Focus: Foreign Investment

JETRO, 1221 Avenue of the Americas, NYC, NY 10020July 29, 2002


Japanese Economy Offers Investors a Source of Global Diversity

Uncertainty over the U.S. economy has led many investors to regain their appreciation for the benefits of international diversification. As a result, Japan – the world’s second largest economy – is beginning to attract more attention from global corporate and portfolio investors. While the long term implications of this trend remains to be seen, the Nikkei 225, Japan’s primary market index – has outperformed the U.S. Dow Jones Industrial, S+P 500 and NASDAQ, as well as most major European, indexes over the past year.

Following almost a decade of sluggish growth and stagnation since the collapse of its bubble economy in the early 1990s, Japan is showing signs that it is emerging from its troubles. Dramatic changes in its regulatory infrastructure have lead to a surge in foreign direct investment. While still small compared to the levels seen in the U.S. and other major economies, incoming investment is playing a leading role in changing the corporate dynamic and way that business is conducted in Japan.

Further change is indeed necessary and substantial steps need to be taken to build on the momentum that has been achieved. Nevertheless, the growing attractiveness of Japan’s refined and highly sophisticated market – containing more than 100 million consumers with ¥1,400 trillion in personal assets – is increasingly recognized by U.S. and foreign businesses, who are coming to understand the opportunity and potential that it offers.

In recognition of these trends and the importance of facilitating cross-border investment flows between Japan and the U.S., a bilateral Investment Initiative was established in June 2001. In addition to high- and working-level discussions, the Initiative has organized public symposiums in the U.S. and Japan, including two events earlier this month in New York and Chicago. During these forums, senior public and private sector leaders, including representatives from prominent U.S. firms such as Goldman Sachs, Johnson and Johnson, Pfizer, Solo Cup, Walmart, WL Ross and Co. and others recounted their experiences, and offering advice for U.S. investors and executives seeking to enter and operate in the Japanese market.

The Japan External Trade Organization (JETRO) provides the following information examining these issues in greater detail.


Japan Maintains Progress in Achieving Comprehensive Economic Reform

Recognizing the essential need to initiate comprehensive change in the Japanese economy, its government adopted a comprehensive "Action Plan for Economic Structural Reform" in 1996.

This has led to a wide range of initiatives designed to enhance corporate competitiveness and flexibility. Programs include measures to promote small and medium enterprises, to utilize information technology,to increase the flexibility of Japanese labor markets and to reduce the high cost of doing business in Japan.

While much more needs to be done, significant progress has been achieved since this initiative was introduced five years ago. Achievements include an end to the prohibition on holding companies, introduction of stock swaps and transfers, facilitated listings and use of stock options, establishment of technology licensing organizations, enhanced information technology policies and deregulation of financial services, energy and logistics.

Over the past year one major success includes significant reform of Japan’s Commercial Code. "This will allow Japanese firms for the first time", in the words of Vice Minister of Economy, Trade and Industry Hidehiro Konno, "to speak a common language in terms of corporate governance with their colleagues in the U.S. and other markets ." Changes include measures enabling more transparent accounting, additional liberalization of stock options, increased labor mobility and improved real estate liquidity. This will help to further advance increasing foreign investment flows as well as to promote productivity and economic growth.

Revisions to Japan’s Commercial Code Allow Adoption of U.S.-Style Corporate Governance System

Specifically, in April, 2003, large Japanese firms will be able to adopt a U.S.-style corporate governance system. As opposed to the present system, which is comprised of separate boards of directors and statutory auditors, Japanese firms will be able to establish nomination, compensation and auditing committees within their boards of directors. This change will provide the board with more power to monitor and influence the internal affairs of the company. The majority of members in each committee will be comprised of outside directors. It will facilitate the ability of these companies to delegate the authority needed to effectively manage their financial and operating needs.

Next year companies will also be able to use certifications issued by lawyers and accountants as an alternative to reports by court-appointed inspectors to value in-kind capital contributions. This will facilitate their ability to enact and consummate mergers and acquisitions. Furthermore, the requirement that foreign companies conducting continuous business operations in Japan have to set up a branch office will be abolished.

Additional reforms over the past year include a further liberalization of restrictions on stock options. Permission has also been granted to utilize the Internet and other electronic means to exercise voting rights and to release shareholder notices. Companies are also now able to satisfy their disclosure requirements by making the full text of income and balance sheet statements available on company web sites and other Internet forums for five years. Other notable recent reforms include a relaxation of restrictions on equities pricing and the issuance of tracking stocks.

Japan Adopted New Mark to Market Accounting Standards in 2001

Following the "Big Bang" reform of Japanese financial services in November 1996, the Business Accounting Council carried out research on the accounting practices of the U.S. and other major industrial countries. This was done to identify best practices and measures that would enhance competition and market discipline in a manner that satisfies the objectives of being "free, fair and global".

Over the past five years the Council has developed a series of measures designed to improve disclosure of consolidated financial information. This includes measures to improve the accounting treatment of cash flow statements, R&D costs, retirement benefits and taxation.

As of last year, Japanese accounting rules were reviewed entirely and revised accordingly. Consolidated cash flow statements have become mandatory. Tradable securities are now measured at fair-value, with any unrealized gains and losses included on income statements. Other securities, including cross-shareholdings must also be measured at fair-value, with unrealized gains or losses recorded on the firm’s balance sheet. Other measures will help to more accurately gauge the effect of hedge, derivatives and retirement benefits accounting.

Japan Initiates Measure to Enhance Labor Flexibility and Pension Portability

As Japan shifts from a system based on lifetime employment to one that rewards labor flexibility, the perceptions of both workers and business owners have begun to change. Many are beginning to appreciate the benefit of mid-career hiring. The number of temporary workers has risen from 570,000 in 1993 to 1,390,000 in 2000 and the ratio of temporary/part time to regular workers has risen from 20.8% to 27.2% over the same time period. As a result, Japan is seeking to adopt human resource practices that emphasize the needs of workers and to establish a better evaluation system to determine vocational abilities. This includes an expansion of alternatives in corporate pension practices, such as the introduction of defined contribution and hybrid plans that enhance pension portability.

Steps have also been taken to help Japanese workers advance their careers by facilitating their ability to change jobs and to obtain the skills and training needed to compete in a globalizing world economy. This includes a dramatic expansion of the number of jobs eligible for temporary employment and a general relaxation of measures regulating the employment placement industry. Measures have also been adopted to promote employment of women and displaced middle-aged and elderly workers.

Recognizing the need for ongoing and comprehensive restructuring on the firm level, Japan has also been active in clarifying the rules and standards that govern corporate divestiture and the dismissal of workers. This is being done to avoid useless disputes and to allow the rational application of judicial precedents and standards that will protect both workers and shareholders and allow for a more rational and transparent divestiture and reorganization process.

Japan Perceived as Source of Potential Growth in the Face of Market Turmoil

As the U.S. economy continues to work off the excesses of the late 1990s Internet bubble, foreign corporate and portfolio investors are coming to more fully appreciate the underlying attractiveness of the world’s second largest economy.

Possessing a Gross Domestic Product (GDP) about half as large as the U.S. or Europe – and more than four times the size of China – Japan is one of the world’s most affluent and sophisticated consumer and industrial markets. It contains more than 100 million consumers with ¥1,400 trillion in personal assets.

Despite its economic problems -- per capita income in Japan remains larger than the U.S. and major European nations. On average, households headed by persons in their sixties hold assets averaging about ¥60 million, of which roughly ¥20 million is accounted for by financial assets. This combination of scale and income level makes Japan an ideal market for the upscale goods and services that constitute a major portion of U.S. exports.

Japan also possesses one of the best-educated work forces in the world. 49.3% of its students go on to Universities and Junior Colleges. This compares to only 45.9% in the U.S. and 21% in Singapore. Japanese workers are also extremely diligent. According to the International Labor Organization, Japan firms lost only about 5% as many man/days to strikes and labor unrest as companies in the U.S. in 1999 and Japan consistently ranks as one of the safest countries in the world.

Recognition of this trend has caused FDI inflows into Japan to increase significantly in recent years. The value of transactions rose from ¥598 billion in 1997 to ¥3,283 billion yen in 2000 – an increase of over 500%. The number of M&A transactions has also grown substantially, from 531 transactions in 1995 to 1241 in 2000. Entrepreneurship is also on the rise. While unemployment has risen modestly, over one million people are said to be hoping to start businesses. Of this figure, over half state they are already making preparations.

Japan Offers Safe Haven and Upside Potential to Corporate and Portfolio Investors

While Japan has far to go in delivering on the promises of reforms measures enacted in recent years, investors have begun to realize the stage is being set for an environment that can lead to an increased valuation of Japanese assets. Many perceive Japan to be a relative safe haven during a turbulent time. While the long term implications of this trend remains to be seen, the Nikkei 225, Japan’s primary market index – has outperformed the U.S. Dow Jones Industrial, S+P 500 and NASDAQ, as well as most major European, indexes over the past year.

In the recent New York Investment Initiative Symposium organized by the Japanese and U.S. governments, Wilbur L. Ross, Jr., Chairman and CEO of WL Ross & Co. LLC emphasized that Japanese real estate, stock and country club membership prices remain at twenty year lows. This is far below the level currently seen in the U.S. even accounting for the recent downturn. Ross also noted the reduction in cross shareholdings (from 18% in 1990 to 10% in 2000) and other equity holdings by Japanese banks will make a larger supply of securities available to foreign investors. Other key advantages include the ability of Japanese markets to provide a liquid source of diversification for investors seeking a safe haven in view of current market trends. Additionally, Japanese government spending and a comparatively lower cost of leverage can enhance the return of equity investors in Japanese securities. Finally, foreign direct investors can obtain very low cost financial leverage to enhance potential returns and can profitably hedge their yen investment back to U.S. dollars.


Foreign Direct Investment is Beginning to Change the Business Dynamic in Japan
Only a few years ago foreign companies and investors considered Japan to be a relatively closed market. They found it very difficult to establish themselves and to acquire the human resources needed to succeed in an environment in which the most promising candidates sought to enter a lifetime career path with a few select Japanese government or corporate entities.

Over the past few years a rising number of foreign companies -- who have entered Japan through either greenfield or the acquisition of Japanese assets – have begun to radically change entire sectors and the way that business is conducted in Japan.

Change is most visible on the consumer level and firms such as Starbucks, Toys-R-Us, Walmart, Costco and the Gap have dramatically changed the face of Japanese retailing. Citibank and other U.S. financial institutions as well as foreign-owned Shinsei Bank and Kansai Sawayaka Bank have introduced major innovations in the field of financial services. Equally notable is the success achieved by Carlos Ghosn at Nissan, who one Japanese government official has described as a "Japanese national hero". Less well known are the success of major U.S. pharmaceutical firms such as Johnson and Johnson, with $1.5 billion in 2001 revenues and Pfizer – which ranks third in overall pharmaceutical sales in Japan and first in cardiovascular and second in anti-infective sales.

In addition to resuscitating specific troubled enterprises, foreign investment is helping to introduce new business models and practices in Japan. It is changing the way in which Japanese firms market, finance and operate their enterprises and is presenting more options to Japanese consumers. Employment practices are also changing, with many prominent students from prestigious Japanese universities now preferring to begin their careers with foreign firms. This was simply unheard of in the past. It is also encouraging a shift away from lifetime employment to an environment that allows mid-career transition.

Japan Hopes to Accelerate the Involvement of Foreign Investors in Coming Years
For more than 50 years, Japan maintained its own style of employment and financial systems, with corresponding corporate governance and other institutions and practices. Today, however, in recognition of the need to speak a common language with other global trading and investment partners, all these systems are changing. The objective is to shift from a system that gave priority to high efficiency to a new system that facilitates the smooth transfer of resources from low- to high-productivity sectors. Drastic reforms have been made to help Japan transform itself into a more market-oriented system. In the years to come Japan hopes to build on these efforts, to accelerate -- both its ongoing restructuring and reform efforts as well as the increasingly important involvement of foreign companies and investors.

As one of the three top global economies, Japan possesses one of the world’s most sophisticated and affluent consumer markets. Combined with its leading edge in numerous technologies and manufacturing processes, along with its high quality, highly motivated workers and well-maintained industrial infrastructure, Japan represents an excellent place to track market trends and to sell U.S. products and services. In addition to the attractions of its own domestic market, Japan can also serve as a hub for expansion to the vast Asian market.

U.S. corporate and portfolio investors who are seeking to expand their international market presence and to achieve greater diversity in their portfolio investments will find a welcoming environment and source of future growth that is perhaps unmatched in the world. Furthermore, it is by no means farfetched to say that no global business strategy can be complete without investment in Japan.

This thought is reflected in the words of John A. Thain, President and Co-Chief Operating Officer of the Goldman Sachs Group, who delivered a keynote address at the recent N.Y. investment seminar. Mr. Thain noted that "as a global firm, Goldman Sachs is concerned with not only the US market, but also global markets with the Japanese market being especially vital." He further explained that "Goldman Sachs has about 1200 employees in Tokyo, making it their second largest office after New York, making it a very important part to their business."

For additional information, please contact Satoshi Miyamoto, Executive Director of JETRO NY at Tel: 212-997-0416, Fax: 212-997-0464, E-mail:

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This material is published and disseminated by JETRO New York in coordination with KWR International, Inc. JETRO New York is registered as an agent of the Japan External Trade Organization, Tokyo, Japan and KWR International, Inc. is registered on behalf of JETRO New York. This material is filed with the Department of Justice where the required registration statement is available for public viewing.