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Economy

'Dango' unchained -- Japan's recurring construction scam

Abe's reform push has not changed clubby practices of Japan Inc.

Bid-rigging at Japan's major contractors suggests corporate governance reform has not made much headway.

Wondering how Abenomics is doing five years on? You could plow through reams of data and charts. Or peruse investment bank reports and speeches by Bank of Japan officials. But the best insights may come from the nation's teeming construction sites, where you will find ample reason for disappointment.

On the surface, the frenetic bulldozing and hammering is contributing to the best run of growth in 16 years. Below ground is a bid-rigging scandal involving Obayashi and other big companies that is dousing optimism about Prime Minister Shinzo Abe's progress with revitalizing the economy.

For all the doubts about Abenomics, improving corporate governance seemed one field in which the prime minister could show real advances. Since December 2012, Abe's team has pushed Japan Inc. to increase returns on investment, shareholders to speak up and corporate boards to add outside directors.

But this narrative took hits in recent weeks amid quality-control failures at Kobe Steel, Mitsubishi Materials, Nissan Motor and elsewhere. And now the controversy at Obayashi, one of Japan's "big four" construction groups, has erupted into an even more damning signal that corporate change is far less sweeping than Team Abe claims.

On Dec. 11, prosecutors raided Obayashi's Tokyo headquarters on suspicion of "deceptive obstruction of business." The allegations relate to a public-backed $79 billion magnetic-levitation rail network. Staff at Kajima are being queried by the Tokyo District Public Prosecutors Office. With executives at Shimizu and Taisei also being queried, four of Japan's five main construction companies are now being roped into the scandal.

Long-time -- and suffering -- Japan investors have seen this movie before. The plot revolves around allegations about the age-old practice of dango, whereby Japan companies essentially get together, decide who gets projects, how to inflate the costs and how to exclude foreigners. The tradition has long been a source of tension between Japan and trading partners. Tokyo and Washington brawled over dango in 1989 and again in 1991. In 1994, two senior Obayashi executives were arrested on bribery charges that saw former Sendai Mayor Toru Ishii sentenced to three years in prison.

Obayashi's latest brush with investigators dates back to an April 2016 contract for a maglev station in Nagoya. That period, remember, was firmly on Abe's watch and two years after his governance push began making headlines and cheering markets.

It all raises questions about whether the Nikkei Stock Average's 128% surge under Abe is running ahead of improvements. "Abe's corporate governance initiative just sank further into the quagmire of standard operating procedure in Japanese firms," says Jeff Kingston, director of Asian studies at Temple University's Tokyo campus. "Following the cascade of other revelations about sleazy practices in Japan Inc., one wonders what it will take to pop the Nikkei bubble."

It is high time Abe brought Japan Inc. to heel. Bid-rigging, after all, adds to Tokyo's crushing government debt, currently more than 250% of gross domestic product. Look no further than the price tag for the 2020 Tokyo Olympics, which is almost three times initial estimates.

An obvious first step is increasing the penetration of foreign players. The dango system is largely about keeping giant projects within the Japan Inc. family. Such insularity runs directly counter to Abe's stated desire for a more productive and innovative corporate system. Greater competition would reawaken Japan's animal spirits and pull in more long-term investment, not just hot money into stocks. It is no accident that Japan's most competitive industries, such as cars, are the most exposed to international rivalry. The least competitive, including construction, are protected.

Increased transparency would buttress the credibility of the process. Why not put all proposals online to allow rigorous peer review? Why not, too, create online whistleblowing platforms to police price-gouging and abuse? If Indonesian President Joko Widodo can move to put bidding and procurement processes online, so can far more advanced Japan. For all Abe's talk that "Japan is back," the economy fell three rungs on Transparency International's annual corruption perceptions index. Japan is now 20th, trailing Ireland and Hong Kong versus 17th in 2012.

Paradoxically loose

Abe must give upgrades real teeth. He should create a corporate responsibility watchdog independent of the "iron triangle" at the root of today's construction-industry reckoning. The reference here is to the incestuous links between bureaucrats, elected officials and corporate chieftains that Abenomics has yet to smash. Increased investigatory and enforcement capabilities must be brought to bear, including stiffer punishments for malfeasance. Abe's team should use the bully pulpit to call out offending executives.

It is not just construction. Even Japan's most international industries resist pressures to improve standards. How is it possible, for example, that Takata CEO Shigehisa Takada still has a job? Three years after U.S. congressional hearings on Takata's potentially deadly airbags, Tokyo largely looks the other way. As a parade of quality-control scandals dents the Japan brand, it is vital to internalize the root cause. Top-down, rules-obsessed Japan is paradoxically too laissez-faire about dodgy corporate dealings.

That goes, too, for executives not sharing the spoils of Abenomics. Thanks to ultraloose BOJ policies and a weaker yen, Japan Inc. is hoarding roughly $2.7 trillion of tax reserves that could be used to boost wages to help achieve Tokyo's 2% inflation goal. Abe could propose a tax on excessive cash or lower levies for companies deploying this embarrassment of riches.

Above all, though, Japan needs to raise its reform ambitions. Twenty-eight years ago, 99 Japanese construction companies paid about $33 million to settle U.S. claims of bid-rigging -- America's first successful action against dango. Here we are, nearly three decades later and five years into Abenomics, still grappling with the same old tactics undermining competitiveness. If Abe is serious about building a more international economy, the local construction site is as good a place as any to start.

William Pesek is a Tokyo-based journalist and author of "Japanization: What the World Can Learn from Japan's Lost Decades." He has written for Bloomberg and Barron's.

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