IP: speech by Joichi Ito to be given in three hours at Trilateral Commission

[Dave Farber <dave () farber net>]

From: Joichi Ito <jito () neoteny com>
Date: Sun, 07 Apr 2002 18:53:35 +0900

I am attending the Trilateral Commission Annual Meeting this year to
participate as a speaker. Yesterday, Secretary of State Colin Powell and
Defense Secretary Rumsfeld talked about the US response to 9/11. Sadako
Ogata and Henry Kissinger talked about International Order. Tomorrow,
Prince El Hassan, of Jordan and the President of the Club of Rome will
speak about Islam. Yoshimasa Hayashi and I will talk about reform in Japan.
Finally the Vice President of the US will make some remarks. I am still not
sure why Tony Kobayashi, the Pacific Asia chairman, has allowed me to speak
my mind in the company of people like this, but following is a draft of
what I intent to say tomorrow. Since I haven't given the speech yet, any
comments would be helpful. Thanks.

I would like to briefly describe what I think is going to happen to Japan,
where we are now in that process, and what do we do afterwards. I would
like to qualify my remarks by saying that I am not an economist or a
historian and since I speak primarily in Japan, my remarks tend to be on
the more radical side since I find that points need to be made very clear
to avoid being transformed into apathetic understanding.

I believe that the primary problems facing Japan today are a dysfunctional
or even the lack of a market, an aging population and a bad debt and
thereby an impaired balance sheet issue. I believe the bad debt issue is
being thoroughly discussed and considering the fact that it is probably
about 1/12th of the financial savings of Japan, I believe it is a
procedural issue. I think that, the fact that the balance sheet of Japan
has such a high savings cushion, hinders the kind of intense sense of
urgency that is required to move reform ahead quickly as it has in
countries such as Korea.

My theory, so that you don't all wonder where I am going with this, is that
I believe Japan has the resilience to rebound from a hard landing if we do
it before the aging of Japan makes it impossible. I believe that Japanese
entrepreneurialism after WWII shows that, given the opportunity, Japanese
can be entrepreneurial, focused and efficient.

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

The problem that needs to be solved for Japan to have a true productivity
and growth revival is for Japan to build new businesses that it can be
competitive globally considering the recent changes in the global markets.
Japan can no longer be competitive in manufacturing long-term considering
the emergence of China and other competitors in Asia. Although Japan is
still weak in these areas, a shift towards IT, bio-tech and service
businesses is the only alternative. For this reallocation of human and
financial resources to occur, a major change is required in Japan. I
believe that unlike the socialist sort bureaucracy planned Japan Inc.
methods which are prone to central planning rather than being market
oriented have thus far been popular in Japan A market oriented shift is the
most efficient and appropriate. In fact, I would argue that it is the
industries that the government has not meddled in that have thrived in
Japan, such as automobiles, and industries such as financial services that
have been tightly controlled that have failed in Japan.

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

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

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

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

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

Most employees in Nissan knew what it would take to turn Nissan around, but
the CEO was unable to execute these changes because of the social contracts
in place. Carlos Ghon, although he is a great leader, made his biggest
contribution by defaulting on social contracts. Tim Collins' fund,
Ripplewood, has shown through it's acquisition of the Long Term Credit Bank
of Japan and the following turn-around into Shinsei bank that banks in
Japan can actually be efficient and profitable if allowed to execute
unencumbered by old social contracts.

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

I am not an anarchist, but I predict a certain level of anarchy, and I
believe that this is necessary to create the true bottom of the market
which will be the platform of rebuilding Japan. A soft landing with a false
bottom will not root out the entrenched corruption and will not set in
motion a true open and free market. Japan missed the opportunity to create
such a market after the war because the American's allowed the old Japanese
power structure to remain in place after the war in order to fight
communism so this may be the first such opportunity since the Meiji
restoration.

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

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

I think that many large companies will collapse and the basic fabric of
Japanese trust will be damaged causing crime to increase and many other
problems to occur. I believe that a increased role of women, proper
representative political system, financial literacy and self-esteem will be
essential elements of rebuilding Japan into a globally integrated and
productive country. Although many Japanese are trying to back-peddle on
best practices since Enron, I think that foreign investors such as
Ripplewood and foreign CEO's such as Carlos Ghon will help Japanese
understand that companies can be competitive without being woven into the
fabric of traditional Japanese relationships. I believe that Japanese
business has some great unique traits such as the hard working
stick-to-it-ness of Japanese workers and the ideological flexibility that
allows quick changes when necessary, but I believe these Japanese features
to Japanese business should be added to our system once we prove that we
can manage a free and open market with global best practices.



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