Japan's Economic Power Rises on a Tide of Cheap Capital

DAVID HALE likes to toss bits of history into his economic analyses to provide, as he explains, ``some kind of anchor.'' In a recent talk, the chief economist for Kemper Financial Services Inc. noted that there have been two major upheavals in the national stock market power during the past 100 years. The first occurred during the early years of this century when rapid expansion of the American economy and the crippling effects of World War I on Britain caused New York to displace London as the world's dominant capital market.

The second, he says, has just happened. During 1987-88, Japan's share of world stock market capitalization - the value of all the shares on the world's stock markets - shot up to 45 percent. The United States share shrank to below 30 percent from 55 percent in 1980.

In other words, Japan has become a financial superpower. Yet the markets are not the only area where Japanese financial might is being displayed. In the fiscal year ended March 31, Japanese direct investment in other nations probably topped $40 billion, up from $33.4 billion in fiscal 1987, according to Japan's External Trade Organization.

The net outflow from the US for direct investment in plant and equipment abroad was $20.4 billion in calendar 1988, down from $44.5 billion in 1987, the US Commerce Department reports.

Since measures of capitalization must be reduced to a common denominator - namely, US dollars - foreign exchange rates affect the size of the national pieces of the world's stock pie. The relatively strong yen makes Japanese stocks especially valuable in dollar terms. Some observers think the yen overpriced. Contrariwise, Mr. Hale predicts the yen will get stronger still.

Whichever is correct, Hale admits there are some distortions to these numbers. Japanese stock prices are blown up by the corporate cross-holdings of Japanese banks. The banks own chunks of industrial companies and vice versa. Thus there tends to be, in effect, some double counting. In the US, banks are banned from owning stock of industrial companies.

US companies have also been buying up their own shares, either as a result of leveraged buyouts or as a means of discouraging takeovers. Those trends reduce the numbers of shares traded publicly.

Nonetheless, if the definition of corporate capital is broadened to include bonds as well as stocks, the US corporate sector has a market value of about $3 trillion compared with $4 trillion for Japan.

Hale sees two reasons why this decline in the US capitalization share is important:

The relatively low value placed on US stocks ``suggests that investors are deeply distrustful of the long-term economic legacy of the Reagan administration.'' They fear that policy contradictions (in other words, a tight money/loose fiscal policy) could produce either a sharp drop in corporate profits or a large rise in interest rates.

Japan's growing economic power will result in new competitive challenges to the US and Europe financial services industry.

``Japanese financial power is not an endorsement of laissez-faire capitalism and the simplistic free-market economic dogma which Reagan and his Chicago-trained economists brought to Washington nine years ago,'' Hale says. ``It represents instead the triumph of ... corporatism.''

Hale defines corporatism as an economic system that, like capitalism, embraces private ownership and use of the marketplace as a screening device to allocate resources. But unlike capitalism, corporatism does so within a framework that strives to achieve targeted objectives rather than trusting the market alone to serve national interests.

In other words, the Japanese government uses a mixture of tax incentives, subsidies, and active coordination of private decisionmaking to encourage the development of new high-value-added industries and the orderly contraction of declining ones. Similarly, the government indirectly manages Japan's financial system.

Hale notes that buoyant markets in real estate and stocks have greatly strengthened the balance sheets of Japanese banks. The top 13 commercial banks are valued at $500 billion by the stock market.

``Because of their access to cheap equity, Japanese financial institutions are poised to dominate the world financial system during the 1990s, while American banks will be constrained by low share-price multiples and a stock market capitalization of only $95 billion for the nation's 50 largest institutions,'' he says. ``Indeed, nine of the world's 10 largest banks are already Japanese.''

These and other factors lead Hale to forecast that the US, increasingly fearful of Japanese economic power, will move to a ``managed trade system'' in financial services. Rather than giving foreign financial institutions the same regulatory treatment as domestic banks or other financial institutions on the basis of reciprocity, the US government will play a greater role in the 1990s.

The Federal Reserve System will use moral suasion to regulate the growth of the foreign share of the US banking marketplace. Japanese institutions will exercise self-restraint in pursuing US market share through aggressive pricing actions.

Congress will monitor more closely how US financial institutions are performing in Japan, demanding special policies if Japanese liberalization of its financial markets does not open wider the door for American institutions. Politicians could become ``national champions,'' as Hale says, for their countries' banks and financial companies.