Remaking Japan Requires Breaking Rules

By Aki Ito and Yuki Hagiwara - Oct 11, 2011 5:00 AM GMT+0700
Bloomberg Markets Magazine

Yoshihiro Murai, governor of Miyagi, the prefecture that was the ground zero of the March 11 earthquake and tsunami, stands before a gathering in Tokyo of 300 representatives of Japan’s biggest companies and community organizations.

It’s his last stop of the day and his third visit to the capital in a month. He’s 190 miles from home.

Murai grips the microphone and apologizes in advance for the rapidity with which he’s about to speak, Bloomberg Markets magazine reports in its November issue. He then races through the high points of his 80-page plan to rebuild Miyagi, to raise it up from its devastation with the help of economic development.

Suddenly, Murai, nothing if not an optimist, pauses. His face breaks into a grin.

“We’re coming up with a lot of benefits for businesses in Miyagi,” he says. “So I hope you come before we run out of land.”

Murai, 51, has traveled to Tokyo on this day in late July to sell corporate Japan on his grand vision of remaking the ruined region. The one-time Self-Defense Forces (SDF) helicopter pilot says he’s not drinking a drop of alcohol until the last of the 320,885 people who were evacuated from their coastal homes are able to move out of the prefecture’s makeshift gymnasiums- turned-shelters.

‘Japan Will Sink’

Murai’s eye is already on something much larger and more daunting, however: turning Miyagi’s 120 miles (200 kilometers) of wrecked coastline into the country’s most attractive investment spot. Murai says he wants to create a model economy in Miyagi that could be replicated in Japan’s 46 other prefectures.

Japan as a nation, like Miyagi and the region that surrounds it, Tohoku, cannot afford to return to its pre- disaster trail of deflation and debt, he says in an interview during his Tokyo visit four months after the March 11 disaster.

“If things continue along the same path, Japan will sink,” he says.

The Japanese economy has been underwater for some time. The country’s strongest recorded earthquake slammed the world’s third-largest economy after two decades of stagnation that saw nominal gross domestic product repeatedly rise only to fall back down from 1991 to 2011.

GDP, seasonally adjusted, stood at 462 trillion yen ($6 trillion) in the three months ended on June 30, down from 469 trillion yen exactly 20 years earlier.

Lost Hope

Against that backdrop, policy makers long ago lost hope that domestic consumers and businesses would drive growth. Instead, the country banked on exporters such as Toyota Motor Corp. and Nintendo Co. to keep the economy ticking.

Yoshihiko Noda, whose selection as prime minister was confirmed by Emperor Akihito on Sept. 2, has inherited those two lost decades, a yen that’s surged about 50 percent against the dollar in the past four years and a benchmark interest rate that has long stood near zero percent.

Murai’s prescription for Japan’s malaise is in line with what many critics of government policy have recommended. For years, economists have urged the central government to transfer power and grant more autonomy to local authorities, ease regulations that stifle business, wrest control of the nation’s farms and harbors from the powerful agriculture and fishery cooperatives and cut one of the world’s highest corporate tax rates.

Recipe for Rebirth

Tailored to Miyagi, Murai’s recipe for rebirth is built around deregulation and tax incentives. He says he wants to eliminate the barriers that have prevented bigger businesses from investing in agriculture and fishing industries that because of regulation and tradition have been dominated by big cooperatives made up of independent fishers and farmers.

He wants to create manufacturing hubs for cars and high- tech electronics and machinery by offering tax holidays and government subsidies. And he wants to ease about a dozen urban planning and environmental laws that he says currently stand in the way of building in a timely fashion factories that would create jobs.

Finance Minister Jun Azumi, who comes from Ishinomaki, a coastal city in Miyagi where more than 3,000 people died in the disaster, has sent out some encouraging signals to Murai and the people of Miyagi.

“When there’s a disaster, we must not be stingy,” Azumi told reporters in Marseille, France, in September after meeting with his Group of Seven counterparts. “It’s imperative to budget enough money so people become hopeful again. For Japan to show the world that it’s bouncing back even after a disaster of that scale, it’s important for the government itself to approach the task with enthusiasm.”

An Open Economy

And yet seven months after the disaster, the Japanese parliament has not passed any legislation that would turn Murai’s vision into reality.

“Miyagi’s plan is in essence the making of an open economy,” says Masaaki Kanno, a former senior official at the Bank of Japan (8301) and now chief economist at JPMorgan Chase & Co. in Tokyo. “This isn’t just about Tohoku. These are reforms needed everywhere in the country.”

This sort of structural change will not come easily for Noda, says Takuji Okubo, chief Japan economist at Societe Generale SA in Tokyo.

“He cannot push reform policies,” he says. “I think he’s more focused on fiscal policy, and I don’t think he would want to make many enemies by pushing these reforms.”

Growth and Catastrophe

Motohiro Adachi, a professor at Wakayama University who specializes in regional economies, agrees with Murai that Japan can’t sustain itself without changing. Standing in the way of Murai’s reforms, he says, is 940 trillion yen of government debt combined with a gridlocked parliament that has forced two prime ministers out of office since the ruling Democratic Party of Japan (DPJ) came to power in August 2009.

This sort of dysfunctional performance is exactly why reconstruction this time around could be more successful than in the past, says Hideki Toya, whose research on the relationship between growth and catastrophe shows that societies hit by extreme adversity can often change in a way that boosts economic growth.

“When you’re like Japan today, after 20 years of stagnation, there’s a sense that something needs to be changed,” says Toya, an economics professor at Nagoya City University. “There’s a greater chance people will let go of the things that were holding back the economy.”

Post-Bubble Nightmare

In March, the state of the Japanese economy was a textbook example of a post-bubble nightmare. Hobbled by persistent deflation and stop-and-go rebounds, the economy had grown at an average annual pace of 1.2 percent since the peak of the country’s asset bubble in 1989.

Share prices of once-global pioneers such as Sony Corp. (6758) had shriveled to one-fifth of their height, China overtook Japan in 2010 as the world’s second-largest economy and government debt was set to grow to more than twice the size of GDP.

In the meantime, the country was preparing to dump its seventh prime minister in a decade, a pattern that had left few leaders in office long enough to articulate, let alone implement, a vision that would resuscitate the country. Miyagi, one of six prefectures in Tohoku, was a microcosm of that decline -- only magnified.

The economy of Miyagi’s capital, Sendai, the commercial hub of northeastern Japan, first developed in the early 1600s by feudal lord Date Masamune, was deteriorating as large-scale retailers such as Seven & I Holdings Co.’s Ito-Yokado supermarket unit started closing stores to cut costs.

Tuna Palaces

Formerly booming fishing towns such as Kesennuma, home of Miyagi’s biggest harbor, were withering at an even faster pace as international quotas cut catches, depressed income levels and ended the glamour of an area once known for extravagant homes dubbed maguro goten, or tuna palaces.

Miyagi’s future was looking bleak. A forecast by the Ministry of Land, Infrastructure, Transport and Tourism said that a rapidly aging population with a slumping birthrate meant Tohoku would lose 40 percent of its population by 2050, with 19 percent of now-inhabited areas expected to be deserted by then.

“All my customers were passing away or entering nursing homes,” says Sueko Saito, 63, who ran a barbershop in Kesennuma. “Things were becoming quiet.”

Then, at 2:46 p.m. on March 11, an undersea earthquake struck 80 miles off the shores of Miyagi. Minutes later, tsunami sirens sounded throughout the harbors that line the Pacific Ocean.

‘This Is It’

Especially given his military experience, it didn’t take Murai long to sense the scale of the disaster; within 16 minutes, he had requested an emergency deployment of SDF soldiers based in Sendai.

Murai was sitting in his official car, a black Toyota Alphard, near the government’s Sendai headquarters when the earthquake hit. “The ground rolled, and the traffic lights swayed like tree branches,” he recalls. “I thought, this is it.”

That was only the beginning. Within an hour, waves as high as 130 feet (40 meters) slammed the coast. Flipping over ships, uprooting trees, crushing homes and swallowing vehicles racing to outpace the tide, the black, debris-filled waves looked more like lava than water.

As of Oct. 7, 15,822 people had died, another 3,926 were still missing, and in Miyagi, the hardest-hit area, the death toll stood at 9,488.

Plutonium, Iodine

The tsunami flooded 217 square miles (561 square kilometers) of land from as far north as Aomori to as far south as Chiba, according to the Land Ministry. In the middle of the affected coastline, 60 miles south of Sendai, stands Tokyo Electric Power Co.’s Fukushima Dai-Ichi atomic power plant, where the waves knocked out the reactors’ cooling systems and unleashed the world’s worst nuclear crisis since Chernobyl.

Plutonium, iodine, cesium, cobalt and strontium that spewed from the melted fuel rods in Fukushima deepened Miyagi’s crisis, as consumers shunned vegetables, milk and meat from the entire northeastern region that they feared had been contaminated. Even though Miyagi is outside the 20-kilometer evacuation zone that surrounds the nuclear plant, the government has continued monitoring the level of radioactive material in the air, drinking water, seawater and outdoor swimming pools.

“It’s been tough,” Murai says during an interview after lunch with a trading company executive in Tokyo. His trademark grin is gone.

“Instead of protecting the happiness of my constituents, my job’s been more about pulling them out of rock bottom after the disaster,” he says. “But there’s so much that needs to be done.”

Rotting Fish

The task ahead is overwhelming. The ground sank as much as 4 feet because of the tectonic shifts caused by the earthquake, creating swamps of trapped seawater and rotting fish next to the expanding piles of wood, cement and wires that mechanical cranes separated from the rubble.

If businesses in the flooded areas are knocked out of commission for more than a year, the economy of Kesennuma, with 73,000 residents, will halve to 220 billion yen, according to estimates from Sendai-based 77 Bank Ltd. (8341)

Fishing and farming provide an income for one in every six households in coastal Tohoku cities such as Kesennuma. Noboru Onodera, who runs a sushi bar atop a hill in Kesennuma, feels the effects firsthand.

‘Total Darkness’

“We reopened this place 43 days after the tsunami, but I don’t know when we’ll have to close our business,” Onodera, 58, says. The tsunami-driven water surged to within 130 feet of his shop.

“Who’s going to eat sushi when all the jobs are gone?” he says. “The future’s total darkness. You look left and you look right, and all you see is debris.”

Japan’s previous major earthquake struck Kobe in 1995. The reconstruction objective, local and national political leaders said at the time, was to return Kobe to its pre-temblor state as a port and manufacturing city of about 1.5 million people. Kobe missed the chance to remake what in the 1970s had been the world’s largest container port, says Makoto Iokibe, a historian and head of Hyogo Earthquake Memorial 21st Century Research Institute.

“Kobe remade the same port it had before, and it kept losing competitiveness,” says Iokibe, who’s now head of the government-appointed post-Tohoku quake reconstruction committee. “This philosophy of back to before restoration was a ridiculous waste. We can’t repeat that mistake.”

Jump-Start Growth

Kobe is typical of how most reconstruction drives end, disaster economics specialist Toya says, with just enough rebuilding to avert a dramatic loss of capacity while missing an opportunity to jump-start growth. On average, catastrophes around the world have left neither a positive nor a negative long-term footprint on national economies, according to a 2010 Inter-American Development Bank study.

Murai wants to break that cycle. His goal is to attract more companies to the region and therefore more jobs for the survivors to return to and more private capital to help fund rebuilding and reverse the economic slide in Miyagi and across Japan that had begun before the earthquake.

In 2010, land acquisitions for new factories in Japan slumped to 786 permits, a record low since the Ministry of Economy, Trade and Industry started tracking the data in 1967.

During the three months following the Tohoku earthquake, more than a quarter of overseas businesses that were set to invest in Japan delayed, scaled back or canceled their plans, according to a Trade Ministry survey.

Miyagi Newcomer

Murai is a relative newcomer to Miyagi. He was born in Osaka, 390 miles southwest of Sendai, in 1960 at a time when Japan was in a radically different stage of its economic history. That year, then-Prime Minister Hayato Ikeda unveiled a plan to double Japan’s GDP in a decade, a goal that was completed in eight years.

On the eve of Japan’s asset bubble that tripled the Nikkei 225 (NKY) Stock Average in a half-decade, Murai graduated from the Yokosuka-based National Defense Academy, the training ground for the military’s officers. After flying helicopters in the SDF, Murai attended the prestigious Matsushita Institute of Government and Management, then a three-year adult boarding school that has educated much of the nation’s political elite, including Noda.

After graduating, Murai ran as a Liberal Democratic Party (LDP) candidate for a seat in the prefectural parliament in Miyagi, where he had been based back in his military days. He won.

Firestorm of Criticism

Running as an independent, Murai became governor of Miyagi in 2005. His first priority was to make manufacturing the new growth engine of the prefecture. He raised levies on existing businesses to fund tax breaks for new factories, a move that drew a firestorm of criticism.

He pushed ahead anyway and persuaded global titans such as Toyota affiliate Central Motor Co. and semiconductor equipment maker Tokyo Electron Ltd. (8035) to build plants in Miyagi.

Those two deals alone brought about 2,200 jobs to the prefecture, according to government estimates. In 2009, Murai won his second term as governor, with four times the votes of the runner-up.

Before the earthquake, Murai, who is married and a father of two daughters, was best known outside Miyagi for his proposal that all sex offenders in the prefecture wear a GPS-trackable device. The measure has yet to win approval in the prefectural parliament.

Case for Change

At first, Murai’s attempts to break the grip of powerful fishing cooperatives incurred the wrath of the federal Fisheries Agency.

“But I told them that these fishers used to be my supporters, that I’m risking losing their votes because I’m doing this for the survival of Japanese fishing,” he says. The agency came around to his way of thinking in the end.

“Even if I get criticized, I need to do what I need to do,” Murai says.

After the quake, Murai took his case for change to Tokyo. In May, he asked the DPJ-led central government to approve eight prototypes of special economic zones designed to cater to specific sectors, from manufacturing to health care, to clean energy.

While special zones of one kind or another exist now as a result of former Prime Minister Junichiro Koizumi’s 2003 push to experiment with deregulation, Koizumi’s program failed to spark similar changes nationwide, according to Hideo Fukui, a professor of administrative law at the National Graduate Institute for Policy Studies.

Meaningful Experiments

“The relevant ministries rejected any proposal that had the hope of turning into a meaningful experiment for the country,” Fukui says.

Under Murai’s plan, disaster-hit businesses and new employers that agree to move into the special zones would be exempt for 10 years from as-yet-unspecified levies on corporate earnings. Japan’s effective corporate tax rate is the second- highest in the world after the United Arab Emirates, according to a 2010 KPMG LLP survey of 114 nations.

Murai says he also wants to lower hurdles that manufacturers have traditionally had to clear before they construct new plants, simplifying the cumbersome process of winning building-site approval. The logic behind his vision is simple, he says.

‘Strangling Ourselves’

“Labor’s expensive, land’s expensive, taxes are high, regulations abound,” Murai says. ”We’re strangling ourselves with our own restrictions. Of course foreign companies don’t want to come to Japan.”

For example, says Masayoshi Honma, a professor of agriculture policy at the University of Tokyo, regulations have barred companies from owning farmland even though they’re permitted to rent it, depressing corporate investment. A half century-old marine law gives established fishing cooperatives first priority in obtaining fishing licenses.

Masayuki Komatsu, a former senior official at Japan’s Fisheries Agency, says this denies market access to companies that don’t want to pay a variety of fees to these cooperatives.

By eliminating barriers -- to foreign and Japanese companies alike, “thoroughly, one by one” -- Murai says he hopes to win back some of the businesses that have drifted to neighbors such as South Korea in recent years.

Lively Harbors

“All it takes is one success model,” Murai says. “If we can just get one test case where people say tag teaming with companies went well, that young people are coming back, that the harbors are lively again, all the other regions carry the same problems. When they want to change, too, they can come check out Miyagi. Those reforms can spread throughout the country bit by bit.”

Murai’s vision won’t get far without a push from Tokyo. On Oct. 7, Prime Minister Noda’s reconstruction headquarters announced an outline for the incentives it wants to give companies, local governments and residents within designated disaster areas.

Under the plan, a variety of regulations including those pertaining to fishing licenses would be eased, and local authorities would gain access to grants that fund infrastructure projects. Businesses would also be able to deduct from their corporate taxes 10 percent of the salaries they pay to disaster- affected employees and write off 100 percent of their machinery expenses for a year.

The array of tax breaks will cost 100 billion yen, according to estimates from the government’s tax panel. Even so, the government wants to expand those incentives to include a five-year corporate tax exemption for businesses that build facilities inside the special zones, the Asahi newspaper reported on Oct. 8, citing Economy Minister Motohisa Furukawa.

Falling Short

In that spirit, Noda’s government is now drafting the full special reconstruction zone bill, which the prime minister is expected to submit to the Diet for a vote in coming weeks. To finance the measures, the prime minister must push an unpopular proposal to raise taxes on the rest of the country through a parliament over which his party lost full control.

Tokyo’s track record of political inaction does not bode well for Miyagi’s grand vision.

“Noda has indicated he wants to raise taxes, but he needs to actually get that passed in parliament,” says Takayoshi Igarashi, a Tokyo-based professor of political science at Hosei University who was an adviser to Kan.

Biggest Break

There are politicians, however, who see cause for optimism.

“If someone in the disaster areas says, ‘This is what we want to do to rebuild,’ my question is, are you really going to stop them?” says Yuichi Goto, a DPJ lawmaker who’s been involved in assembling the special zone legislation for Tohoku. As a Trade Ministry official, Goto was involved in the creation of Koizumi’s special zones.

“The argument carries more weight this time,” he says. ”It will be easier to get the necessary approval.”

For the time being, the new government has done what it can to lift hopes among the people of Miyagi.

“I’d like to listen to their requests and carry out those requests through the budget as much as possible,” says Finance Minister Azumi, a 49 year-old former broadcast journalist.

Murai’s biggest break so far has been Toyota’s decision to build a 2 billion yen factory in Miyagi as part of a strategy to create a small-car hub in the region. The new plant will employ about 100 workers and assemble 100,000 engines a year.

‘Shortest Route’

“If Tohoku revives, that will be the shortest route toward Japan’s revival,” Toyota Chief Executive Officer Akio Toyoda said when he unveiled the plans on July 19.

Other influential business leaders say they’re waiting for policy makers to take concrete steps in the reconstruction process.

“It’s too early to commit to investments when the details aren’t set,” Yoshimitsu Kobayashi, CEO of Mitsubishi Chemical Holdings Corp. (4188), Japan’s biggest chemical maker, said in an interview with Bloomberg News in July.

Murai landed in Miyagi by accident 27 years ago. As an SDF pilot, he asked to be posted to Hokkaido. His instructor sent him to Miyagi. When Murai decided to change careers and go into politics after eight years of military service, it wasn’t his birthplace or the nation’s capital, Tokyo, that he chose to represent.

‘A Prosperous Place’

“I thought Tohoku was such a wonderful place from the sky,” he says wistfully. “I got this sense that it was on the verge of growth.”

Outside their sushi bar on a hill in Kesennuma, Noboru Onodera’s wife, Mikie, 60, clings to the hope that Murai will get his way.

“If companies really do come here, that will create more work,” she says. “What we lost was so huge, but maybe our gains will end up being greater. There was a time when this was such a prosperous place.”

To contact the reporters on this story: Aki Ito in Tokyo at aito16@bloomberg.net; Yuki Hagiwara in Tokyo at yhagiwara1@bloomberg.net

To contact the editor responsible for this story: Michael Serrill at mserrill@bloomberg.net.