Why Japan Needs High Interest Rate

32 THE INTERNATIONAL ECONOMY WINTER 2006
Why Japan
Needs
Higher
Interest Rates
The first step
toward shifting to a
consumption-based
economy.
The biggest challenge facing the Japanese economy is to move
toward consumption-led growth. When conventional monetary
stimuli were ineffective following the bursting of the socalled
“bubble” economy, the Bank of Japan rolled out its
zero interest rate policy in February 1999 and initiated its
quantitative easing strategy in March 2001. These emergency
measures, however, accelerated the already excessive transfer
of income from the household sector to the corporate sector,
and have stifled a recovery in household consumption.
Meanwhile, thanks to the fall in borrowing costs and a decline in labor’s share,
corporate profits have improved dramatically. But with domestic consumption
still weak, corporations have only had reason to pursue export-related capital
investment. Sadly, this shows that Japan’s economy is still heavily dependent on
exports and export-linked investment as major growth engines.
The greatest harm from the ultra-low interest rate policy has been the transformation
of the household sector into a net payer of interest. According to the
Annual Report on National Accounts, the household sector received a healthy ¥12
trillion in net interest income in 1992. Due to the decline in interest rates, however,
households became net payers of interest in 1996, and have remained so ever
since. The latest available data show that the household sector received ¥5.3 tril-
Tadashi Nakamae is President of Nakamae International Economic Research,
and Tomoko Saito is his associate.
BY TADASHI NAKAMAE AND TOMOKO SAITO
THE MAGAZINE OF
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WINTER 2006 THE INTERNATIONAL ECONOMY 33
NAKAMAE AND SAITO
lion in interest income in 2003, but made interest payments
of ¥14.1 trillion. The ¥8.8 trillion deficit runs
counter to the fact that households’ net interest-bearing
financial assets actually increased from ¥365 trillion to
¥525 trillion between 1992 and 2003.
Interest rates on financial assets held by households
plummeted from 5.4 percent in 1992 to 0.6 percent
in 2003. The average rate of interest paid by
households on financial debts also fell, but only from
7.8 percent in 1992 to 4.3 percent in 2003. If we take the
actual interest income received and interest payments
made by households from 1993 to 2003 and compare
them with hypothetical interest income and payments
calculated using 1992 interest rates over the same
eleven years, cumulative net losses total a staggering
¥218 trillion.
Against this, the cumulative gains in the net interest
income of non-financial corporations and the government—
sectors riddled with financial
liabilities—stood at ¥140.6 trillion and ¥125.2 trillion,
respectively. In the case of corporations, these cumulative
gains equal about 40 percent of the current profits
earned over the eleven-year period.
Another damaging trend has been untenable profit
growth at corporations and corresponding cuts in
employee compensation. Since 1997, when nominal
GDP peaked in absolute terms, corporate restructuring
has become a social norm and corporations have
eagerly been cutting employment and wages—including
the increased use of part-time over full-time workers.
As a result, corporate profits have surged at the
expense of wages, while total national income has stagnated
or even shrunk.
Total gross income for full-year salaried employees
has dropped annually since peaking at ¥211 trillion in
1997, according to the national tax agency. The total
hit ¥190 trillion in 2004, the latest year for which data
is available. Even though the gross income of female
workers—who saw employment gains in 2003 and
2004—rose by 1.8 percent to ¥46 trillion in 2004, the
falling number of higher-paid male workers kept the
combined income figure in decline.
The zero interest rate policy has not only facilitated
income transfer from households to corporations, but
has also accelerated the polarization between big firms
and small firms. Since large firms are generally capitalintensive
and small firms labor-intensive, large firms
have naturally derived greater benefits from capital cost
declines under ultra-low interest rates. Meanwhile, small
firms—which account for roughly 70 percent of private
sector employment—have seen the negative impact of
low interest rates. Their subsequent wage cuts are a
major cause of the slump in consumption.
Rock-bottom interest rates have also allowed moribund
firms to stay afloat, creating over-crowded markets,
and encouraging inefficient and wasteful
investment. The indifferent expansion of capital expenditures
due to zero-cost financing has resulted in excessive
competition and triggered a fall in prices,
accelerating deflation. Large retailers that open more
shops in response to falling sales perfectly illustrate this
problem.
The METI’s Current Survey of Commerce shows
that sales at supermarkets have barely grown since
1998, but the number of stores has increased by 40 percent.
As a result, sales per store are 38 percent below
1998 levels. Such aggressive expansion by large retailers
has dealt a serious blow to local mom-and-pop
stores. In rural areas, the number of “shutter streets”
(streets lined with the shuttered storefronts of out-ofbusiness
local retailers) has been consistently rising.
This pattern becomes more alarming when workforce
distribution is taken into account. Companies with
paid-in capital of ¥10 million to ¥100 million employ
52 percent of the workforce, while another 21 percent
work at very small firms with paid-in capital of less
than ¥10 million, according to the FY2004 Annual
Report of Statistics on Incorporated Enterprises (SIE).
The survey, which covers 45.6 million workers at
private non-financial corporations in Japan, also
showed that annual personnel costs per employee at
large firms (those with paid-in capital of more than ¥1
billion) were ¥7.32 million in FY2004. This compares
with just ¥3.68 million in annual costs per employee at
small firms and a mere ¥2.83 million at very small
firms. Moreover, recent declines in personnel costs at
small and very small firms far outpace those at large
firms. Between FY1997 and FY2004, personnel
Japan’s economy is still heavily
dependent on exports and
export-linked investment as
major growth engines.
34 THE INTERNATIONAL ECONOMY WINTER 2006
NAKAMAE AND SAITO
expenses at large firms dropped 2.1 percent, while the
costs plunged 11.5 percent at small firms and 14.5 percent
at very small firms. Under these circumstances,
it is hard to believe that consumption can achieve a
broad-based and sustainable rise.
Turning back to profits, the SIE shows that it is
large firms that account for most of the recent profit
recovery. Operating profit per employee at large firms
was ¥3.75 million in FY2004, up 50 percent from ¥2.5
million in FY1997. On the other hand, small firms
earned only ¥0.45 million in operating profit per
employee in FY2004 and very small firms saw only
¥80,000. Both figures have hardly grown since
FY1997.
Capital investment per employee provides further
evidence of the dichotomy between prospering large
firms and squeezed small companies. The SIE shows
that capital expenditure per employee in FY2004 at
small and very small firms registered ¥0.4 million and
¥0.28 million, respectively. In stark contrast, large
firms’ capital expenditure per employee was ¥3.3 million.
Clearly, as only large firms have carried out capital
spending on a meaningful scale, they have led the
rise in capital expenditure during the current recovery.
Worse, further scrutiny of the SIE data reveals that
small firms would be unable to expand capital expenditure
even if they wanted to. Labor’s share (the ratio of
personnel costs to added value) at large firms has plummeted
in recent years due to restructuring drives. The
ratio hit 56.4 percent in FY2004. However, labor’s
share at small firms, which have seen a more gradual
fall, stood at 77.6 percent. In the case of very small
firms, personnel costs ate up 81.6 percent of their added
value, leaving little resources for capital expenditure.
Though the end of the bubble era in 1990 hobbled
corporations and paralyzed financial institutions,
household savings were relatively unscathed. As a
result, laying a foundation for economic recovery on
the backs of households—via zero interest rates—has
been the main strategy of post-bubble structural
adjustments. Corporate efforts to streamline operations
have additionally led to a fall in labor’s share
and wages. Now is the time to abandon the emergency
measures that have spurred these trends. Unless this is
done, Japan will be unable to foster a consumptionled
economy.
Beyond the damage they have already done, ultralow
interest rates threaten further harm to the Japanese
economy. If zero interest rates persist, the cash hoards
at corporations will continue to swell. Since investment
at home will look unattractive due to floundering
Japanese consumption, surplus cash will inevitably flow
overseas in search of better returns. The result will be an
acceleration in yen depreciation.
A rapidly weakening yen will lower living standards
via higher import prices. Perhaps more importantly,
a falling yen will run the risk of asset inflation
(i.e., a real estate bubble), which would be a mortal
blow to a quickly aging society like Japan.
In sum, we need to restore market functions and
normalize interest rates in order to reverse the current
flow of income from households to companies. This is
essential to establishing a sustainable domestic demandled
growth structure. Once current emergency monetary
measures are suspended, the next step will be to
revive households’ interest income via higher rates on
deposits.
With 3 percent interest on deposits, ¥1,000 trillion
of net financial assets held by households would yield
¥30 trillion of interest income. Even after paying 20
percent in taxes, households would receive ¥24 trillion—
which is equal to 10 percent of personal consumption,
excluding imputed rent. The revival of
households’ interest income would certainly stimulate
consumption. Once consumption starts to recover and
corporate sales began to rise, then companies of all sizes
will finally be able to raise wages.
Such a virtuous circle needs to be established.
Although large firms can carry economic growth as
long as zero interest rates and strong exports last, a drop
in overseas demand would send the Japanese economy
spiraling back into another recession. In retrospect,
shifting to a consumption-driven economic structure
has been the paramount challenge for the Japanese
economy since the 1980s. The first step toward meeting
that challenge is raising interest rates. ◆
Since investment at home will look
unattractive due to floundering
Japanese consumption, surplus cash
will inevitably flow overseas
in search of better returns.