The Abenomics economic policy has entered its fifth year. The Japanese economy has continued to recover albeit at a moderate pace. In particular, thanks to the yen's depreciation, among other factors, corporate profits have risen to a record high level, and the labor supply-demand balance has become the tightest ever.
Will the recent improvement in companies' business performance create a positive economic cycle by increasing capital investment, income, and personal consumption? In reality, in contrast to the robust business performance and the tight employment situation, companies are behaving cautiously. While companies' cash holdings have continued to increase, wage hikes have remained moderate, and capital investments also have increased but only slowly. Some people have pointed out the possibility that companies' cautious attitudes are acting as a bottleneck for the successful implementation of policy measures.
Can corporate behavior be changed in the future? This article will examine companies' cautious attitudes and the factors behind them while explaining the results of a firm survey I conducted with RIETI Fellow Hongyong Zhang and University of Hong Kong Assistant Professor Cheng Chen.
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When formulating business plans, companies consider the future business environment at both the macro and micro level. In fact, the most recent studies of corporate behavior such as investment and hiring highlight a dynamic viewpoint. Various theories and empirical studies have shown that uncertainty over the future business environment faced by companies causes them to behave cautiously. Uncertainty can delay investment decisions at the firm level, which in turn may result in misallocation of resources such as capital and labor, reducing aggregate productivity.
Although there is no barometer that perfectly measures the degree of uncertainty faced by companies, the development of indexes to measure macro-level uncertainty has proceeded in recent years. Among them is the VIX index (fear index), which uses stock market volatility as a yardstick, and the Economic Policy Uncertainty Index, which uses the frequency of newspaper references to such words as "economic" or "economy," "uncertain" or "uncertainty," and "Congress" or "White House."
On the other hand, there are also attempts to measure the micro-level uncertainty faced by individual companies. Under the leadership of Stanford University Professor Nicholas Bloom, research teams have been established in various countries. I am engaging in measuring the uncertainty faced by companies in Japan and the United Kingdom.
Specifically, our survey asked companies to report five scenario forecasts with respect to future sales and other items in order to develop a index to measure companies' subjective views of the uncertainty that they are facing. Based on data concerning the variance and skewness in the forecasts, we measure the degree of uncertainty facing individual companies. For example, we would like to test if companies with a wide disparity in their sales forecasts across various scenarios are facing a high degree of uncertainty.
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We conducted the Business Plans and Expectations Survey in October-November 2017 at RIETI. We asked companies to report forecasts under five scenarios—most pessimistic, pessimistic, median, optimistic, and most optimistic—with respect to foreign exchange rates, the real gross domestic product (GDP) growth rate, and their own sales. We also asked them to estimate the probability of each scenario coming true (expected probability), trying to identify the subjective distribution based on the five scenario forecasts and expected probabilities.
With respect to the GDP forecast (the period average for fiscal 2017-2018), the median scenario forecast averaged 1.05%, reflecting a cautious outlook on the part of companies. Meanwhile, the most pessimistic forecast averaged 0.19%, indicating companies' perception of some degree of downside risk. The most optimistic forecast averaged 2.34%, meaning that companies' expectations for economic growth are not high even at the optimistic end (see Figure).
British economist John Maynard Keynes coined the term "animal spirits" to explain how the people's expectations drive their behavior. It is important to deepen understanding on how expectations, which may become either optimistic or pessimistic, are formed and how they affect companies' behavior. Our survey also asked companies which of the five scenario forecasts of sales they would use as a basis for formulating capital investment and employment plans. Around 80% of the surveyed companies said they would use the median sales forecast. Only around 10% said they would use the optimistic forecast as a basis for capital investment and employment plans, so it is apparently difficult to expect much of companies' animal spirits for the current situation.
When asked about the uncertainty over the future business and operating environments, 68.6% of the surveyed companies said they recognized "some degree of uncertainty," and 15.3% said they recognized "a high degree of uncertainty."
Compared with companies that recognized "a low degree of uncertainty," companies that recognized "a high degree of uncertainty" showed the following tendencies:
(1) The forecast of the GDP growth rate is lower and the disparity in the forecast across the scenarios is wider.
(2) The forecast of sales is lower and the disparity in the forecast is wider.
(3) The number of workers they plan to employ is smaller.
The results verified the validity of measuring uncertainty based on the distribution of subjective forecasts, and the presence of a negative correlation between the uncertainty faced by companies and their growth forecast and behavior.
In order to examine the underlying factors of the uncertainty faced by companies, our survey also asked the respondents to cite items that affect their forecasted business and operating environments (multiple answers accepted). Of the surveyed companies, 60% cited Japan's economic growth rate, compared with 49% for the domestic price level and 35% for the economic policies of the government and the Bank of Japan (BOJ). Of the policies of the government and the BOJ, the tax policy (e.g., corporate tax, consumption tax, etc.) was cited by 73%, the policy for the system concerning the labor standard and supervision was cited by 48%, and monetary policy was cited by 36%.
The finding that uncertainty concerning the tax system is important is in line with the results of a survey conducted in 2013 by RIETI Vice President Masayuki Morikawa. He also pointed out the impact of the tax system on plans for capital investment, overseas business expansion, and employment.
In order to change companies' behavior, it is necessary to dispel their uncertainty over the future and raise their expectations for growth. This approach is consistent with the analysis by Kansai Gaidai University Professor Kazuo Ogawa (an article dated December 22, 2017, in this column).
The results of our survey also indicate the possibility that the uncertainty related to the tax system, employment-related policies, and monetary policy is contributing quite a bit to companies' cautious attitudes.
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Of the three arrows of Abenomics—bold monetary policy (first arrow), flexible fiscal policy (second arrow), and growth strategy that stimulates private-sector investment (third arrow)—the first and second arrows until now have been the focus of attention. This reflects the high expectations for the BOJ's unconventional monetary policy and the government's active fiscal policy that have been implemented to pull Japan out of crisis.
On the other hand, given the failure to achieve the inflation target, the delay in fiscal consolidation, and the slow economic growth, it is difficult to maintain the view that it is possible to achieve high growth and fiscal consolidation simultaneously through the first and second arrows. Amid the lack of progress in fiscal consolidation, how will Japan curtail the massive monetary base (money supply) in the future? What will Japan do about the consumption and corporate taxes and the social security system while facing fundamental structural problems such as the shrinking and aging population? Uncertainty over these questions may be making it difficult for companies to feel safe about raising wages and making capital investment.
I would also like to point out that over the past five years, Japan has relied so much on fiscal and monetary policies that it has lagged behind in carrying out deregulation and other reform measures. In an interview with Nihon Keizai Shimbun in December 2010, former BOJ Governor Masaaki Shirakawa cited Japan's weak growth potential as the fundamental problem. He also cited the tax system and regulation as the key factors for companies' business strategy and argued that unless Japan addresses those substantive matters, expectations for growth would not grow and deflation would remain unresolved. A growth strategy is as important now as it was back then.
Before returning from crisis to normal mode with respect to the first and second arrows, Japan must adopt and execute a bold growth strategy quickly and pave the way for resolving the medium- and long-term structural problems. Otherwise, companies will not feel secure about raising wages and making capital investment. For the future execution of the growth strategy, it is important to seize the current favorable environment for economic growth as an opportunity to present a medium- and long-term roadmap of sustainable monetary and fiscal policies and engage in dialogue with the market.
* Translated by RIETI.
March 8, 2018 Nihon Keizai Shimbun
