Abenomics’ “Third Arrow”: at the Tipping Point

Don’t miss the forest for the trees. Historically, May 23rd, 2014 will probably be seen to be the date when the ruling party of Japan, the LDP, “changed its spots”, mutating from the Old LDP to the New LDP.

It was on that day the LDP’s key growth strategy committee agreed upon its new “Japan RevivalVision”, a detailed 74-page document which definitively separated the LDP from many of the vested interests and obsolete structures that have dominated its past, by setting forth policies for:

reduction of cross-shareholdings to “as low a level as possible”;
drafting a world-class corporate governance code, covering best practices for the handling of whistleblowers, the role of executive officers, and director training and qualifications;
corporate governance code rules requiring multiple independent outside directors, enforced on a “comply or explain” basis;
modern governance and management practices at the Japanese government’s massive pension fund, the GPIF – the largest pension fund in the world;
reduction of corporate taxes;
increasing the number of working women by using a raft of practical methods, including the removal tax and pension disincentives to work; promotion of child care leave for men and non-regular employees; relaxing requirements for receiving child care subsidies; temporary short-day working hours; disclosure of diversity progress made by companies; and “raising awareness” among men and businesses (perhaps most essential);
promotion of labor mobility and new job types, and supporting mobility by the expanded use of portable “defined contribution” pension plans and tax-efficient matching contributions. (Note: enhancing labor mobility is a prerequisite not only for enabling more women to return to the work force after they bear children, but also for raising Japan’s low level of labor productivity in its service sector, which accounts for nearly 80% of total GDP but is only 70% of the US level);
increasing the number of foreign employees, and making it easier to hire them, by expanding quotas for both specialized staff and international trainees, and the job categories that trainees can shift into so as to work in Japan longer;
improved governance and utilization of funds at universities (e.g., drawing upon “sleeping deposits”); and
setting a goal for Japan to be a“No. 1 Country of Entrepreneurship”, including an office devoted to that goal in the Prime Minister’s office, improvement of stock option structures, allocating a minimum percentage of government procurement and outsourced R&D to small business, guidelines to ease the burdens of personal loan guarantees by founders, entrepreneurship training and mentoring, expansion of crowdfunding and the safety net for entrepreneurs, and the like;
and more.

At last, the “third arrow” has arrived. It is not perfect and it is not finished yet. But it is real progress. It has meat and direction in it, and is grounded on economic realities and analysis.

A group of dedicated LDP diet-members comprising the LDP’s “Headquarters for Japan’s Economic Revitalization” committee, led by Chairman Sanae Takaichi (a woman) and Yasuhisa Shiozaki (a former Chief Cabinet Secretary) have demonstrated true leadership by taking on some of the most difficult sacred cows, and articulating the sort of coherent, concrete vision that is essential in order for Japan’s future.

In the Japanese context, these policies are especially impressive when one considers, for instance,that the measures about corporate governance and cross-shareholdings have largely been pre-negotiated with the Financial Services Agency (FSA).

The promulgation of Japan’s first corporate governance code means that Japan will be catching up with the rest of the world in one of the areas that affects economic productivity the most. For the first time institutional investors will be getting detailed, standardized disclosure about the most important aspect they need to assess in order to be good stewards: corporate governance practices and quality at each company.

At last, a “virtuous cycle” willemerge between enhanced transparency and disclosure, investor stewardship and “engagement”, and improvement of corporate governance practice. In the case of Japan, where people respond quickly to rules when once they are made clear, shareholder rights are strong, and a huge amount of corporate cash is underutilized, the potential upside of this dynamic should not be underestimated.

Thus, it was meaningful that on May 30th, the GPIF announced that it would comply with the nominally-voluntary “Stewardship Code”, which will require it and other signatories to disclose how they fulfill their fiduciary responsibilities, manage conflicts of interests, and vote shares that they own. The signaling effect of this early announcement will lend momentum and impact to the same virtuous cycle.

True, in many areas, details need to be finalized in discussions with the key agencies. In particular, the legal end of labor mobility has not yet been tackled where it most matters – a new, additional form of “regular employee” contract that permits terminations if severance payments are made. This will take another year. Measured steps towards an immigration policy, the most sensitive subject of all, will take longer. But the LDP committee has set down markers, if subtle, on these topics. In this report, it has proposed what can be done at this stage, and in so doing, signaled that in fact it has not given up on these themes.

Given Japan’s political realities and the demographics that the LDP is up against (read: lots of elderly voters with high voting turnouts), the LDP committee’s report is a significant step forward – a crucial tipping point. In truth, it was naïve for anyone to expect drastic reforms across the entireeconomyin only 18 months in a country like Japan.

In some areas, the LDP’s report even sets forth goals, deadlines and accountability. This is a laudable practice one senses that the party will use more. For instance, the FSA and Tokyo Stock Exchange are charged with promulgating the corporate governance code in time for shareholder meetings that will take place in June of 2015, only one year from now.
Last September, Japan’s Prime Minister Shinzo Abe addressed the New York Stock Exchange with the zingy words, “Buy My Abenomics!”. using the sort of salesman’s chutzpah that traders on Wall Street usually appreciate. But at that time, there wasn’t much of a “third arrow” – the most important part of the package– to buy into.

Now, finally – as long as the details in the “Vision” are not watered down during the next few weeks as seconded bureaucrats in the Cabinet Office reflect its contents in the government’s yearly growth policy statement – , global investors and the Japanese public will have something meaningful to examine. (Knock on wood.)

Prime Minster Abe and his comrades Takaichi and Shiozaki need to be vigilant during the next fewweeks. Already, apreliminary draft of the government’s upcoming growth strategy document (Japan Revival Strategy) showed that the word “multiple” in front of “independent director” was conspicuously missing, even merelyas a suggestedpossibleitem for consideration when drafting the new corporate governance code. And the draft lacked much of the coherence, persuasiveness, logic, and detail of the LDP committee's report.

Thus,the upcoming Japan Revival Strategy seemsdestined tounderwhelm again, to some extent. But to understand where Japan is really headed,I recommmend that you read the LDP committee's enitire report instead. Registered users of this web sitecan download the a translation of the full reporthere: http://bdti.mastertree.jp/f/y1xn6oum. (Registration on BDTI's web site as user is simple and free, – just press the button at the top right.)

Nicholas Benes is a Representative Director of The Board Director Training Institute of Japan, a non-profit “public interest” organization certified by the Japanese government. However, the opinions here are his own.

The Board Director Training Institute (BDTI) is a "public interest" nonprofit in Japan dedicated to training about directorship, corporate governance, and related management techniques. It is certified by the Japanese government to conduct these activities as a regulated nonprofit. Read a summary about BDTI here, and see a menu of its services for both corporations and investors here.

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