Crisis Japon

Deflation in Japan

Introduction

On the PBS program “Nightly Business Report” on January 26, 2010 Lucy Craft explained how deflation is threatening to destabilize the Japanese economy. Her report contained phrases like “downward spiral,” “vicious cycle,” and “price war” — all warning signs that there is a system at work.

Links

Lucy Craft’s report

Notes

Summary

In early 2010 everything seems to be on sale in Japan. Jeans sell for $8 and a fast food lunch for $3. Sticker prices for everything from train tickets to business suits to hotel rooms to big-screen TV's have been receding relentlessly by 1 or 2 percent per year throughout most of the last decade.

In order to stay in business with these low prices companies have turned to cutting costs, especially employment costs. Some companies are moving their jobs overseas to lower-cost labor markets, eliminating jobs in Japan. Companies that cannot export their labor only have one option if they want to compete — slash wages. This wage reduction lowers what the Japanese consumer can afford to pay for goods. This puts more downward pressure on prices.

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Figure 1: Japanese currency

One contributing factor to Japan’s deflation is its unique demographics. Japan's population is shrinking and aging; so, demand is contracting. Because most businesses are domestic-focused, they have no way to grow. They are competing for a bigger piece of a shrinking pie. Many individual companies are trying to grow — or at least survive — by taking market share from their competitors. They are doing this by cutting prices and overhead — and that means labor costs.

Needless to say, in this environment consumer sentiment has withered right along with prices and wages. People economize. They will not pay as much as they used to for everyday products. Generic brand sales have increased dramatically.

The solutions being proposed all have to do with expanding the size of the market. Here are a few ideas:

• Expand immigration. Many economists say that this is one of the best ways to spur demand. However, Japan is a very homogeneous nation and has had strong aversion to opening its doors. For example, Koreans whose families emigrated in the 19th century are still not eligible for full citizenship

• Increase their birth rate. A $270 per month in stimulus per child has been proposed. But Japan already has a big debt problem, so where is this money going to come from?

• Export more. This will probably require waiting until the global economy revives and restarts Japan’s export of manufactured goods.

• Artificial stimulus. Some propose expanding the market size by making the government the buyer of last resort.

“Many individual companies are trying to grow — or at least survive — by taking market share from their competitors.”

“...only have one option if they want to compete — slash wages.”

Accountants will tell you: “Overhead wears shoes.”

The Structural Diagram

Figure 2: The structure causing deflation in Japan

Causal Loop Diagrams

Reading the Diagram

Price War

This diagram is being drawn with just two competing companies, Company A and Company B. Using just two companies will make it easier to see the dynamics involved. In reality there are hundreds — if not thousands — of companies involved in creating the deflation dynamic.

Declining profits at Company A have been going on for a while. This has increased Company A’s desire to gain market share. This desire grows until Company A eventually lowers its unit price to attract more customers. This action has two opposing effects:

• If everything else is constant, a drop in A’s price will result in an immediate drop in profits. This completes reinforcing loop R1.

• But a drop in A’s price also makes A’s product more attractive to its customers. More sales will go to Company A rather than Company B, increasing A’s sales. More sales mean more revenue which means A’s profits will increase. This completes balancing loop B2.

While lowering the price may increase volume and even profits for a while, these benefits will be short-lived. This is because the cut in A’s price and the additional sales going to A rather than B are soon noticed

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