No. 34 — September 1, 2000


Weekly Review

--- by Douglas Ostrom

While an increasing number of observers apparently agree that the Japanese economy performed reasonably well in the first half of 2000, opinions regarding prospects going forward still differ. With consumer spending showing few signs of life, corporate investment in plant and equipment will be key to continued expansion. Optimism in this regard is growing, in part because several surveys suggest that companies increasingly are willing to boost capital spending. Whether these outlays will be sufficient to set off a transformation that is broad enough to create a "New Economy" in Japan remains to be seen, however.

Nihon Keizai Shimbun, Japan's leading business daily, conducts one of the best-known surveys of capital spending intentions. The results of its latest inquiry, reported August 22, indicate that the 1,320 firms responding to the questionnaire expect to boost capital spending by 5.1 percent in the fiscal year that began April 1 — more than double the 2.3 percent increase they predicted at the time of the previous survey in February. Should a hike materialize, it would be the first gain in three years and contrast with the 9.3 percent drop in business investment registered in FY 1999. For this reason, capital spending in the current fiscal year still would trail the FY 1998 total. If, however, as often has happened, firms are conservative at this stage regarding their near-term spending plans, FY 2000 outlays could end up higher than those of FY 1998.

An increase of the forecast magnitude would be very important to the economy overall. In FY 1999, capital spending accounted for 14.1 percent of nominal gross domestic product. Although the Nikkei sample does not accurately represent all firms, it is close enough to imply that almost a sixth of the economy could grow significantly. Stepped-up capital spending is especially critical at this juncture since personal consumption, 62.2 percent of aggregate demand, remains flat and public-sector spending, 17.9 percent of the total, will continue to come under pressure as a result of ongoing concerns about Japan's budget deficit, the world's largest.

Nikkei reporters looked beyond the conventional macroeconomic impact of the survey numbers to find evidence of an emerging Japan-style New Economy (see JEI Report No. 32A, August 18, 2000). Clearly, their model was the United States. In the Nikkei analysis, this country has experienced a "two-stage boom." The first part occurred from 1991 through 1994. The second phase began in 1998, with no real dip in between. The key to this expansion, at least in the commonplace Japanese view, has been America's investment in information technology.

The main evidence for a New Economy in Japan that the Nikkei researchers found in the survey results was the 28.4 percent jump in capital spending projected by electrical equipment manufacturers; they pointed to this forecast as an "IT trigger" for further economic gains. Faced with current or expected shortages of semiconductor capacity, for example, such firms as Mitsubishi Electric Corp. have announced record-breaking investments plans amounting to billions of yen for the current fiscal year.

The cited proof does not necessarily add up to an economy-transforming phenomenon, however. The plans publicly announced by specific companies for individual projects sum to a few hundred billion yen, a drop in the bucket of a ¥500 trillion ($4.5 trillion at ¥110=$1.00) economy. Even Nikkei's projected ¥2.2 trillion ($20 billion) total for capital spending by electrical equipment makers is only about 3 percent of all expected business investment. Moreover, the figure no doubt includes a large range of expenditures by Japan's diversified electrical equipment firms, which are not exclusively suppliers of high technology products. After all, these companies produce electric fans as well as chips, and some of their money — even for cutting-edge products — goes into equipment that is low technology in nature.

The American experience suggests that the New Economy, to the extent that it exists, largely is a consequence of the higher productivity that has resulted from investments in computers and communications equipment. In other words, in terms of linking capital expenditures to the New Economy, what is purchased is more important than the identity of the buyer. In that regard, Nikkei's projection of a 2.8 percent drop in investment by communications equipment makers may be more relevant than the big jump in outlays forecast by electrical equipment manufacturers.

These arguments suggest the need to look at the Economic Planning Agency's statistics on equipment orders and the breakdown of those contracts among different types of machinery. According to the agency, computers and communications equipment represented a record 56 percent of all equipment orders in the April-June period. Applying this figure to Nikkei's projected 5.1 percent gain in capital spending in FY 2000 and factoring in the role of equipment expenditures in the economy imply that business investment in computers and communications equipment will add 0.2 percentage point to growth this year. That is less than one-quarter of the contribution made by IT spending in the United States in recent years.

If, despite the hype, IT spending in Japan really is quite modest, it would suggest that the spillover effects on productivity will be small. If the boost to economic performance from IT investment follows the U.S. pattern, then once the recovery is complete, Japan might be able to achieve additional supply side-driven growth of less than half a percentage point, far below the U.S. figure of perhaps a full point.

This comparison indicates that Japan is taking the slow road to the New Economy. Yet the EPA numbers do raise the possibility that Nikkei's forecast of total capital spending may be too conservative. That, in turn, hints that aggregate growth could be healthier than expected, even if the technology-intensive component of business investment proves disappointing.

EPA's report on equipment orders during the April-June period, coupled with projections for the current quarter and assumed level spending in the remaining two quarters of the fiscal year, implies a whopping 15 percent jump in equipment orders for FY 2000. Completing the logic process, this projected hike suggests that even in the unlikely event that spending on facilities is flat, total plant and equipment expenditures could rise almost 7 percent this fiscal year, or significantly more than Nikkei forecast.

The Bank of Japan reportedly used the EPA data on equipment orders in deciding that it could safely abandon its zero interest-rate policy without choking off Japan's young recovery (see JEI Report No. 32B, August 18, 2000). If the central bank based that conclusion on the expectation of spillover effects from high technology, it may have been too optimistic.

Simply as an indicator of future aggregate demand, though, the Nikkei capital spending projection is good news since it points to a rosier economic outlook than existed previously. It does not, however, signal the rapid emergence of a New Economy in Japan. Instead, the survey results provide further evidence that the world's second-largest economy will expand over the next year or two, albeit in a turn-of-the-century Japanese pattern. Real GDP will grow 1 percent to 2 percent annually — less than half what the United States has managed to achieve in recent years.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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