Living with Deflation.

(From Journal of Japanese Trade & Industry (JJTI))

Byline: Hatakeyama Noboru

According to the statistics published last October, the retail price index of Japan has been falling for 49 months in a row. In light of this, some economists, domestic or foreign, may again raise those voices recommending the Japanese government adopt an "inflation targeting policy." Needless to say this policy is the one that tries to artificially induce modest inflation to cope with deflation. Until a year ago or so, I frequently encountered such opinions from American professors whenever I visited the United States.

In Japan, there are many politicians wondering why Japan alone has been suffering from falling prices for such a long period of time. Trying to solve this problem, some of them have been supporting an "inflation targeting policy." However the continuous decline in prices in Japan derives from the fact that price level in Japan is the highest in the world. After such continuous price decline, it is surprising to see Japan's price level is still the highest in the world. According to the "Comparative Price Levels" report published by the Organization for Economic Cooperation and Development (OECD) in July 2002, Japan's price level was 39% higher than that of the United States, and 51%, 29%, 33%, 45% and 26% higher than Canada, France, Germany, Italy and the United Kingdom respectively. Since global markets are now integrated, there is a strong tendency for the price levels of different countries to converge. What is noteworthy here is that in such a conversion higher price levels converge into lower price levels. Otherwise the country or product concerned would lose its international competitiveness. That is why the Japanese price index keeps falling. Trying to introduce an inflation targeting policy is rather like trying to resist a water flow from top to bottom. The fundamental issue here is the so-called high cost structure of the Japanese economy. Almost everything is expensive in Japan including not only wages but also the infrastructure costs such as transportation and electricity. Because of this high cost structure, many Japanese companies have shifted production to other countries, including China. Because of this high cost structure, foreign direct investment (FDI) also tends to avoid coming to Japan. Thus a country with the world's second largest gross domestic product (GDP) ranks only 22nd in receiving FDI. Less FDI means less employment brought about by FDI. FDI in Japan created only 1.4% of total employment as compared to around 5% in the United States and Germany. It is imperative for Japan to rectify its high cost structure as soon as possible. In this regard the inflation targeting policy runs counter to the objective of Japan's economic policy.

There is an opinion that the different price levels of various countries should be adjusted through exchange rates. According to this opinion, the high prices of Japanese products or services should be ...