Japan Inc. is extremely rich. In fact, companies listed on the Tokyo Stock Exchange just set a new world record. They now own cash worth more than 140 percent of Japan’s gross domestic product. This is more than three times higher than the 43 percent of U.S. GDP equivalent held in cash by American companies. More importantly, Japan’s corporate cash reserves have surged by more than one-times GDP over the past 10 years. How — or whether — this enormous corporate liquidity pool will be deployed and invested holds the key to Japan’s future growth and prosperity.
The good news is that this is a great problem to have. Yes, we can decry the fact that Japan’s GDP could have doubled in the past decade — if only the rich listed companies had reinvested their profits back into the economy rather than put them into bank vaults. But no, in reality corporate Japan has done well and acted entirely rationally. Make no mistake — the enormous cash reserves now built put Japan Inc. in a position of huge potential future strength. Sooner or later, today’s idle cash surplus becomes tomorrow’s war chest to help win in the global competitive race.
Meanwhile, Japanese politicians have started to criticize companies for not investing more or for not paying higher wages. This sounds good, but unfortunately it says more about the politicians’ lack of faith in today’s global market economy than about the quality of corporate leadership and stewardship. Why? Because it is easily forgotten that companies listed on stock exchanges — i.e., the ones with the huge surplus cash balances — are large, global and very much incentivized to act in the best interest of their various stakeholders — employees, suppliers, shareholders and community/society.
If at all, the recent introduction of Japan’s corporate governance and capital stewardship codes has significantly strengthened corporate accountability toward multiple stakeholders. Just as their American and Chinese competitors, the leaders of Japan Inc. allocate surplus cash by weighing costs versus benefits. In my opinion, Japanese corporate leaders are doing a perfectly fine job optimizing for multiple stakeholders. If politicians want idle corporate cash to be mobilized for their policy projects it is on them to get more creative and more aggressive.
Politicians calling for higher wages miss the fact that one of the defining characteristics of a free and open economy is that corporate leaders are supposed to try as hard as possible to pay as little as possible to each of the various stakeholders. If management can get away with offering only a 1 percent pay increase without losing or demotivating employees, then it not only will do so, but it should do so. Similarly, if management can get away with raising the dividend by a minimal amount without losing investor interests or triggering a drop in the share price, it also should do so.
Make no mistake. The rising cash surplus of corporate Japan is nothing but a clear indication that neither politicians, or employees, or shareholders or asset owners are doing a good job. In America, investors are much more effective in demanding higher capital returns than their Japanese counterparts; and in Germany labor consistently succeeds in keeping corporate excess cash reserves as low as possible by demanding the best pay packages in the world. Companies will play by the rules and by the demands coming from the various stakeholders, and these differ from economy to economy.
This is where Japanese politics can play an important role. While companies follow rules, politicians make the rules. Only politicians have the power to govern and influence all the stakeholders competing for the wealth created by private companies. Clear-speak: if “Team Abe” really wants a 3 percent pay hike, it should change the labor laws and regulations so that companies that invest less in their workers and employees actually see their people quit and move on to those companies offering higher compensation, greater career development prospects or a better work-life balance.
Here, Team Abe is on the right path, in my view, for focusing on top-down imposed tighter rules of employment conditions in general, overtime practices in particular. However, many of these new rules and re-regulations labeled “Hataraki-kata Kaikaku,” or work-style reform, are de facto punishments or disincentives. It’s all stick and no carrot. Team Abe should be more focused on creating positive incentives for companies to invest in human capital. For example, there is ample room to raise incentives for better and greater employee education in general, computer and English literacy in particular.
Here Japan’s unique corporate cash surplus offers an opportunity for policymakers to be innovative and break new ground. Traditionally, most policy incentives work by offering lower tax rates or tax write-offs. If, for example, employee education is deemed worthy of policy support, corporate spending on approved programs gets preferential tax treatment. Now, the record-high cash balances allow a new tool: The threat to tax cash reserves unless a certain amount is used for greater employee education would trigger the desired investment. If you don’t go for the carrot, you’ll get the stick.
Obviously, the same can work for any project or investment deemed worthy of public policy support. Whether investment in human capital or investment in productive capital, the threat to tax excess cash could create an economy-wide win-win: Corporate managers get an incentive to invest in the future without giving up anything but excess liquidity; the recipients of the investment get the income and new challenges; and the treasury does not lose any tax revenues. In fact, overall tax revenue should rise as the unlocking of the otherwise dormant corporate cash creates new incomes, new consumption and new investment — a new virtuous economic growth cycle starts.
Meanwhile, the corporate war chest of record cash balances also strengthens the structural bull case for Japan: When the next global downturn comes, I expect a new boom of Japanese investments and M&A activity, both at home and around the world. Moreover, the cash buffer makes me confident that Japan’s investment in human and productive capital can go hand in hand with steadfast progress on capital stewardship — today’s record cash surplus allows for tomorrow’s decoupling from the normal business cycle.
Jesper Koll is WisdomTree’s Head of Japan. He’s been researching and investing in Japan since 1986 and has been consistently ranked as a top Japan strategist/economist. He’s written several books in Japanese and publishes blogs at www.wisdomtree.com/blog.
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