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Deflation may save Japan, not destroy it

Japanese businessmen offer prayers at the Kanda Myojin shrine in Tokyo yesterday. Corporate representatives clapped and bowed for better sales and business as Japan went back to work after a New Year's holiday. PHOTO: REUTERS

Japan has declared war on deflation, an enemy that's been attacking the world's second-biggest economy for two years now. The central bank is stepping up its offensive by printing piles of yen. Government officials are spending away to halt the drop in consumer prices.

Yet Reiko Asai couldn't be happier. While Tokyo worries falling prices will devastate corporate profits and wages, the 25-year-old hairdresser is finding that her money suddenly buys more.

"Everything from food to clothing, to electronics is costing less these days," Asai says. "I find myself being pleasantly surprised when I go to the cash register, not horrified."

The world's most expensive country

Quite a change for the average Japanese; folks here have the dubious honor of living in the world's most expensive country.

Even with deflation, you can easily drop US$300 a night for a sparse, closet-size hotel room or US$5 on a cup of coffee (and you don't get to keep the cup). An apple can run US$10, and a ticket for the new Harry Potter movie is more than US$15.

But that may be changing.

For the first time in decades, Japan's consumers are getting a break -- and deflation is the reason. In November alone, consumer prices, excluding fresh food, fell 1 percent.

The drop extended a two-year generalized decline in costs. Weak demand gets much of the blame, but so do changes in how people here shop.

Times were when Japanese proudly tolerated astronomical prices, believing it demonstrated their rising economic status.

Eleven years of recession have convinced them otherwise. Now, households are doing their part to accelerate the drop in prices by changing spending patterns. Discount stores barely existed two years ago. Today, they're the rage.

Stealth tax cut

Deflation is rarely, if ever, good for the broader economy.

It can zap corporate profits, cut wages and eat into a government's tax revenue. But with unemployment at a record high and Japan in the worst recession seen in two decades, sliding prices are about the only thing propping up consumer confidence. It's akin to a stealth tax cut that's leaving consumers with more spending power.

Fears of an economy-killing deflationary spiral are forcing action in Tokyo. On a daily basis, economic policy makers speak out about the evils of falling prices. Yet Japan may be better off letting the dynamic play out for a while.

Ranks of middlemen

Here's why: Prices in Japan are so high because of the bewildering inefficiencies that exist in the economy. One is the lack of competition from imports. It forces consumers to pay dearly for things like rice, electronics, vegetables, fruit and clothing that could be flown more cheaply from China than driven in from 10km away.

Japan's labyrinthine distribution system, which involves myriad middlemen, also inflates prices. And government regulations that favor giant, established companies with bloated staffs over newer ones virtually eliminate competitive pressures.

If prices keep falling, the trend could root out some, if not many, of these inefficiencies.

Bloated companies and corporations would have to downsize or even shut down.

That, in turn, could force corporate Japan to abandon uncompetitive industries.

Amassing debt

Things in Japan never should have become as expensive as they are today. If deflation lowers living costs to more reasonable levels, Japan may be far better off in the years ahead.

The government has amassed a ?666 trillion debt load by building bridges no one uses and tunnels to nowhere.

To avoid modernizing the nation's economy, Japan is still offering artificial life to companies that couldn't survive under normal market conditions.

All of this explains why Tokyo finds deflation so frightening. It's a force it can't control -- and one that could bring about fundamental changes in the economy.

For those reasons and more, falling prices may actually end up doing more good here than bad.
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