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Monday, March 25, 2002

JAPANESE PERSPECTIVES

Sinking investment signals need to embrace deflation


Two sets of key government statistics on economic conditions released earlier this month -- the October-December data on corporate activities issued March 6 and the quarterly 2001 annual gross domestic product released March 8 -- both highlighted the lackluster state of capital investment by Japanese firms.

The corporate activities data released by the Finance Ministry showed capital spending during the three months dropped by 14.5 percent from the same period of 2000 to 9.686 trillion yen.

It was the sharpest decline since the 18.7 percent fall of the October-December period of 1998.

Investment by the manufacturing sector fell 11.5 percent and that by nonmanufacturers by 15.8 percent.

On a quarter-to-quarter basis after seasonal adjustments, spending by all industries in the October-December period fell 6.3 percent compared with the previous three months for the fourth consecutive quarterly decline.

The October-December GDP figure released by the Cabinet Office shows the nation's economy contracted 0.2 percent in real terms -- a modest fall overall -- but the same data also pointed to a 12.0 percent plunge in private-sector capital investment.

The slump in corporate investment shown by these statistics is clearly the result of the protracted recession and the shrinking profitability of Japanese firms. However, sluggish corporate spending is not a problem limited to Japan, but one common to other industrialized nations.

Behind this is a long-term trend. Following the end of the Cold War, companies in the industrialized world rapidly moved their manufacturing operations to developing countries through transfers of capital and technology, but made slow progress in consolidating their own less-competitive facilities back home.

In other words, the industrialized nations have not yet completed efforts to restructure their economies in the face of growing competition from the developing countries, which have the advantages of cheap labor and land.

In the United States, although economists are increasingly bullish that a recovery is just around the corner, business executives are still acting with caution.

True, U.S. firms have managed to reduce their inventories, but the executives know this is largely the result of unprofitable discount sales.

Caution is also being driven by the fact that many American companies are becoming more conservative in their accounting practices to dispel the general distrust of corporate balance sheets that was triggered by the Enron scandal.

Furthermore, it is estimated that profits could fall by 4 to 5 percent if the pending legislation requiring firms to report stock option payments as corporate expenses is approved by Congress.

The situation is similarly tough in Europe, where competition is expected to intensify with the circulation of the euro. Consumers can easily choose among products from various EU members whose prices are now designated in the common currency. This will pressure European firms to integrate and streamline their facilities.

So the world economy faces two major challenges: adjusting product inventories and reducing "inventories of manufacturing facilities" on a global scale.

While there are two engines of growth -- consumption and investment -- the latter fails to rev up fast enough. The priority now is on streamlining, and manufacturers are not yet ready to make additional investments.

This could pose a problem for the future as well, because even if the economy enters an upward phase, companies may not expand their capital investment at home.

The primary goal of corporate management is to maximize profits, rather than utilizing domestic labor or land. Of course they share social responsibility, but that comes only after they have secured sufficient profitability.

We have to realize that companies will not necessarily invest at home, where labor and land are relatively more expensive. And this is the gap between microeconomic and macroeconomic interests that is being caused by globalization.

In the annual wage negotiations between management and labor unions, even the globally successful and profitable firms refused to offer higher basic pay scales to their employees. Why? Because the cost of labor is high in Japan.

While some people decry the ongoing deflation, land and other prices in this country remain far above international standards. Knowing this but still urging the government to fight deflation seems illogical.

As long as the nation remains saddled with inventories of commodities as well as the manufacturing facilities that make them, it is impossible to halt deflation merely through domestic measures, especially monetary ones.

If efforts to reduce price gaps with the rest of the world are pushed back in the name of the fight against deflation, companies will move more of their operations abroad, thereby delaying economic recovery further.

The slump in capital investment highlighted by the recent economic data should be taken as a warning against such a risk.

Teruhiko Mano is an adviser to Tokyo Research International Ltd.


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