How Should We Look at Asian Investments?
A Chat with Arthur Mitchell, former General Counsel, Asian Development Bank
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Interview by Keith W. Rabin |
Hello Arthur, good to see you again. Years ago we first met in New York and your practice focused primarily on supporting Japan-related business and financial transactions. Now even though you are based in Tokyo you have a broader focus. What led to this development?
In some ways the pivotal experience was working with ADB. In the late 80s I helped Japanese clients with real estate investments in the US and later on private equity in the high tech sector. I've also done a lot of Japan-focused M&A and project finance transactions. ADB however broadened my experience beyond Japan and I lived for the first time in a developing country, the Philippines. That helped to give me broader experience and since leaving ADB I have been active throughout the region.
How is Japan doing these days? The election of the DPJ last September introduced promise of change though we already have a new Prime Minister and the Upper House election in July has some analysts even questioning the governability of the nation. What are your thoughts?
I think Japan is in search of a new identity. For almost 150 years since Commodore Perry entered Japan, its citizens knew what it was all about. Developing national strength, at times military strength, and building up the economy. They achieved all of that, particularly economic power, but seem to have lost a sense of purpose. So they are trying to find their role in the world. The DPJ came to power with the idea it would reconstitute Japan's relationship with the US and open a broader engagement with Asia. So far they have failed at both. While it is a viable idea, it has yet to be seen how the new opening to Asia will work. China in particular is not ready to accept Japanese leadership. Therefore the question is what kind of cooperative relationship can be worked out. There is no answer yet because in the past Japan has relied on economic aid and now they have been cutting back due to budgetary concerns.
Japan's relationship with China is complex. It is their largest market right now yet it is the biggest challenge to Japan in terms of its place in the world. And when we hear talk about the "G2", the Japanese get rightfully nervous as they are left out and feel marginalized. That is something they need to work out.
Japan used to be a high trust society. People believed politicians and other institutions served their interest. Now it has become low trust and people are cynical about their leaders and the ability of institutions and businesses to do the right thing. In some respects the "Iron Triangle" of big business, the bureaucracy and politicians still exists -- but they are no longer delivering the goods the way they used to. And if you tune into the Sunday television talk shows, politicians from all parties say we need to gain the trust of the people but noone has it. This is a new phenomenon for Japan and we have to see how it plays out over time.
The DPJ came in with a new approach but they were new and inexperienced and did not implement well. So they lost the Upper House election and their strategy seems to be to try to develop consensuses with different parties on different issues. That is unlikely. We are likely to see a continuing disintegration of the major parties. I see them splintering into what I call pygmy parties. A year ago people thought we would see development of a robust two party system. We now seem to be moving in the opposite direction.
One trend in our work is a growing recognition among companies and investors that the long-term attractiveness of emerging Asia rests on its potential to deliver growth and demand rather than as a platform to lower production costs. Are you also seeing this shift in thinking and how does it manifest itself in terms of client needs?
Japan, China and most other Asian markets all recognize the need to develop their domestic markets further. It is happening, but it is not easy. It is much easier to promote exports. This is how they are organized and until recently there had been huge demand in the US and Europe. The winds though are now going against the structure as demand tapers off in these markets - yet it is still early to think of Asia as the replacement.
So why isn't domestic demand driving the Japanese economy? People have grown up with a savings mentality and they are not certain about their future. So they don't want to spend money. Japan does have pensions but the system does not provide a strong social safety net compared to the US and Europe. Furthermore during the Koizumi period they restructured the work force. One third of the 55 million currently working make less than $20,000 a year in jobs that are completely insecure. And wealth is concentrated in the hands of people over 60, who don't spend much. So some people have no money and some have too much. Part of the DPJ strategy is to reallocate money to the middle class but they are also saving it and not spending as expected.
China has more limited pensions and health care though as a country they are hugely wealthy in terms of foreign reserves. But it is poor and still developing.
According to the IMF, in 2009, China ranked 98th with $3,678 in nominal per capital income while Japan ranked number 17 with $39,731.
Therefore, my development economist friends might disagree but, based on my experience in Asia, I think that we need to distinguish between countries in which a significant part of the population is "relatively poor" and those where they are "absolutely poor", the latter being defined as earning less than $1 or $2 a day. As I said, Japan is a wealthy country with many wealthy people mostly over 60 years of age. At the same time there are many younger people with tenuous jobs, making them "working poor". I would say that these people are "relatively poor" as compared to the rest of the population. China is a wealthy country with over $2 trillion in reserves. At the same time it has a large absolutely poor population and a growing middle class. By contrast, the Philippines is a poor country with many people who are "relatively poor" when compared to their cohorts but because of the family support system and the large amount of remittances from Filipinos working overseas, simple comparisons of per capita income may not reflect reality.
That is important to understand why domestic demand is not likely grow large enough or soon enough to make many foreign investors happy. So when we speak of China, the domestic market and middle class is growing, but it is still small in the context of the country as a whole. Therefore we need to be cautious about how much of the domestic market can be captured by foreign enterprises. Remember in history class when we read how American whalers dreamed about supplying all of the "lamps in China" with whale oil?
Additionally, despite the strong grip of the Communist Party there is tremendous insecurity beneath the surface. So that is why even though the Obama administration wants the US to raise exports it will be difficult to sell things into China, especially as we don't have as much of a monopoly on brands as we used to. The bottom line is it is not a mass market yet. Incomes need to rise in China and to be reallocated in Japan as well.
Having said that there are big opportunities for businesses. Areas such as aircraft and technology should do well. Clean technology is another bright spot. Energy is urgently required in China. But the West does not have an automatic advantage and we will have to work for it.
When companies look to Asia they are told they need to adopt a longer-term mode of thinking and emphasize flexibility and relationships rather than the more contractual approach we see in the US. Is that an accurate view and if so how can companies achieve the level of certainty and stability needed to fund expansion and necessary investments?
The first question companies need to ask is whether there are legal restrictions on how much an investor can own in a market. Do they need to have a joint venture or can they establish a wholly-owned company? And if they can have a wholly-owned company is that the right way to go?
For example, in the Philippines many industries are restricted and you need to have a joint venture partner. Personally I think even if you are not required to have one it is usually wise to have a local partner so long as you choose one with great care. You need to find one with capital, experience, compatibility and integrity. If you do, the contract will follow from that. If, however, they don't have the underlying structure and skills, it does not matter what the contract says.
Every country is different however. Even today in India if you enter into a joint venture you are not allowed to do another in a similar sector unless your existing partner agrees to it. So you can handle that by getting your partner to agree up front that is ok. In the Philippines you don't have that problem. You are restricted in terms of the equity share you can hold, but you can have multiple-layers of subsidiaries. This is legal and allows you to obtain economic benefits that are commensurate with your invested capital.
The major issue is can you do it alone and do you want to do alone. Unless you have been in the country for a very long time you likely need help and in most countries are better off with partners. There are many kinds of partnerships though and companies need to decide what they need out of a partner and then work out the right arrangement.
It is true though in a sense that Asia is less open than the US and more subject to local culture and relationships and customs. Over time one gets a better understanding and becomes part of the local environment. Coca Cola Japan for example has been here for over fifty years. They have local staff and support and in a way have almost become a local company. Localization is also a big trend and multinational companies are hiring more local managers with fewer expatriates than in the past.
You are particularly bullish about the Philippines. What causes you to characterize it as an attractive opportunity and how does it compare to others in Emerging Asia?
This might surprise you but the picture is brighter there than at anytime in the last ten years because the election went very smoothly with little corruption or violence. Prfesident Aquino seems to be a reformer. He appears sincere and honest and has chosen good people for his cabinet. There are big challenges however. First, the people around him cannot engage in "grand corruption". He must get a hold of key officials. Second, they need to increase tax and customs revenues to put the country's finances in better shape. Third he has to pursue past corruption in a way that does not disrupt the system and cause gridlock. That means going after past leaders but keeping things in balance. Finally he has to keep the military on the bases, which will happen if they think the political system is under control. Nevertheless that is a tough job.
What are the needs? This is a country that officially has 90 million people with another 10 million overseas, though it may be more than that. They have huge needs and a young population. They need everything including power and infrastructure but investment in these sectors has been limited so there is a lot of pent-up demand. Energy is also important and they recently passed a new renewable energy law, which allows for feed-in tarrifs. The nation is also rich in minerals of all sorts and mining is a key sector.
In addition, the Philippines rates well in comparison with its neighbors. They speak English and have many skilled workers with high levels of education. Thailand is not high on the list right now given political uncertainty. And China despite the propaganda does not enjoy a good reputation among foreign investors right now. The sentiment is the government is not encouraging FDI the way it used to. It goes back to the domestic demand issue we discussed earlier. Foreigners used to develop the factories. But China now has large reserves and is starting to encourage more domestic demand. What does the government want in terms of foreign participation? It doesn't seem to be the same level as before. The “indigenous innovation” policies now emerging are also troubling.
Due to political instability during the Arroyo administration, foreign investors have avoided the Philippines for some time. But as I mentioned, it is a country of about 90-100 million people. That is a meaningful but manageable number. In comparison India has about 1 billion. It also has more absolute poverty, whereas Filipinos can be said to be "relatively poor" given the strong family networks. Per capita does not make sense when looking at the Philippines, as you need to look at broader measures of family income. The bottom line is the Philippines has great potential - so long as corruption is controlled and stability maintained.
In contrast many firms and investors do not seem to be paying much attention to Japan and other developed Asian markets even though these constitute large markets with lots of buying power. Is it wise to look past these markets and what kinds of opportunities are being overlooked?
I don't know if it is possible to generalize as you need to look at every market on a individual basis. What is your competitive opportunity and advantage? Take Japan. Markets here are saturated in many areas so mid-sized Japanese companies are all trying to expand overseas. On the other hand if you have the right product and niche there is a market. Starbucks for example came to Japan and people thought they would never make it as there were so many coffee shops. They did succeed as they were able to execute and deliver value but they are not expanding the way they were. In China, however, Starbucks is able to keep expanding as this is a service they never had before.
Most people outside the region know little about the Asian Development Bank and other institutions helping to drive growth in the region and in some cases to support and reduce risks for foreign investors. What should foreign companies and investors know about ADB?
ADB is a regional version of the World Bank whose aim is poverty reduction. They make loans to governments and to private enterprise and can issue guarantees and make equity investments. So they can be a partner to private industry and a private sector division was formed for this purpose. They can be slow in processing projects but part of their value is they provide political cover for investors who may have difficulties in developing Asia. For example right now I am working with ADB on the Asian Cleantech Guarantee Facility (ACGF). The ACGF will provide licensors with an unconditional guarantee from a triple A-rated international financial institution, such as ADB, against non-enforcement of arbitral awards following defaults by a licensee under technology licensing agreements. Defaults could include failure to pay compensation to the licensor or unauthorized use of the technology that has been guaranteed. If this goes forward, this should minimize concern over intellectual property rights and speed the transfer of new clean and other technologies into the region.
While globalization has certainly made the world smaller there are still many differences between Asian firms and those in the US and Europe. What do you see as the key differences between Asian and US firms, how has this changed over the years and do you think the trend has changed in the face of present economic problems in the US?
Ten years ago people would probably have said cutting edge business models came from Silicon Valley and New York. That is changing since the 2007-2009 financial crisis and we are now seeing a shift from an emphasis on shareholder value to one that focuses on stakeholder value. Stakeholder value is more compatible with Asian views. Now that does not mean that management in Asian companies always treat all of their stakeholders well but there needs to be a balance and this type of thinking seems to be gaining currency in the US as well.
Thanks Arthur for your time and attention. Look forward to speaking soon.
This interview is part of an ongoing series highlighting Asia-related business, trade and investment opportunities and issues.
Keith W. Rabin serves as President at KWR International, Inc., a consulting firm specializing in the delivery of Asia-focused trade, business and investment development, research and public relations/public affairs services for corporate and government clients. For more information, please visit http://www.kwrintl.com
While the information and opinions contained within have been compiled from sources believed to be reliable, KWR does not represent that it is accurate or complete and it should be relied on as such. Accordingly, nothing in this article shall be construed as offering a guarantee of the accuracy or completeness of the information contained herein, or as an offer or solicitation with respect to the purchase or sale of any security. All opinions and estimates are subject to change without notice. KWR staff, consultants and contributors to the KWR International Advisor may at any time have a long or short position in any security or option mentioned.
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