Summary
Transport Minister Hon. Seiji Maehara wasted no time stepping between troubled carrier Japan Airlines Corporation and its three main creditor megabanks, but the latest rehabilitation plan may require a major overhaul to address three main issues: personnel, pensions and profitability. A political decision must be made regarding which stakeholder group should enjoy the benefits of a massive injection of public funds.
Analysis
Japan Airlines is no ordinary corporation. The troubled carrier plays an integral role in the country's transportation and tourism infrastructure and is universally considered too important to fail. JAL has an uncompetitive cost structure the core components of which, salaries, pensions and landing fees, have been set in place well before its privatization in 1987. While nearly everyone understands the need for injection of public funds, no one group of stakeholders - shareholders, creditors or employees - can be seen to benefit disproportionately. Nor should public funds allow the airline to gain unfair advantage over domestic competitor All Nippon Airlines, which faces many of the same challenges. In many ways, JAL faces challenges as complex than the society it serves. Yet, the immediate issues at hand can be narrowed to three categories: personnel, pensions and profitability.
JAL pilots and senior cabin attendants enjoy salaries and benefits well in excess of the industry average based on seniority and length of service. The basic pay scale, set well before the Plaza Accord of 1985, reflects internationally competitive wages during an era in which the Japanese yen was undervalued. Company labor unions have resisted decades of effort by management to rejigger salaries and benefits, and Japanese law seems to be on their side. In recent years, the airline has sought to reduce costs by hiring foreign pilots and cabin attendants as well as hiring Japanese as contract staff rather than full-time, permanent employees.
The current rehabilitation plan calls for a reduction of 9,000 to 14,000 staff through solicitation of early retirement and severance of foreign contract employees, but this may not do much to make JAL more competitive. Presumably, foreign contract employees cost the airline less, so reducing their ranks may prove counterproductive. At the same time, Japanese law makes it difficult to reduce senior staff because any solicitation for early retirement must be made to all employees on a nondiscriminatory basis. A disproportion number of young employees, who are lower cost, more productive and have better prospects of finding another job, tend to take advantage of such offers. Perhaps the only way to solve the salary and benefits issue would be to enact a new law for that purpose or initiate a court mediated bankruptcy.
Similarly, the airline's pension scheme reflects Japan's economic situation prior to the 1989 collapse of the Bubble Economy, which led to two decades of economic stagnation, deflation and ultraloose monetary policy. In order to meet its projected benefit obligation, the company's pension scheme needs to generate a 4.5% annual return on assets. In an ordinary economy, a low risk portfolio of JGBs and local government bonds would have been capable of providing such a return. With the yield on 20-year bonds having been stuck around 1.5% for more than a decade, however, the company now faces a deficit of 330 billion yen in underfunded pension liabilities.
The current rehabilitation plan calls for a 230 billion yen reduction in pension liabilities, but the mechanism for achieving such a reduction remains elusive. Company unions have fought for decades against changes to the company's pay scales, and no one expects 2/3 of current and former employees to vote in favor of a reduction in pensions. Other alternatives include enactment of a new law to address the issue, initiation of a court mediated bankruptcy or injection of public funds. The first two solutions may face Constitutional challenges premised on the guarantee of individual property rights whereas the third would equate to taxpayers footing the bill for lucrative pension payouts to current and former JAL employees. There is no easy solution here either.
Even with a reduction of debt and an infusion of fresh capital, Japan Airlines cannot survive if it continues to generate massive operating losses. Business travel and tourism have declined due to the financial crisis and economic recession, but Government policy must share the blame. Domestic route schedules and fare pricing are tightly regulated by the Ministry of Land Infrastructure and Transport. Tourism and business travel are highly seasonal in Japan, but airlines must maintain route schedules all year round. Domestic airlines in Japan serve dozens of regional airports that handle fewer than 10 flights per day. Part of the cost of building and maintaining such airports is recovered through the steepest landing fees in the world. It is said that landing fees as a percentage of revenue are twice as high for Japanese airlines as their overseas competitors. Yet, local governments vocally oppose route schedule changes that lower peak travel capacity or make life less convenient for residents. Also, ruling party politicians routinely use such flights to travel between Tokyo and their respective constituencies.
JAL cannot be allowed to fall into a court mediated bankruptcy or any other situation that would impede travel to regional airports. Such a scenario would result in massive follow on losses for domestic hotels and travel agencies, not to mention the broader impact on commerce and regional economic development. JAL provides exclusive service on more than two dozen domestic routes, and no other airline is capable of picking up the excess capacity. Over the long term, policy makers need to stop funding the construction or expansion of airports that are clearly unnecessary and redundant, such as Kobe Airport. The Transport Ministry and local governments need to reduce landing fees at regional airports to relieve domestic carriers of the burden of subsidizing the cost of unprofitable operations. Yet, such changes will still be insufficient to bring the market mechanism to bear on the domestic airline industry.
In conclusion, the Hatoyama Cabinet has no choice but to facilitate a massive injection of capital into Japan Airlines within the next several months sufficient to (1) significantly reduce in the carrier's debt burden, (2) cover restructuring costs related to the severance and early retirement, (3) fully fund the company's pension liability and (4) provide a pad against operating losses over the next two years. There will certainly be political opposition to any proposal for an injection of public funds, but Government leadership and financial support will be essential to fostering agreement of stakeholders. I expect to see the government provide at least JPY 1 trillion in indirect financial assistance in the form of loan guarantees and debt purchases through public finance bodies such as the Development Bank of Japan and the Enterprise Turnaround Initiative Corporation of Japan.
Finally, a political decision needs to be made regarding the extent to which each group of stakeholders (shareholders, creditors and employees) bears responsibility for the situation and/or enjoys benefits at taxpayer expense. Perhaps this is why the Liberal Democratic Party of Japan left this issue for the new government to resolve.
