Studying Service Productivity: Necessity and direction

KATO Atsuyuki
Fellow, RIETI

The issue of how to improve the productivity of the service sector may appear irrelevant in this time of severe global financial and economic crisis. Achieving long-term growth based on higher productivity in the service sector is certainly a peripheral discussion given the present situation of deteriorating corporate earnings, employment conditions, and increasing public anxiety. Yet the issue remains one of the most important topics for the long-term economic growth strategy of Japan should the current trends of low birthrate, longevity and the economy's shift toward services continue.

Service sector revitalization is necessary

Consequently, short-term responses to the current crisis must not be inconsistent with the long-term direction described above. Despite Japan's financial sector experiencing relatively minor fallout from defaults on subprime mortgage loans, the phenomenon of the overall economy's underperformance and sharp deterioration compared to other developed nations is a testament to its vulnerability to export demand. It is conceivable that this vulnerability could be eliminated by enhancing the service sector, which accounts for 70% of GDP.

In addition, should Japan aim for creating employment and growth based on technological innovations similar to the Green New Deal proposed by the Obama administration in the United States, excellent technological development and highly advanced business services capable of efficiently linking these technologies with social needs will be essential. Developing these services is one of the urgent tasks facing Japan.

Seeking a more accurate international comparison of productivity

The importance of ongoing research focused on service sector productivity is clearly important to achieving short- and long-term improvements in the Japanese economy, but many questions remain unanswered due to an insufficient amount of analysis that has been holding back the implementation of specific industrial policies. As indicated in the results of a survey that I conducted earlier (* 1), service sector productivity has been studied from the following perspectives: (1) Identification of the subjects of analysis (the issue of defining and measuring service productivity); (2) The mode and impact of the shift to a service economy; and (3) An analysis of the determinants of productivity. However, there is a difference of opinions regarding the issue of how to measure service productivity in relation to (1), particularly how to compare services with different levels of quality.

Nevertheless, this is an important problem that could have major implications on the international productivity comparisons that indicate Japan's service sector is considerably less productive than other developed nations, particularly the U.S. (* 2). The Japanese government referred to these comparisons when it addressed lagging domestic service productivity. But services providers and productivity researchers in Japan have consistently been critical of these comparisons, pointing out that as the quality of services offered in Japan and the U.S. differ, a comparison based on statistics that do not reflect these differences will not be accurate. In relation to this problem, the Japan Productivity Center (formerly the Japan Productivity Center for Socioeconomic Development) recently reported the results of a comparison between the quality and prices of services in Japan and the U.S. based on questionnaires (* 3). An accumulation of similar surveys will be reflected in the productivity study, likely leading to more accurate comparisons and analysis.

Also, as for (3) above, a significant issue remains: How can we distinguish between changes in productivity from those in demand? In many cases sales (or added value) are used as an output of services for measurement purposes, but this poses a problem because sales rise or fall due to changes in demand and associated changes in prices, even if productivity remains unchanged as a technical relationship between input and output.

The shape of the demand function must surely have a large impact on the analysis. This issue needs to be addressed when analyzing the determinants of productivity, particularly when the market is not one of perfect competition. In this regard, I analyzed (* 4) the productivity of department stores and supermarkets in Japan under the assumption of monopolistic competition by applying a method proposed by Professor Marc Melitz of Princeton University. However, it seems that an analysis considering the effects of demand needs to be conducted for other service industries.

In addition, as a more fundamental issue in relation to (2), identifying the reason why a structural change in the shift toward a service economy arises in the first place is essential for making specific policy proposals. This is also directly related to the question of whether moving toward a service economy will cause the productivity growth rate to stall - the so-called Baumol disease (* 5) - at the macroeconomic level in the long term.

With respect to this issue, Buera and Kaboski (2009) (* 6) attempted to explain the shift toward a service economy in the U.S. from the 1950s by focusing on the expansion of service consumption and the role of highly skilled and specialized workers in each industry. Their theoretical model indicates that the increase in the number of specialized and highly skilled workers will shift service production from "home" to "the market." Their findings have policy implications on issues such as labor supply (particularly the use of female labor) and subsidies to industries (such as the nursing care industry) that are currently increasing their share of the total economy.

The Buera and Kaboski model also shows that the Baumol disease is not always a consequence of the trend toward a service economy. Although their model seems capable of explaining phenomena such as the service production trends toward high skills and a rise in the U.S. skill premium, I wonder if Japan is experiencing the same phenomena in its movement toward a service economy. Or if their model cannot adequately explain the experience and current situation in Japan, what kind of model can? Studies that can answer these questions are needed.

A library of studies should be created to facilitate specific policy proposals

The global economy is experiencing unprecedented changes wrought by financial and economic crises of exceptional severity. Although the economy will ultimately recover once the crises abate, there is no guarantee that it will return to its past form, which was based on huge trade imbalances between nations. Indeed, the possibility of the old economy restoring itself is remote. To emerge from this serious recession and thrive in the new world economy Japan must aim for economic growth based on an expansion of domestic demand through the vitalization of its service sector. This will require a library of studies to facilitate specific policy proposals.

April 28, 2009
  • (* 1) Kato, A. (2007), "Survey of Productivity in the Service Sector," RIETI Policy Discussion paper, 07-P-005
  • (* 2) Cabinet Office (2004), "World Economic Trends, Spring 2004"
  • (* 3) Japan Productivity Center (2009), Report of "US-Japan Comparative Studies on Differences in Quality Level in the Same Service Area"
  • (* 4) Kato, A. (2009), "Productivity, Returns to Scale and Product Differentiation in the Retail Trade Industry: An empirical analysis using Japanese firm-level data"
  • (* 5) Baumol, W.J. (1967), "Macroeconomics of Unbalanced Growth: The anatomy of urban crisis", American Economic Review, 57 (3), 415-426
  • (* 6) Buera, F.J. and J.P. Kaboski (2009), "The Rise of the Service Economy," NBER Working Paper, No.14822

April 28, 2009

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