Japanese National Railways' financing schemes and bankruptcy

Japan’s prewar railroad business (Ministry of Transport) was transferred to a public corporation, Japanese National Railways (JNR), after World War II and eventually went bankrupt. This was due to a number of factors, including the decline in the position of railroads, ballooning personnel costs, and the existence of unprofitable local lines. However, the issue that directly caused the crash was the failure of the financing scheme that formed part of the company’s third long-term plan, which commenced in FY 1965. The company had not taken government subsidies or increased its borrowings from the Fiscal Investment and Loan Program (FILP), but instead went outside the FILP and issued large volumes of high-interest rate tokubetsu (special) bonds without a government guarantee, so that by FY 1967, interest and debt-related expenses totaled 101.2 billion yen, or about the same as the 104 billion yen raised by tokubetsu bonds. In other words, tokubetsu bonds were being issued to finance the payment of interest on railway bonds. As a result, the company went bankrupt in the first few years of its seven-year plan, which changed into a financial rehabilitation plan starting in FY 1969. a) Graduate School of Economics, University of Tokyo, 7-3-1 Hongo, Bunkyo-ku, Tokyo, Japan, nobuta@e.u-tokyo.ac.jp A version of this paper was presented at the ABAS Conference 2019 Autumn (Takahashi, 2019). © 2019 Nobuo Takahashi. This is an Open Access article distributed under the terms of the Creative Commons Attribution License, which permits unrestricted reuse, distribution, and reproduction in any medium, provided the original work is properly cited. Annals of Business Administrative Science 18 (2019) 263–276 http://doi.org/10.7880/abas.0191117a Received: November 17, 2019; accepted: December 2, 2019 Published in advance on J-STAGE: December 13, 2019


Introduction
The post-war reform of the government railways began in July 1948, when the Japanese government received General MacArthur's letter from the occupation forces' General Headquarters (GHQ) calling for the prohibition of strikes by public servants and reorganization of the government railways and other major government enterprises into public corporations (Imashiro, 1988, p. 201). In June 1949, the Railway Board of the Ministry of Transportation, which had been operating as a business in the state's special accounts until then, was transferred to a public corporation called Japanese National Railways (Nihon Kokuyu Tetsudo, JNR) (Aoki, Imashiro, Kato, & Wakuda, 2000, p. 121). JNR did reasonably well until the early 1960s, but it went into the red in FY 1964, when the Tokaido Shinkansen (bullet train), the first of its kind in the world, started operating (Kikuchi, 2016(Kikuchi, , 2018, and JNR's operations deteriorated from then on. Starting in the late 1970s, the Board of Audit of Japan, which was concerned about the situation, wrote special descriptions of JNR's operating conditions (A, B) and proposed measures to improve the situation (C, D, and E) (Takahashi, 2000(Takahashi, , 2001.
A) JNR profit and loss (FY 1976 Audit Report, pp. 194-196, special description) B) Construction conditions, operating conditions, and facilities investment effects, etc., for administrative improvement (FY 1977 Audit Report, pp. 229-240, special description) C) Freight business (FY 1980 Audit Report, pp. 167-175, special  increasing fares and charges and taking various financial measures, the company had a huge net loss in its general account, and it concluded, "We recognize that it will be difficult to return to break-even" by the target year of FY 1979. The cause of JNR's bankruptcy has usually been attributed to the decline in the popularity of railroads, bloated personnel costs, and the operation of too many unprofitable local lines during the 1970s. However, these were not really the direct causes of the bankruptcy. The direct cause of the bankruptcy was the failure of the third long-term plan's financing scheme, which was launched in 1965 (Takahashi, 2000). The third long-term plan that began in FY 1965 was supposed to be a seven-year plan, but the company failed within a few years, and in FY 1969, the plan had to be converted into a financial rehabilitation plan.

A Scenario for Bankruptcy
JNR had a bright future around the time that the third long-term plan was launched. The Tokaido Shinkansen, which began operating in 1964, drew worldwide attention, and "the word shinkansen even became synonymous with high-speed train in English language" (Aoki et al., 2000, p. 181). In a state of euphoria, JNR loudly proclaimed a bright future, saying, "Never have so many people been so excited by our third long-term plan" (Ichijo & Ishikawa, 1966, p. 3).
In actuality, in the wake of the Mikawajima accident in May 1962 (160 dead) and the Tsurumi accident in November 1963 (161 dead), "Public opinion was overwhelmingly critical of JNR's overcrowded schedule" (Ichijo & Ishikawa, 1966, p. 44). The reason for such tight scheduling was that many track segments ran both commuter trains and medium/long-distance trains. It was thus necessary to improve track to alleviate the crowding in the Tokyo and Osaka schedules. Hence, the third long-term plan was born.
However, when the third long-term plan was being formulated, JNR Advisory Committee submitted a report titled "How JNR Should Be Thus, government subsidies and additional FILP funding were passed by, and large volumes of tokubetsu bonds with higher interest rates than those guaranteed by the government were issued outside the FILP, so that in FY 1967, funding rates increased to 7.1% per annum and interest payments had gone up 10-fold over their level in FY 1955. We can see the gravity of the situation when we consider that passenger revenues grew 4.4-fold and freight revenues doubled over the same period (Kokutetsu, 1973, pp. 162-163, p. 167). As a  1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 Percentage of FLIP funds Percentage of FILP   1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 Figure 3, most of the increase in the skyrocketing interest and debt-related expenses was due to interest on railway bonds. In other words, two years after JNR started issuing tokubetsu bonds, JNR had already fallen into the situation in which it was issuing tokubetsu bonds to meet the interest payments on its railway bonds.

Discussion
At the end of FY 1968, JNR started to receive assistance in the form of "construction subsidies" to subsidize its losses under the financial rehabilitation plan starting in FY 1969. Before that, JNR was supplementing its construction costs by floating public bonds and using its earnings to pay for improvements (Nakamura, 2019). However, the third long-term plan adopted a financing scheme covering improvement costs with borrowings and bonds. So why didn't JNR set aside earnings, or internal reserves, to cover the necessary improvement costs in its upgrade construction and equipment updates? Stated bluntly, the answer is that the government and local governments were not respecting JNR's financial independence but were milking it of money.
The government made JNR take over the costs of its social, educational, and industrial policies, so that from its founding in FY 1949 through FY 1967, JNR had shouldered 951.4 billion yen in expenses, consisting of 742.4 billion yen in passenger fares (including 691.5 billion yen from commuter and school passes), 157.8 billion from freight, and 51.2 billion yen from special newspapers and magazines (Kokutetsu, 1973, pp. 170-172). In addition, local governments took 99.7 billion yen of municipal levies from JNR between FY 1956 and FY 1967, based on the Act Concerning Grants and Levies on State Assets, etc., Located in Municipalities (Kokutetsu, 1973, pp. 170-172). In short, funds totaling 1,051.1 billion yen were lifted from JNR by the national and local governments. This is almost equivalent to the 1,020.4 billion yen ( = 326.6 billion yen + 330.4 billion yen + 363.4 billion yen) that had been raised by JNR in the form of interest-bearing debt in the first three years of its seven-year third long-term plan.
Furthermore, while privately owned railway companies were periodically raising their fares in line with inflation, JNR's fares were kept down by the government as an anti-inflationary measure, which was a mistake. The Public Finance Act enacted in 1947 stipulated that JNR's fares were to be determined by law or by a resolution of the National Diet. In fact, the JNR Fare Act was enacted the following year, in 1948, so that the basic charges for passengers and freight were statutory. These harsh fare regulations remained in place until the end of 1977, when the Diet resolution requirement was changed to government approval, as long as the fare increase remained within the scope of the expected increase in expenses from inflation (Nakanishi, 1988, pp. 311-312). This undoubtedly interfered with JNR's ability to retain adequate capital reserves. In fact, in the 1940s and 1950s, JNR fares were frozen as a way to fight inflation, and even in the case of the fare hike of March 1966, although JNR had requested a 37% increase in passenger fares with a 15% increase in freight charges to help fund its third long-term plan starting in FY 1965, the request has been shelved for a year, after which the passenger fare hike was cut back to 31.2% and the increase in freight charges was limited to 12.3% (Nakanishi, 1988, p. 322).

Conclusion
To go bankrupt in line with one's own crisis scenario is very foolish. Still, the Japanese people have now forgotten the lessons of JNR as an era of extremely low interest rates has prevailed for several decades. We must not forget that railroad construction and the railroad business is a contest with interest payments. Back in December 1989, the Cabinet decision laying out the steps to be taken to repay the debt of the JNR Settlement Corporation stated, "Disposition of the corporation's debts is, in other words, a contest with interest rates." However, the subsequent increase in the corporation's debts shows that the corporation's revenues from asset dispositions ultimately lost the contest with interest payments on the debt principal (Ishido, 1999).
After JNR was privatized and broken up in 1987, the East Japan Railway Company (JR East) was able to skillfully navigate the winds of the low-interest period, raising long-term financing by converting high-cost debt into low-cost debt. As a result, it succeeded in lowering the nominal interest rate on its long-term debt from 7.13% at the beginning of FY 1987, when it was founded, to 4.62% at the end of FY 1998. If the company were to fall into a situation where its interest payments ate up its operating income, like JNR from the 1970s onward, it would not be able to do anything operationally, and before one knows it, the business efforts themselves would probably be forgotten (Takahashi, 2000).