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Tuesday, Feb. 10, 2004

'Next big thing' key to growth

During Japan's bubble-economy years of fiscal 1987-1990, consumer spending grew at an annualized 5.5 percent in real terms. But during the Heisei recession of fiscal 1991-2001, consumer-spending growth slowed to an annualized 1.0 percent. Most experts agree that the slowdown in consumer spending, which accounts for 60 percent of gross domestic expenditures, was mainly responsible for the recession.

So, what should be done to stimulate consumer spending? World-renowned economist Paul Krugman argues that the public should be encouraged to expect inflation. His theory is based on psychology: Consumers tend to increase spending if they expect inflation, and cut spending if they anticipate deflation.

In my opinion, though, this psychology applies only to real estate. During the bubble economy, land prices in and around Japan's six largest cities soared at an annualized 23.2 percent. In five years starting in fiscal 1985, land prices in the same area grew 2.8 times. In such a situation, people naturally rushed to obtain mortgages and buy homes.

Land prices started falling in fiscal 1991. During the subsequent recession, prices in and around the six largest cities plunged 73 percent, or an annualized 10.2 percent, from fiscal 1990. The plunge led to a sharp depreciation in real-estate values, causing potential home buyers to expect further drops. This dampened real-estate transactions and touched off a chain reaction in price declines.

Such a scenario, however, is unlikely with the new generation of high-tech products such as personal computers, digital cameras and DVD systems. These products command surprisingly high prices when they debut, but mass production causes prices to drop by more than half within several years. Consumers expect deflation over the years for new high-tech products, which often sell out at first due to strong demand.

Real-estate prices are based on asset value (present value incorporating future gains) while consumer-product prices are based on utility value (value of convenience and satisfaction obtained from using the products).

Consumers buy new digital cameras for their convenience and new features. Thus expectations of future price drops are unlikely to discourage them from making purchases.

Expectations of inflation do cause people to rush to buy real estate, but there is no significant correlation between consumer spending and expectations of inflation. However, should expectations of inflation cause a benign cycle of inflation and a strong rise in real-estate prices, the "asset effect" can lead to an increase in consumer spending.

The spending boom during the bubble economy years was due not only to the asset effect stemming from rises in land and stock prices but also to the debut of a new generation of consumer products. These products made the greatest contribution to the 5.5 percent annual increase in consumer spending during the period. Consumers will only spend if they see products they want.

During the bubble years of fiscal 1987-1990, consumers were enticed by new products such as luxury cars, automobile phones, home-use fax machines, CD players, large-screen TVs and cordless phones. Big-ticket items, such as luxury cars and large-screen TVs, and revolutionary products, such as home-use fax machines and CD players, especially expanded spending.

Meanwhile, the rise in real-estate prices stimulated home purchases, which in turn led to increased sales of furniture and home items.

Since the start of the Heisei recession in May 1991, other new products have hit the consumer market: car-navigation systems, Sharp Corp.'s Viewcam LCD video cameras, cellular phones, notebook PCs and digital cameras.

The Viewcam, a new-generation video camera, replaced old video cameras, while digital cameras made film-based cameras and photographic films obsolete. The new products did not have such a big impact on consumer spending because the surging demand for them was offset by decreasing demand for the old products. The car-navigation system is probably the only product that does not replace existing products.

To activate consumer spending, a new generation of products that everybody wants are necessary. Digital cameras, plasma TVs and DVD systems are considered new types of electronics products, but it remains to be seen whether they will dampen demand for other products, causing a "zero-sum" effect.

The advent of new products as revolutionary as the first automobiles will have continuous, major effects on consumer spending and put Japan on the path to an economic recovery led by domestic demand.

Takamitsu Sawa is a professor of economics at Kyoto University, and director of the university's Institute of Economic Research.

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