Recently I have become somewhat unpopular among corporate leaders in Japan. Yes, they are sincerely fascinated and even envious of my unfaltering Japan optimism, but they do not like to hear my view that now the primary obstacle to a new Japanese golden age is a lack of corporate leadership and ambition, rather than bad politics.
Don’t get me wrong. There is plenty of work to be done to improve the finer points of Japanese economic policy, but the basic parameters laid out by Abenomics are consistently delivered. This is a stable, predictable, highly coordinated and fundamentally pro-business government. Make no mistake, if you think Abenomics is not working it is in large part because of the lazy defensiveness and apparent lack of ambition of the many “salarymen” corporate leaders.
Just look at the data: Corporate Japan reports record profits, with the earnings of listed companies up almost three-fold from the 1990s average. So far, so good. But what do companies do with this newfound record profitability? There are five basic choices: invest in productive capital: Invest in your brand and intellectual property assets; invest in human capital; buy growth through acquisition; or pay your shareholders a higher dividend or buy-back shares.
The other option is to, well, do nothing and simply hoard cash. And that latter option is exactly what salarymen corporate leaders have been doing: Cash holdings of listed companies have surged from just about 30 percent of GDP 10 years ago to almost 140 percent of GDP (this is cash and cash equivalent, i.e., short-term securities). In contrast, business investment, human capital investment, R&D investment, M&A investment and shareholder yield (dividends plus share buybacks) have basically stayed flatlined relative to cash flow and earnings generated. There has effectively been no change in the structural allocation of corporate cash flow and, ultimately, corporate capital; the only structural change has been cash-hoarding of unprecedented magnitude.
Of course, in absolute terms, corporate investments in productive and human capital (and M&A and dividends etc.) have all grown, lifted by the improvement in the macro economy in general, the resulting uptick in cash flow and profits in particular. However, over and above the cyclical pick-up. Corporate Japan has not raised investments in its own future growth potential. If at all, corporate Japan has been a “free rider” of the positive macro-backdrop created by Abenomics (and, until recently, the favorable global business cycle).
Let me be more specific. To start, let’s look at human capital. Here, the general narrative is that corporate Japan supposedly takes great pains to compensate labor. Unfortunately, the numbers tell a different story: Workers compensation is barely 33 percent of corporate value add in Japan, significantly lower than 48 percent in the United States and 78 percent in Germany. Yes, Japanese companies are extremely kechi (stingy) when it comes to paying their workers.
The Abe administration has been trying to lobby for higher wage growth and better compensation, but corporate leaders prefer to hoard cash and earn no return (interest rates are zero), rather than to invest in their employees. Want stronger domestic demand and consumption? Take just 1 percent of the cash pool to invest in employees and you’d boost consumer spending by as much as a full percent (which means you’d basically double the growth rate of consumption). No wonder Prime Minister Shinzo Abe is frustrated with his corporate leaders. And back at the company levels, no wonder morale in many companies is so low. If your boss thinks it is better to invest in a zero-return asset rather than invest in you, the signal is pretty clear: He must think your contribution is worth less than zero.
Of course, a prudent corporate leader will want to keep a cash buffer. You need it for times of trouble and business downturns (when, typically, your banker won’t lend to you). Or you’ll want it as a war chest to buy assets when they become cheap in a crisis. Mitsubishi UFJ Bank did this brilliantly by snapping up a good part of Morgan Stanley on the cheap during the global financial crisis. However, this was a notable exception.
The general rule is that corporate Japan has de facto no historic track record of actually making bold and opportunistic acquisitions during times of crisis or opportunity. If at all, it goes the other way with Japan famously overpaying for supposedly strategic overseas acquisition, e.g., Japan Post buying Australia’s Toll Holdings.
There is a strong case to be made that Japan’s record cash balances breed false financial confidence and bad governance. Frankly, the relentless cash-hoarding by corporate Japan is one of the big unresolved puzzles of global finance.
Why does the leadership of a multi-stakeholder, for-profit enterprise choose to hold more of a zero-return asset rather than invest in one of its stakeholders where, by the fact they are a stakeholder, there must be a positive return?
To add insult to injury, all corporate leaders agree that, yes, Japan must raise productivity. All too often, productivity gets confused with process efficiency. Just trying to save costs and streamlining process efficiencies may get you higher efficiency and even higher profit margins, but if you use these profits to simply hoard cash, your productivity of capital is unlikely to go up.
You’re sweating your workers and your factories harder and harder, only to add a dead-weight zero return asset to your balance sheet. Return on assets or return on capital will stay flat at best — despite greater efficiency (and probably ever unhappier and frustrated employees). To raise productivity of capital and labor, you’ll need to invest in future returns by, for example, buying better productive capital, i.e., technology, and mobilize better use of human capital, i.e., pay for performance.
All of this is easier said than done, but if a corporate leader has no “animal spirits,” has no vision for where the future of the enterprise should be and will be, has no urgent need to invest and put capital to work, then how can he or she claim to be a leader? And no, merely playing defensive and preserving the status quo is not an option — at least not for publicly listed companies.
All said, you can see why I have somewhat fallen out of favor with some corporate leaders. It would be so much easier if we could keep on blaming Japan’s “structural problems” on bad political leaders. And yes, during the 1990s and the early years of the millennium that was basically correct. Now, however, the narrative must change.
In the end, every nation deserves the political leaders they have, but a nation’s economic performance and prosperity depends first and foremost on the animal spirits and leadership of private enterprise. And I am convinced that Japan’s corporate leaders will rise to the challenge.
Jesper Koll is WisdomTree’s head of Japan and is consistently ranked as a top Japan strategist/economist. He publishes blogs at www.wisdomtree.com/blog.
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