What Needs to Be Done to Link IT Revolution to Revitalization of Japanese Economy?

Senior Fellow, RIETI

Tax system reform for fiscal 2003 has introduced a new tax reduction measure to promote private-sector information technology (IT) investments by allowing companies to take a 10 percent tax credit on designated IT investments. The step is remarkable in that a broad range of IT investments - including the purchase of software - by all companies have been made eligible for the credit, as compared to the previous scheme that was applicable only to hardware investments by small and midsize enterprises. The new tax credit scheme is counted on to promote the introduction of spearhead IT systems by companies, thereby contributing to the revitalization of the whole Japanese economy. The expansion of IT investments, however, does not necessarily lead to the improvement of corporate performance. Then, what can and should the government do to link the expected IT revolution to the revitalization of the Japanese economy?

IT Revolution and Prolonged Stagnation of Japanese Economy

Development in the IT field has been spectacular as given by the Moore's Law, which says that the logical density of silicon integrated circuits doubles in every 18 months. Also, as seen in the explosive spread of the Internet since the late 1990s, the informatization of economy is proceeding rapidly. At a time, it was said that the IT bubble burst. But the productivity of the U.S. industry has been going up even after the last half of 2000 when the U.S. economy began to slow down. The "new economy" theory, which attributes the postwar longest economic boom of the United States in the 1990s to the structural changes brought by the IT revolution, is generally supported by economists.

Meanwhile, the Japanese economy has been bogged down since ever the 1990s. Japan's annual economic growth barely exceeds 1 percent now, falling sharply from the 4 percent level during the 1980s, while the current employment situation is perceived to be the postwar worst. Hasn't Japan cashed on the IT revolution that remarkably proceeded especially since around the last half of the 1990s? Based on my own estimates, Japan's macro-level productivity has been on the rise since the last half of the 1990s. At the same time, the IT revolution's contribution to the growth rate has also gone up. Thus, at least on the macroeconomic level, the same phenomena as those in the U.S. have been observed in Japan.

Gap between Japan and the U.S. in Non-manufacturing Sector Performance

At a sectoral level, however, Japan and the U.S. show distinct differences in the relationship between the IT revolution and productivity. A rise in macroeconomic productivity has been largely led by the IT industry where tremendous technological innovation has been taking place, a symptom that is commonly observed in Japan and the U.S. In the U.S., however, service sectors such as the retail and financial service industries have also made substantial contribution to the macroeconomic productivity growth. McKinsey & Co., based on its survey, says that the wholesale and securities industries together accounted for roughly 40 percent of the U.S. productivity growth in the 1990s. In Japan, on the other hand, no industries other than the IT industry can be cited as a major contributor to the productivity growth. More specifically, robust IT investments by non-IT industries have not led to the productivity growth of their respective sectors. Particularly in the last half of the 1990s, the retail and financial service industries dragged down the whole Japanese economy, rather than contributing to the productivity growth.

Coexistence of the efficient manufacturing sector led by highly-productive export industries and the inefficient non-manufacturing sector has long been a distinct feature of the Japanese economy. Such a sectoral gap in productivity, however, has conspicuously widened in the recent years. In the manufacturing sector, which is exposed to fierce global competition, the informatization of production systems and the development of supply chain systems have resulted in the further improvement of productivity. In contrast, the non-manufacturing sector with low productivity, including the retail and financial service industries, have been mostly unable to take advantage of IT. To upgrade overall performance of the Japanese economy by utilizing IT, it is important to provide a competitive environment in the non-manufacturing sector.

Regulatory Reform and Innovation of Non-manufacturing Sector

A closer look at the productivity growth of the U.S. retail industry finds that the advance of general merchandise stores (GMSs), as exemplified by Wal-Mart Stores, Inc., has had a significant impact. Wal-Mart is known for its vanguard warehouse management system as well as for the implementation of an advanced supply chain management system under which sales and inventory database is shared by its suppliers. While Sears, Roebuck and Co. and other rival retailers try to catch up, Wal-Mart has been turning out new applications to maintain its lead. By developing new business applications that take full advantage of IT, Wal-Mart is realizing the continuous improvement of productivity.

Meanwhile, in Japan, the presence of the Law Concerning the Adjustment of Retail Business Operations in Large-Scale Retail Stores (Large-Scale Retail Store Law), which imposed restrictions over the opening of large-scale retail stores to protect small retailers, had long prevented innovation competition among retailers. Although the law was abolished in 2000, there still remain a number of other restrictions including the Law on Special Measures for the Adjustment of Retail Business, which provides protection over small retailers, as well as licensing systems for retailers selling liquor, drug, rice and other designated goods. Those restrictions should be reduced to the minimum to facilitate healthy competition among retailers.

In the U.S., a virtuous cycle between regulatory reform and innovation can be observed not only in the retail industry but also in many other non-manufacturing industries, as pointed out in "Nihon Keizai: Kyosoryoku no Koso (Japanese Economy: Vision of Competitiveness)" (coauthored by Haruhiko Ando and Kazuyuki Motohashi, published by Nihon Keizai Shimbun, Inc.). Regulatory reform has been spurring new innovations in such industries as telecommunications, electric power, aviation and transportation, and financial services, thereby helping enhance productivity in each industry. Many of those innovations - customer relationship management (CRM) systems such as those seen in the aviation industry, financial derivatives, and so on - have been realized by utilizing IT.

The introduction of an IT system, in itself, would not help improve corporate performance. Only when accompanied by business innovation that effectively utilizes the introduced system, desired effects can be derived. In the Japanese non-manufacturing sector, which is particularly low in competitiveness, a number of industries have yet to have an environment that facilitates innovation competition among companies. In order to revitalize economy through IT investments, it is necessary to accelerate regulatory reform in those industries lagging behind and build foundation for companies to take up a challenge and strive for innovations.

March 11, 2003

March 11, 2003