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Monday, Dec. 25, 2000


Demise of IT bubble compares with '80s Japan

Signs of a slowdown in the U.S. economy are growing, and the most symbolic of them is the decline of the technology-laden Nasdaq index. The Nasdaq composite index, which stood at 3,700 points at the end of last year, shot up into the 5,000 range in May. But its plunge has also been quick, and it recently fell at one point to as low as 2,332, half its peak and about the same level at which it began 1998.

Let's look into the factors behind such wild fluctuations and make some comparisons with Japan's infamous bubble economy of the late 1980s.

At the beginning of the year, American investors were flocking indiscriminately to any information technology-related stock, encouraged by a theoretical "new economy" triggered by an "IT revolution."

This trend was encouraged by the ample liquidity that monetary authorities of the world's major economies pumped into the market during the yearend and New Year periods to safeguard against potential threats posed by the Y2K computer software problem.

In Japan, the growth of the bubble was propelled by skyrocketing land prices. But what appears to be common to both of these cases is the excessive liquidity in the markets and the illusion that the uptrend will eternally continue.

Another similarity is the race to set standards. Players in the IT business have engaged in excessive investment and competition in a bid to establish de facto standards in their fields.

Japanese companies have also competed fiercely to win market share or industry standards, exemplified by the format war waged among videocassette manufacturers over VHS and Beta. They believed such competition, while not bringing immediate benefits, would earn them huge profits in the future after their products became dominant. In the end, they were left with excessive production capacity.

Later, they aggravated the situation by actively expanding overseas to deal with yen appreciation but without consolidating their domestic plants quickly enough.

A similar situation is happening in the U.S., where rivalry with Indian high-tech industries has intensified competition among domestic IT firms.

It must be noted here that the race for supremacy in the IT business, in terms of both hardware and software, is taking place over an extremely short cycle.

Particularly in the field of software, entrepreneurs do not necessarily have to inject a huge amount of capital to explore new business opportunities. This has made entry fairly easy for newcomers, but it has also resulted in making competition very tough and the establishment of industry standards quite difficult.

Many players in the IT business are engaged in a race that lacks a final destination.

With these factors in mind, the recent wild fluctuations of the Nasdaq can be divided into several different stages.

In the first stage, the excessive liquidity paved the way for the steep market advance seen in the spring, but those gains were quickly lost as monetary authorities adjusted their policies.

In the second phase, intensifying competition and the short business cycle for IT started to create winners and losers, particularly among dot-coms. The downgrading of Yahoo! Inc. was reportedly caused mainly by a decline in online advertising revenue.

In the third phase, a gap began to emerge between technological progress and consumers' needs. As a market for new goods or services expands, not all of the consumers will necessarily crave state-of-the-art technologies.

Some will want greater convenience instead. They will demand easier-to-use products, which will make it difficult for manufacturers to earn enough profits to cover the cost of investing in new technologies. This is undoubtedly one of the factors behind the market's decline.

It is true that the IT revolution has stimulated the U.S. economy in recent years, but IT industries, which once enjoyed the perception of having ever-brightening futures, are beginning to show signs of a slump in earnings.

That U.S. industrial productivity was boosted by information technologies is undeniable, but if their benefits were so powerful, why does the nation have to worry over a 0.25 percentage point change in the interest rate?

One of the aspects of U.S. business practice that stands in contrast with Japan's is the American investor's emphasis on short-term profits, an item that raises their sensitivity to quarterly earnings reports.

This practice enables the U.S. stock market to serve as an early warning system of sorts, but it also causes wild gyrations in stock prices.

Teruhiko Mano is an adviser to Tokyo Research International Ltd.

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The Japan Times

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