Inflation!
Who’s afraid of the big I? Not Japan.
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A specter is haunting the world economy, the shadowy specter of inflation. Economists are fiercely debating from where it has come, politicians are busy blaming their opponents and, as always, the average citizen is left with no choice but to pay up. Yes, we all know inflation is lurking all around when you now must pay $50 for your $40 haircut that you used to get for $25 when you had hair.
Japan stands out as the one economy in the world with a relatively benign inflation shock. Whereas in the United States consumer prices are up by almost nine percent from a year ago, Japan’s consumer price index prints barely above two percent. This may come as a surprise, given the global nature of the inflation shock: excess money and credit, supply bottlenecks, the war in Europe, the surge in pent-up demand as the pandemic abates. Further, the global cost-push pressures—from rising energy, electronic component, and food prices—have been compounded by a falling yen.
Oil and Oligopoly
In the United States, the price of oil is up about 60 percent in US dollars compared with the end of December. In Japan, the yen price of oil is up almost 85 percent. And yes, the United States is a net exporter of energy—and food—while Japan is one of the world’s largest importers of energy—and food.
So, how come, despite greater and more severe exposure to global inflationary pressures, Japanese consumers are much less affected by the global inflation tsunami than their American counterparts?
There are two primary reasons:
- The government here is not afraid to intervene in markets to preserve the purchasing power of the people
- Japan’s industrial structure is more cutthroat competitive
The net result of this seeming contradiction—government intervention going hand in hand with extraordinary competition—is a much lower inflation equilibrium here in Japan compared with what we get in the less interventionist and more oligopolistic US economy. There, a few producers are price-leaders and effectively control the market.
Let’s start with the industrial structure. In the United States, of all the industries in the services and the manufacturing sectors—from hairdressers to pharmacies to steelmakers and semiconductor companies—on average, the top four players in each sector control about 32 percent of their respective total market. In contrast, here in Japan, the leading four companies command less than 15 percent. Clearspeak: Japan is much more fragmented and more competitive, while the US industrial structure has been consolidated and has, de facto, become more oligopolistic.
The net result is significantly lower price power for suppliers of goods and services in Japan relative to the United States. No matter how differentiated a product or service you offer in Japan, within days or weeks, a competitor will follow suit offering something similar but at a lower price point. Remember: every two weeks, a new soft drink is launched, and just about every 12–15 years, the equivalent of the entire central Tokyo grade A office supply comes onto the market. Good luck raising soft drink prices or rent.
Capitalism without Costs
There are, of course, complex reasons that excess competition has prevailed in Japan. The first investment report I ever wrote in Japan, back in the late 1980s, was entitled Capitalism without Costs. In it, I argued that corporate Japan effectively had no cost-of-capital constraint. In contrast to those in the United States, owners of capital in Japan simply did not hold corporate executives accountable to maximize return on capital.
Today, this still holds true, because just as the changes in capital stewardship and corporate governance have shifted private-sector capital allocation closer to the US model of demanding higher returns, Japan’s public sector intervention in capital markets has been stepped up dramatically. The Bank of Japan has purchased up to 10 percent of the TOPIX equity market as well as capped the cost of long-term debt at just about zero for almost a decade.
Whether this public sector provision of a cushion in capital markets is good or bad policy is subject to debate. But, for the purposes of trying to determine whether Japan does or does not face an inflationary threat, there is no question that the reality of a relatively low cost of capital has kept many marginal companies afloat. This, in turn, continues to restrict the price power of Japan Inc. in the domestic market. If your competitors don’t have to care about delivering a proper return or profit, whoever raises prices is doomed to lose customers and market share.
Which gets us right back to the first reason Japan is not afraid of inflation: government intervention and de facto price controls.
When you analyze Japan’s consumer price index, you quickly find that about one-quarter of the goods and services for which Japanese consumers pay are subject to government rules and regulation, i.e., de facto price controls.
Healthcare services and pharma are an obvious important example, as is education, much of transportation, and several staple foods. For the last of these, the Japan Agriculture Cooperatives, commonly known as the JA Group, plays a key part in expertly balancing fiscal support for producers while preserving the people’s purchasing power.
Line in the Sand
The willingness to fight immediately against threats of inflation that undermine consumer well-being was just demonstrated by Prime Minister Fumio Kishida. In April and May, he drew a line in the sand for the consumer price of regular gasoline at ¥170 per liter and passed, in record time, a supplementary budget to fund this price-keeping operation.
Again, the contrast with US government priorities could not be greater. Not only does the Japanese government see its primary mandate as protecting its citizens from economic shocks, but it also has the necessary parliamentary control and supermajority to act decisively and quickly. It is both the willingness to act and the ability to act that, in my view, make Japan’s parliamentary democracy and model of capitalism a worthy role model for the free world.
Be that as it may, practically speaking, the fact that Japanese political leaders actually can—and do—mobilize fiscal resources in a timely manner allows much greater flexibility for Japan’s central bank. Where the de facto political gridlock in Washington makes it unlikely that government policies can be mobilized to cushion US consumers against the ills of inflation, here in Japan the government can be counted on. No wonder, then, that the United States must rely on the Federal Reserve as the lone fighter against inflation, while here the Bank of Japan gets plenty of backing from all the other parts of the policy toolkit available.
All said, the current strong surge in global inflation is very real and is definitely having a strong impact on Japan. However, the Japanese system is responding well to the challenges and is doing so on its own terms. Resilience to shocks is what Japan excels at and, in my view, the inbuilt systemic priority placed on preserving consumer purchasing power makes it unlikely that inflation will force another lost decade.
