Writing in yesterday’s Financial Times, Martin Wolf argued that without structural reform to the corporate sector, the BoJ’s efforts to reflate the economy are doomed to fail, either as a result of any recovery eventually petering out, or through a shift to ultra-high inflation. His argument is that a dysfunctional corporate sector, where savings rates have been exceptionally high in recent years, leading to an enormous stash of cash in the corporate sector, risks derailing the entire recovery process. This cash, he argues, means that the corporate sector is “featherbedded” against the effects of its own inefficiencies. Thus, unless these cash balances are tackled. Japan is doomed to perpetual economic failure.
There is no doubt that the corporate sector’s saving rate in Japan has been abnormally high in recent years. But so have those in much of the rest of the developed world, as firms have slashed investment in the face of insipid demand, high levels of economic uncertainty and concerns over their ability (particularly for smaller firms) to access finance through deleveraging banking systems. The question is whether there is something peculiarly structural about Japan’s high corporate savings rate? Or whether, having faced 20 years of continually disappointing demand, and the opportunity of earning a real return just by holding cash, this is merely the result of Japan’s peculiarly weak growth and the perverse incentives that deflation can provide?
Certainly, before Japan’s bubble burst back in the late 1980s, the behaviour of Japanese corporations was exactly the opposite. Japanese firms amassed huge debts ahead of the crisis and by 1990 Japanese non-financial corporations were running a deficit of around 10% of GDP. Post-crisis, that all (slowly) changed and by the late 1990s the sector had begun to run a financial surplus and, faced with perpetually weak demand, has done so ever since. But the level of corporate savings has not been immune to the cycle – as the economy recovered through the mid-noughties the corporate savings rate fell as firms saw increased investment opportunities as demand strengthened (see chart). And as the financial crisis hit, and the Japanese economy went into a nosedive, corporations understandably slashed their investment spending and raised their savings. That, more or less, is the position they remain in.
Japan: Financial surplus and deficit by sector
Source: BoJ, Cabinet Office and Daiwa Capital Markets Europe Ltd.
None of this suggests, as Martin Wolf argues, that the Japanese corporate sector is structurally predisposed to running large financial surpluses – indeed, the evolution in the corporate savings rate in the mid-noughties suggests that, with a tailwind of stronger demand, a weaker yen and the prospect of inflation, lowering the incentive to hold cash, Japanese firms will boost their investment, raising both growth and productive capacity. Firms should also be more willing to raise wages, another key piece of the jigsaw in definitively ending deflation. Japan’s firms therefore represent a huge source of untapped demand, not a structural impediment to recovery.
Of course, nobody argues that the Japanese economy, and its corporate sector in particular, would not benefit from structural reform. As Wolf points out, Japan’s per capita GDP is now almost 25% below that in the US, while productivity levels in the service sector in particular are low in international comparison. And that is exactly what Abe’s “third arrow” of structural reform, including eventual membership of the Trans-Pacific Partnership (TPP), is designed to do. But with or without structural reform, all of the evidence suggests that, if they are given the right macroeconomic backdrop, Japanese firms will once again revert to normality, borrowing to invest and supporting recovery.
Grant Lewis, Head of Research