Annual Report on

The Japanese Economy and Public Finance


- Japanese Economy Heading for New Growth Era

with Conditions for Growth Restored -

Cabinet Office

Government of Japan

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Section 5 Summary

    This section summarizes trends of changes in the business sector's behaviors and the financial sector's completion of non-performing loan disposals, as reviewed earlier, and addresses key points of future trends of the business and financial sectors.

(Business behaviors normalized through restructuring after bubble burst)
    The business sector has ended tough restructuring and has been enjoying robust earnings topping those during the bubble economy period. However, business behaviors indicate that companies are more cautious than in the past. For example, the business sector has retained net savings since the second half of the 1990s.This is because companies curbed business investment and personnel costs to lower debt ratios under the economic rationalism. A mechanism might have worked for the business sector to autonomously recover equilibrium. More recently, however, balance sheet conditions have exerted more influences on business behaviors, indicating that companies have placed a greater emphasis on profitability or capital efficiency than in the past under their financial strategies. Companies have reviewed a uniform wage-setting formula based on seniority and have adopted performance-based wages. A possible result is that improvements in corporate earnings are not linked to those in employee compensations as directly as in the past.
    Even though business behaviors have grown more cautious, the elimination of the three excesses in employment, capacity and debt has allowed a normal mechanism to work for a corporate earnings increase leading to more business investment and dividends. Companies' restructuring efforts made several years ago have at last begun to make visible contributions to boosting earnings. Given the current situation, the business sector is expected to sustain improvements.

(Japanese firms' comparative advantages in international competition have been rooted deep in Japan's corporate cultures)
    Globalization of business activities has prompted many Japanese companies to compete with foreign firms in global markets. What are the characteristics and advantages of fairly competitive Japanese companies? From a global viewpoint, Japanese companies have had comparative advantages in high-technology industries. A factor behind this situation is that Japan's science and technology capabilities are at globally high levels. Human capital accumulated within companies has played a key role in developing such capabilities and in utilizing them to produce excellent products. In this sense, Japan's long-term employment practices, known as lifetime employment, are closely linked to Japanese companies' comparative advantages in technology.
    Business investment and financial behaviors of Japanese companies are not so different from those of other industrial countries. In a sense, this may be natural as far as companies are trying to maximize earnings. Japanese firms' employment adjustment speed, though described as slower than in other countries in the past, has accelerated considerably since the early 2000s. But capital efficiency indicators including the ROA in Japan have remained lower than in other industrial countries. This may be because cross shareholdings and other business practices in Japan have prevented shareholders' pressures from working effectively. Over the recent years, however, capital efficiency has improved in Japan as companies have placed a growing emphasis on shareholders.

(Some Japanese-style management practices have changed while others have remained unchanged)
    Some people say the progress in globalization of business activities and institutional reforms might have prompted Japanese companies to change their characteristic management practices. We have conducted a questionnaire survey of Japanese companies to look into the present state of Japanese-style management practices including lifetime employment and seniority-based wages, corporate governance based on internally promoted managers and banks, and long-term business relations between companies. The survey has found that a fairly large number of companies still maintain Japanese-style management practices in corporate governance, financial strategies, employment policy, inter-company relations and other areas. However, some elements of Japanese-style management have weakened while others have remained unchanged. For example, a fairly large number of companies still emphasize long-term employment and position employees as key stakeholders, while many companies no longer view relations with main banks or long-term inter-company relations as important. As for financial strategies, the economy of scale is still given priority. However, many firms now emphasize higher capital efficiency including higher ROA figures, as well as cash flow.
    Regarding correlations between Japanese-style management and corporate performances, the survey indicates that capital efficiency has been relatively higher for companies that maintain Japanese-style management including the emphasis placed on employees. As corporate earnings have recovered, companies might have recovered and deepened their confidence in Japanese-style management. On the other hand, companies that still depend heavily on main banks have tended to downsize themselves through restructuring. Business performances have remained slack at these companies. A change in Japanese-style management has been indicated by many companies' growing emphasis put on shareholders. These companies have earned higher ratings in the stock market by demonstrating their emphasis put on shareholders and have taken advantage of such higher ratings for raising funds positively.
    These points indicate that the emphasis placed on employees, a key element of Japanese-style management, still remains as a strength of Japanese firms. As noted above, Japanese companies' comparative advantages against foreign firms in high-technology areas are closely linked to their in-house human capital accumulation. This indicates that in-house human capital accumulation will remain a key to successful business management.

(Institutional reforms involving companies and future problems)
    How have Japanese companies rated legal, accounting, tax and other major institutional reforms involving them between the late 1990s and the 2000s. The questionnaire survey has found that companies have given high ratings to reforms in six areas -- corporate governance, business realignment and reorganization, corporate tax, accounting, corporate pensions, and employment and wages. We have analyzed companies giving high ratings to these structural reforms and found that firms that have conducted business realignment and expanded research and development spending have welcomed reforms related to such measures.
    At the same time, companies have strong requests for further institutional reforms. Particularly, responding companies in the questionnaire survey called for improving the convenience and transparency of administrative procedures, for reviewing corporate tax, and for promoting deregulation and opening of public sector services to the private sector. Based on these requests, the government will have to implement further reforms.

(Present state and problems of banks)
    Banks have made steady progress in disposal of non-performing loans through financial system reforms. In order to prevent the financial system from being shaken by a non-performing loan problem in the future, banks are required to expand their capital base, to set lending rates at appropriate levels, and to improve their profitability to solidify their financial infrastructure. Japanese banks have improved and enhanced all of their performances. However, they still lag behind some major overseas banks. As Japanese firms' heavy dependence on main banks, one of key Japanese-style management practices, has declined, banks see difficulties in expanding earnings through loans. Under such circumstances, banks have been shifting to financial conglomerates and retail banking services and making investments and alliances across business boundaries. In the future, banks should create value added through their proprietary efforts while seeking to meet households' demand for financial services and solve various problems facing companies.

(Business sector's future outlook and problems)
    The business sector has been enjoying robust earnings thanks to its restructuring efforts since the late 1990s. Japanese companies have achieved their revival by improving their financial efficiency thoroughly and establishing their comparative advantages utilizing their in-house human capital. Among the elements of Japanese-style management, financial efficiency and long-term inter-company relations might have changed dramatically. On the other hand, many companies have retained the emphasis put on employees. Japanese companies should take advantage of their in-house human capital for growing further. At the same time, they should develop an environment that would allow shareholders to keep surveillance on management to prevent management efficiency from having a negative effect by putting emphasis on employees. There may be no single correct way to do so, but companies should always consider how to achieve a well-balanced corporate governance system. The government sector for its part should take prompt, precise measures to flexibly reform institutions and administrative procedures in line with the rapid changes in business environments. Furthermore, the government should promote a shift from public sector to private sector.

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