What if Japan is winning?

Andrew McDermott uncovers emerging realities of Pax Nipponica

In this guest contribution, my old friend and long-term Japan investor Andrew McDermott challenges you to focus on actions taken, rather than stories told in the great game of global industrial leadership in general, the “Free and Open IndoPacific” in particular. Japan’s strategy and persistent leadership has been much more forceful and successful than generally acknowledged; and, as Andrew uncovers, is based not on headline grabbing grandstanding, but centered on pragmatic, delivered-as-promissed hard-power. Asian spheres of influence, powered by Japan. Enjoy & Many Cheers ;-j

What if Japan is winning?

by Andrew McDermott

The most interesting stories in Japan remain untold due to thirty years of cognitive bias, a bias reinforced by the precipitous decline of Japan expertise across academia and within financial and policy circles. This bias takes for granted that Japan is weak economically, politically, militarily and culturally. It therefore casts geopolitics as a clash between a rising China and declining America. What if the rising power is in fact Japan, or, more properly, Greater Japan-the group of countries politically, geographically and, increasingly, militarily aligned with and led by Japan.

If you consider the possibility that, instead of being the dumbest player in the room, Japan has been the smartest, a non-consensus picture emerges. In this picture, Japan has quietly implemented the political, diplomatic, military and economic tactics required to create what Prime Minister Abe, in 2016, called “a Free and Open Indo-Pacific.” What no one (yet) seems to have noticed is that both the US and China have recognized the success of this strategy. The US 2025 National Security Strategy explicitly references “FOIP.” This formulation is an extension of US foreign policy doctrine promulgated as early as 1949 by George Kennan and explicated by both Clyde Prestowitz in his 2015 book Japan Restored and Peter Zeihan in Disunited Nations.

Perhaps because the National Security document bears President Trump’s imprimatur, the media reads into it a willingness to concede Taiwan to China in a grand bargain over spheres of influence. Who knows what Mr. Trump thinks, but the document itself simply recognizes what has, due to forty years of (unforgivable) neglect, become a necessity. US leaders long hoped that Japan would become strong enough to independently guarantee a “FOIP” with support from, but not leadership by, the United States. This has happened over the last few weeks. The ability of Japan to deploy missiles, many developed internally, along its southern perimeter while Japan, Korean and Indian forces did the same for the northern Philippines represents a passing of the torch from the US 7th Fleet to Greater Japan. It is symbolized by the US agreement to let Japan, Taiwan, Korea and Australia develop their own military hardware using domestic technology or in collaboration with the US via partnerships with Anduril, shared nuclear submarine technology and integrated control systems. This policy makes a virtue out of necessity, as American contractors are incapable of supplying American’s domestic needs, let alone those of allies. There is a $20bln backlog of US arms sales to Taiwan, with some projects nearly a decade late…and it’s getting worse.

Consider hypersonic missiles and frigates, two critical areas on which the US has spent tens of billions of dollars over the past 30 years for no working products. The US Navy cancelled both its Halo hypersonic missile and Constellation frigate programs in 2025, effectively choosing Japan’s solutions. The DoD is directly funding Japan’s effort in missiles while Australia is deploying Japan’s superior frigates after picking Japan over the UK and Germany (the US could not even compete). Both will be on station next year, nearly a decade before the Pentagon hopes the US will catch up.

The map below illustrates how Japan has quietly assumed regional leadership. This strategy and these tactics would have been inconceivable 10 years ago when both South Korea and the Philippines were openly courting the PRC and when Japan relied almost exclusively on the US military for protection and weapons development. As host of the rapidly deteriorating 7th Fleet, Japan saw first-hand the declining ability of the US to fulfill its commitments. Under Mr. Abe, Japan began to do something about this, beginning with the formation of the Quad.

The PRC has also recognized the emergence of “FOIP” in word (through its hyperactive reaction to PM Takaichi’s restatement of the obvious fact that an attack on Taiwan could involve Japan) and deed (radar lock on Japanese jets, joint patrol with Russia around Japan with nuclear bombers, videos showing missile strikes on Japan, massive internal propaganda campaign against Japan via tourism, cancellation of concerts, rare earths, and biggest military exercise since 1945).

Diplomatically and militarily, Japan now maintains a lattice of agreements stretching from Korea to Australia to India to ASEAN. All center on defending the first island chain around Taiwan, which has become, for all practical purposes, part of Japan. How else can you describe a situation in which a Japanese general sits on Taiwan’s defense council, Taiwan’s most valuable company goes “all-in” on Japan, and diplomatic/cultural/defense/education fields merge? The quiet change in Japanese immigration policy in favor of Taiwan over China is particularly telling. Perhaps as important as these government-to-government “hard power“ links are Japan’s “soft-power” advances over the last 30 years. These are expressed in everything from the popularity of anime to the global prevalence of One Piece “pirate flags” to inbound tourism to Japan’s FDI, particularly in the United States, but also throughout Asia. And, of course, the ultimate example of Japan’s progress is the Run Ri phenomenon that continues to attract many of China’s best and brightest to Japan. JesperKoll and Gearoid Reidy have expertly chronicled this trend.

All of the above are captured in Jesper’s exceptional Pax Nipponica concept, which is the latest iteration of work that stretches back to Inanzo Nitobe, Teddy Roosevelt, Kennan and Prestowitz. While the rest of the world has missed this trend, China (rightly) sees it as a major threat to its strategy. This is why it has sanctioned Iwasakisan (former Japanese general) and Seikisan (a naturalized Chinese citizen and outspoken CCP critic who has become a Japanese politician).

Show me the money

What does all of the above mean for financial markets? The operating assumption for the last thirty years has been that all roads lead to the US or China. The teleological vocabulary of asset allocation encodes the assumption that “developing” or “emerging” markets will reach the “developed” stage, which is (or was) assumed to mean “they will be like the US.” Risk is defined as volatility in “Sharpe World“, not systemic change. As domain-agnostic experts trained in finance to optimize ROE have taken over leadership across the US economy, Japan’s emphasis on operating competence has been increasingly out of step. Japan’s decision to remain in the manufacturing game with China, albeit always pursuing the high end and prioritizing resilience and redundancy (in skills, capital, supply chains and end markets) has been viewed as a defect to be fixed rather than a virtue to be emulated.

These assumptions channel nascent enthusiasm for Japanese equities into private equity and activist strategies (often in tandem) while capping public allocations below 10%. Allocators implicitly assume that Japan needs private equity to “fully” develop.. This seems obvious to leaders for whom ignoring Japan has been essential to promotion as Japan’s share of public and private equity “benchmarks” has plummeted. Henry Kravis, who genuinely considers himself an “industrialist,” made precisely this point over a thirty-day interview with the Nikkei and via a continuing charm offensive patterned on his industry’s successful regulatory capture of the US and UK.

KKR’s marketing and financial success has not been matched operationally in Japan, at least so far. The best deals for KKR and the industry have been those in which the target was already well managed (ie: spin offs from Hitachi). When KKR has gotten its “hands dirty” with management, the results have been similar to the impact it has had on the deindustrialization of the US. Curiously, Mr. Kravis seems to exult in this feat: see his admiration of Jack Welch and his citation of KKR’s Houdaille deal as an example of what Japan can expect from a partner like KKR. In Japan itself, KKR’s highest profile deals have featured the operating failures of the twice-bankrupt Calsonic and PHC (now on its fifth CEO after a disastrous operating performance post IPO). An auto industry assessment of Calsonic’s failure aptly describes what KKR has delivered: High debt + low R&D = vulnerability. A similarly mixed operating assessment applies to deals ranging from Carlyle/Willcom to the Bain/Toshiba/Kioxia transaction, a deal that provides a Rorschach test for observers.

For the financial industry, Toshiba was an unqualified success. The deal perfected tactics used to great effect in subsequent campaigns. A “Wolfpack” of activists exerted effective control without paying a premium, paving the way for a leveraged recapitalization led by one or more (often directly or indirectly related) private equity firms. For leaders entrusted with Japan’s long-term stability, the Toshiba deal taught a different lesson. Unlike prior recapitalizations led by Japan’s “insiders” such as the rescues of Hitachi, Sony and Olympus part one (in which Sony provided the equity) or the first round of PE deals such as Shinsei that helped clean up Japan’s banks, the Toshiba deal created bifurcated outcomes for foreign financial investors and for Japan itself. In the process of enriching Bain, Brookfield, 3D and Effissimo, Japan lost control of all or part of two strategic assets: the nuclear business at Westinghouse and the Kioxia memory business. The financial industry to date has focused on the first part of the drama, raising billions of dollars for dedicated activiststrategies in hopes of replicating the Toshiba gameplan (while downplaying organic change). The returns of early deals and closed doors elsewhere have attracted more and more PE firms with preditible results. Prices have levitated from early deals done below cash and securities for decent businesses to EBITDA multiples that settle in the mid-teens (or higher) for below-average businesses.

But what if Japan shows the hand instead of the money?

What has been lost in this rush to PE/activism is the possibility that Japan might not “develop” the way the US has. The assumption that Japan “needs private equity” to fully emerge rests on the idea that Japan needs to become more like the US to thrive. As Jesper Koll and GMO (among others) have shown, Japan is already thriving relative to the US on almost every metric other than fees generated for investment managers and returns (not earnings) relative to a gravity-defying US stock market. The Japanese financial services sector, led by TSE chair Mr. Yamaji’s alma mater Nomura (proud buyer of Macquarie) and its stablemate SMFG (who just bought Jefferies), is clearly rooting for PE’s ascendancy and the fees it will generate. But this group has been wrong about everything since Nomura led the NTT IPO at the market peak in the 1980s. Japanese investment banks have been on the wrong side of most trades since then ( Madoff, Lehman, Archegos) while spending most of their energy building business outside of Japan even as Japan’s corporate leaders did the hard work of restructuring at home. Consequently, a wide swathe of Japanese society, including many Japanese executives, distrusts Nomura and Co. More to the point, there is considerable evidence that the US needs to become more like Japan rather than the reverse.

Are you talking to me?

Consider two statements by the Japanese prime minister and the US President over the past few months. Each leader called time on the prioritization of finance over operating competence. When Mr. Trump exhorted defense contractors to cap executive pay and put production before buybacks and dividends, he was asking them to act more like the Japanese conglomerates who are already doing these things (and who are often better at making and maintaining US weapons systems than their US counterparts). Consider RTX compared to Japan’s three “heavies,” all of which supply key components to RTX (and have had to share in multi-billion dollar cost to repair RTX’s mistakes in its civilian engine business). Between 2010 and 2024, RTX spent $40bln on buybacks against $26bln on capex and $39bln in depreciation while paying its CEOs (including Greg Hayes, who trained as an accountant) over $300mm in compensation. The three heavies spent $180mm (total) on buybacks and $40bln on capex while spending far less than the $5mm/year CEO salary cap proposed by Mr. Trump (all numbers from Capital IQ). It is no wonder that Mr. Hayes’ successor (a lawyer) needs Japan’s help in dealing with its multi-year Patriot missile backlog…help Japan’s heavies (all led by experienced engineers) can fortunately provide, while introducing a slew of new products from nuclear power plants to energy efficient turbines to advanced frigates and submarines in the bargain.

Perhaps this contrast informed PM Takaichi’s views. When she told the Diet that companies have focused “too much on shareholders,” she clearly had a particular group of shareholders in mind, and it wasn’t Warren Buffett or the GPIF. And, when you look at the important deal flow in both the US and Japan over the last five years, you will see a striking absence of financial investors in areas that really matter even as private equity firms have bid up the prices of Japan’s lowest quality assets.

Toshiba was ultimately rescued by a consortium of Japanese corporations. The recent strength of Kioxia has occurred in spite of, not because of, leadership by Bain (whose primary management contribution was Stacey Smith, a former Intel CFO and finance MBA, not an engineer). Absent several government-engineered bailouts, Kioxia never could have survived to see the recent spike in flash memory prices. A similar financing pattern characterizes other semiconductor initiatives. In contrast to the disappointing PE-backed financing of Intel, whose finance-dominated board “needed more engineers,“ Japan has had tremendous success. This success extends from the smooth progress of TSMC in Kumamoto to Rapidus’ progress towards advanced geometries: a path funded by a consortium of IBM, the Japanese government, and Japanese corporates.

Notable in all these strategic deals is the participation of Denso and Toyota. In marked contrast to KKR-managed peer Calsonic and its weakened (thanks to Mr. Ghosn’s financialization policy) former parent Nissan, these firms have remained robustly capitalized and engineer-led. The ability of Japanese corporates to innovate internally, rewardshareholders and fund ventures that extend from semiconductors to shipbuilding to quantum computing to rare earth magnets to successfully building new jets results directly from their refusal to “optimize” their balance sheets under the tutelage of private-equity inspired “modern portfolio management” theorists.

When asset allocators encounter Japanese CFOs, they often (rightly) complain that the CFOs “don’t speak the language of modern finance.” But what they do speak is much harder to learn, and much rarer today in America than it once was. Compare the actual technical experience of the Rapidus board today with the Intel board of today and of yesteryear. I have had the distinct pleasure of knowing Les Vadasz (Intel’s 4th employee and early board member) and meeting Mr. Koshiba of Rapidus. They are peas in a pod, as were Andy Grove, Gordon Moore and Rapidus’ Mr. Koike. Collectively, they look nothing like today’s Intel board and would not have abided Bob Swan, the Intel CEO at the controls when Intel’s decline became apparent. Swan, a business major and MBA, began his career in GE’s finance department and landed in private equity after receiving over $100mm for his last four years at Intel. Like Jim McNerney, who ran the same game at Boeing, Swan was a GE protege of KKR’s guiding star Jack Welch.

The ¥1,192 trillion question

The question for the future is: which way will Japan move? Is it really true, as has been often claimed, that “the Japanese government is the biggest activist” and that “they” want “us” to “act in concert” to “discipline companies?” Is it likely that the Japanese government, who, through the BOJ and GPIF directly owns nearly $1T of Japanese equities, is ready to concede significant value to foreign PE firms who spent the last 30 years tearing down US industrial capacity and building the Chinese AI/war machine? Can KKR, who was recently feted by the Shanghai Communist party and criticized by the US Congress for aiding China’s AI complex, or Bain, who recently funded a major PRC data center project, expect Japanese government officials, whose heads have been called for by Chinese diplomats, to hand over control of Japan’s most important assets? Or is it possible that the PE firms and their activist helpers are being allowed, in fact encouraged, to bid high prices for Japan’s lowest quality assets while Japan’s corporates (who have proven far better capital allocators than Japan’s for-profit financial services industry) get on with the important business of ensuring that Japan’s economy can service its economic, diplomatic and security needs?

It’s hard to tell from the outside what “the government” intends. Most probably, it depends on who you ask. But it is easy to see that the biggest buyers of Japanese equities during the wilderness years have been the government itself via the GPIF (Y69T/$440bln) and BOJ (Y37T cost, Y65T ($420bln) market), Japanese corporates (announced buybacks of Y116T/$750bln since 2013), and Warren Buffett. It seems unlikely that this group would willingly surrender the lion’s share of value to anyone. Of course, all things are possible. It has been unwise to bet against the best sales team in history. Nevertheless, a series of pending legislative changes will require a change in the tactics that have been so profitable for the PE/activist firms. These changes come at a time when they already manage billions more than when the first deals were done (with much more on the way).

Taken together, these changes will bring the Japanese rules on acting in concert, creeping takeovers, frivolous activism, and insider trading closer to the US and UK. The last page of this GLI report and of this FSA report provide useful summaries. The rules will also broaden the government’s ability to block purchases of assets deemed critical to national security. While bidding for dying consumer brands and low-yield real estate will continue to be encouraged, the “good stuff” may well remain out of reach for financial speculators, particularly those with strong PRC ties (which is the definition of any self-respecting global PE firm). Interestingly, the regulators in Japan seem to be following the advice of Jamie Dimon in their attempt to balance the rights of shareholders with their responsibilities. Nothing in these rules will prevent the salutary actions of investors like Mr. Murakami. His prior efforts sent him to prison, but his current approach falls squarely in the lines of ensuring fair pricing tension. But takeunders will become more difficult while, hopefully, disputes over the nature of coercive group tactics will diminish.

Follow the leader…but who’s ahead?

From the perspective of national and economic security for both Japan and its allies, especially the United States, such developments would be welcome. During what the Wall Street Journal calls America’s 25 Years of Decline, three stars have risen. The first two are tightly linked:

1. The US financialization industry, including but not limited to PE

2. The Chinese industrial juggernaut, financed largely by the $2T PE industry

3. The economy of the Southeastern United States, which has quietly overtaken the Northeast as the largest contributor to US GDP

As one of the governors of the six-state SEUS association told the assembly at its 47th convocation in Tokyo this past October, this growth could not have happened without the nearly $1trln investment by Japanese corporates into America. This investment has created 1mm manufacturing related jobs around America even as American companies (especially those controlled by financial engineers) cut more than 5mm manufacturing jobs. As the governor of Tennessee remarked, when Toshiba first arrived in 1974, Tennessee had 0 manufacturing jobs. Today, it has over 300,000, with nearly 200 Japanese companies (and growing) providing the catalyst. This entire fifty year project has happened with little input from the private equity industry but with a great deal of hands-on transference of actual operating competence from Japanese “masters” (a point made by none other than GE’s Larry Culp). As the US attempts to bring back more jobs from China, it is Japan’s corporates who will be leading this charge, not private equity firms.

Back to the Future?

Perhaps all of the above is speculation. However, the days seem to be ending in which the “corporate manager” could expect to make millions without actually knowing much about how to make or do the actual “thing” his or her company did. Thanks to “asset-lite,” “six-sigma” outsourcing by the likes of former Boeing CEO Doug Calhoun (who trained as an accountant at GE), planes are literally falling out of the sky. Calhoun’s traipse from a media LBO (Nielsen) to PE (Blackstone) to an airline manufacturer without knowing anything particular about any of these businesses epitomized the ethos that created today’s problems. He would not qualify for a junior engineering job at MHI, KHI or IHI, all of whom make aircraft engines under the leadership of CEO’s with decades of hands-on experience making things.

Unless the US, Europe and Greater Japan are content to let China make everything, someone is going to have to actually do stuff, not just make powerpoints about it. And no one is better positioned to make “stuff that works” than engineer-led Japanese public companies. In the “slow but steady” transition to “Japan Inside” that Ulrike Schade expertly documents, Japanese companies have maintained the #1 share in “world product complexity ranking” since 1995. They’ve done so by taking their names off commoditized consumer goods while becoming essential, often dominant, producers of up-stream and down-stream products ranging from photomasks to precision robots to image sensors. Basically, anything China can do bigger, Japan can do better.

Thinking inside the box

The cognitive biases of a generation of investors, writers and executives trained on modern portfolio theory make it difficult to imagine that “alpha” can be created within companies, particularly industrial conglomerates. A longer view of history shows that it is the idea of “value added money managers” that is the anomaly, not the idea of value-creating engineers. As David Murrin writes:

The lesson from history and industry is clear: leadership by engineers and builders produces lasting strategic strength; leadership by financiers alone optimises for short-term gains at the expense of long-term readiness.

It is Japan today that is more like the old Boeing, the old GM, the Intel under Grove/Vasdasz or the 3M under Sir George Buckley. In short, it is probable that the “government” has been, and remains, on the side of the team that optimizes Japan’s chances for national survival. Until private equity proves otherwise, Japan’s public companies seem like the best picks for that team. Perhaps the future of Japan holds more, not fewer, public companies, including those from Greater Japan. If it makes sense for Europe, as Germany’s chancellor argues, why not Asia? And the success of Japan’s public companies may, in the long run, benefit America too. When I look around my native Tennessee, evidence of this partnership already abounds (see map). Based on the last investment of his storied career, it seems that Mr. Buffett, at least, shares this hope. How about you?

Here a link to Andrew’s previous guest contribution Buffett & Japan which includes his bio & photo

And here a link to our debate on “Japan Public Markets under Attack”

The opinions expressed are my own. They are not intended as investment advice. I currently own and may in the future own positions in securities mentioned in this article. Andrew McDermott, Nashville, 1/12/26