Japanese Companies Remaining in Long-term Stagnation Conditions for Post-COVID-19 Recovery

The vitality of a significant percentage of Japanese companies and industries, i.e., business dynamism, seems to have been lost. Such worries are becoming stronger as the COVID-19 pandemic reveals the fact that Japanese companies have lagged behind in digitalization (DX) and data utilization.

Regarding business dynamism in Japan, it was once thought that the existence of so-called zombie corporations that originated from the bad loan problems in the 1990s has hindered new entries and exits and hampered the metabolism of industry. However, in recent years, this issue has been temporarily hidden due to the business expansion supported by Abenomics. On the other hand, business dynamism in the United States had been considered stronger than that in Japan, but its stagnation has recently been recognized as a factor that has hindered productivity growth and efforts are now being made to ascertain the actual status of the U.S. business dynamism and to analyze background factors.

In this paper, I will quantitatively ascertain the business dynamism in Japan from the perspective of inter-business transfers of resources, such as people, goods and funds, and gaps in the performance of companies, and look for recent characteristics and future challenges, in line with the research on the US economy by Mr. Ufuk Akcigit, professor at the University of Chicago, and Mr. Sina T. Ates from FRB (Federal Reserve Board).

This series of analyses is based on the ongoing joint research with Mr. Miyakawa Daisuke, associate professor at Hitotsubashi University, and Ms. Takizawa Miho, professor at Gakushuin University. I used the data, which comprise information of approximately one million companies for each year with the variables necessary for analyses from the corporate database of Tokyo Shoko Research, Ltd., especially focusing on the period after the Lehman Shock. Hereinafter, figures shown that are accompanied by an arrow (→) indicate changes of the weighted averages of the indices by industry from 2010 to 2018 calculated by using sales, added value, or the number of employees as weights.

First, regarding entries and exits and inter-business labor movement, the rate of new entries showed a temporary increase in the services industry but the overall rate has been on a decline (0.25→0.21％). Due to a stagnation of entries, the share of employment by companies younger than five years has also been decreasing (4.3→3.4％), except for the construction industry and some other industries. Furthermore, when looking at inter-business labor movement in terms of the job destruction rate and the job creation rate, the job destruction rate increased (5.2→14.0％) while the job creation rate decreased (4.9→4.2％).

Next, let's look at gaps in the performance of companies. The standard deviation of sales growth among companies that was calculated while excluding outliers, which shows variation in growth, decreased (0.214→0.185). Younger companies generally show higher sales growth, and the decrease of the standard deviation is attributable to the decline in the share of such younger companies. Then, looking at gaps in companies' labor productivity, a 7.4-fold increase was observed over eight years for companies with high labor productivity that ranked in the top 5%, while labor productivity only increased by 1.2 times for the remaining 95%. This represents a phenomenon called the polarization of productivity, which is also observed in the United States. According to the research by economists from the OECD (Organisation for Economic Co-operation and Development), polarization of productivity is likely to cause deterioration of the productivity of the economy as a whole.

Why has business dynamism remained stagnant both in Japan and the United States for the past ten years or so? In the case of Japan, it should especially be noted that over this period business dynamism declined further from an initial low level.

There may be a combination of factors, such as a declining birthrate and aging population, but here, I place the focus on competition in the market. In general, active competition is considered to strengthen the motivation of entrepreneurs to enter into a new business or create or embrace innovation, but when competition intensifies beyond a certain amount, it leads to wars of attrition and may somewhat hinder entries and innovation. There are also cases where active competition results in increases of market shares held by a small number of winners, leading to an end state of an oligopoly or monopoly. In other words, the correlation between market concentration and business dynamism shows an inverted U-shaped curve.

Since the 1980s in the United States, competition has been lost in the markets of many industries and those markets have become oligopolistic. There were four main reasons for this phenomenon. The first is the fact that superstar companies in the field of IT, such as GAFA, initially created new technologies and markets through active competition revolving around innovation, enhancing productivity, but came to monopolize technologies and data through M&A and protection of intellectual property rights, eventually hindering market competition through the use of political pressure. The second is the fact that the advancement of IT has enabled businesses to manage operations in multiple markets simultaneously and some highly-efficient companies have increased their shares in many markets. The third is the fact that only a limited number of companies have had the capability to accumulate and efficiently utilize intangible assets, such as R&D, brands, software and data. The fourth is the fact that leading companies in respective industries have utilized aggressive strategies that have taken advantage of the low interest rates over a prolonged period of time and thus pulled away from other competitors. Competition in the United States gradually weakened and business dynamism began to stagnate while concentration levels increased. Such changes are represented in the right half of the inverted U-shaped curve. As a result, profit rates increased and labor shares decreased.

What is the situation of competition in the Japanese market? The Herfindahl index, which shows levels of market concentration, decreased (164.2→157.0) in contrast to the United States and competition increased. More simply, market shares of the top 20 companies decreased (29.2→27.9％). As shown in the left half of the inverted U-shaped curve, market competition has intensified in Japan and it is considered that business dynamism has stagnated while market concentration levels have decreased.

However, the return on turnover increased (1.8→4.8％) and labor shares decreased (50.8→43.6％) in the same manner as in the United States. Companies whose profit rates increased significantly have typically enhanced productivity by reducing assets and employment while they increased sales and added value at the same time.

In order to restore business dynamism in Japan, it is important to facilitate the transfer of resources to companies that can create businesses that can embrace and take advantage of digitalization and new lifestyles after the end of the COVID-19 pandemic. Financial and fiscal policies need to be formulated and implemented carefully so that crisis response measures centered on cash flow support would not be continued beyond the period of the crisis and thus not hinder reallocation of resources. Financial institutions, which are now taking urgent measures to provide liquidity, need to decide which new policies to adopt, such as intensively investing in companies that can create new businesses and business models and suggesting mergers or exits to companies that cannot. It is important to make a shift from the current policy which prioritizes employment maintenance towards a positive labor policy centered on education and training to adapt to rapid digitalization and a policy that expands the safety net.

Promoting mergers and exits through these measures may reduce the competition in the market, restoring business dynamism. Needless to say, it should be noted that excess oligopoly may undermine dynamism as has been observed in the United States. Restoring dynamism in the midst of the aging of the population with a declining birthrate presents a significant challenge, but the Japanese economy will never achieve sustainable growth without such efforts.

(For references, see Akcigit, U. and S.T. Ates, 2020. Ten Facts on Declining Business Dynamism and Lessons from Endogenous Growth Theory. American Economic Journal: Macroeconomics, forthcoming. Andrews D., C. Criscuolo and P.N. Gal, 2015. Frontier Firms, Technology Diffusion and Public Policy: Micro Evidence from OECD Countries. OECD Productivity Working Paper No. 2: https://www.oecd-ilibrary.org/content/paper/5jrql2q2jj7b-en)

>> Original text in Japanese

* Translated by RIETI.