Japanese Economy Update

By Jun Saito
Senior Research Fellow
Japan Center for Economic Research

How Private are They?  Privatization in Japan

(November 15, 2017)

Different stages of privatization

Since the mid-1980s, a series of privatization of major government bodies has taken place. It started with the privatization of the Nippon Telegraph and Telephone Public Corporation in April 1985, followed by the privatization of the Japanese National Railways in April 1987. The most recent example would be the privatization of the Postal Services in October 2007.

While they are described as "privatization", they differ greatly in terms of the degree of private-sector ownership and the liberty of business operation. I would categorize them as corporatization, partial privatization, full privatization, and perfect privatization (Figure). This month's column discusses the differences between these stages of privatization, and why there needs to be such stages.

Figure: Four Stages of Privatization

First stage: corporatization

The first stage is corporatization. Corporatization is a reorganization of public bodies into joint-stock companies. They are usually done by enacting special legislations that establish the companies: the companies are thus called "special companies".

Being a special company does not necessary mean that their shares are held by the private sector. It usually starts with government holding 100 percent of the shares. According to the statutory law, a portion of the shares could be sold, and considerable number of companies does proceed to such a stage.

However, number of companies are required by the law to be 100 percent held by the government (e.g. Japan Finance Corporation <JFC>, Japan Bank for International Cooperation <JBIC>). A number of companies are also held 100 percent by the government even though the statutory law usually requires only a portion (usually a half or one third) of the shares to be held by the government (e.g. Development Bank of Japan <DBJ>, the three Nippon Expressway Companies <NEXCO>).

Even if the shares of the special companies are held by government 100 percent, it is still better than staying as public bodies. As joint-stock companies, they have to publish their financial statements in an accrual basis, not in a cash basis. It is an improvement in terms of the transparency of the financial situation and it provides them an incentive to be efficient.

On the other hand, special companies that have all of its shares held by the government face a risk of moral hazard, especially when they can assume that the government would help them when they face difficulty. Advantages of privatization will not be fully achieved unless shares are sold to the private sector.

Second stage: partial privatization

The second stage is partial privatization. Partial privatization is a situation where shares are sold to the private sector, but the government retains the ownership of some portion of the total shares. It includes special companies where the government is actually holding just about the required amount (usually a third of a half of the total shares) (e.g. Nippon Telegraph and Telephone Corporation <NTT>, Japan Tobacco Inc. <JT>), and also those where the government holds shares in excess of the required amount as stated in their statutory laws (e.g. Japan Post Holdings <JP>).

Pressure by the private shareholders will provide an incentive to the company to be efficient in its business operations. However, it will also be limited if the majority of the shares are still held by the government. Even when the government holds only one third of the shares, it is enough to prevent significant changes to the business, and thus efficiency may be limited.

Third stage: full privatization

The third stage is full privatization. It is the stage where all of the shares that had previously been held by the government have been sold to the private sector. They include the four regional passenger Japan Railways companies (i.e. East Japan, Central Japan, West Japan, and Kyushu Railway Companies, and Japan Airlines <JAL>).

These companies have achieved full privatization in terms of their ownership. The companies are under full control by the private sector and the special legislation that established the company no longer applies.

However, since they still operate in industries that are subject to government price regulation, they are, in a sense, still under government influence, and are different from the group of companies that belongs to the fourth stage.

Fourth stage: perfect privatization

The fourth and the last stage is perfect privatization. They are the companies that are free from shareholdings by the government and are also free from price regulation by the government. There are not many examples that can be included in this category (e.g. Tohoku-Kaihatsu K.K.).

Reasons for the government to hold shares: policy objectives

The government currently holds shares of some special companies in excess of the legislative requirement. As far as this portion goes, the government will be selling the shares to the private sector. The timing of the sales, of course, needs to be well planned, taking into account the stock market condition in particular: It would be best if the sales maximizes the government's revenue from the sales, and if it does not disturb the market. It is in fact gradually selling the shares of JP for instance. (It was recently announced that all of the remaining excess holdings of JP shares by the government will be sold during FY2018.)

On the other hand, as the statutory laws establishing the special companies show, the government is required to hold a specific amount of shares in most of the special companies. That is because special companies are considered to play an important role in implementing policies.

For example, 100 percent of the shares of the government financial institutions is required to be held by the government. This enables the government to use lending and interest rate polices to pursue certain policy objectives.

In the case of Japan Post Holdings, the government is required to hold at least one third of the shares, and Japan Post Holdings, in turn, is required to hold 100 percent of the shares of the Japan Post, which is responsible for the services of post offices and postal service. But there is no requirement with regards the shareholdings of Japan Post Bank and Japan Post Insurance: The shares of these companies that Japan Post Holdings currently hold is expected to be sold to the general public in the future.

Similarly, NTT, which is a shareholding company is required to hold 100 percent of the shares of both NTT East and NTT West companies. But there is no requirement for the NTT to hold shares of another subsidiary, NTT Docomo. (Nevertheless, NTT still holds 66.65 percent of NTT Docomo's shares.)

Government's holdings of the shares of these special companies is required in order to make sure that universal service would be secured. It can easily be expected that, without the government holding of shares enough to block significant changes to the business, the costly universal service will be withdrawn by the companies from the profitability point-of-view.

Reasons for full privatization and not perfect privatization: natural monopoly

Government price regulation is necessary when the industry has the features of natural monopoly. In that sense, it is inevitable that the special companies are subject to price regulations even after the full sales of its shares to the private sector if they operate in industries subject to natural monopoly.

However, in cases like the Tohoku-Kaihatsu K.K., the reason for the government to directly engage in operation was the development of Tohoku region. Its business was not in industries that are subject to natural monopoly. In such cases, privatization can proceed to perfect privatization.

Shareholdings by the Bank of Japan: a new challenge?

So far, privatization has been focusing on the relationship between the companies and the government. However, the recent development is that the Bank of Japan has become the shareholder of many private sector companies.

If the QQE and the purchase of ETFs continues, BOJ may become an influential shareholder of these companies. Since BOJ is itself a special company established by the Bank of Japan Law, and the government has a 55 percent stake in the Bank, these companies could be considered as being held indirectly by the government.

A new dimension is being added to the issue of privatization. How we understand the impact of the BOJ's shareholdings, and how we design polices towards such a situation is a new challenge for policy makers.

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Jun Saito is a Senior Research Fellow in Japan Center for Economic Research (JCER).
After receiving Bachelor and Master of Economics degrees from the University of Tokyo, he joined the Economic Planning Agency in 1978. He held a number of senior positions in the Government before serving as the Director-General of the Cabinet Office's Economic Research Bureau between 2007 and 2012. He also has spent some time outside the Government; studying at the University of Oxford, and working as economists in the International Monetary Fund (IMF) and the JCER. He is currently a Visiting Professor at the International Christian University (ICU), and also teaches at Aoyama Gakuin, Keio, and Tokyo Universities. He assumed the current position at the JCER in 2012.

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