April 5, 1991
"Close the Gap in Industry's Cost of Capital"
San Jose Mercury News
By Timothy Taylor
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WANT TO make a strong electronics industry executive cry?
Walk up and say: "You know, your Japanese competitors can borrow as much
as they want for long-term investment at 5 percent interest."
In May 1989, for example, the prime lending rate at Japanese banks was 3.4
percent, compared with 11.5 percent in the United States. If a company chose to
borrow by issuing bonds, the Japanese rate was 5 percent, while the U.S. rate
was 9.8 percent.
Trying to compete with cheap capital is like trying to swim with concrete galoshes.
To keep a margin of safety for risky projects, U.S. firms have been limited to
investments where they could reasonably expect profits of (say) 20 percent. Meanwhile,
Japanese firms could take on all sorts of expensive, high-risk projects, knowing
that a single-digit return would still be plenty to pay the interest bills.
Little wonder that the cost of capital has become a hot topic in the electronics
industry, an industry where risky projects with high capital requirements are
Last year, for example, the American Economic Association held a "Cost
of Capital Summit," because "the No. 1 problem cited by members... was
the cost and availability of capital." The AEA distributed economic studies
to show that even after adjusting for different tax laws, inflation rates, and
other factors, U.S. firms were paying two or three times as much as their competitors
in Japan for funds.
A report released by the National Advisory Committee on Semiconductors in February
sounded a similar note:
"...the semiconductor industry is particularly dependent on securing access
to large quantities of capital, at a competitive cost, to invest in improved manufacturing
facilities and expensive research and development. Any disadvantage in capital
costs can have long-lasting effects on a semiconductor firm's ability to develop
technology to meet current and emerging market demands, and to deliver products
on time and at competitive prices."
On a broader note, the Council on Competitiveness has just released "Gaining
New Ground: Technology Priorities for America's Future." Among the "key
lessons" of the report are that American technology companies are competing
well against the world in technologies with low capital requirements, like software
However, the council also finds that U.S. technology companies tend to be "weak"
or "losing badly" in areas that have high capital needs and require
investment for long periods of time, like automated equipment and optical information
Ironically enough, even as these industry groups were issuing their reports
emphasizing the cost of capital problem, Japanese and U.S. interest rates were
growing closer together.
The Japanese central bank has been jacking up interest rates since the middle
of 1989, while the Federal Reserve has been cutting U.S. interest rates since
December. The prime lending rate in Japan is now 8.25 percent, compared with a
U.S rate of 9 percent. When a Japanese firm borrows by issuing corporate bonds,
it is now paying about 7.5 percent, compared with 9.2 percent for U.S. firms.
This is a phenomenal change. In Japan, the reduction in credit that accompanied
the higher interest rates helped drive Japan's stock market down by 50 percent
during the first nine months of 1990, a loss of about $2 trillion. (Since then,
the market has recovered about one-third of those losses.) Prices of Japanese
real estate also fell sharply, and bankruptcies are on the rise.
Meanwhile, lower U.S. interest rates are helping to push American stock prices
close to record highs, while also stimulating consumer borrowing for interest-sensitive
items like houses and cars.
Want to see a strong electronics executive giggle with child-like joy? Explain
that that much of the cost of capital differential with Japan has faded away.
But precisely because the cost of capital is so important, it makes sense to take
additional steps to assure that U.S. firms can raise investment capital at competitive
For example, both the AEA and Council on Competitiveness mention the importance
of keeping federal borrowing under control, so that more funds will be available
for private investment.
The National Advisory Committee on Semiconductors also recommends tax policies
to cut the cost of buying semiconductor manufacturing equipment. Specifically
targeted policies like this are far more sensible and defensible than broad-brush
calls for a tax cut on every capital gain.
All the industry groups support the sensible step of making the tax credit
for research and development permanent, rather than leaving it in the off-again,
on-again limbo it has suffered through for the past few years.
The cost of capital has been almost an invisible issue. But as the paradigm
of a high-technology company matures from a couple of guys in a garage to hundreds
of engineers and scientists in laboratories and production lines, no issue is
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