What has improved in recent years?
The year 2020 will be the eighth year since Abenomics started. Although quantitative policy impacts are difficult to identify, many economic indicators have improved over these few years. Corporate operating profits have increased by 70% from FY2012 to FY2018, and non-manufacturing profit margins have hit a record high (Note 1). The unemployment rate has declined to the low 2% range, a level before the "lost two decades." Against the background of labor shortages, labor participation rates of women and elderly people have risen.
Life satisfaction score has improved in Japan, hitting a post-war record in 2018 (Note 2). This is probably because of the improved employment environment and low rates of price increases. The 2% inflation target set by the Japanese government and the Bank of Japan has not yet been met, but low inflation rates positively affect people's life satisfaction. The life satisfaction score has especially increased among young males, although this may be partly attributable to their lowered aspirations. However, high life satisfaction itself is good news.
It can also be pointed out that political stability has helped reduce uncertainty. Between 2006 and 2012, there were many short-lived (about one year) administrations before and after the regime changes. Many studies show that factional conflicts and unstable politics have negative influences on the business cycle and economic growth (Note 3). Since the beginning of the second Abe administration, especially since the summer of 2013 when the divided Diet was resolved, political uncertainty has decreased significantly (Note 4). Japan is not able to avoid influences arising from heightened uncertainty abroad, such as Brexit negotiations, U.S.-China trade conflicts, and growing tensions in the Middle East. But domestic political uncertainty has decreased, causing less negative impacts on Japan's economy.
Sluggish productivity and declining international competitiveness
On the other hand, there are many unsolved problems such as a slowdown in productivity growth, sluggish wages, decreased international competitiveness, accumulation of government debt, and declining local economies. The average economic growth rate in the last few years is about 1%, slightly beyond Japan's potential growth rate. Therefore, to further increase the growth rate, we need to raise the potential growth rate. While Abenomics has helped increase the potential growth rate by 0.3 percentage points, this increase is dependent on increases in inputs such as labor participation of women and elderly people; in fact, the growth rate of total factor productivity (TFP) has been gradually decreasing. According to the estimates by the Cabinet Office and the Bank of Japan, the TFP growth rate decreased by 0.5–0.7 percentage points from FY2012 to FY2018. The current no-wage-increase trend is regarded as a problem, but wages and productivity are strongly linked. Although changes in labor share also affect wages, those effects have been quantitatively very limited. Movement in wages is largely explained by productivity growth (Note 5).
Japan's international competitiveness has also experienced a long-term decline. While the word "international competitiveness" can have many meanings, from the viewpoint of economics, it can be captured by movements in terms of trade (Note 6), which is defined as the prices of exported goods and services relative to imported goods and services. Changes in terms of trade are not reflected in GDP or macro-economic productivity measures, but they do have influences on gross national income (GNI) in the form of trade gains or losses. Japan's terms of trade have declined by about 40% since the 1990s. When calculated mechanically, Japan's relative international competitiveness has weakened by some 2% annually. The decline seems to be flattened in the last few years, but the improvements are marginal.
Innovation—especially product innovation involving the development and diffusion of excellent new products and services—plays a major role in improving both productivity and terms of trade. Investments in innovation involve uncertainty and so require active risk-taking. That is why it is important to create an environment where engineers and companies engaged in innovation activities have the ability to work on their projects flexibly, without excessive external constraints.
Regulation, compliance, and productivity
Until recently, Japan's growth strategy had emphasized reform of bedrock regulations in order to encourage a productivity revolution. Regulations have negative effects on productivity and innovation through (1) direct cost increases associated with compliance, (2) negative influences on business start-ups and incumbent companies' entry into new markets, and (3) decreased risk-taking that arises from uncertainty in interpretation and execution of laws and regulations.
You may think that the number of industries that are regulated by the government is quite limited, but our survey targeted at Japanese companies reveals that 56% of companies engage in businesses requiring legal licenses or permits (Note 7). By industry, the percentages are 49% of manufacturing companies and 64% of service companies.
While industry-specific license and permit systems still exist in fields such as transportation, electricity and gas, health and welfare, and education, the majority of current regulations are cross-industry social regulations, rather than licenses and permits targeted for specific industries. These social regulations include labor regulations, environmental regulations, and land use regulations. Some studies show that these regulations exert a great negative influence on GDP and productivity (Note 8).
A significant portion of labor hours is used for development and execution of internal rules in response to government regulations and administrative guidance. Even regulations that are less stringent than those requiring specific licenses/permits force companies to undertake various tasks such as providing regular reports and preparing documents for inspection. Although the costs for each individual rule may be small, they are a steady drain on productivity. According to our survey, direct costs for regulatory compliance account for 2.6% of operating costs on average (although they are vary heterogeneous by company). This may sound like a small amount, but relative to value-added, these compliance costs account for about 16%. In other words, if the costs can be halved, productivity will increase by about 8% on average (Note 9).
Since compliance costs are in a sense fixed costs, it is likely that they have a larger effect on smaller companies. It is indeed observed that the ratio of compliance costs rises by around 8% for half-sized firms. This may be one cause of the lower productivity of SMEs and may also decrease market entry rate by raising costs for business start-ups.
According to our survey, a significant majority of companies report that labor regulations represent the largest compliance costs. The second most expensive field of regulations they point to is environmental regulations. These two fields are far more notable than business licenses/ permits (See Table 1). Companies wish most for deregulation of labor regulations, followed by land use/construction regulations, environmental regulations, business licenses/ permits, and the corporate law and related regulations. A large number of labor regulations and other social regulations are designed to ensure safety and security, not to improve productivity or economic growth, so deregulation may involve tradeoffs between these different values. In this respect, easing of social regulations is important as a growth policy, but it is politically difficult. Yet, in the current situation where public and private sectors are experiencing labor shortages and work style reforms are expected, it is desirable to put in place a simplified mechanism that will reduce the labor inputs necessary to deal with laws and regulations.
Table 1: Views of Companies on Regulations
||(1) Requires large compliance costs
||(2) Deregulation is most wished for by companies
|Business license/ permits
|Land use/construction regulations
|Consumer protection regulations
|Corporate law and related regulations
|Occupational licensing system
|Note: Prepared from Survey of Corporate Management and Economic Policy (2019).
Detrimental effects on businesses caused by uncertainty in interpretation and execution of regulations
Another problem of regulations lies in uncertainty in interpretation and execution. Even when the scope and content of regulations are clearly documented, there is room for discretion and uncertainty in interpretation and execution, because it is impossible to foresee all possible eventualities. Many companies report that uncertainty concerning labor regulations, consumer protection regulations, environmental regulations, etc. affects corporate management (Note 10). Many studies show that uncertainty concerning macro-economic and trade policies has negative effects on real economic activities such as investment, hiring of employees, and export (Note 11). Empirical studies on the effects exerted by uncertainty concerning domestic regulations and their execution have been limited, but regulatory uncertainty is likely to cause companies to act too cautiously.
This raises serious problems especially for new technology and business development. Uncertainty in interpretation and execution of regulations makes active risk-taking difficult. It may discourage companies from taking action as the public and the media are paying increased attention to legal and regulatory violations. Against this background, the government has established the System to Eliminate Regulatory Gray Zones (2014), which is intended to facilitate entry into new fields when the coverage of laws and regulations is unclear, and the Regulatory Sandbox System (2018), which allows for experimentation of new technologies regardless of existing regulations. But using these systems requires considerable input of labor.
The government's interest in regulatory reform seems to be weakening. To increase productivity and potential growth rates, it is hoped that the government will once again place regulatory reform at the center of its growth strategy. It also needs to conduct empirical evaluations of not only financial support programs including subsidies and special tax credits but also of laws and regulations, and to develop cost-effective and evidence-based regulatory mechanisms.
December 20, 2019