Corporate Profits and Business Fixed Investment: Why are Firms So Cautious about Investment?

We examine why Japanese firms have been so persistently cautious toward business fixed investment decisions, despite posting record high profits. Specifically, we find that the key factor underlying the expansion in corporate profits in the current economic recovery phase is the improvement in the terms of trade, rather than the increase in sales volume. Next, using simple time-series analysis, we show that, (1) a rise in profitability due to an increase in sales volume has a statistically significant and positive effect on business fixed investment at a relatively early stage, whereas (2) an immediate impact from increased profitability due to price effects (i.e. an improvement in the terms of trade) is insignificant at first, requiring a certain time lag for a statistically significant effect to show up. This result can be interpreted to be that increased sales volume leads to a rise in real growth expectations (intentions to stretch production capacity) through increases in capacity utilization, while the improvement on the part of prices is likely to be regarded, at least initially, as a temporary factor for profit increase.