Chart 13: Real labor income and private consumption Chart 14: Workers’ saving rate at all-time high

Chart 13: Real labor income and private consumption Chart 14: Workers’ saving rate at all-time high 270 330 22 265 - 320 20 260 310 18 255 - 300 16 250 290 14 245 280 12 wo ico} led foe} Lo2} Q x N oO s+ wo ico} Ss 8s 8S SSESSESESESES 10 NSN SH NN YN AS NSN NS NON 2oM ODO OAM Or AHR A MH ANA YN MS Eee MHEe womnnonoeoelmlUtlhlhlmUhchSDhUcOUCOCUCUOULUCUCUNUCULDLSLDLUMD onooonnonnmWmrdrDd on DOD DP ODO 0D GD G2 GS NN NNN NN ———Real employee compensation, JPY trn saar (LHS) ; ; ‘ Private consumption, JPY trn saar (RHS) —— Saving rate of workers’ households, % 4qtr ma Source: BofA Merrill Lynch Global Research, CAO Source: BofA Merrill Lynch Global Research, MIA 2. Capex revival We also see a fundamental case for higher capital spending. Borrowing rates are very low and will fall further in real terms as inflation rises. Stronger growth and improved confidence should also encourage higher capex. And deepening supply-side constraints offer a strong incentive for Japan Inc. to accelerate productivity-enhancing capex, ensuring that this expansion is durable. For these reasons, we think that the impulse of capital expenditures will likely be higher in the non-manufacturing sector, where capacity utilization rates are higher, and labor shortages (and hence wage pressures) are more acute (Chart 15 and Chart 16). Chart 15: Capacity utilization rates by sector Chart 16: Labor shortages by sector 40 Insufficient AO Insufficient 0 -20 10 0 20 20 30 40 40 Excess 60 Excess 2003 2005 2006 2007 2008 2010 2011 2012 2013 2015 2016 2003 2005 2006 2007 2008 2010 2011 2012 2013 2015 2016 ———BoJ Tankan production capacity - manufacturing, Dl ———BoJ Tankan employment conditions - manufacturing, Dl BoJ Tankan production capacity - non-manufacturing, Dl BoJ Tankan employment conditions - non-manufacturing, DI Source: BofA Merrill Lynch Global Research, Bo} Source: BofA Merrill Lynch Global Research, Bo} Chart 17 shows the ratio of personnel costs to sales, using MoF corporate survey data. The ratio is particularly high for lodging & accommodations (23%), eating & drinking services (27%), medical, healthcare & welfare (37%) and education & learning support (37%). Somewhat surprisingly, personnel expenses are fairly restrained in retail. But this is partly due to the relatively heavy reliance on lower-cost part-time workers. Given the rapid growth in part-timers’ wages, such cost savings is likely to become increasingly difficult to maintain. Bankof America 6 Japan Economics Viewpoint | 18 November 2016 Merrill Lynch HOUSE_OVERSIGHT_014415