TOKYO Abenomics has given foreign investors plenty of reasons to be interested in Japan. In the three years since the prime minister's economic policies were rolled out, corporate Japan has achieved record earnings and unemployment has dropped to about 3%.
But while Prime Minister Shinzo Abe's recent vow to shift his focus back to the economy has stoked investor interest further, corporations are not funneling their earnings back home. That's a problem for Abe and Bank of Japan Gov. Haruhiko Kuroda.
A look at a few key economic indicators can explain this unhelpful corporate behavior. In indexes using fiscal 1992 values as their baseline of 100, Japan's nominal gross domestic product, non-consolidated sales and personnel costs for fiscal 2014 were all at about 100.
The Japanese economy is no bigger than it was two decades ago. Total pretax profit at corporations, on the other hand, increased by a factor of 2.5 over the same period. With the domestic market stagnant due to deflation and a shrinking population, corporations have looked for -- and found -- earnings power abroad.
BRINGING IT HOME Corporations have been criticized for holding onto the money they have earned, but the numbers say otherwise. Retained earnings of leading companies for the year to June 30, 2014, increased by 14.9 trillion yen ($126 billion). In the same year, those companies added long-term stockholdings to the tune of 15.3 trillion yen, the result of carrying out aggressive mergers and acquisitions, mainly outside Japan, and establishing foreign subsidiaries.
The outstanding assets of Japan's international direct investment stood at 143.9 trillion yen as of the end of 2014, double what it was five years prior. In the auto industry, the overseas production ratio is now almost 70%, compared with about 50% before the global financial crisis.
The profit margin on external investments by Japanese companies between 2001 and 2014 was 4.8%, while that on investments by foreign companies in Japan was 11.5%. Japan clearly has room for improvement in this area, and that can be achieved by polishing the Japan brand.
Using returns on overseas investment to boost growth at home, a path taken by the U.S. and the U.K. in the past, requires an organic link between domestic and international investments.
To encourage companies to pour more money into jobs and investment at home, "the most important thing is to create an environment where corporations have an easier time operating," according to KKR Japan Chairman Atsushi Saito, former CEO of the Japan Exchange Group.
The government will lower the corporate tax rate to 29%, on a par with Germany, in fiscal 2016, sooner than it originally planned. Kuroda, meanwhile, has indicated he will not hesitate to pursue additional easing to eliminate the business community's deflationary mindset.
In response to government prodding, Sadayuki Sakakibara, chairman of the Japan Business Federation, or Keidanren, the nation's top business lobby, announced his organization's commitment to increase domestic investment by 10 trillion yen by fiscal 2018.
But the fact remains that many, if not most, of Japan's CEOs feel it is unwise to expand production capacity in a shrinking market, and changing their minds on that issue will not be easy.
THE NEW REVOLUTION The way forward may lie in the "Industry 4.0" model, which applies cutting-edge technology to manufacturing and other business areas. Investment in related concepts, such as the "Internet of Things," big data, artificial intelligence and robots, is on the rise across Japan.
In a recent public-private dialogue on investment, Hitachi Chairman Hiroaki Nakanishi described his company's current projects, including a remote monitoring system to detect technical problems on moving train cars and the use of big data to estimate and reduce health care costs related to lifestyle diseases.
The U.S. and Germany have taken the lead in embracing Industry 4.0. Without bold investment and development, Japan's manufacturing and other conventional industries could soon fall behind those of the rest of the world.
"Technologies evolve quickly only when they are used in the real world," said Chairman Kazuhiko Toyama of the IoT Acceleration Lab. To this end, the government should offer venues for ambitious social experiments and implement sweeping deregulation. What Abenomics needs is not slogans, but action.
Additional reporting by Robin Harding at http://ft.com/japanandworld