Japan: Selected Issues
Author: International Monetary Fund
Publication Date:
11 Aug 2004
eISBN:
9781451820577
Language:
English
Keywords:
ISCR; CR; firm; business cycle; debt; bank; recession; distressed firm; debt ratios; nonviable firm; firms' profitability; medium-sized firm; Employment; Corporate sector; Manufacturing; Labor costs
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This Selected Issues paper analyzes the key features of the Japanese business cycle, and investigates whether the current recovery differs from past recoveries. In particular, this paper poses the following questions: what are the main characteristics of Japanese business cycles since 1980, and what happens to output, expenditure components, and prices over the cycle? The paper reviews the recent performance and policy issues with respect to the banking sector, insurance sector, and public financial sector in Japan. The stability of the financial sector is also assessed.

Abstract

This Selected Issues paper analyzes the key features of the Japanese business cycle, and investigates whether the current recovery differs from past recoveries. In particular, this paper poses the following questions: what are the main characteristics of Japanese business cycles since 1980, and what happens to output, expenditure components, and prices over the cycle? The paper reviews the recent performance and policy issues with respect to the banking sector, insurance sector, and public financial sector in Japan. The stability of the financial sector is also assessed.

III. Recovery of Japanese Firms1

A. Introduction

1. The financial health of Japanese firms has improved significantly over the last several years, following a long period of sluggishness during the 1990s. Reflecting the economic expansion and the fruits of past restructuring, nominal profits of listed firms set an all-time record in FY2003, business sentiment as reflected in the BoJ’s June 2004 Tankan survey rose to the highest level since the late 1980s, and bankruptcies have steadily declined.

2. This chapter reviews trends in key corporate sector indicators since 1990, focusing mainly on corporate profitability and debt. It sets these developments in a longerterm context by making comparisons with data since 1980. This chapter also describes various characteristics of the recent corporate sector recovery, the strongest recovery since 1990, to facilitate a better understanding of the underlying forces driving it.

3. In doing so, the following questions are posed:

  • What progress has been made since 1990 in restoring the corporate sector to health?

  • What are the main remaining problems?

4. The main findings are as follows:

  • Overall, firms have made good progress in reducing the problem of the “three excesses” in debt, production capacity, and employment, although there is clearly still room for further improvement;

  • Profitability in relation to sales has improved due to extensive cost reductions. However, many firms still have unproductive assets. Therefore, additional downsizing of these assets as well as increases in sales are key to further improving profitability.

5. The rest of the chapter is organized as follows. Section B chronologically describes how firms ameliorated the three excesses and low profitability. Developments are discussed in terms of three phases: 1990–1995, the immediate aftermath of the asset price bubble; 1996–2000, the decline in sales and prices; and 2000–2004, the marked profit recovery. Following that discussion, developments of debt, capacity, employment, and profitability are examined more closely in Section C, with a focus on differences across sectors and remaining problems.2 Section D concludes by pointing to other remaining problems affecting the Japanese corporate sector, particularly weak industries and regions.

B. Corporate Problems and Recovery

Corporate Malaise (1990–1995)

6. Following a period of high investment and employment in the late 1980s and early 1990s, the Japanese corporate sector entered a prolonged slump in the 1990s. During the late 1980s and early 1990s, overly optimistic business plans amid an asset-price bubble encouraged excessive investment and employment. The bursting of the late 1980s asset price bubble then triggered a deterioration in the health of the corporate sector. Most importantly, the capital loss from the decline in real estate prices, which reached over ¥1,100 trillion (over 230 percent of GDP), hurt the financial capacity of firms, particularly because most corporations relied on real estate as key collateral for borrowing. After the collapse of the asset-price bubble and subsequent economic downturn, firms regarded their debts as excessive compared with sales; manufacturing firms experienced sharp drops in capacity utilization rates; and firms also had more workers than desired although they failed to curb payments to workers.

uA03fig01

Corporate Balance Sheet

(Four-quarter moving average)

Citation: IMF Staff Country Reports 2004, 247; 10.5089/9781451820577.002.A003

Source: Ministry of Finance.

Historical Development of Selected Indicators

article image
Source: MoF, BoJ, CAO and METI and staff calculations.

Four quarter moving average.

Quarterly data (2004 1Q).

“Excessive” minus “insufficient”.

Quarterly data (June 2004 Survey).

Monthly data (April 2004).

Annual data (2002).

Data for 1983–89 are used due to data problems in 1980–82.

7. At the same time, firms suffered from declining profitability. Profit/sales ratios declined steeply in the first half of the 1990s amid the drop in asset prices and economic weakness. Also, firms owned relatively high levels of unproductive assets that did not generate sufficient sales and thus profits, which depressed corporate returns on assets (ROAs).

uA03fig02

Corporate Income Statement

(Four-quarter moving average)

Citation: IMF Staff Country Reports 2004, 247; 10.5089/9781451820577.002.A003

Source: Ministry of Finance.

8. In addition, firms were generally slow to adjust to the period of lower growth. Firms stuck with their old business models, which prolonged the period of adjustment. Particularly during the early 1990s, firms delayed cutting employment and investment relative to their cashflow even though economic conditions and profits had slumped severely.

Initial Efforts (1995–2000)

9. Beginning in the mid-1990s, firms started to cut investment to deal with their excesses. The failures of major banks in 1997 changed the financial relationship between banks and firms: banks sought to unwind lending to firms—particularly to SMEs—while these firms tried to pay off their debts to banks in order to minimize risks associated with possible financial turbulence in the future. Also faced with a long-term slump in sales and in expected growth, firms cut investment spending—and in particular after 1998—containing it to within their cash flow both to repay debt and to eliminate idle production capacity. As a result, the average age of production facilities of Japanese firms increased from 9.7 years in 1993 to 11.4 years in 1999.3

uA03fig03

Cashflow and Investment

(Four-quarter moving average)

Citation: IMF Staff Country Reports 2004, 247; 10.5089/9781451820577.002.A003

Source: Ministry of Finance and staff calculations.

10. In addition, firms tried to contain increases in labor costs. Firms at first relied mostly on conventional but moderate measures such as cutting back on new employment and overtime work hours, but then began to replace long-time or full-time workers with shorttime workers (those who work less than 35 hours per week). Between 1995 and 1999, the number of short-time workers increased by about 2.4 million, and the number of long-time workers decreased by about 1.8 million.4

11. During this period, despite limited progress on the surface, the Japanese economy did experience a degree of structural adjustment that set the stage for the consequent corporate recovery. Corporate bankruptcies and labor migration reveal the extent of important adjustments that took place. Bankruptcies rose to historical highs in the 1990s, with nonviable firms thereby exiting more quickly than in the past. Bankruptcies as measured by total debt involved in relation to GDP soared in 2000 to more than five times the 1980s average.5 Also, amid increased bankruptcies and costcutting at distressed firms, the unemployment rate rose to historical highs, and labor migrated from traditional sectors to newer and more viable sectors, partly helped by reforms in labor and other regulations.6 During 1998–2004, 4.5 million jobs were lost in agriculture, construction, manufacturing, and the wholesale and retail sectors, and 2 million jobs were created in industries such as medicare, social welfare, and other service sectors.

uA03fig04

Debt of Bankrupt Companies

Citation: IMF Staff Country Reports 2004, 247; 10.5089/9781451820577.002.A003

Source: Tokyo Shoko Research.

Labor Force by Sector

(In millions)

article image
Source: MPHPT.

12. Corporate efforts to address their problems, however, were undercut by sales declines and price deflation in the late 1990s. Falling nominal sales due both to weak demand and price deflation squeezed corporate profits and made it difficult for firms to service existing debt. In addition, declines in prices inflated already high corporate leverage by boosting the real value of debt. Moreover, particularly at the early stage of price deflation, firms were not able to adjust some expenditure items such as pension liabilities and nominal wages, which was reflected in slow progress in containing labor costs.

13. Due to sales declines and continued adverse effects of the asset-price decline, firms’ efforts to improve their financial health bore very limited fruit in this period. For instance, total labor costs increased through 1999 even in the face of declining sales. As a result, although the profits/sales ratio bottomed out in 1994 and was on an gradual upward trend thereafter, it remained low by historical standards for an extended period. Indicators of debt levels and production capacity also showed little improvement.

Corporate Revival (2000–2004)

14. As the new decade began, firms began scaling up their efforts to reduce costs. Firms not only continued to contain investment expenditures and to replace full-time workers with short-time workers, but also abandoned customary annual wage increases that prevented labor costs from declining.7 Thanks to this greater effort, labor costs declined markedly after 2000.

15. Against this background, firms’ profitability improved markedly even in the face of a continued decline in sales. Owing mainly to labor cost reductions, firms lowered their break-even points. The accompanying profit rebound while sales continued to decline characterized the initial stage of the current corporate recovery during 2002. Of course, the sustainability of the recovery in corporate health, however, remained in doubt in the absence of a revival in sales.

uA03fig05

Current Profit: Manufacturing

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2004, 247; 10.5089/9781451820577.002.A003

Sources: Ministry of Finance and Cabinet Office.
uA03fig06

Current Profit: Non-Manufacturing

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2004, 247; 10.5089/9781451820577.002.A003

Sources: Ministry of Finance and Cabinet Office.

16. The decline in sales was finally reversed in late 2002. First, manufacturing firms recorded sales increases, helped by strong overseas demand, particularly from China. Then, with a lag of a few quarters, sales of nonmanufacturing firms also began to rise, as domestic demand recovered. The sales increase was also supported by a gradual easing of deflationary pressures.

17. With the increase in sales, the corporate recovery strengthened, feeding into indicators of profitability, debt, production capacity, and employment. In particular, the profits of small nonmanufacturing firms, which were hit most severely by the sales decline and lagged the most, finally turned positive. (Since these firms account for a third of all sales, their recovery is critical to the health of the overall economy.) In addition, the debt/sales ratio began to decline. Moreover, fewer firms regarded their production capacity as excessive; and the percentage of firms that adjusted employment through measures such as suspending new hiring decreased from 31 percent in the first quarter of 2002 to 17 percent in the first quarter of 2004. Accordingly, the unemployment rate peaked at 5.5 percent in early 2003 and gradually declined to 4.6 percent by May 2004. demand recovered. The sales increase was also supported by a gradual easing of deflationary pressures.

C. Development of Selected Indicators

18. This section takes stock of corporate restructuring by examining selected indicators of corporate health—those on debt, production capacity, employment, and profitability—in somewhat more detail.

uA03fig07

Debt/Sales Ratio

(Four-quarter moving average)

Citation: IMF Staff Country Reports 2004, 247; 10.5089/9781451820577.002.A003

Source: Ministry of Finance.

Selected Indicators: Comparison of Manufacturing Firms

article image
Source: MoF and U.S. Census Bureau.

Data for 2003 Q2–2004Q1 (covered by the most recent publication for the U.S. data).

Data for 2000Q4–2004Q1.

Debt

19. The debt levels of Japanese firms have come down sharply from the peaks recorded in the mid-1990s. Firms across all sectors and sizes (particularly medium-sized firms and non-manufacturing firms) have reduced their debt levels, even during 1997–2002 when nominal sales were declining significantly. In this connection, the average debt/sales ratio for Japanese manufacturing firms is now equivalent to that for U.S. manufacturing firms.8

20. Despite the progress in debt reduction, corporate debt remains high by historical standards, and a further reduction of corporate debt is desirable. Manufacturing firms have reduced their debt/sales ratios close to the levels that prevailed in the first half of the 1980s, but nonmanufacturing firms’ debt ratios remain higher. In that connection, it may be noted that with nominal sales growing strongly (2.5 percent annual growth in FY2003), and firms reporting ample cash flow (¥17 trillion in the first quarter of 2004, an all-time high), debt levels may be expected to come down further in the period ahead, while also leaving room for a continued recovery in investment.9 At present, firms are spending about 75 percent of cashflow for investment, while the historical average is 100 percent.

uA03fig08

Debt/Sales Ratio

(Four-quarter moving average)

Citation: IMF Staff Country Reports 2004, 247; 10.5089/9781451820577.002.A003

Source: Ministry of Finance.

Capacity

21. Firms have slashed investment spending since the mid-1990s to repay debt and reduce excess capacity. In the Tankan survey of corporate sentiment, the balance of firms that perceive that they have “excessive capacity” versus “insufficient capacity” (June 2004 survey) has declined to below its historical average, although a larger fraction of firms still perceive that they have excess capacity (Figure III.1). Since the current drop might be partly attributed to cyclical factors, it remains to be seen whether firms will continue to reduce capacity levels.

Figure III.1.
Figure III.1.

Corporate Judgment on Excessive Capacity and Employment

Citation: IMF Staff Country Reports 2004, 247; 10.5089/9781451820577.002.A003

Source: Bank of Japan.1/ Diffusion index of “Excessive capacity” minus “Insufficient capacity”.2/ Diffusion index of “Excessive employment” minus “Insufficient employment”.

22. The low level of investment compared with cashflow for many years may now imply significant pent-up demand for new investment. Although in the 1980s investment spending was almost equivalent to cashflow, at present more than a fourth of cashflow is not used for investment. With a prolonged period of low investment after 1994, the cumulative difference between investment and cash flow since 1980 turned negative in 2001 and is still rapidly dropping. Against this background, there could be substantial room for new investment to replace aging facilities in the period ahead.

Employment

23. Labor costs and excess employment have declined since the early part of the current decade, but costs remain high by historical standards (Figures III.1 and III.2). In contrast to the debt/sales ratio, which started to decline around 1994, the labor cost/sales ratio and the labor cost/value-added ratio continued rising until 1999. As already noted, Japanese corporate efforts to reduce wage burdens finally started to bear fruit early in this decade. However, the labor cost/value-added ratio in 2002 remained above its historical average for both manufacturing and nonmanufacturing firms, and labor compensation remains high as a percentage of national income. Accordingly, looking ahead, it is likely that firms will seek to continue to hold down wage increases.

Figure III.2.
Figure III.2.

Labor Compensation and Costs

Citation: IMF Staff Country Reports 2004, 247; 10.5089/9781451820577.002.A003

Source: Ministry of Finance.1/ Data from 1983–1989 were used due to data problems in 1980-1982.

Profitability

24. Profitability as measured by the profits/sales ratio has almost reached the peak recorded in the bubble period, although the return on assets remains below the 1980s average. The profit recovery has occurred not only for large manufacturing firms but also for nonmanufacturing firms and SMEs. However, ROA has recovered slowly because of both low growth of sales and unproductive assets that do not generate sales and thus profits. Thus, a further increase in sales and further asset unwinding would be desirable for continued corporate recovery.

uA03fig09

Current Profit/Sales

(Four-quarter moving average)

Citation: IMF Staff Country Reports 2004, 247; 10.5089/9781451820577.002.A003

Source: Ministry of Finance.
uA03fig10

Current Profit/Sales

(Four-quarter moving average)

Citation: IMF Staff Country Reports 2004, 247; 10.5089/9781451820577.002.A003

Source: Ministry of Finance.

D. Remaining Problems

25. Some weaknesses of Japanese firms still deserve close attention, despite the improvement in their financial health. The weaknesses, as well as remaining problems in debt, capacity, employment, and profitability mentioned above, include corporate vulnerability to an interest rate hike and weak sectors and regions. This section sheds light on these weaknesses, which suggest that further policy advancements such as on special zones for structural reform might be needed to boost regions and sectors that have not benefited fully from the current economic revival (see Chapter VI).

26. The health of Japan’s corporate sector remains vulnerable to rising real interest rates. In particular, the improvements in the financial condition of firms have occurred in an environment of very low long-term interest rates. In the event that these rates were to rise to more normal levels, albeit together with an end to deflation, this could reduce firms’ profits. Further progress in reducing debt would help in dealing with the risk of rising interest rates.

27. Moreover, some industries are still weak despite the broad improvement across the corporate sector. The Tankan survey shows that the construction, textile, retail, and hotel industries are still in a weak financial condition. In addition, due to the reduction in public investment, some small-sized firms, which depend more on such investment than larger firms, have lagged behind in revitalization.

28. In addition to the differences among sectors, there are also significant differences among regions in the degree of recovery. Although some regional differences were observed in earlier recoveries, the difference between the strongest region (Chubu) and the weakest (Hokkaido) in this recovery is much larger than in the past.10

29. The large regional differences in economic performance reflect differences in economic structure across regions and a key characteristic of this business recovery—declining public demand:

  • On the one hand, the Chubu region, which is located at the center of Japan and produces digital electronic devices and automobiles, has performed strongly;

  • On the other hand, the Hokkaido region relies more on public investment, which is declining. The Hokkaido region’s dependence ratio on public investment in 2001 was 10.3 percent, while the national average was 5.2 percent.11 In addition, agriculture and construction are more important and manufacturing is less so in the region when compared with the nation as a whole. In FY2002, agriculture accounted for 3.3 percent of production in Hokkaido versus 1.3 percent in the nation as a whole; construction for 11.8 percent of production versus 7.3 percent nationally; and manufacturing 10.4 percent of production versus 21.5 percent nationally.

References

  • Bank of Japan (BoJ) Research and Statistics Department, 2003, “Recent Trends in Business Fixed Investment and the Issues Attending a Full Recovery: Restoring Firms’ Capacity to Generate Capital Investment” (available via the Internet: http://www.boj.or.jp/en/ronbun/ronbun_f.htm)

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  • Cabinet Office (CAO), 2003, “Annual Report on the Japanese Economy and Public Finance 2002–2003”

  • Cabinet Office (CAO), “Monthly Economic Report”

  • CAO Economic and Social Research Institute (ESRI), 2004, “Annual Report on National Accounts 2004”

  • Kang, Kenneth, 2003, “Health and Vulnerability of the Corporate Sector in Japan,” Japan: Selected Issues, IMF Country Report No. 03/282, September 2003.

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  • Komori, Takuo, 2003, “Structural Changes in Japan’s Labor Market,” Japan: Selected Issues, IMF Country Report No. 03/282, September 2003.

    • Search Google Scholar
    • Export Citation

  • Citron, Laura and Richard Walton, 2002, “International Comparisons of Company Profitability,” Economic Trends, No587 (October), Bank of England, pp21–34

    • Search Google Scholar
    • Export Citation

  • Ministry of Public Management, Home Affairs, Post and Telecommunications (MPHPT), “Labour Force Survey.”

1

Prepared by Takuo Komori (ext.37613).

2

This discussion also uses data for the United States as comparative benchmarks although simple cross-country comparisons are not always appropriate.

3

METI’s calculations. Low investment continued after 2000, and the average age of production facilities increased further to 12 years in 2002. This increase in vintage risked eroding Japanese firms’ competitive edge in a number of sectors.

4

Source: MPHPT “Labour Force Survey.”

5

Thereafter, bankruptcies rapidly declined due to the cyclical recovery, but the level in 2003 remained significantly higher than the historical average.

6

The growth of the IT and service sectors contributed to job creation. Also, the greater involvement of foreign investors in management of firms, which facilitated early responses to problems, also contributed to the revival of the corporate sector.

7

Between 1999 and 2002 the number of short-time workers increased by about 0.8 million, and the number of full-time workers declined further by about 0.8 million. As a result, between 1995 and 2002 the share of short-time workers in the labor force rose from 17 percent to 23 percent.

8

U.S. data from “Quarterly Financial Report for Manufacturing, Mining, and Trade Corporations” by U.S. Census Bureau covers mainly manufacturing firms, while Japanese data from MoF’s quarterly “Financial Statements Statistics of Corporations by Industry,“ cover both manufacturing and non-manufacturing firms.

9

If corporations keep reducing debt and increasing sales at current paces, the debt/sales ratio of manufacturing firms will return to its 1980s level in the third quarter of 2004, and that of nonmanufacturing firms will do so by the end of 2005.

10

The CAO has examined the current production recovery of each region based on METI’s industrial production data and compared it with that in the past two business cycles. Other data, such as on employment and business sentiment, broadly support the conclusion based on the industrial production data.

11

The ratio is measured by dividing capital formation of the general government spent in the region by regional gross expenditure.

Same Series

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Cover IMF Staff Country Reports
Japan: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2004: Issue 247
Publisher:
International Monetary Fund
ISBN:
9781451820577
ISSN:
1934-7685
Pages:
70
DOI:
https://doi.org/10.5089/9781451820577.002

Corporate Balance Sheet

(Four-quarter moving average)

Corporate Income Statement

(Four-quarter moving average)

Cashflow and Investment

(Four-quarter moving average)

Debt of Bankrupt Companies

Current Profit: Manufacturing

(Year-on-year percent change)

Current Profit: Non-Manufacturing

(Year-on-year percent change)

Debt/Sales Ratio

(Four-quarter moving average)

Debt/Sales Ratio

(Four-quarter moving average)

Corporate Judgment on Excessive Capacity and Employment

Labor Compensation and Costs

Current Profit/Sales

(Four-quarter moving average)

Current Profit/Sales

(Four-quarter moving average)