A New Era For Japan?

Andrew Smithers
Nikkei Veritas - Market Eye column, 29th September 2009

There is a reasonable chance that the election of the new DJP government is a signal of a major change in the economy as well as in politics. I have regularly pointed out in previous articles, that the major economic imbalance in Japan has been between investment and consumption. Japan has invested too much and consumed too little. The only purpose of investment is to generate growth and, although Japan has invested much more than other mature economies, it has grown more slowly. Much of the money spent on investment has therefore simply been wasted. An increase in consumption at the expense of investment should therefore allow the economy to grow just as fast as before. This is a highly desirable outcome which will result in an increase in the wellbeing of the Japanese people.

The new government appears to favour consumption over investment and has therefore the right attitude towards overcoming this problem. Attitude alone is not, however, enough. Sensible objectives are only achieved if the policies are supportive. The new government may not, therefore, succeed in shifting the economy towards consumption and away from investment. It is, however, much more likely to be successful than the previous government, which seemed stuck in the outdated attitudes of the post-war world with its emphasis on companies, rather than people, output rather than demand and investment rather than consumption.

Japanese households are no longer big savers. It is, therefore, difficult for them to increase their spending by reducing savings. So, a shift from investment to consumption requires a rise in wages. But such a shift must be at the expense of companies and, if profits fall, the normal reaction of companies is to resist wage increases and cut back on employment. What is needed is for wages to rise, without profits falling. This is usually very difficult, but fortunately this is possible in Japan today, because the charge on companies for depreciation is so high. These high costs are simply a reflection of the excessively high level of investment in the past. Recently, depreciation has taken 65% of Japanese profits before depreciation, compared with less than 50% in the US. This means that Japanese companies’ profits are exceptionally sensitive to changes in depreciation. Now that investment is falling, the charge for depreciation will also fall and, provided that the decline in investment continues, this will be a progressive benefit to profits. Japanese companies will then be able to pay higher wages without finding that their profits decline.

The historic over-investment of Japanese companies is thus both the cause of the country’s economic problems and the potential source of their solution. The new government needs to encourage companies to increase wages and to cut back investment. It is too early to tell whether they will introduce suitable policies to achieve these ends, but Japan seems, at last, to have a government whose instincts fit the needs of the economy.

The new government is not, however, the only important sign of change in Japan. The proposed merger between Kirin Brewery and Suntory is another. It is obvious that, as Japan has a falling population, there are many products where demand in the domestic market is bound to decline. Companies which wish to grow must therefore chose between trying to expand their market share at home, or increase their sales abroad. Although this choice has been evident for many years, Japanese companies seem usually to have been reluctant to accept the logic of the situation. But if everyone tries to increase its market share in a falling market, competition is ferocious and profits will be poor. The originality of the Kirin and Suntory merger is that the companies have decided to give preference to expanding their sales abroad.

There are signs that the logic behind this idea is becoming accepted more generally among Japanese corporations. If it does, the result is likely to be a reduction in their investment in Japan and an increase in their investment abroad. This will help the domestic economy switch from investment to consumption, as lower investment at home will reduce the cost of depreciation and allow companies to pay higher wages without finding that their profits fall.