By Clive, an investment technology professional and Japanophile
It’s raining acronyms – all with the stated aim of helping improve global trade. Regular Naked Capitalism readers will need no introduction to the Trans-Pacific Partnership (TPP), described by the U.S. as “enhancing trade and investment, supporting jobs, economic growth and development” which sounds worthy enough but does suggest that trade needs some help.
Then there’s the Transatlantic Trade and Investment Partnership (TTIP) which promises that “Thanks to this agreement, Americans could find it a lot easier to sell goods and services to consumers in the European Union (EU)” suggesting that, without the T-TIP, things are a bit difficult at the moment.
Finally on our tour of Things Our Governments Are Doing to Help Us is the Trade in Services Agreement (TiSA), “which should further advance services liberalisation and regulatory disciplines.” I’ll confess that I’m not entirely certain how you advance services liberalisation but obviously the thinking is that “services” need “liberating”, although from what isn’t particularly well explained. However, cleverer minds than mine believe it is something worth doing.
Not one, then, but three different treaties or agreements are now required to help trade. Or are they? For these various initiatives, the common thread running through them all is that, like Mommy’s Little Helpers, they’re there to offer assistance to, presumably, meet a need that exists and is not currently being met. So the evidence for erratic, static or even declining trade should be – as a minimum – clear and – preferably – significant. But it is not. Just the opposite in fact and for the U.S. imports keep on growing, exports keep on growing and the flows are huge.
Maybe in amongst all that international trade there are casualties and the cause of those casualties are barriers to trade of some description. You don’t need to look too hard to find casualties when it comes to international trade. There’s plenty of examples to go round. Let’s take a look at some of these examples and find out what’s going wrong.
I’ll concentrate on Japan because for historic reasons Japan is traditionally viewed as a country which is hard for non-domestic companies to find success in because of ill-defined but oft cited “barriers” to trade. Dragging Japan into participation in the TPP was seen by the US Trade Representative as being crucial because, under lobbying from U.S. interests, it was deemed to be a huge market just waiting for exploitation by these same interests, but they were prevented from doing so because of Japan’s unfair restrictions on trade.
While reading these tales of woe, keep in mind one thing that even the dumbest MBA flunker would be expected to know. Enterprises should only ever consider expending outside their home market into overseas territories if:
• they have an unquestionable competitive advantage
• that competitive advantage can also be replicated in the overseas county
Both factors must be in place. It is obviously silly to attempt to start operations overseas if you are uncompetitive in your home country. But even if you are successful in your home market, whatever has made you successful must also be applicable in the new overseas market. If you rely on buying politicians, getting tax breaks, financial engineering, implicit or explicit government support, being a state-tolerated monopoly, practicing dubious treatment of suppliers or labour, being responsible for tolerated or covered-up environmental degradation or suchlike, then you are not running a successful enterprise, you are running a looting operation targeting your country of origin. It will be very difficult to recreate those sort of pre-requisites for your business to succeed elsewhere. Regulations may be tougher. Enforcement may be less compromised. You won’t know the culture so you won’t know who to buy favours from, when and for how much. And local competition may be doing all this already and won’t want you muscling in so will try to thwart you.
Who could blame Citi for eyeing up retail banking in Japan? As a nation, it is a banking dream come true, with a prosperous population and a high propensity to have at least a checking account and a savings account. The Japanese retail banking market is dominated by a few large domestic players with nationwide coverage and then a few dozen also-rans who operate only in some prefectures. Fees are high and while service is excellent on basic transactions, the service offer is fairly unambitious. And once you try to do something a little non-standard, while the politeness never varies, incompetence increases exponentially.
Citi could have tried to be long term greedy and gradually carve out a niche in Japan by attracting retail customers with a good basic service, as Japanese bank customers expect, plus a few novel add ons (a currency credit card perhaps, or a top spec internet channel?) And while not a huge market initially, non-Japanese foreign residents would be expected to be attracted by Citi’s brand and there was a sector to be built up offering expats remittance products and an easier time when trying to open a checking account in Japan, something which is notoriously difficult without a local friendly Japanese national to vouch for you. Those things might have worked. Not instantly – and not massively profitable immediately – but over time a viable Japanese-market presence could have been established.
Citi instead took the scarcely credible decision to, in essence, make currency carry trading a business model. It was nice while it lasted, but it didn’t last very long. The Forbes article gives the outline and sets out the inevitable consequences when market conditions broke their only unique selling point.
What Citi did was to try to make a fast buck but it was completely dependent on a volatile piece of arbitrage, not a fundamental competitive advantage. When the Bank of Japan changed market conditions, Citi’s game was up. It is an interesting question whether, under the TPP’s Investor-State Dispute Settlement (ISDS), Citi would in the future be able to sue the Bank of Japan for breaking its business model by drowning the Yen in a bath of QE.
In no way was a restricted market to blame for Citi’s failure. Retail banking in Japan is tightly regulated, but not significantly out of alignment with the U.S. or most of Europe. The Bank of Japan not only allowed Citi to open up a local operation in Japan but gave it a licence to take deposits. It was then allowed to be, shall we say, adventurous, in its retail product design. In short, Citi was allowed to do exactly as it pleased. It used that freedom to drive itself into a cul-de-sac. But under TPP would Citi’s Japan retail operation have been able to die so quickly and with so little fuss? Or Citi have been tempted to try an ISDS suit, however vexatious? Why not, what would it have had to lose?
Maybe that example of a total Fail was due to something specific in the retail banking market? No, as the following shows, wholesale banking is also the graveyard of non-Japanese wannabes.
The world of ZIRP is a world of hurt for fixed income (trading in bonds, either sovereign debt or private issuance, in a variety of currencies but which in Japan is predominantly Yen, US dollars or Euros). Without going into too much detail, the lower the interest rate, the lower the margin for the banks doing the trading.
While margins are squeezed, volumes have been, conversely, high because debt has increasingly replaced equity financing. But only those money centre banks with stamina can afford to stay in the game. In Japan, there’s a Godzilla-vs-Mothra fight to the death going on with the leading US and a couple of European TBTFs leveraging their genuinely world-class trading systems wringing out the last tenth-of-a-basis-point in efficiency set against the incumbent Japanese banks who don’t have quite the systems advantages but have local market knowledge and contacts going back generations.
Whoever survives will get the spoils – and there would, with less competition, even in a margin constrained market, be rich pickings. So far, so creative destruction. But lurking beneath this seeming great example of free markets in action is an underlying conceit. Both the Japanese and non-domestic banks cross subsidise marginally profitable (if not outright bleeding red ink) fixed income divisions with surpluses from better performing units. Because they are too big to fail, they can sustain losses for far longer than enterprises which had to stand their own two feet could do. TBTF leads directly to anti-competitive, anti-free trade practices on the part of the institutions which benefit from being TBTFs.
Once the British government signalled to state-owned RBS that it was no longer willing to throw taxpayers money in support of overseas dalliances with exotic Japanese financial instruments, all RBS could do was head for the exit with its dignity unintact. RBS could continue with the corporate me-too willy-waving only so long as it knew that the taxpayer backstop was in place. As soon as the British government told them that part of their business was not going to shelter under the TBTF umbrella and could not be cross-subsidised, RBS said sayonara to Japan. RBS had neither a genuine competitive advantage nor could it now count on the one thing it had going for it in its home market, government protection.
If the TPP was really serious about improving competition and market access, the very first thing it should have done in financial services was insist that the concept of TBTF should be dismantled. But TPP does nothing whatsoever about TBTF. If the TPP were to end TBTF, initially only the strongest of the incumbent fixed income market players’ divisions would be able to operate in Japan without being bailed out by the other divisions in the TBTF. Margins would go up at first because the hopelessly uncompetitive participants would have to quit. But then new entrants could enter the Japanese fixed income arena because it would have become that much talked-about but seldom-seen animal, a genuinely free market.
TBTF is the single biggest impediment to increasing trade in financial services. And the TPP does nothing at all about it.
Enough of financial markets. They are opaque which is a feature not a bug, so let’s move on to something simpler. There is, superficially, nothing simpler than general merchandise or grocery retailing and it is from that sector that we can look at our next example of a company which crashed and burned but again for reasons which have little to do with tariffs, regulations or restrictive practices in Japan.
The English, so the proverb has it, are a nation of shopkeepers. That’s as maybe, but if you’re unlucky enough to have to visit a typical Tesco outlet here, you might think of changing that to a nation of surly demoralised shop staff, dirty and poorly maintained stores and a lucky dip approach to stock keeping. But Tesco does certainly lead the world in into-tescos-treatment-of-suppliers” rel=”nofollow”>screwing over suppliers and financial engineering. So perhaps that is what possessed it to make a heroic Fail in Japan. Maybe it mistook its ability to abuse suppliers, customers and investors as business genius and/or thought that what Japan needed most was to be shown how to do retail the Tesco way?
Retail in Japan could fill several articles in itself so I won’t attempt to describe in detail everything that makes it one of the world’s most competitive and unique environments. The main thing to note from a business perspective is that for most product lines, these do not make much of a profit or are even sold at a loss. What does generate the profits, especially in the “conveni” (or convenience store) format units are seasonal produce and an ever-refining range of new, novel and distinctive niche products which are discovered by the retailers through endless cycles of rapid reaction trial-and-error.
This is turn calls for hand-in-glove relationships with suppliers and a responsive distribution chain. Sophisticated inventory management systems play a part too, but are a secondary consideration compared to empowered and communicative store managers who can – and more importantly actually do – tell head office what is shifting, what is sticking and what the local market trends are likely to be.
Tesco either did not want to do these things or couldn’t do them. Competing only on price meant it was a one trick pony and, worse, Japanese customers given a choice between price or service and quality almost always pick service and quality.
Maybe it was those dastardly regulations or restrictive taxes or tariffs which caused the problems for Tesco? If you’d tried to make that point in the 1990’s, you might have had a case.
But – cajoled by the Regan administration – Japan began to reform retail regulation by steadily loosening the constraints imposed under the Large-Scale Retail Stores Law. This change is an absolutely fascinating insight into how regulations – so often held up as the cause of restricting trade and keeping prices high – do not prove to be the causes for markets to be what they are.
Rather, how markets are shaped and determined by a complex interaction of producers, consumers and government actions. The best summary I can find is here which isn’t that great but unfortunately all of the best analysis of the deregulation of the Japanese retail sector between 1990’s and the early 2000’s are in Japanese rather than English. Hopefully the Zurich University piece will give you the outline, if readers are interested I will translate one of the better Japanese language articles and ask if Yves can post on Naked Capitalism.
While it is off topic for this post, it might be interesting for readers to consider why this data-rich and well documented (in Japan) phenomena of a regulation that was held up as being suffocating to the development of trade being reformed – but where the reform did not change the market in the way which the promoters of the reform predicted it would – should have received such scant attention in mainstream economics outside of Japan.
My take on this is the unequivocal proof that, contrary to the prevailing orthodoxy which holds that always and everywhere consumers in a mass-market will gravitate to that which offers better efficiency and thus lower prices, was such a threat to too many sacred economist cows that it was easier to ignore it than to evaluate it. This was all the easier because the findings were, dare I say it, from funny people a long way away who must be somehow different because, after all, who doesn’t want the biggest, the most efficient and the cheapest possible every time?
The reforms to the Large-Scale Retail Stores Law in Japan did not result in a move away from service and quality led retailing to price conscious consumption. New entrants to the grocery retailing market such as Tesco have found that, despite regulatory changes, traditional Japanese expectations still persist. Customers did not want fewer but larger stores and they hadn’t been “prevented” from having them because of the Large-Scale Retail Stores Law; such stores simply did not meet their needs. Interestingly, this trend is now being observed in Europe too, ironically leaving traditional retailers such as Tesco with an impaired asset base comprising 100,000+ sq. ft. stores which are increasingly unsuited to changing customer demand.
Put even more succinctly, deregulation in Japan led to inward malinvestment by the unwary – the regulations had served to save stupid and ignorant management of foreign corporations from their own bad judgement.
In summary, then, there is little available evidence to support the hypothesis that, absent the TPP, trade with Japan is somehow being strangled. On the contrary, our lessons from Japan have shown that:
• In financial services there are no barriers to entry for foreign competitors in the Japanese retail banking market and the Citi example demonstrates that you cannot polish a turd. Breaking into a new territory requires a compelling product and/or service offer or a combination of time, patience and money. No “trade agreement” such as the TPP can provide enterprises with any of these things. The private sector must be willing to develop that which will give a competitive advantage and then stay the course while they establish themselves in their target country. Blaming non-existent regulatory burdens is not a good enough excuse.
• Competition is, however, definitely stifled by zombie companies propped up for no good reason by government support, either tacit or overt. RBS was only able to participate in the trade in fixed income securities when it was implicitly backstopped by the taxpayer. Once taxpayer support ended, RBS had to quit the fixed income market in Japan. This was a correct outcome and should be encouraged. But the TPP does nothing to end the problem of Too Big to Fail institutions which distort the competitive environment.
• Even if a market is being influenced by the presence of regulation, such as Japan’s retail sector was presumed to be with the Large-Scale Retail Stores Law, removal of such regulations does not necessarily result in the outcomes that those agents pressing for the removal (usually those who are hoping that deregulation will be to their advantage) seek. Deregulation of the Large-Scale Retail Stores Law only weakly, if at all, increased total trade and any such increase was dwarfed by overall – and unrelated – changes in the wider economy such as demographics and the participation of women in the workplace. The TPP would not force Japanese consumers to suddenly start switching their preference from quality and service to price sensitivity. If, say, U.S. companies want to compete in the Japanese market, do they really have the ability to provide what the market has, repeatedly, shown that it wants? If not, no amount of TPP “help” is going to increase trade.
Could it be that instead of Japan having barriers to trade which the TPP is supposed to remove, U.S. (and other western) companies have simply lost the ability to compete? Another explanation is that, as we have previously stated http://www.nakedcapitalism.com/2015/11/the-tpp-is-a-multi-dimensional-simultaneous-equation.html the TPP is nothing but kayfabe covering moves to establish a regional security treaty without scaring China. But while China is many things, stupid isn’t one of them.