Does Abenomics invigorate small and medium sized enterprises?

A virtuous circle for economic recovery appears to have started since the start of the Abe administration (December 2012) and the introduction of the “quantitative and qualitative monetary easing” under the Bank of Japan Governor Kuroda (April 2013). The rise in equity prices and a weaker yen have stemmed from the purchase of foreign investors of Japanese equities as well as the sales of mid- to long-term and short-term bonds (buying dollar and selling yen). As a result, the GDP growth rate turned positive, supported by the recovery of earnings by exporting companies. In addition, the corporate goods price index has turned positive since December 2012, due to the rise in the yen-denominated export and import price indices. Spillover effects to bank lending and corporate business investment—which have been matters for concern—are beginning to become evident in the form of the increased lending by city banks and local banks as well as forward-looking plans for business investment by large enterprises. There is a possibility for small and medium sized enterprises (SMEs) to benefit somewhat, as high profits of large enterprises—their counter-parties—would lead to increased orders, while increased value of assets such as stocks and land would increase the value of collateral, making borrowing easier. Nonetheless, it is not likely that Abenomics starting with quantitative easing will encourage the change in characteristics of SMEs, which is likely to invigorate them.

Real Problems for Small and Medium Sized Enterprises

The most important management issue for many SMEs is not the strong yen or lack of funds.

It is true that the structure of the Japanese economy is vulnerable to the strong yen, with its high ratio of external demand to GDP despite the low ratio of export. Only a few large companies in certain industries directly suffer from its impact, however. (For instance, the Toyota Motor Corporation is seeing its operating profit ratio recover from 1.9% in FY2012 to 6.0% in FY 2013 as a result of the weaker yen). In the case of SMEs, if we ignore the differences between industries, purchases from overseas exceed sales to overseas in terms of monetary amount, and therefore, on average, they have more advantages than disadvantages from a stronger yen.

The impacts on small and medium sized enterprises mainly stem from the burdens passed from their clients; the root cause of their problem is their weak negotiating position for pricing that they cannot demand legitimate compensations to large companies. Considering that they cannot reflect the rise in purchase prices to sales prices, a weaker yen increases yen-denominated prices of resources and thus further reduces the SMEs’ profit margins. Without changing such a situation, Abenomics could further increase the wage gaps between large companies and SMEs. For reference, according to a paper by the Japan Institute for Labour Policy and Training, the average wage at companies with 1,000 employees or more was 1.85 times higher than that at companies with 10 - 48 employees—which shows wider gaps among different sizes of companies than in the United States, with 1.68 times, and in Germany, with 1.37 times.

Of course, we need to bear in mind that these gaps are regarded as average, and are not an accurate expression of the actual situation of SMEs. This is because, in the manufacturing sector, companies are polarized between companies with high labor productivity and those with low labor productivity, regardless of whether they are SMEs or large enterprises. It is true that there are some SMEs that are realizing profit margins higher than those of large companies; SMEs are not necessarily as weak as we tend to see them.

Then what does the average number mean? Construction, wholesale, and retail are the industries that significantly lower the average for profit margins and wages. They are the industries that have not been able to foster innovation, having failed to break away from multi-layer distribution channels and old business practices. Moreover, one characteristic that is common among the less-than-average companies—even if they are in the manufacturing sector—is a high debt ratio (outstanding debts/total assets). Rather than lacking funds, they are in a negative spiral that high dependency on borrowing squeezes the already low profit margins further, which in turn necessitates additional borrowing for repayment. The problem is that the involvement of public finance such as credit guarantees to save such a situation further delays changes in SMEs’ characteristics. In relation to the policy of quantitative easing, companies with high debt ratios are highly likely to become unable to repay when long-term interest rates rise due to the end of such a policy. At such a juncture, if we give priority to postponing measures by introducing as a modified version of the SME Finance Facilitation Act, the sense of stagnation in Japan will be reinforced.

Toward Changes in SME Characteristics

It is essential to improve profit margins (or cash flows for retained earnings—i.e., earnings after deducting executive bonuses and stock dividends—with the addition of depreciation) in order to decrease debts and raise wages. Regardless of their capital, net sales, and the number of employees, companies realizing high profit margins have common features: high ratios of completed/final products; a number of business partners; low dependency on primary business partners; strong brand/product development; and clear management philosophy. We need to conduct further research on what is behind their realization, in order to propose specific measures. To improve profit margins, it is important to pursue goals such as: 1) enhancement of price negotiating power (standardization of parts, reinforced cooperation that enables mass production, diversification of business partners, and the like); 2) strengthening of brand power, designing power, marketing power, and sales and advertisement power; 3) an increase of productivity of knowledge creating sections (strengthened research and development system); 4) a business and technological alliance with third parties which have no capital ties; and 5) acquisition and development of human resources (excellent liberal-arts-major students and global human resources; utilization of female employees; development of work place environment with due consideration of work-life balance.

What government should do is to sort out please-everyone policies which combine social policy (protection administration) and economic policy (growth strategy), and then to implement incentive policy measures to promote replacing the old with the new, such as: tax reform that contributes to the improvement of profit margin; support for the acquisition and development of human resources or promotion of launching new businesses; effective utilization of idle assets; and vitalization of self-employment.

What is more important could be changing the mood not only of SME managers but also of the Japanese people. We cannot get out of doldrums without wiping out the “spirit of subservience and mistrust” and creating “individual independence” (Yukichi Fukuzawa) as our foundation. There is truth in the words of Ango Sakaguchi: “We should discover ourselves and find salvation by descending a path of depravity to the bottom. Salvation by politics is superficial and nonsense.”