At first glance, corporate earnings reports for the first half of fiscal 2002 seem too good to be true, given the continuing economic slump. On average, pretax profit surged nearly 40 percent in April through September from the same period a year earlier — a dramatic reversal from the 40 percent decline in fiscal 2001 profits. For the full year to March 2003, a huge increase of more than 60 percent is forecast.

One reason given for this is that stepped-up restructuring produced better-than-expected results. Another reason is that exports, particularly to the United States, expanded markedly. Record earnings in a number of well-off sectors, such as automobiles, also raised the overall level of before-tax current profits.

The earnings outlook for fiscal 2003 and beyond does not warrant optimism, however. Exports will probably level off because of growing uncertainties over the U.S. economy. At home, a speedup in bad-loan write-offs by commercial banks is likely to drive more deadbeat clients into bankruptcy and throw more workers out of their jobs.

According to the Shinko Research Institute, midterm earnings reports show that pretax profit jumped 38 percent from the first half of fiscal 2001, exceeding earlier estimates by a wide margin. By contrast, sales declined slightly, providing a distorted picture of performance. About 90 percent of major firms listed on the Tokyo Stock Exchange — excluding banks, brokerages and insurers — had published their consolidated semiannual results by last Friday.

Profit forecasts for all of fiscal 2002 are even more impressive: a 65 percent increase from the year before. Sales are expected to rise slightly in the second half. Remarkably, too, many companies set a new profit record in the first half; they also expect to put in their best annual profit performance ever.

By far the most profitable company is Toyota Motor Co., which expects to make a record profit of 1.3 trillion yen for fiscal 2002. Record full-year profits are also predicted by companies such as NTT, Nissan Motor Co., Honda Motor Co., Takeda Chemical Industries, Shin-Etsu Chemical Co. and JR East Japan. About one in six firms is expected to produce the best result in its history.

All this, however, needs to be taken with more than a grain of salt. The fact is that the companies doing well both at home and abroad, not only in profits but also in sales, are confined to a handful of sectors such as autos and pharmaceuticals. Corporate health as a whole remains disturbingly frail. Thus, the rapid rise in the overall profit level is no cause for celebration.

The biggest reason for the profit rebound is the progress in restructuring (read: layoffs). Companies across a broad spectrum of industries slashed full-time jobs in favor of part-time and temporary employment. Younger regular employees took pay cuts across the board, while older ones were nudged into early retirement. These cuts in payroll costs improved the profit picture substantially.

In a deflationary economy where prices continue to decline on a broad front, it is difficult to secure profits through increased sales. In these circumstances, a quick way to improve the balance sheet is to reduce fixed costs such as labor costs. In fact, restructuring is a top priority for corporate management.

Understandably, many companies have compelling reasons to shed jobs. But layoffs in a deflationary period will make things much worse. Higher unemployment and lower incomes would further erode consumer confidence, prompting more people to save rather than spend. A weakening of consumer demand will prolong the slump, thus putting the squeeze on sales and profits.

With many companies planning further job cuts, the restructuring storm is not likely to abate anytime soon. The think tank for Dai-Ichi Life Insurance Co. estimates that the unemployment rate will reach 5.8 percent by the end of the year and 6.2 percent by the end of March 2004. Corporate managers need to think more seriously about the side effects that restructuring would have on the Japanese economy.

Along with the twin domestic problems of persistent deflation and bad-debt disposal, the grim prospects for the global economy — particularly the likely deceleration of the U.S. economy and the possible consequences of a war in Iraq — are making things increasingly difficult for Japanese companies as well. Certainly, a profit recovery achieved mainly through defensive restructuring is no excuse for complacency.

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