Asia’s struggle to change

Arthur Mitchell, a leading lawyer specializing in Asia-related investment and financial transactions and former general counsel of the Asian Development Bank
discusses with Keith W Rabin, president of KWR International, the economic prospects of China, Japan and countries in Southeast Asia. Mr Mitchell is a member of the Council on Foreign Relations and Chair of the Government Relations Committee at the American Chamber of Commerce in Japan.

Keith W Rabin: The election of the Democratic Party of Japan [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?

Arthur Mitchell: 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 “G-2” [a suggested partnering of the United States and China, in the manner of the Group of 8 or Group of 20 leading nations] 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 no-one 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.

KWR: 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?

AM: 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 [Junichiro] Koizumi period [prime minister, 2001-06] they restructured the work force. One third of the 55 million currently working make less than US$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 International Monetary Fund, 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 Barack 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.

KWR: 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?

AM: 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 if 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.  -atimes