Photo courtesy of Satoru Mishima (Nikkei Business Publications Inc.)

Japan’s once-proud construction industry is painfully realizing its glory days are gone. Construction was once a pillar of the Japanese economy, accounting for nearly a fifth of GDP and employing nearly 7 million people. But after a decade in which the economy has hovered near zero growth, private sector spending has dropped precipitously. And a new government promises a tougher stance toward the public works spending that has kept a floor under the construction market.

INFLATED NEEDS Kansal airport (above) and Honshu-Shikoku bridge met expectations and are in debt.(Photo courtesy of Honshu-Shikoku Bridge Authority)

Perhaps more importantly, the industry has largely lost the admiration of the public. Young people are avoiding construction careers. The heavy debts of the contractors and wasteful public works spending are now seen as hindering the nation's economic recovery. "The future of Japan's construction industry is not very rosy," understates Hajime Suzuki, executive director of the Research Institute of Construction and Economy, a government-affiliated think tank.

The clearest sign of the tough times is the trend in total construction investment. After peaking at $700 billion in 1992 it has dropped to an estimated $586 billion in the fiscal year through March 2001 and is projected to decline even further this year, according to the Ministry of Land, Infrastructure and Transport, recently formed by the merger of the former ministries of Construction and Transport. Even while total construction investment was dropping, construction employment and the number of registered construction companies increased through the mid-1990s as the government poured $550 billion into public works through supplemental spending packages to generate jobs for those laid off in other industries. Partly as a result of this and other deficit spending, however, combined national and local governmental debt totals $5.56 trillion, which is 128.5% of the nation's gross domestic product, by far the highest ratio of any industrialized nation.

"Governments just don’t have room for more stimulus spending," says RICE’s Suzuki. "Publicly funded Japanese projects are getting unsustainable as their government debt to GDP ratio [hits] 120%," says Jay H. Bryson, global economist of First Union Corp., Charlotte, N.C. "In the U.S., the ratio is in the high 50s."

The last fiscal stimulus package with a sizable public works component was adopted in 1998, and construction employment and the number of registered contractors has dropped sharply since then. Declining demand is only one of the industry’s problems. Japan’s largest general contractors "owe money most wouldn’t be able to pay back even in a couple centuries," says Etsusuke Masuda, construction sector analyst for HSBC Securities (Japan) Ltd., in Tokyo. HSBC estimates that $11.6 billion worth of bad debt, or roughly 11% of the non-performing loans on the books of Japan’s 16 biggest banks, is owed by construction companies.

Last year, banks waived $5.13 billion owed by just four publicly traded contractors, including Japan’s largest ever debt waiver, of $3.6 billion owed by Kumagai Gumi Co. Kumagai borrowed heavily during the 1980s to finance aggressive growth, largely through investing in its own real estate ventures. But by last fall the contractor was staggering under a debt load of $9.3 billion, and interest payments were roughly equal to total operating profit. Kumagai has had net losses for 8 years running and still owes $5.0 billion.

The company announced a 15-year restructuring plan last fall under which it will cut 2,000 jobs, reshuffle top management and reduce its capitalization. But most industry analysts regard the plan as ridiculous. Unlike Kumagai, a lot of companies have already reached the end of their rope. Some 6,000 construction firms went bankrupt last year, according to Teikoku Databank, a financial information service. And even the majors are suffering. In the fiscal year through this past March, both Obayashi Corp., of Osaka, and Tokyo-based Shimizu Corp. reported losses, of $51.6 million and $537 million respectively. The other two of Japan’s big four, Kajima Corp. and Taisei Corp., both of Tokyo, eked out small net profits.

Kajima is apparently the healthiest of the bunch, reporting net profit of $77 million on total revenue of $15 billion. Yet even this giant is restructuring. In a plan to boost profits and reduce debt announced in April, Kajima will cut some 1,200 jobs, or about 10% of its work force. This is on top of already shedding 1,800 jobs in the past three years. (Officials at Kajima and at the Japan Federation of Construction Contractors, which represents the industry’s 52 largest companies, declined requests for interviews for this article.)

Things are expected to get tougher before getting better. RICE’s Suzuki says private sector nonresidential work has probably hit bottom. But even economic recovery is not likely to provide a big lift. In major cities office vacancy rates are currently high and a significant amount of new office space is already under construction. And Suzuki notes that the nature of industrial work has changed. In the era of heavy manufacturing, construction costs accounted for a healthy percentage of investment in new facilities. For today’s high-tech manufacturing, construction costs are a fraction of the total, with most of the money going into equipment. And with Japan’s rapidly aging population and low rate of new household creation, Suzuki says, "Housing won't be a growth sector."

But the biggest upheaval is likely to be in public works spending. Indeed, it was one of the key issues in the recent election of reformer Junichiro Koizumi as head of the Liberal Democratic Party. Excepting a 9-month period in 1993 and ’94, the LDP has ruled Japan since shortly after World War II, and the head of the party is automatically prime minister. In the recent contest to choose a new prime minister, the party’s old guard was represented by Shizuka Kamei, who promised to put together another spending package to stimulate the economy. Koizumi was vague about details, but promised "fiscal restraint."

Koizumi signalled his intention to depart from the LDP’s previous spendthrift ways in his inaugural speech to the Diet, Japan’s parliament. Koizumi told the parliament that the government’s previous attempts to spend its way out of stagnation "has only left Japan with a tremendous fiscal deficit." He pledged to "improve this situation," but so far has provided few details. The 21st Century Policy Forum, a citizens’ policy study group, says balancing national and local expenditures and tax income would require reducing public works spending by 5% per year in each of the next 8 years while increasing the consumption tax to 13% from its current 5%.

There is no guarantee that Koizumi will be able to get his party to swallow such bitter medicine. "It’s not clear that the Koizumi government will survive for very long," says Gerald Curtis, a Columbia University professor and long-time Japan watcher. Despite his popularity among ordinary citizens, Koizumi is a maverick within the party and has only limited support among LDP Diet members. One possible scenario is Koizumi will survive long enough to nominally lead the party through elections for the less powerful upper house of the Diet, scheduled for later this summer, and then be replaced.

Curtis says the party old guard is desperately trying to solidify its base of support among its special interest groups. And historically, the construction industry has been one of the LDP’s most stalwart supporters. "Public works spending is likely to be the line in the sand over which the reformers and the old guard battle," Curtis says.

The only concrete measure to emerge from Koizumi’s new government is a proposal to shift a portion of fuel tax revenue from highway construction to other public works categories, and even that modest idea is getting a chilly reception. There are already clear signs that if the LDP doesn’t reform the public works process, voters may well turn them out of office. Last November, Yasuo Tanaka, a political independent, won the governorship of Nagano Prefecture on a pledge to review all dam construction in the prefecture. And he followed through, canceling two major dam projects and declaring there would be "no more dams" for the prefecture.

The prefectural assembly is trying to override the governor’s decision. But a recent poll of the electorate found he had an unprecedented 84% approval rating, surprising given that an estimated 60% of the prefecture’s households have some connection to construction. This spring another independent, Akiko Domoto, became governor of Chiba Prefecture at least partly on a pledge to review plans for a massive wetlands reclamation project on the eastern shore of Tokyo Bay that is fiercely opposed by environmentalists but strongly supported by the local construction industry.

Scandals, overbuilding and skewed priorities have soured the public's appetite for public works. Nagano's Tanaka says, "The really problematic rivers were all dammed in the 1950s and 1960s." He says local bureaucrats have continued to push dams because up to 80% of the cost is ultimately borne by the national treasury. Alternatives, such as strengthening river banks and dredging, would have to be paid for out of local taxes. But there’s a catch. Tanaka says that over 80% of dam-related contracts go to large Tokyo-based contractors, whereas local firms would be entirely capable of performing the more modest channel improvement work.

There is also growing conviction that project planners deliberately inflate projected needs. Consider the showcase Honshu-Shikoku Bridges. The mammoth $27 billion project comprises three bridge and highway routes connecting Honshu, the main island, with small, underdeveloped Shikoku. With both the world’s longest suspension bridge and the longest cable-stayed span, the effort is indisputably an engineering tour-de-force. But the volume of traffic has barely reached 70% of projections. Toll revenues don’t even cover the interest on the loans.

To bail out the quasi-public Honshu-Shikoku Bridge Authority, the Land, Infrastructure and Transport Ministry is calling for the central and local governments to provide long-term interest-free loans of $667 million each year for the next 10 years. Even eventually getting this money back depends on optimistic projections of future traffic volume. The landmark Kansai International Airport, built on a completely man-made island in Osaka Bay, is another example. The airport has posted net losses since opening in 1994. Passenger arrivals and departures are 20% below projections made just 5 years ago. But the Kansai International Airport Corporation is going ahead with plans for a second man-made island for a second runway at a cost of about $13 billion.

"The Kansai airport case is a symptom of the wasteful nature of the Japanese public works system," the influential Asahi Shimbun newspaper concluded in a recent editorial. And ordinary citizens increasingly agree. Even before Koizumi took office, a survey by the prime minister’s cabinet office found 46.6% of 3,000 citizens polled said they see no need to build new highways, up from 30.4% in a similar 1995 poll. And the number of respondents in favor of further highway construction dropped to 36.8%, from 45.6%, making it the first time a clear majority is opposed to new highway building.

"People just don’t want their taxes wasted on futile public works anymore," says Kumiko Ushino, a spokeswoman for the Chiba Prefecture Nature Preservation Association. Even for projects that are deemed worthy, commissioning bodies are taking a tougher stance on performance. The Land, Infrastructure and Transport Ministry is considering requiring financially shaky contractors take out completion insurance covering up to 30% of a project’s cost instead of the standard 10% that will continue to be the norm for financially sound firms. If the ministry does adopt such measures they would further tend to promote consolidation of the industry.

And practices once winked at are now under increasing fire. In the first case of its type on record, the Osaka municipal government is trying to recover damages from Ogami Komuten, a firm that bribed a city assembly member to disclose the supposedly secret highest acceptable bid for a high school gymnasium project in 1996. Thanks to Japan’s infamous "dango," or bid-rigging, all other bids came in high and Osaka-based Ogami won the project with a bid of $5.6 million, which was just a hair under the maximum.

Ogami then turned around and subcontracted the entire project for $5 million (Y598 million). The ruse was exposed when the assembly member was nabbed for this and other bribes. Now Osaka is claiming the true cost of the project was $5 million and is demanding Ogami return $600,000.

A spokesman for the municipal government says they hope their push for compensation will have a deterring effect. "This government intends to take a tougher stance against these irregularities," he told enr.

The bottom line is that Japan's construction industry faces a painful period of consolidation. HSBC’s Masuda says that some "innovative contractors" are using information technologies to get a handle on costs, which have previously been obscured by the predominance of lump-sum contracts with fat risk premiums.

Contractors who learn to control costs, "will be the winning group," he says. With their world-class technology and new-found cost-control skills, the survivors are likely to be tough competitors both at home and abroad.