The Sustainability of Fixed Investment Expansion

Fixed Investment Falling Below Cash Flow

Fixed investment has continued to increase since 2003, reaching a high growth of 7.5% (compared to the previous year)　in 2005. Compared with periods of economic expansion in the past, the characteristics of current fixed investment are that while the cash flow of enterprises has almost uniformly increased since the mid 90s (with the success of restructuring and etc.), the current level of fixed investment still remain at about half of cash flow.

During the bubble economy, the increase in fixed investment was such that it significantly exceeded cash flow (at the peak in 1991, fixed investment was at a level of about 1.4 times that of cash flow). This figure represents substantial increases in enterprise borrowing and expansion of fixed investment. However, after the bubble burst the situation reversed into a state of overcapacity, and this fettered economic recovery.

Enterprises are currently diverting abundant capital-on-hand into fixed investment. Yet, the fixed investment level is about half that of cash flow, and in terms of excessive cash flow there is room for enterprises to further increase fixed investment. Unlike in the past, enterprises currently holding cash flow will be considered unable to effectively use capital and could become targets for takeovers, and as such are being forced into action. In the absence of quality investment plans, there is an increasing trend of demands that the extra cash flow be used as capital for M&As, and in the absence of this plan that stockholders be rewarded in the form of dividend payments.

Given this situation, there is a strong likelihood that enterprises will continue in the future to increase investment from a variety of different angles. Furthermore, while it is true that fixed investment is currently increasingly, the total amount does not even reach the level of the post-bubble temporary economic expansion of 1997.

Is the Speed of Fixed Investment Growth Appropriate?

Looking at the levels of cash flow and fixed investment in the past, it is clear that there is room for enterprises to increase fixed investment. However, if the speed of fixed investment growth is too fast, a situation of overcapacity – much like the bubble period – could develop. Excessive fixed investment amplifies economic oscillations to an unnecessary degree, and is undesirable in terms of long-term economic maintenance.

With this in mind, an analysis was conducted to determine whether or not the current speed of investment expansion is in fact appropriate considering the potential of the overall economy. From a mid to long-term perspective, the growth of capital stock is decided by a rise in the expected economic growth rate, and the trend of the depleting percentage of capital stock and the capital coefficient. From this relationship, and with the trend of the depleting percentage of capital stock and the capital coefficient as a given, we can surmise that fixed investment growth in this period is decided by the relationship of the percentage of fixed investment and capital stock in the previous period and the expected growth rate. In other words, if an expected growth rate that predicts the extent of growth for the entire economy in the future is decided on with regards to the percentage of the capital stock of fixed investment of the previous period, then the necessary amount of fixed investment for the current period can be decided – this is the relationship. If the percentage of fixed investment capital stock increases with time, the annual growth of fixed investment will gradually become refined because the necessary amount of capital stock has been met (as long as the future expected growth rate does not rise).

Based on this relationship, it can be seen that the sharp growth in fixed investment from 2003 to 2005 was maintained by the process of the expected economic growth rate increasing from 0% to 1%. In other words, as economic expectation increases so does the necessary amount of capital stock, and fixed investment is then increased to satisfy this demand. The rise in fixed investment of 7.5% in 2005 would correspond to an expected growth of around 1.5%.

The current expected growth rate is about 2% (the enterprise expected growth rate is 1.9% according to the “Questionnaire Survey Concerning Enterprise Movement”, published by the Cabinet Office in January 2006). With this rate as a premise, fixed investment growth in 2006 should have reached 6%, an upgrade from 2005. However, in reality the pace of growth is higher, with the average private forecast having the 2006 fixed investment at 8.5% (Association for Economic Planning’s “ESP Forecast Research”, November 2006). It can be concluded that the current growth in fixed investment is somewhat above the commensurate amount to the 2% potential growth rate.

With a 2% expected growth rate as a premise, fixed investment growth in 2007 should be calculated as being even more refined. However, if fixed investment growth shows an opposite trend in the future, it would mean that the expected growth rate would transition into an ever higher level of 3-4%. Yet, considering the current capability of the Japanese economy, this rate is not necessarily appropriate. One condition for realizing long-term economic expansion in the future will be to gradually refine and sustain fixed investment. The balancing of interest rates after the release from the zero interest rate policy will require thorough examination from this viewpoint.