What to do with Excess Corporate Savings?
Risaburo Nezu
Senior Executive Fellow, Economic Research Center
April 15, 2010 (Thursday)
Financial strategy of Japanese companies: bubble collapse as turning point
Over-saving by Japanese companies is stirring a new problem in the Japanese economy. After the bubble collapsed, Japanese companies shifted from a financial strategy that depended on external borrowing to one that reduced debt and increases retained earnings. The bubble burst and stock and land prices plummeted in 1990. Following this, unrealized gains morphed into unrealized losses and eventually bad loans. Partially a result of government policy, banks were called on to dispose of bad loans in the late 1990s, leading to a widespread credit squeeze on and credit withdrawal from indebted companies. Japanese companies emerged from these difficult times believing that debt reduction and capital growth were essential to stable management. As a result, wages were held down and the capital-to-asset ratio was significantly raised even in the long post-war period of economic recovery since 2002. This trend rapidly improved the financial make-up of companies, but has also produced a surprising result.
Pattern of households saving and companies investing in the 1980s
The unexpected result is this: despite lower household savings, the savings rate in the overall economy has seen no decline because companies have become a “savings sector.” Government bonds have been steadily digested in the market, and the potential risk of the budget deficit has gone unrecognized. The following graph shows this from the perspective of the savings-investment balance.
Above the horizontal axis is net savings; below is net investment. Savings turn into investment through various routes, and in the end the two are balanced in the overall economy. The existence of foreign economies, however, means excess savings are invested overseas as a current-account surplus. Conversely, companies with higher investment than savings depend on external capital to cover shortfalls. If such shortfalls exceed the total supply of savings, Japan will fall into a current-account deficit.
The graph looks at this savings-investment balance since 1980. The movements of non-financial corporations—in other words, ordinary companies—are particularly noteworthy. Until the mid-1990s, non-financial corporations were always below the horizontal axis. Put differently, companies borrowed money externally, mostly from households, for business investment. Financial institutions and primarily banks naturally served as the go-between, but as simple capital intermediaries they are not shown in the graph. Household savings were greater than company investments, so the difference flowed out as surplus funds and Japanese people increased their holdings of overseas assets.
Corporate sector’s shift to a savings sector
This pattern changed dramatically in the late 1990s. Non-financial corporations began to appear above the horizontal axis of savings-investment graph; in other words, companies starting saving. Companies typically sell products or services and receive payment in exchange, and pay out the costs such as basic materials and payroll. Profit is what is left over. Depreciation is also subtracted from profits as a cost, but isn’t counted as cash outflow. A portion of profits are distributed to shareholders after taxes are paid, and the rest is accumulated within the company as retained earnings. In this way, retained earnings and depreciation are freed-up money for companies; growing companies move this money into investment. The option, however, to hold on to these funds to pay back loans or for the uncertain future is also available. The remaining cash is entrusted to the bank, or turned into securities such as stocks and bonds.
Non-financial corporations quickly fattened their savings from 2001 to 2005. The economy continued to expand after 2006, and companies became more eager to invest and trim savings. Yet, private companies did not borrow and then invest as before, and since the global recession hit in 2008, they have once again curbed investment and reemerged as a savings sector. In addition, financial institutions previously absent from the savings-investment graph above have emerged as a savings sector, a trend especially strong since 2000. This is because the Koizumi Administration strongly encouraged the disposal of bad loans at financial institutions, a move that made banks stop lending, improve profits and use them as funds to pay off bad loans. Another reason is banks are strengthening their capital base in response to a global trend of stricter capital regulations by BIS.
Using accumulated savings to purchase government bonds
In this way, households, private companies, and banks have all become savings sectors. What should be done with these accumulated savings? One option is to move them overseas, but this has natural limits: if pursued excessively, this would bloat surpluses, reignite trade friction, and invite exchange rate risks. Purchasing government bonds becomes the only remaining alternative.
A budget deficit is therefore unavoidable. A glut of government bonds could trigger a price collapse, causing interest rates to rise and the government to struggle to digest bonds. Such a collapse is avoided because individuals and private companies are working hard to pay back debt and save money. This money accumulates in banks, which, lacking alternatives, purchase government bonds. The government is not forcing banks to buy bonds. Interest on Japanese government bonds is currently the lowest in the world, and the yen’s exchange rate is the most stable. This mollifies the sense of crisis and fuss over Japan’s largest government debt in the world. Absent clear policy for how to reduce excess individual and particularly corporate savings, scenarios for fiscal reconstruction are unclear.
Companies should stop over-saving and start investing productively
The mission of companies is to efficiently manage the money entrusted to them by investors, and produce and share profits with these investors. Companies should not hold on to extra money; the current situation in Japan is undesirable. Passing on surplus money to stakeholders is a way to reduce company savings. There are three reasonable methods for this.
The first method is to increase dividends to shareholders. Though Japanese companies have recently raised dividend rates, they are still behind their US and European counterparts in this area. There is room to bring the rates up to global standards, a move that would spur shareholders to consume.
The second method is to boost wages. Wages at Japanese companies have seen marginal increase over the last decade. Raising wages would increase purchasing power for workers, and could also offer clues for overcoming deflation and reviving the economy.
The third method is to increase government revenue; in other words, raise corporate tax. Japan’s corporate tax, however, is already relatively high, and a further increase is unrealistic as it would run counter to popular opinion.
From the perspective of enhancing the growth potential of the Japanese economy, companies should use surplus funds in ways that will drive economic growth. The problem is a dearth of promising investment opportunities. From a different viewpoint, however, there are many new areas that should be developed. Supporting the growth of young venture companies with new technologies and innovative ideas is an issue Japan must urgently address. For these newcomers to succeed, it is essential that existing companies buy their technologies, products and services, and launch joint ventures. The surplus funds of companies should be used for such purposes. Corporate tax cuts, a possibility that is set to be examined, should not thoughtlessly favor existing companies. Rather, such support should be limited to companies involved in new and innovative efforts.
More meaningful social investment
Private companies should not be solely depended on for investment that promotes Japanese economic growth. Services in areas with expected growth such as healthcare, nursing care, and education have been provided under government subsidies and supervision; these services cannot be handed over entirely to private companies in the future. Thinking of investment in these areas exclusively in terms of company profitability is in many instances unrealistic. On the other hand, social investment would reap great social benefits for society not reflected in individual company profits.
I personally believe it is important to encourage socially marginalized autistic and reclusive youth to return to society. Helping these young people, who could spend their lives as societal baggage if left alone, to become independent and participate in productive activities would have an immeasurable effect on society as a whole. In a more familiar example, companies should consider structures that encourage spending on child care facilities for employees and re-education programs for their families.
Social entrepreneurialism is garnering increasing interest among primarily the younger generation. Using the dormant money within companies for these motivated young people could significantly change the Japanese economy and society. On the other hand, companies that let stockpiled funds sleep will likely become the target of takeovers by foreign capital. Hedge funds sniff out such cash rich companies, and if the yen weakens the risk of takeover will become even stronger.
Looking to the future, domestic business investment will continue to decline in Japan with the shift of manufacturing to overseas. This will make it difficult for the corporate sector to return to an investment sector. In this case, instead of thinking of the current problem as temporary, Japan should examine structures that will inject funds into growth areas over the long term.
