- into a larger pattern of dumbing down edu- en to MEXT. cation, whitewashing textbooks, promoting Japan needs HSS Many in Japan have criticized MEXT’s patriotic education and stifling dissent. Takamitsu Sawa, President of Shiga initiative, including Keidanren, the big busi- University, a national university, condemned ness lobby. This directive has also prompted Power shift the MEXT proposal in a Japan Times col- a petition campaign by European scholars. In 2015 the government tabled legislation umn, drawing a parallel to the wartime And yet, some scholars in Japan say that the that will concentrate all decision-making exemption from conscription accorded to HHS departments, and many colleges in power in university presidents’ hands while students in natural sciences and pointing out general, do not provide the kind of education downgrading the role of faculty councils, a that Nobusuke Kishi, Abe’s grandfather and needed in today’s world and say MEXT major shift that is consistent with prime minister from 1957-1960, also favored appears to be trying to address that problem. Keidanren’s lobbying on the topic. Currently science and practical training. Sawa argues In response to the critics, Education the faculty is in charge of hiring new faculty that, “A majority of Japanese political, Minister Shimomura Hakubun told a news and appointing department heads, but that bureaucratic and business leaders today are conference in late July, “We do not mean to power would shift to the president, who also still those who studied the humanities and treat the studies of humanities lightly. We stands to gain greater control of discre- social sciences. This is because those who also do not put special priority just on fields tionary funding in the form of MEXT block studied these subjects have superior faculties of practical sciences that immediately grants. This proposal is aimed at making it of thinking, judgment and expression, which become useful in society.” Yet that priority is easier to impose changes from above that the are required of political, bureaucratic and exactly what PM Abe emphasized in a May faculty has been resisting. business leaders. And the foundation for speech at the OECD. these faculties is a robust critical spirit.” Japanese officials are concerned that Financial crunch Koichi Nakano, a political scientist at Japan’s universities don’t come out well in All of this comes in the context of a financial Sophia University, describes the proposed international rankings and apparently be- squeeze at the universities. Between 2001 changes as “an utter disaster. Liberal arts lieve that focusing on STEM (Science, and 2009, basic subsidies for national uni- education is what Japan needs more of, not Technology, Engineering and Math) will get versities dropped 29%, while support for less.” Nakano adds, “The government may more Japanese universities into the top 100. basic expenditures out of total allocations be trying to silence academic opposition to

OCTOBER 2015 THE ORIENTAL ECONOMIST 12 its policies by threatening and undermining introduction of a gap year for students to others, diversity, flexibility, lifelong learn- the subject areas that produce and hire those broaden their experience and perspectives, ing, IT, etc., skills that will help us cope with critical voices.” Indeed, HSS faculty mem- and improvement in English skills and the rapidity of changes on a global scale in a bers constitute the vast majority of signato- teaching capabilities of educators. Appar- global context and in a global language…If ries of a scholar’s petition opposing Abe’s ently Keidanren felt that critics of MEXT the attempt is to eliminate the arts and unpopular security legislation and have been were blaming employers for pushing the lat- humanities at national universities, then that prominent at rallies protesting the unconsti- est reforms toward a utilitarian education is obviously a horrible policy. I say ‘if’ tutionality of the laws. and sought to clarify that Keidanren fully because it is not clear to me that this is the Relatively few of the roughly 300 core supports HSS. real intent here. When Japanese talk about members of Students Emergency Action for In July, the Science Council of Japan, a global human resource development, that Liberal Democracy (SEALDs) who have national organization of some 2,000 scien- means creating graduates who are able to taken to the streets to protest PM Abe’s secu- tists, also expressed “profound concern over communicate, understand and deal comfort- rity legislation, are students at national uni- the potentially grave impact” of the MEXT ably with others unlike them. In order to do versities, but most are in the humanities and directive, saying that, “Any disparagement that they have to blend what are traditional social sciences. With their social media of the HSS may result in higher education in elements of the liberal arts into their curricu- savvy, they have inspired similar protests all Japan losing its richness.” The Science la. This is a recognized component of MEXT over the nation, mobilizing well over a mil- Council calls for maintaining liberal arts policy, and they have spent one helluva lot of lion protestors since June. Their ability to education because it promotes critical think- money doing just that.” initiate, improvise and motivate is striking. ing, nurtures “global human resources” and Philip Seaton, a professor of history at Moreover, they demonstrate excellent cross- promotes understanding of, “the human and Hokkaido University’s International Student cultural communication, marketing and social contexts within which scientific Center, believes that MEXT is nudging uni- design skills. For example, they designed knowledge operates.” versities to undertake overdue reforms that placards that like-minded groups can print Foreign firms in Japan often lament that are in their own interests in a climate of out at any convenience store. Surely they are it’s hard to recruit suitable employees declining student numbers and educational exactly the kind of people Japan needs more because most candidates lack strong critical budgets. He argues that, “There is a big dif- of, embodying the virtues of a liberal arts thinking skills, have poor English, and are ference between universities at which the education. overly passive, waiting for instructions humanities/social sciences (HSS) play a key Some of Japan’s liberals see downsizing rather than taking the initiative. Liberal arts role in other strategic goals and universities HSS as an attack on democracy. But many education is no panacea, but downplaying its at which the HSS are relatively isolated. For conservatives view these protestors as trou- role in university education is more likely to example, when HSS are central to an in- blemakers. Back in 2012, when these stu- exacerbate than rectify such deficiencies. bound degree program or international stu- dents were protesting Abe’s proposed State Japan is hardly the only advanced dent exchange program (which contributes Secrets Act, Shigeru Ishiba, then Liberal industrialized country attempting to down- to internationalization and/or rankings Democratic Party (LDP) secretary general, play HSS in favor of “more practical” areas. strategies) they are not in danger of being called the demonstrators “terrorists.” Academic associations in Britain and the US cut. But, if the departments are providing also complain of budget cuts aimed at HSS. education mostly to Japanese students and Keidanren vs. MEXT enrollment is declining, then pressures to Higher education at its best prioritizes criti- Education reform is needed reorganize are somewhat inevitable.” cal thinking and prepares students to engage Not every educational expert sees the MEXT in an increasingly globalized workplace. proposals as wrong-headed. Bruce Stronach, Conclusion Hence, business executives are also dis- Dean of Temple University and former pres- At this point it is too soon to draw conclu- mayed about plans to marginalize HSS. ident of Yokohama City University, thinks sions because the impact will only begin to Keidanren said MEXT’s emphasis on sci- that the MEXT directive might serve a use- become apparent in 2016 when universities’ ence and vocational skills is misguided and ful purpose. Traditionally, he says, “faculty initial responses take effect. Given MEXT’s “exactly the opposite” of what employers saw themselves as intellectuals and not nec- power of the purse, early reports that many want. In its September 9 statement, essarily as educators.” In this system, “stu- universities are complying to some extent Keidanren emphasized that liberal arts edu- dents could go through university basically with the directive regarding HSS are not sur- cation imbues future employees with prob- doing nothing…because companies spent prising. However, there are also signs that lem-solving skills and the ability to under- years educating and training them once they coping strategies by national universities stand other cultures and societies. Indeed, in became company employees.” Today, how- will cushion the impact and preserve HSS, at June 2013, Keidanren made a proposal for ever, “Rapid advances in technology, com- least for now. As older faculty retire and fostering global talent, writing “it is neces- munications and science have created a administrators use new powers to redirect sary to enhance liberal arts education for bet- greater need for specialization, and as finan- hiring and funding, the impact could become ter training of global citizens.” cial problems cut down on lifetime employ- far more profound. Will MEXT’s reforms It also called for more interdisciplinary ment and corporate education, budget improve the poor level of education that cur- studies to break down barriers between HSS adjustments had to be made.” rently prevails at too many Japanese univer- and STEM, expanded overseas student In his view, “What is necessary today sities? On that score, there seems scant rea- exchanges and international collaboration, are critical thinking, communication with son for optimism.

THE ORIENTAL ECONOMIST OCTOBER 2015 13

and trade growth than with a multi-currency system? Or, do you see it resulting in some INTERVIEW sort of crisis? Eichengreen: Either scenario is possible. During the 1930s Depression, we saw the latter scenario as Britain devalued the pound Barry Eichengreen: in 1931, which caused a panic on foreign exchange markets and we got a global liq- China financial turmoil uidity crisis. On the other hand, disenchant- ment about US budget deficits, US monetary policies, and disappointing US growth could Barry Eichengreen is a Professor of Economics and Political Science at Berkeley and play out more as a kind of slow motion a former senior adviser to the International Monetary Fund. His 2010 book, Exorbitant grinding down of growth if other currencies Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary did not play a growing role. System, focused on the issues we are discussing here. TOE: A couple decades back, people talked TOE: You have long believed that the inter- Adjusting the short-term exchange rate fluc- of the yen as a reserve currency. national monetary system would do better tuations, the dollar’s share may have fallen Eichengreen: A true international currency with more than one reserve currency, not just by a 1 or 2 percentage points over this peri- has to have three attributes: size, stability, the dollar. od. The dollar is involved in about 85% of all and liquidity. The yen didn’t make it because Eichengreen: The foundation for interna- foreign exchange transactions worldwide. it didn’t have the stability. In the 1990s, the tional monetary systems is safe and liquid That’s down a little bit from the late-1980s, Japanese financial system didn’t have the assets. For many years, that has meant US when this data was first collected. The dollar stability and now there are questions about treasury securities. As the world continues to still accounts for nearly 80% of total trade the stability of the yen exchange rate with become less US-centric economically, it has financing worldwide and 45% of the world’s the push for depreciation. But there’s also to become less US-centric financially. The exports are still priced in dollars. the issue of the size of the platform. The rea- US cannot all by itself provide enough safe son that the US, the Eurozone and China are and liquid assets to meet the global econo- TOE: Is it meaningful that less than half of the three most logical candidates is that their my’s needs. exports are denominated in dollars? issuers are engaged in a lot of international A multi-currency system means that Eichengreen: Not really. Europe has always merchandise and financial transactions. exporters will price more of their exports in done a lot of invoicing in its own currencies. Japan has not been a growing economy for a euros or Chinese renminbi (RMB), as well while now. I think there can be a subsidiary as settle their trade and financial transactions TOE: The failure of this to change—even role for subsidiary currencies, like the Swiss in those other currencies. Central banks will though people have been saying for decades franc and the yen. hold other currencies as part of their that it should and would change—raises the reserves. Corporations will hold some of question: maybe, it doesn’t need to change. TOE: The Wall Street Journal had a front their liquidity in securities that are denomi- Eichengreen: The reason those expectations page article pointing out that world trade nated in other currencies. have been disappointed is the failure of the growth has been slower than global GDP obvious candidates for alternatives to make growth for three years in a row. That is TOE: What would be the consequence if we faster progress. 15 years ago, everybody said unusual compared to the last few decades, did not move into more of a multi-currency- the euro would rival the dollar, but the euro when globalization has led growth. based system? has been deeply troubled. Now, the story is Eichengreen: This is a major mystery and I Eichengreen: A global liquidity shortage. similar for the Chinese RMB. China is trying don’t have a satisfactory explanation. There Central banks would not be able to accumu- to build deeper and more liquid financial are a few factors to point to. There has been late the reserves they need to feel secure and markets, but in the last few weeks, it’s tight- some murky protectionism. Trade credit has to intervene in international financial mar- ened a variety of capital controls because of become harder to obtain in a variety of coun- kets. Corporate treasurers would not be able the weakness of the currency and the insta- tries. China’s slowing growth has a lot to do to accumulate and hold enough of the inter- bility of financial markets. On the other with this because China imports components nationally accepted liquid assets they need hand, up to now, the US has avoided the in order to export final goods, and we count for foreign investment and trade finance. worst. We have raised the debt ceiling on both the import components and the export 21st century globalization would be at risk. Treasury debt and avoided alienating bond- of final goods. I think the logic for trade holders. growing faster than GDP—a growing inter- TOE: To what extent is this evolution national division of labor—remains intact already occurring? TOE: Let’s assume the US Congress doesn’t and we should expect to see trade growing Eichengreen: It is occurring, but at a glacial do something crazy, like refusing to raise the faster than GDP again. The current aberra- pace. The share of central bank reserves held government debt ceiling. Do you see the tion is a bit perplexing. in dollars has fluctuated at a little more than adverse consequences as a slow corrosion of 60% for the last couple of decades. the system, and therefore slower global GDP TOE: The International Monetary Fund

OCTOBER 2015 THE ORIENTAL ECONOMIST 14

(IMF) has said that the RMB is no longer stock market more transparent, and create a timeframe for the RMB becoming a major undervalued. proper corporate bond market. After all that, global reserve currency? Eichengreen: The RMB looks appropriately then liberalize the capital account. Eichengreen: In my 2010 book Exorbitant valued at this point. China’s current account The Chinese leadership basically has Privilege, I said I could imagine that, by surplus [the broadest definition of the trade the same view that financial strengthening at 2020 or so, the dollar might account for less surplus] has shrunk. The RMB has strength- home must come first, but I worry that they than 50% of global foreign exchange ened an awful lot on a real effective basis have erred a bit in going too fast on the cap- reserves and other transactions; the euro [i.e., adjusting for the difference between ital account liberalization and too slow on maybe 30%; and the Chinese currency price changes in China and price changes in domestic financial reform. Still, Chinese maybe 10-15%. I was too optimistic; it will its trading partners]. policymakers have studied the 1997-98 probably take longer. The Chinese are serious about wanting financial storms, and they drew the right les- to rebalance their economy away from sons. TOE: Is a multi-currency system sort of like excessive reliance on a trade surplus and fusion power: no matter when you make the move toward domestic spending. So, a weak TOE: One of the interesting things—which forecast, it’s always a couple decades away? exchange rate is no longer integral to their is being ignored in the US Congress—is that Eichengreen: If that’s true, then I would growth and development strategy as it was in the Chinese spent an estimated $120 billion worry where we will get the liquidity needed the past. They have been saying this for long in August, and perhaps another $40-50 bil- for global financial markets and global trade. enough and consistently enough that I think lion so far in September, to prevent the RMB It cannot only come from the US forever. they really mean it. from falling. So, they seem to prize stability. Right now, we’re having a test. A weak- If they were to open up the capital account TOE: In their efforts to control both the er currency will do a little bit to boost their before strengthening their domestic financial RMB rate and the stock market, the Chinese exports and boost their economic growth. Do system, would money flow in and raise the government has not only intervened in mar- they care more about economic growth or level of the RMB, or would it flow out and kets, but also arrested investors and journal- about rebalancing the economy? I think they cause the RMB to fall? ists. Do you think such actions stabilize are serious about the rebalancing part. Eichengreen: Many studies have concluded things? Or, do they end up destabilizing there’s no way to tell. Until this summer, my them because they show how worried the TOE: One of the things we learned from the view was that inflows and outflows would be government is, and how you can lose your 1997-98 Asian financial shock is that, when pretty evenly balanced. At present, there’s no ability to withdraw money just when you you want to do financial liberalization, question that the money would mainly flow really want to? sequencing is extremely important. There out. Not so many people want to invest in Eichengreen: There is no question that, in have been calls for China to liberalize the China right now, and lots of Chinese have the longer run, those steps are counterpro- capital account on RMB movements [i.e., noticed that foreign financial markets are ductive. They will discourage international allowing people to freely buy and sell the more stable, more liquid, and more transpar- participation in Chinese financial markets. RMB for capital and other financial flows, ent than their own. We would have the iron- There may be some stabilizing effects in the not just for trade]. That’s one of the things ic situation where Congressional pressure on short run. But, if you’re trying to build deep, the IMF says China has to do if the Chinese China to free its capital account would just liquid, transparent, and credible financial want the RMB to play a big international lead to a weaker RMB. markets, the Chinese actions are the opposite role. How do you think the sequencing of what one would want. would best be done? TOE: I think there is a Chinese proverb: be Every first class international currency Eichengreen: The best way is for China to careful what you wish for. In the absence of in history—and there have only been a few go much further in strengthening domestic domestic financial strengthening, would we of them—has been a currency of a democra- financial markets and regulation before see a lot more volatility in net inflows and cy or republic governed by the rule of law. opening the capital account further. The outflows, and therefore in the RMB rate, and People will tie up their money in the curren- Chinese are going slow on capital account whatever consequences that has for Chinese cy of a country only if the state cannot arbi- liberalization and trying to go as fast as pos- interest rates? trarily change the rules of the game sible with financial strengthening and devel- Eichengreen: Yes. More than a century of overnight. I don’t know whether the Chinese opment. historical experience teaches that open capi- political system is compatible with their I do worry about any attempt to use cap- tal accounts can be an engine of volatility, international currency ambitions. If not, how ital account liberalization and RMB interna- that capital flows can reverse on a dime, and modestly or radically would the political tionalization as kind of a lever to force faster that financial markets, economies, and polit- system have to change? domestic reform. There are people who say: ical systems can find it hard to cope with the open the capital account, let foreign banks consequences. For an open capital account to TOE: Is that a question of having democrat- in, because this will force the Chinese banks be a positive for economic development, you ic elections, or just the rule of law? to modernize and respond to the chill winds need strong financial markets, strong finan- Eichengreen: It’s fundamentally a question of competition. I think that’s dangerous. The cial institutions, and a strong political sys- of the rule of law. Are democratic and non- Chinese would be better advised to first tem. democratic political systems equally capable bring the shadow banking system into the of enforcing and respecting the rule of law light, privatize the state banks, make their TOE: What does all this mean in terms of over time? I don’t know the answer.

THE ORIENTAL ECONOMIST OCTOBER 2015