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Recently, American and European newspapers and other media have been discussing whether the West will face a “lost decade” similar to the one Japan experienced after the economic bubble burst.
My question is, “Was the lost decade really lost?”
Conditions leading up to Japan’s economic collapse in the 90s were different than those leading up to the recent bursting of the sub-prime bubble, the consequence of which Western countries are now facing. So there is no simple comparison.
But there are things Japan’s experience can teach the West.
What is an economic bubble burst?
An economic bubble burst is often explained as a rapid surge in asset prices, including stocks and real estate, as a result of excessive liquidity and a frenzy of stock market speculation. Falling asset prices lead to a credit crunch, deflated assets, and stagnating consumption.
While this explanation may be accurate in terms of economic theory, it does not take human factors into consideration. Those who have studied economics, however, are more inclined to view this field in terms of numbers and models. I, along with other company leaders, tend to view economics as a combination of human psychology and human behavior. Because we’ve studied management, we put people front and center. This doesn’t imply that one view is better than the other, but only that people have different approaches.
What happened with Japan’s economic bubble (from a manager’s perspective)?
So here’s what happened with Japan’s bubble, from my managerial perspective: First, errors in management gave rise to the bubble. Eventually, the economic bubble burst. Then the “lost decade” that rolled in after the bubble burst wasn’t really lost at all, but was actually ten years of learning for strategic and structural reform.
What were those “errors in management” that caused Japan’s bubble to happen? In my view, there were three:
- Money management was conducted without any concept of the cost of capital.
- Excessive capital investments were based on overconfidence in the continued growth of the market.
- There was no concept of strategy, which lead to lockstep management.
This may sound harsh, but the bubble itself was entirely the result of the ignorance of management. Naturally, the companies led by ignorant managers went bankrupt or merged. Most are no longer around today. And those that survived? Their management teams and shareholders have entirely changed.
During the time of the economic bubble burst, money managemet was conducted without any concept of the cost of capital. I still clearly remember an article from the Nihon Keizai Shimbun stating that equity finance was cheap because it only required the cost for dividend yields with no obligation to pay back the money—as if that was simply how things worked. What’s worse, it seemed most managers in Japan back then believed this to be true. This is why they repeatedly engaged in “cheap” equity financing and took on as much “debt” as possible. These managers then used their funds to invest in stocks, bonds, and real estate, as well as excessive capital investment and the purchase of overseas companies.
They called it “money management.”
I began my studies at Harvard Business School in September 1989, at the peak of the bubble. At the beginning of the finance class for first-year students, I was taught the concept of the cost of capital. I learned that equity finance costs more than debt finance. Stock prices will fall unless a company produces a higher return than the cost of shareholder equity.
The moment I learned this, I predicted that Japan’s stock market was doomed to go into a tailspin. Newspapers—respected newspapers!—in Japan were writing about “cheap” equity finance, and the public perception believed in it, as well. Managers didn’t question the model, and as they pursued it, the ROE of Japanese companies plunged. In addition, as profits per share dropped, a stock price correction kicked in, and the Japanese economic bubble burst was primed and ready.
All because of bad management.
Excessive Capital Investments
The excessive capital investments that contributed to the bubble, too, came down to poor management. In particular, overconfidence. Japanese managers were convinced there would be continued growth of the market.
That hubris came crashing down in a harsh reality when the economic bubble burst.
No Concept of Strategy
No concept of strategy led to lockstep management. Lockstep management is, essentially, a rigid seniority system in which salaries and bonuses are based on seniority. This was only found in Japanese companies at the time. When Professor Michael Porter came to Japan, he often used the term “rat race,” saying Japanese electronics makers were all following the same strategy. Hitachi, Toshiba, and Panasonic were no exception. So despite high sales, their profit ratios were extremely low.
In short, managers all across Japan had no concept of money management and were investing left and right, believing they could do no wrong. And because lockstep management allowed them unquestioning trust, there was really no stopping Japan’s economic bubble from bursting.
What happened during Japan’s lost decade?
Japan’s economic bubble burst early in 1992. What have Japanese companies done in the decade following this collapse?
They have been single-minded in their pursuit of learning.
During my studies overseas in the last years of the bubble, other Japanese nationals would often ask why I was studying in the States. They believed there was nothing to learn from America anymore and there would be no point in getting an MBA. But after the bubble burst, Japanese companies reflected on the road to the collapse and quickly dove back into learning the latest in business administration.
GLOBIS was established in 1992—just after the bubble burst. I still vividly recall how surprised I was that we were providing training for a leading bank at the time. The bank simply had no concept of cash flow or IRR.
What lessons did Japan learn after the bubble burst?
Today, concepts such as the cost of capital, cash flow, and strategy have spread throughout many companies. I believe GLOBIS’s corporate training program, school, and publication business, including the GLOBIS MBA Series, have somewhat contributed to this change.
Japanese Money Management Today
Japanese companies have completely shifted their management style to enhance ROE. Furthermore, they have reinforced their capital base and reduced unnecessary debt. Currently, a couple dozen top Japanese companies collectively maintain more than 40 trillion in cash.
Japanese Capital Investment Today
Japanese companies have established a flexible production system that allows them to adjust capacity by disposing of superannuated equipment and eliminating waste and work overloads (both personnel and equipment). In short, these businesses have carefully strengthened their facilities and equipment. This cautious stance was sometimes criticized in a world after the Japanese economic bubble burst, but they steadily moved forward, one step at a time.
Japanese Strategy Today
To escape the rat race, companies have implemented a select-and-focus approach. Electronics manufacturers have withdrawn from dynamic random access memory (DRAM) production and other areas and sold off or streamlined business units. They have worked to narrow business operations to fields they can dominate, even among global competition. Things have changed.
What can global bubbles learn from Japan’s bubble?
Ten years have passed since Japan’s economic bubble burst, and now the sub-prime bubble has burst in the U.S. Maybe it’s time for American, European, Chinese, and Indian companies to reflect and learn. Chinese companies, in particular, are sure to face aftershocks from the excessive capital investment made under the assumption that markets would continue to grow. In addition, European and American financial institutions and companies will have to pay for enhancing—to an extreme degree—capital efficiency through leveraged financing.
During the lost decade (if you really want to call it that), Japan single-mindedly continued to learn. Companies here made a sustained effort to improve strategy and structure. I’ve seen it. Corporate training for leading Japanese companies accounts for more than half of GLOBIS’s sales. Lecturers and staff from our corporate education division have dedicated their efforts to developing human resources for businesses in Japan, including foreign-owned companies.
The Japanese economy may slow down again, but Japanese companies will remain relatively strong. It is said that Toyota faces a drop in profits of more than 70%, but the company is still generating 500 billion in profit. On the other hand, most Western companies (particularly American ones) are projected to be in the red.
The best thing any company can do facing these circumstances is learn. Japan didn’t understand the importance of this until its economic bubble burst. Other countries and companies can surely learn from our mistake.
What should Japanese companies do now?
Japan, too, should continue to relentlessly pursue learning and steadfastly improve strategies and structures. Personnel who are able to play an active role globally will be in particularly high demand in the future. This is a time in which Japanese companies can also purchase foreign businesses at bargain prices. Japanese companies can recruit. Sufficient funds are available. All that is needed is human resources.
What I learned after the Japanese bubble burst was this: at the end of a crisis, strong companies become stronger, and weak companies die out.
Strong companies are relentless in their efforts. They nurture human resources, maintain strong organizational cultures, and focus on their core businesses to confidently achieve success. A positive economic cycle for the future starts with the development of human resources.