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Chart 17: Personnel costs to sales, % ratio 4qtr ma (as of Apr-Jun 2016) 40 35 30 29 20 15 10 Source: BofA Merrill Lynch Global Research, MoF Analysis by METI suggests that many of these non-manufacturing industries have the scope to raise productivity. Wholesale/retail, utilities, and eating & accommodation have particularly low levels of productivity relative to the US (Chart 18). We think the solution is to boost capex, especially in ICT and automation. More broadly, an acceleration in capex is needed if we are to see a pick-up in productivity and sustained profits. Though we are by no means in the late stages of the profit cycle, the trend clearly points to higher wage costs going forward, requiring proactive efficiency-enhancing investment by corporates. Bottom-up data capex data for MSCI Japan also suggest that the investment cycle has troughed and will pick up next year as earnings momentum improves (Chart 19). Chart 18: Japan's labor productivity relative to the US: services is low Chart 19: Capex — YoY change in Japan vs Global Earnings Revisions (2003-07) 18 140 16 120 3 100 > 14 80 8 12 60 3 40 yg 10 20 © 08 0 S g 0.6 a B od 02 meen Global Earnings Revision Ratio (LHS) Source: BofA Merrill Lynch Global Research, METI 3. Policy priorities and redistribution We think an increase in government pressure on corporations could speed up income redistribution at the margin, ensuring that money circulates to those sectors and agents with a higher propensity to consume. Elevated corporate savings remain a focal point for the government. Cabinet Office officials have used the concept of the “cash-out ratio” to highlight the creaky transmission from corporate profits to spending. Chart 20 3 The idea of the “cash-out” ratio was first raised by private sector representatives of the Council on Fiscal and Economic Policy. The measure is defined as cash out / cash and deposits. The numerator includes capex, personnel expenses, R&D, dividends, and changes in equity investments in related companies, The denominator includes cash and deposits, and securities, short-term lending, and investment securities classified under liquid assets. Since we are restricted to Ministry of Finance Corporate survey data, our version of the “cash-out ratio” is defined as capex + personnel costs + dividends / cash and liquid assets. 90 92 94 96 98 00 02 04 06 08 10 12 14 16 30% 20% 10% 0% -10% Japan CAPEX (YoY Chg) -20% -30% eee SCI Japan capex %YoY (RHS} Source: BofA Merrill Lynch Global Quantitative Strategy Bankof America Merrill Lynch Japan Economics Viewpoint | 18 November 2016 7 HOUSE_OVERSIGHT_014416