Improve Japan's Productivity by Selection and Concentration

Yutaka HARADA (Chief Economist at Daiwa Institute of Research)

It is widely pointed out that Japan's international presence and competitiveness have been declining in recent years. To address this issue, we need to examine what international competitive really means.

A nation's economic level is determined not just by the productivity of internationally competitive sectors such as global companies, but by that of the nation's industry as a whole. In the case of Japan, the international competitiveness of exports, which account for 15% of its GDP, is important, but even more important is the productivity of the remaining 85% of the Japanese industry, namely, agriculture, construction, distribution, etc. For example, government services such as public pension administration, are purely domestic, but the people's quality of life crucially depends on the productivity of such services. Thus, Japan's future growth is determined by the productivity of its industry as a whole, whether inside or outside the country.

Needless to say, this does not imply that international competitiveness or the productivity of export industries is meaningless. In reality, since 1990, Japan's share in world total exports has been decreasing substantially, as such developing economies as China and India have been growing rapidly. This is due to the fact that those developing countries have been catching with already developed economies such as Japan by closing an abnormally large gap that they faced when they finally abandoned their wrong economic models such as old traditions, communism and socialism. In a sense, given the constantly growing Chinese economy around 10% per year, Japan's presence in the international economy would have declined anyway, even if Japan had not gone through the so-called "lost decade."

In order to see what needs to be done to improve Japan's productivity, let us compare Japan with the U.S. in terms of sector-by-sector labor productivity. First of all, to compare labor productivity between the two countries correctly, we need to use purchasing power parity rates as international prices to measure each industry's value added and divide it by the corresponding labor hours in each country. By normalizing the labor productivity of each industry in the U.S. as unity, our studies show the following results on the Japanese industry for the period of 1973 through 2003:

(1) The productivity of Japan's industry as a whole was less that 60 percent of that of the U.S. throughout the period. (2) Japan's industrial productivity as a whole was increasing up to 1991 (that is, closing the Japan-U.S. gap), but became stagnant after that year, indicating the so-called "lost decade." (3) There is a contrast between rising and declining industries in terms of productivity with improving productivity, relative to the U.S., in such industries as public utilities (electricity, gas and water), construction, communications and postal services, declining productivity in such industries as agriculture, and more or less average performance (meaning not much improvement in low productivity) in such industries as manufacturing, distribution, finance, insurance and real estate.

While declining productivity in Japan's agriculture is just as expected, the result for manufacturing is somewhat surprising. A closer look at the manufacturing industry reveals the following. (1) The productivity of the food sector is lower than the average manufacturing productivity, as that sector has too many firms, not enjoying scale economies, thus requires industrial reorganization through M&A and other methods. (2) The performance of the electric and optical machinery industries is not better than the average, and somewhat declining in recent years, probably reflecting the fact that many electronic and high tech companies have been struggling with computer parts, product development, etc. (3) Chemicals, transportation machineries, and primary metals are better than the average, but the chemical industry is the only one with the productivity level higher than its U.S. counterpart. It is somewhat unexpected that the productivity level of Japan's transportation machineries turns out to be less than its U.S. counterpart, and this is due to relatively low productivity in Japan's shipbuilding and rail transport machineries compared to high productivity in the U.S. aircraft machineries, and not due to productivity differences in automobiles between the two countries.

Then, what should be done to improve Japan's overall productivity? First of all, further deregulation is needed for such industries as agriculture, distribution and finance. The same may be said about construction and electricity. For agriculture, more entry, whether individuals or corporations, should be encouraged to increase supply in an efficient way.

In the U.S., productivity improvements have been achieved through creation of new industries and abandonment of old industries. Replacement of a part of domestic industries by export liberalization leads to higher productivity. The main reason why the U.S. transportation machinery industry has a higher productivity level than that of Japan is because the U.S. aerospace manufacturing is more productive than Japan's shipbuilding and rail transport machineries. The productivity of the U.S. electric and optical machineries is higher than its Japanese counterpart, since they have abandoned home appliances, and focused on computer-related systems and components.

On the other hand, Japan has been losing international competitiveness and national power, as it is still holding onto the existing industries, supposedly to protect employment. Productivity improvements could never be achieved without "courage" to abandon the old, and to adopt a strategy of "selection and concentration" on the national level. Japan seems to have many options for productivity improvements such as encouraging M&As for business reorganization and welcoming foreign investments for managerial innovations.

(The original Japanese article appeared in the February 26, 2008 issue of Weekly Economist)