Abenomics has a critical weakness: Japan’s companies are not playing along and it’s hard to blame them.
Japan’s economy, struggling to end decades of deflation and recession, grew at a disappointing 2.6 per cent annualised clip in the second quarter, a full percentage point below forecasts and a marked slowing from the first three months of the year. While the poor showing immediately focused minds on whether the economy could withstand a planned hike in sales tax, the real puzzle lies in the story behind yet another fall in investment by companies.
So-called capital expenditure fell by 0.1 per cent in the quarter, frustrating predictions of the first gain in almost two years. That’s critical because an unwillingness by Japanese companies to invest and to hire is acting as a circuit-breaker on Abenomics, effectively blunting the transmission of monetary and fiscal policy to the real economy.
Abenomics, a cocktail of fiscal and economics stimulus poured over a base of reforms, is intended, among other things, to drive down the value of the yen, which in turn should allow newly competitive companies to export more, hire more workers and contribute to a virtuous cycle of investment, consumption and growth. The yen part has worked perfectly, with the currency falling about 20 per cent against the dollar in the past year.
That has certainly been a boon for Japanese companies, many of which have seen profits double. High profits have not translated into investment and growth however, despite reasonable demand for Japanese products globally.
Perhaps even worse, recent surveys of purchasing managers point to a worse outlook for the coming months.
“Worryingly, PMI data also showed companies cutting headcount again after two months of job creation, reflecting growing uncertainty about the economic outlook,” according to Chris Williamson, chief economist of Markit, whose combined manufacturing and services barometer fell to 50.7 in July, just above the 50 reading which divides contraction from growth.
So why aren’t companies playing their part? Because they don’t have to, for one thing. While the yen means companies could cut prices to expand market share, they have another quite attractive option: simply keep prices competitive on exports but, rather than expand market share, allow profit margins to expand.
That is especially attractive given all the uncertainty in Japan’s outlook. The weak yen is by no means permanent and many factors might mean that investments made in Japan now don’t pay off.
For one thing, Japan’s quadrillion-yen (Dh37.6 trillion) debt (yes, that’s right, public debt passed 1,000 trillion, or a quadrillion, yen in June, equal to 200 per cent of GDP) might force it to raise sales taxes as planned. That in turn would crimp domestic demand, with about a third of economists forecasting a recession if the sales tax rises from 5 to 8 per cent next April as proposed.
So far, the behaviour, as opposed to the rhetoric, of major Japanese exporters shows a tendency to book profits and play conservatively. Toyota almost doubled its net profits in the second quarter even though it sold fewer cars. And while Nissan bumped US sales of cars by a fifth after it cut prices, Ford, GM and Chrysler all gained market share in their home market so far this year.
In other industries profits are improving, as are exports, but it mostly seems to be a demand story rather than a result of the newly weak yen. To be sure, investment is a long process, and Japanese companies are not known for making lightning-fast decisions about significant expansions. It may well still turn out, should the yen remain weak and should the domestic economy seem stable, that Japanese companies in the end do come through with investment, improving the outlook perhaps for 2014 and beyond.
Interestingly, the phenomenon of just sitting back and enjoying fat margins without making new investment probably has a different cause in Japan than in other places, like Britain.
While when the pound dropped in 2008, British companies “priced to market,” simply allowing fat profits to roll in. That was likely driven in part by compensation practices in Britain, which tie executive pay closely to stock market movements through share options. British CEOs, faced with the option of a gratifying short-term bump in the value of their shares versus a risky long-term investment in more production, usually chose to take the money now.
In Japan, executive pay practices are significantly different, making low investment more likely to be the result of risk analysis coloured by the very difficult experience anyone managing a big company in Japan has had these past 20 years.
While there are a quadrillion reasons Abenomics may not work, the weight of history only adds to the count.