22 May 2018
During campaigning for last year’s lower house election, Prime Minister Abe cited the fact that the bankruptcy rate was close to a 25-year low as evidence that his economic policies were working. Typically, the bankruptcy rate tends to be negatively correlated with economic growth so this outcome should indeed be welcome. However, a closer look at corporate default trends in Japan points to a more complex relationship. While the business cycle has fluctuated materially over the last quarter of a decade, the number of defaults has edged ever lower, with even economic contractions proving incapable of stopping the grind lower (see Chart 8). Indeed, even during the height of the financial crisis the default rate did not exceed 3.5%. So what explains this secular decline in bankruptcy rates?
Let us start by looking at productivity rates and their implications for competitiveness. On the face of it, Japan has seen relatively strong productivity growth in recent decades, modestly exceeding the OECD average. However, this disguises fairly significant sector divergences with Japan’s export-oriented manufacturers pulling the countrywide average up significantly. Indeed, Japan’s international competitiveness appears to have declined substantially with the nation’s share of world exports having halved from its peak in the early ‘90s. The big caveat here is that this period coincided with the integration of China into the global trading system. However, even accounting for this development there is little evidence Japan’s competitiveness has declined. A more persuasive explanation may come through the sustained period of easy financial conditions and in particular ultra-low and negative interest rates that have accompanied the stalling of growth. The cost of credit has remained low while Japan’s bloated banking sector has been prepared to endure a squeeze in net interest margins in order to secure lending growth. Some critics have argued that low interest rates, increased forbearance and a lack of alternative lending opportunities for banks have led to a widespread phenomenon of ‘zombie firms’. These firms tend to be loss-making and are unable to pay back their loans but lenders feel disinclined to withdraw their capital partly because they are eager to avoid booking losses. This explanation is consistent with the idea of low productivity firms dragging down aggregate levels. Furthermore, the existence of zombie firms may be stifling corporate dynamism, as reflected in the low rates of firm closures and business start-ups. However, this explanation is not entirely satisfactory. It has been noticeable that the most recent rise in the bankruptcy count has occurred as both nominal and real interest rates have fallen as a result of the Bank of Japan’s yield curve control policy framework.
One final factor worthy of investigation is the relatively high level of cash on Japanese balance sheets, which represents nearly 50% of GDP. Japanese firms hold a disproportionally large amount of precautionary cash holdings due to worries about large cash outflows or limited cash inflows. This has led to unintentionally large buffers against both cyclical and structural forces. Given the need for higher productivity growth, and with the labour market already extremely tight (see Chart 9), it may be time for companies to reduce this idle capital and allocate it to more productive activities even if it results in a higher default rate.