Jun 18th 2009 Economist

Business in Japan 　

No exit　What Japan needs is more bankruptcies, not fewer

JAPAN has long practised a form of familial capitalism. In good times industrial collusion, overseen by bureaucrats, is practically official policy. The so-called "convoy system” lets corporate stragglers retain a small market share as bigger and better firms steam ahead. For decades this cosy form of capitalism ensured that competition was never too fierce and everyone prospered at least a bit. It certainly smoothed out the occasional ups and downs during the country's stunning post-war economic development, as it rapidly caught up with the West. So it is not surprising that many politicians and business leaders are advocating an even stronger dose of such medicine now. As Japan struggles with its deepest recession since the war, the government has established a mechanism to give financial help to poorly performing firms, companies are being encouraged to provide support to their weaker suppliers, and banks are being asked to do their bit, too.

There is nothing unusual about any of this, you might say. Governments around the world are racing to protect their cherished, if dented, national champions. Financial institutions and carmakers have been bailed out in both America and Europe. But in the West such assistance is the exception; in Japan it is central to the system. The problem is that keeping ailing companies on life-support holds back healthier firms and harms the economy overall. That is true everywhere, but Japan provides an extreme case that illustrates the dangers of coddling weak companies.

Japan's stronger firms have responded relatively quickly to the recession, in marked contrast to the dithering during the "lost decade" of the 1990s. It is still unclear whether they have done enough. But it is certain that efforts to keep their struggling rivals afloat are hurting them.

Politicians, having been unwilling to push through painful structural reforms in relatively good times, are even more reluctant to put forward tough measures when times are bad. Banks are being pressured by the government to roll over existing loans and make new ones, and firms encouraged to extend credit and maintain business relations. The government's recent stimulus measures give failing firms taxpayers' money. A plan approved in May allocated ¥2 trillion ($21 billion) to prop up (indirectly) troubled companies. Pioneer, an electronics firm, Elipda, a chipmaker, and Japan Airlines are among the first to look for government support.

All of this does enormous harm. Weak firms need to exit the market, either by going bust or being sold to another firm, or the whole business environment gets stifled. Japan has far too much capacity in many businesses - eight mobile-phone makers, for instance, few of which make much money. This squeezes prices and margins, thus denying better-run firms the surplus capital they need to hire talented people, buy competitors or invest in research and development. It also locks up resources, both human and financial, that could be used more productively by stronger firms. Before the downturn, Japanese companies' return on equity averaged around 10%, about half the level of American firms.

Tellingly, the shut-down rate of companies in Japan is around half that in America and Britain. And the number of corporate insolvencies is expected to increase in Japan this year by only 15%, despite the depth of its recession, compared with more than 30% in western Europe and 40% in America. Normally a scarcity of corporate bankruptcies is a sign of economic vitality; in Japan, it is a sign of its economic weakness. Of course, keeping struggling firms alive protects jobs. But it also fossilises industry structures and hinders the development of a more flexible labour market and a business environment more supportive of new-company creation?two areas where Japan is also sadly deficient.

And the zombies march on

With a general election due to be called by September, in which a new political party may take the reins of government after more than half a century of almost uninterrupted rule by the Liberal Democratic Party, no one has said a word about reforming the economy to introduce more competition in more industries. But this should be on the agenda. During its post-war boom Japan built its reputation on the back of innovative products and fastidious quality; it has since become better known for zombie companies.

As governments around the world come under pressure to bail out everything from retailers to travel companies to automotive firms, Japan's experience - a downturn followed by years of stagnation - serves as a reminder of the importance of destruction in capitalism. Instead of continuing to prop up struggling companies, Japan and other countries need to let them go under, so that new, better ones can be created.