How to make the West more Like Japan – and vice versa

I saw Andrew Smithers – of strategy firm Smithers & Co – last week. He has long been of the view that the best thing Japan can do to sort its problems out is to change the way depreciation is treated in company accounts.

There’s a reasonable explanation of this in a letter Andrew wrote to the FT recently. The upshot is that profits in Japan are regularly understated relative to profits in, say, the US. This is why many analysts look at cash flow rather than profits when attempting to value Japan.

At the same time, Smithers would like to see corporation tax in Japan slashed – it is currently around 40%. Add that to the generous treatment of depreciation, and Japanese corporations end up with more incentive to invest than to focus on profits.

Here in the West, however, we have the opposite problem. Our corporations tend to prioritise short term profits rather than returns on long- term capital investments. You can put that down to the skewed incentive structures we give our executives (as we often do here), but you might also put it down to a stricter depreciation regime and to a much lower corporation tax level – making profits isn’t penalised here.

One of the things we have been talking about recently, is the way in which economic models work differently in different places – they can be destroyed by changes in behaviour or by existing structural differences. This is one example of this. In Japan there is over investment; here, we are constantly told there is underinvestment.

Another letter to the FT (which I am afraid I now can’t find) suggested that we could deal with that by doing the opposite of what Japan needs to do – shifting to tough tax and easy depreciation measures.

It wouldn’t find much favour from our profit-driven markets and executives, but we might find in the short term at least (before everyone found new ways to off shore their profits) that it boosted capital investment.