In Fact: The service sector in Japan

Consulting Fellow, RIETI

What is "Trade in Value Added?"

The service sector accounts for approximately 70% of Japan's gross domestic product (GDP) and approximately 75% of employment, so developments in this sector have a large impact on Japan's economy as a whole.

Its large size is not the only factor that makes the industry important. Growing attention is being paid to the service sector given its function of encouraging regional economies. In the manufacturing industry, efforts to promote a strategic shift toward services are also rapidly progressing. As demand for a range of services is increasing in step with economic growth and rising incomes in Asia, the Japanese service sector is also showing signs of international expansion.

In addition, interest in individual service industries is growing from the perspective of how to meet social demand for services (such as those for the elderly and childcare) arising from ongoing changes such as the aging population and greater participation of women in society.

As such, the service sector has become one of the focuses for discussion of the economy, industries, and social systems of Japan.

Although we can't emphasize enough the importance of the service sector, there is still quite a lot of misunderstanding about it, fed by some off-base reporting. Let's look at some of the facts.

"In fact, the added value ratio of the service sector is high."

Some appear to have the image that the added value ratio (ratio of added value to sales) of the service sector is low. However, even if there is some truth to this with respect to the wholesale and retail industries and services related to daily life (and indeed there are policy concerns in this aspect), it is not necessarily true for the service sector as a whole. In fact, the added value ratio of the service sector is generally high.

The 2012 Economic Census for Business Activity (conducted by the Ministry of Internal Affairs and Communications and the Ministry of Economy, Trade and Industry) shows that the added value ratio of Japanese companies is 18.6%. However, looking at the ratio by large industrial classification, we notice that Education, Learning Support has the highest ratio at 46.9%, followed by Accommodation, Eating and Drinking Services at 37.8%. In the service sector, there are many industries with a high added value ratio, such as Scientific Research, Professional and Technical Services, which ranked fourth at 35.0%; Services, n.e.c., which ranked fifth at 33.0%; and Compound Services, which ranked sixth at 30.4%.

However, the added value ratio is low in the consumer businesses, such as Living Related and Personal Services and Amusement Services, which ranked 14th (17.0%), and Wholesale and Retail Trade, which ranked 17th, the lowest (10.6%).

Meanwhile, Manufacturing is ranked 15th at 15.6%, which is lower than the overall added value ratio.

While some may be surprised that the added value ratio is generally high in the service sector, the result may become more persuasive if we recall the following formula: Added value ratio = (operating income + personnel expenses)/sales. Naturally, the concept of productivity (= output/input) and that of the added value ratio are different. As the added value that is generated by humans is regarded as personnel expenses, it comes as no surprise that the added value ratio is generally high in the service sector, which has a strong tendency to depend on human abilities.

"In fact, the service sector is earning foreign currency."

Some argue that the service sector cannot earn foreign currency. They claim that Japan will run into difficulties unless the manufacturing industry puts its efforts into earning foreign currency. It is true that Japan needs to have a vibrant manufacturing industry. In fact, however, the service sector is earning foreign currency by supporting manufacturing exports as well as engaging in the service trade.

According to the Trade in Value Added (TiVA) database published by the Organisation for Economic Co-operation and Development (OECD) and the World Trade Organization (WTO), as of 2009, approximately 30% of the export value of the Japanese manufacturing industry is generated from the service sector. In other words, 30% of the factors that support the international competitiveness of Japanese goods are derived from the efficiency of the service sector. Moreover, approximately 40% of added value in total Japanese exports is generated from the service sector.

In terms of added value, the service sector plays a considerable part in the total exports of Japan, either indirectly by supporting the international competitiveness of the manufacturing industry or directly in the form of service export.

"In fact, there are large potential productivity gains in the service sector."

It is generally believed that productivity growth is actually small in the service sector and that it is difficult to improve its productivity. One of the main factors for the low productivity growth is that service businesses generally have strong local characteristics while competitive pressure is small, as there is simultaneity between production and consumption (no inventory).

Looking at this backward, however, we see that there is in fact a way to improve the productivity of the service sector, through efforts outside of the market. If the sector cannot improve productivity from the limited market pressure, then it is simply a matter of providing opportunities to learn from the examples of others outside of the market, such as forums and study sessions.

Actually, large productivity gaps have been noted within the service sector. Considerable improvement in productivity can be expected by learning from a high productivity model that exists in the same industry. The problem comes down to who will provide the opportunity to learn outside of the market, and policy consideration is necessary in this regard.

There are large potential productivity gains in the service sector, given that the creation of a new business model with high productivity can be expected. As the business model in the service sector in a nutshell is the combination of solutions and hospitality, it is possible to create a large variety of business models. For example, in the case of Peach Aviation Ltd., a low cost carrier (LCC), the business model of an LCC itself was the provision of a new solution, but the company is promoting other new solutions by developing various business models that go beyond the simple provision of a low-cost carrier service. In addition, it has achieved a level of customer satisfaction no less than that of non-LCC airlines. If a high productivity business model that meets or creates needs grows, the productivity of the service sector as a whole will also increase.

We looked above at some of the facts about the Japanese service sector. These facts can be translated into some effective policies.

March 5, 2013

March 5, 2013