The Nikkei’s Big Surprise: A Quest to Oust Foreigners : Japan: The collapse of a stock average hardly presages the bursting of the “bubble” economy. Worse, it diverts us from fundamental problems.

The Tokyo stock market’s loss of 50% of its value since 1989 has prompted many an epitaph for Japan’s economy. Daily declines, some huge, in the Nikkei index of 225 stocks are glibly explained as the price Japan must pay for creating a high-growth “bubble economy,” one inflated by artificially cheap capital and rampant asset speculation. Japan, it turns out, is “just another competitor,” its myth of economic invincibility irrevocably shattered.

Wishful thinking, perhaps. More than penance for profligate economic management, the Nikkei’s steady slide may reflect the desire of many Japanese bureaucrats and businessmen to insulate their country’s economy from growing foreign influence and criticism. As a Japanese banker recently said, “We want to bring our overseas assets back” while preserving “our control at home.”

Although the Tokyo market’s downturn was not engineered or planned with this goal in mind, it is being allowed to develop in a way that will harm domestic interests less than foreign. When the decline ends, overseas investors and recipients of Japanese capital will likely be the big losers. By contrast, Japan’s basic technological and industrial capabilities will remain intact. Instead of Japan being taken down an economic notch, the increased polarization between the Japanese and the world economy will stimulate even more intense bilateral and global conflicts.

Certain characteristics of Japan’s equity markets, including the consolidation of stock by Japan’s ubiquitous business groups, or keiretsu , make it possible for Japan to export much of the pain caused by the Nikkei nose-dive. Most, if not all, of the firms that make up the Nikkei 225 index are members of keiretsu groups--Mitsubishi, Toyota or Sumitomo, for example. Close to 70% of their outstanding stock is cross-held by other group members. These joint holdings are rarely, if ever, traded; they are locked away for protection against corporate control battles and to cement long-term relationships among affiliates.

Japan’s largest firms and shareholders are thus relatively unaffected by dramatic declines in Tokyo stock prices because they never sell the bulk of their holdings. When keiretsu firms dabble in the market, they use their influence to hedge their bets. Scores of Japan’s blue-chip companies, for instance, recently obtained covert investment guarantees from the four major Japanese brokerages, in effect compelling smaller and foreign investors to insure their profits.

Put another way, Japan’s domestic equity market is primarily structured to preserve Japanese control of the country’s major companies. Unlike in Europe and the United States, it is a marginal source of capital.

The effect of the Nikkei decline on credit will also disproportionately fall on overseas interests. A commonplace in reporting on Tokyo’s stock-market fall is that Japan’s leading banks are taking a direct hit, because they make loans against the value of their stock holdings. With their stock portfolios on the skids, the banks are forced to reduce lending, thus curtailing domestic expansion.

But it’s more likely that overseas lending will be scaled back before Japan’s major banks would cease supporting their keiretsu affiliates or other Japanese customers. Japan’s overseas financial activity has, in fact, slowed considerably during the Nikkei’s three-year descent. Moreover, if domestic credit did tighten, the government has a number of options to pump money into the economy.

Even the smaller Japanese companies, individual investors and peripheral brokerages that are hurt by a falling stock market have a safety net of sorts--Japan’s labor shortage. With two jobs for every applicant, and tightly regulated immigration, it is highly unlikely that mass unemployment will result from small-investor stock losses.

While the Western media never seem to tire of stories about individual Japanese investors fallen upon hard times, almost no one believes the sharp collapse of the Nikkei will trigger depression-like conditions. Indeed, by tolerating the Nikkei drop, the government can reign in independent investors, which it has unsuccessfully tried to achieve for decades, without great political risk.

Far from deflating the Japanese “bubble,” the Nikkei’s decline may be the mortar of a new “fortress” mentality in Japan. Many Japanese resent the increased scrutiny and criticism of their economic practices that comes with overseas investment and foreign market participation at home.

Purchases in the United States have exposed Japanese companies to continuing criticism, from technology transfers to minority-hiring practices. After pouring billions of dollars into Japanese equities, American institutional investors demanded much more influence over the Japanese corporations in which they bought a stake, an issue now central in U.S.-Japan bilateral trade disputes. Unsuccessful efforts by U.S. corporate raiders such as T. Boone Pickens to take over or join the boards of Japanese companies, reputedly blocked by the keiretsu system, raised serious questions about the openness of Japanese markets.

To keep the Pickenses of the financial world at bay, Japanese bureaucrats and larger firms have reason to let the stock-market decline unsettle foreign investors and to encourage domestic firms to bring their money back home. This may help explain why the Japanese media increasingly blame “irresponsible” foreigners for the sliding Nikkei. It may also account for the puzzling fact that huge declines in the Nikkei index occurred on days when trading volume was extraordinarily low. Typically, stock-market crashes set off selling binges as panicked investors compete to unload their shares.

Not so in Japan. The keiretsu groups and the major brokerages sat on their holdings and watched marginal--especially foreign--investors engage in a stock-price blood bath. The Nikkei recently sank to five-year lows, for example, on some of the lightest trading in years. During this period, companies like Chrysler dumped virtually all their Japanese stocks, flooding the domestic market with cheap blue-chip equities.

But if the Nikkei’s decline is consistent with efforts to reduce foreign influence in the domestic market and repatriate capital, it is a perilous strategy. Japan may be courting long-term disaster if it seeks to withdraw into a closed society that excludes, or handcuffs, foreign participants in its economy while pulling back from its overseas commitments.

Learning to collaborate with foreigners on an equal, reciprocal basis remains the most significant challenge facing Japan in the post-Cold War era. It will likely determine whether the country is able to sustain stable, mutually beneficial relations with its neighbors and trading partners. A retreat into an all-Japanese economy, even if possible in an interdependent world, is a major step backward.

Furthermore, while the Japanese economy may absorb many of the smaller investors hurt by the Tokyo market’s slide, the process could adversely affect the very industrial capabilities that are the nation’s greatest strength. Increasingly independent, smaller producers have provided technological dynamism and flexibility to Japan for decades. Restructuring the economy in a fashion that would retard their continued development would destroy one of the country’s greatest assets.

The Nikkei index’s long march to a lower level is, in part, a story told in the jargon of price-earnings formulas and corporate profit statements. Perhaps more important, it is also a story of a country’s continuing, historical struggle to accommodate foreigners as legitimate players at home and abroad. One thing is clear: Despite the economic fantasies of many, Japan has not become irrelevant. An obsession with the deflating Nikkei not only diverts our attention from fundamental bilateral problems; it also leaves us unprepared for the new ones that are likely to emerge.