|
Japan Is Back, For Real This Time
Good. they are a good ally of ours right now and can offset China's expansion in the region.Japan is back as a high-growth economy. A combination of positive cyclical forces and structural changes suggests that an upgrade to the short- and medium- term outlook for the country is in order. Over the next five to 10 years, the Japanese economy's growth potential is poised to be close to 2.5% -- much higher than the 1% to 1.5% estimates commonly proffered by economists. This paves the way for the Japanese economy to become an even more powerful engine of prosperity for Asia. Several factors underlie this newfound optimism. The country's private sector no longer faces an overhang -- Japan has successfully worked off its post-bubble legacy of excess debt, excess capacity and excess employment. On the supply side, there has been an unprecedented reduction in unit labor costs -- the rise in corporate Japan's profitability and global competitiveness has only just begun. Meanwhile the demand side is also growing, as more and more Japanese companies begin to reinvest in domestic factors of production (land, labor and capital). For the first time in more than 15 years, Japan's leading companies are building new factories at home. Looking at the period of the next four to six years, Japanese demographics can be considered a structural positive, as asset-rich baby-boomers retire (and spend), and their offspring -- the echo boomers -- land better-paying, more secure jobs. Furthermore, there is evidence that Japan's monetary policies are, at last, starting to work. The velocity of money is rising, and by early next year, a new bank credit cycle is poised to follow, thanks to the recent reorganization of money-center bank capital structures, which will allow for the completion of long-overdue bad-bank-asset write-offs by March 2006. The fundamental structure of the economy was such an impediment during the 1990s that whenever the global cycle turned down, the country fell back into recession. That structure has now changed dramatically, freeing Japan to grow. Essentially, the following forces are at work: ⢠Reduced cross shareholdings. Corporate Japan's move away from the old cross-shareholding system has forced unprecedented changes in governance. The country is shifting from "insider capitalism" to "outsider capitalism." So-called "stable shareholdings" have dropped to around 22% of market capitalization from a peak of 53% in 1987. With a narrower definition of cross shareholdings, the corresponding drop is to about 15% from 38%. ⢠More competitive resource allocation. Reduced stable shareholdings and an increased free float effectively raise the cost of capital. This is because free-float investors are much more concerned about quarterly/semiannual corporate performance than stable cross shareholders. Japan's average price-earnings ratio has come down, so the cost of equity capital has gone up. Specifically, the equity-earnings yield is now around 6%, against a historic average of barely 2%. ⢠Increased profits. Over the past decade, the increase in competition forced by the unwinding of cross shareholdings may have had some demand-deflationary effect. This is because inefficient producers and suppliers were forced into bankruptcy. However, in the last couple of years positive demand-pull factors have definitely taken over. Bankruptcies have fallen consistently since the end of 2002, while corporate profitability has surged to new historical highs: operating profits for listed companies now stand more than 40% above the bubble-economy high of 1990. ⢠Improved balance sheets. Structural change in corporate balance sheets has also progressed. The debt overhang has been paid off. For the first time in over a decade, corporate managers are free to use their cash flow to reinvest in the business, rather than just pay back their bankers. As the chart nearby shows, the Bank of Japan flow-of-funds data confirms that total corporate sector interest-bearing liabilities have been cut by about 200 trillion yen ($1.7 trillion) since 1996. As a result, the gearing of the corporate sector has dropped to below 80% of GDP, from a peak of around 125% of GDP in 1996. Japan's corporate balance sheets are in their best shape since the early 1970s, a fact reflected by credit-rating agencies issuing a steady stream of corporate credit upgrades in recent months. The combination of record profits and successful degearing is very powerful. Freed from the demand drain forced by debt repayment, corporate managers can now use their record cash flow. One manifestation of this is the steady rise in share-buybacks, now running at around 1% of market capitalization. Moreover, dividend payouts are increasing. ⢠The capacity overhang has been worked off. The Ministry of Economy, Trade and Industry's index of capacity utilization is now back to levels last seen in 1989, the peak of the bubble economy. ⢠Companies need to reinvest. Japan's productive capital stock has aged. Factories are almost 12 years old on average, versus the historical average of eight to nine years, suggesting that reinvesting in structures -- rather than just upgrading machinery -- is poised to become a major demand driver in Japan. For example, several high-profile electrical machinery companies have recently announced plans to build new factories in Japan. ⢠The big drag from Japan's globalization is over. From a macro perspective there are good reasons to argue that the worst of Japan's "hollowing out" is over. Recall that Japan has long been a champion of globalization. Currently, almost 45% of total global production capacity of Japanese exporters is located outside the country, up from 20% a decade ago. (Although this is considerably lower than U.S. off-shore production of almost 60%.) However, Japanese companies tend to prefer to produce at home for the domestic market, and this has recently been re-enforced not just by the rising profitability of domestic operations, but by increasing problems of supply-chain management, human-resource management and infrastructure, particularly in China. ⢠A job-rich recovery. The most important new dynamic is a fundamental change in Japan's human-capital investment. Where companies build new factories, new jobs will be created. Data on job offers confirms that today more companies are looking to hire more people than ever before. Almost 800,000 new job offers are put on the market every month. However, actual job creation runs at only about 40,000 jobs to 50,000 jobs. This points to a mismatch in the labor market where demand actually exceeds supply. To put it bluntly, companies want to hire engineers or qualified nurses, but can only find unemployed construction workers. However, the fact that demand does exceed supply bodes well for further falls in unemployment and further increases in wages. Moreover, the quality of jobs is now improving. Over the past decade, most of the jobs created were on a part-time or contract basis only. Cost-conscious managers were afraid to lock in potentially high fixed costs and focused on employing cheap and easily fired part-time workers. By one estimate, almost 42% of employees at companies listed on the stock exchanges are now part-time or contract workers, up from 15% just 15 years ago. In contrast, since the start of this year, full-time job growth is outpacing part-time job creation for the first time in almost 10 years, and several multinational companies have announced that they will exclusively hire on a full-time basis in order to build a better human-capital base. ⢠A structural upshift in productivity. The net result of all this should be significantly faster productivity growth than the 1.5% average recorded over the past 15 years, as the chart nearby shows. Indeed, Japan's productivity baseline over the next five to 10 years will likely be around 2.8%. The chances of Japan re-emerging as a high-growth industrialized powerhouse are very high. This is based on the tremendously positive private-sector backdrop that has been created by Japan's private-sector managers. The biggest risk to this scenario would be mismanagement on the part of public-policy makers. So far, Japan's monetary and fiscal authorities deserve the highest praise for having coordinated their policies with the sole purpose of increasing Japan's revitalization potential. A premature tightening of either monetary or fiscal policy is always a risk. For now, however, the prospects look good for Japan to once again become a powerful engine of Asia's growth. Mr. Koll is chief economist at Merrill Lynch in Tokyo. Extracted from the October issue of The Far Eastern Economic Review (www.feer.com). Posted by: lotp 2005-10-24 |
| http://www.rantburg.com/poparticle.php?ID=133012 |