Productivity Growth in the Global Economy: Innovation in the Service Sector and the Role of Intangible Assets

The following opening remarks and comments were made by President Fujita.

Rising productivity, reflecting the IT revolution, and globalization have had a major impact on the world economy since the 1990s. While Japan implemented various fiscal and monetary policy measures during its extended period of economic stagnation in the 1990s, it did not take measures toward boosting productivity. Japan does not even release official statistics on total factor productivity (TFP), a representative index of productivity.

With these problems in mind, the Research Institute of Economy, Trade and Industry has launched a project led by Professor Fukao Kyoji of Hitotsubashi University and Professor Miyagawa Tsutomu of Gakushuin University titled "Productivity of Companies and Industries, and Japan's Economic Growth." This project has the following two key characteristics.

1. Growth in macroeconomic productivity is analyzed by aggregating productivity growth by industry. Similarly, growth in industry productivity is determined by aggregating the productivity growth of firms and factories. Industry total factor productivity indices obtained from this study have been made available to Japanese researchers and government agencies as common property in the form of the Japan Industrial Productivity (JIP) database, and are now beginning to be used.
2. The output of this study enables international comparison. The project represents Japan in the EU KLEMS Project started two and a half years ago for comparing productivity in the European Union, the United States, and Japan.

We will start our symposium today with reports on findings on economic growth and productivity in Japan, the EU and the U.S. based on the JIP database and the EU KLEMS database. The reports will be followed by discussion. We know from the JIP database that large disparities in productivity exist among Japanese industries, and that the Japanese service industry lags significantly behind its U.S. and EU counterparts. It is also widely understood in the U.S. and EU that the accumulation of intangible assets has contributed to productivity growth in the service industries.

Capital accumulation and productivity growth are key factors in Japan's economic growth. Moreover, ICT capital (information and communication technology, or IT capital) has an important role to play in capital accumulation. However, the accumulation of IT capital in Japan has not contributed productivity growth yet. This has led researchers to focus on the role of intangible assets.

Professor Miyagawa and his associates have measured intangible assets and have undertaken an international comparison with the UK and the U.S. Their findings are as follows.

Japan's economic recovery that started in 2002 has become the longest period of uninterrupted growth in its postwar history. During this period, Japan has achieved a growth rate of 2.1%, which is lower than growth rates marked in previous recovery phases. International comparisons using EU KLEMS indicate that Japan's growth rate since 1995 has been the lowest among all advanced industrialized countries.

Economic growth can be viewed in terms of the contributions of capital, labor and TFP. In the case of Japan, all three factors are negative.

TFP growth in Japan's IT industry (information services, electronic component manufacturing, etc.) exceeds that of other countries, but this has not affected service industries as a whole. For example, retail industry TFP has been growing at 4% in the U.S. but is negative in Japan.

Comparisons of labor productivity in Japan and the U.S. also indicate that productivity is particularly low in Japan's service industries.

International comparisons of growth in IT capital services between 1995 and 2004 identify three groups of countries. In the top group, consisting of the U.S. and UK, IT capital has grown about fourfold. The second group, consisting of France and Germany, has registered a threefold growth. Finally, the third group, consisting of Japan and Italy, has achieved less than twofold growth. Consequently, the contribution of IT capital to economic growth has been lower in Japan than in the U.S. and EU.

Japan has outpaced the U.S. in the accumulation of IT capital. However, this has not contributed to TFP growth. This is related to the accumulation of intangible assets, which can be classified as follows: computerized information (software and other information assets), innovative properties (research and development [R&D], patents, licenses, and other innovative assets), and economic competences (human capital, organizational capital, and brand equity).

The U.S. enjoys a steady upward trend in intangible assets. In comparison, Japan's trend line has been flat since 1998. A comparison of the component factors reveals the following. In terms of GDP ratio, Japan has outpaced the U.S. in the accumulation of computerized information and innovative properties. However, in terms of economic competences, Japan falls short of the U.S. by more than 50%.

While Japan's IT capital is comparable to that of the U.S. and EU, its growth rate remains low. The Japanese government must introduce measures supporting capital accumulation. Due to Japan's stagnant demand resulting from its declining population, expansion into overseas markets is needed to achieve productivity growth in the service sector. However, because systems for overseas human resource development have not been developed, the accumulation of intangible assets must play an important role in the globalization of Japan's service industries.

Japan registers high levels of software investment. But because the use of packaged software involves costs related to new training and organizational adjustment, a large portion of these investments pertains to order-made software. Compared to the U.S. and EU, which use packaged software, Japanese levels of human capital and organizational capital are low. Consequently, Japan must spend more on human resource education.

To implement necessary measures, the Japanese government must develop systems for assessing the accumulation of intangible assets.

The Japanese economy is recovering, but this has been a weak recovery. We are learning that this reflects problems in the service sector. We are also learning that intangible assets have an important role to play.

Japanese productivity is slowing down, and it has been pointed out that per capita GDP and GDP per unit of capital have both stopped growing relative to the U.S. Reviewing the determinants of the economic gap between Japan and the U.S., we see that productivity is actually declining. Japan's labor hours are also becoming shorter than in the U.S., and the differential with the U.S. in working age population is narrowing. These observations point to the essential need for productivity growth.

Growth can be decomposed into capital, labor, and intermediate inputs, and the residual is referred to as multi-factor productivity (MFP). MFP is conceptually the same as TFP and can be used as a proxy measure of technological innovation.

The contributions of the factors of production to economic growth were compared for the EU, U.S., and Japan for two periods covering 1980-1995 and 1995-2004. The results show that Japan's labor hours, non-IT capital, and IT capital decreased relative to the EU and U.S. On the other hand, Japan registered an improvement in labor quality. The high economic growth rate in the U.S. is sustained by MFP growth. By contrast, in Japan and the EU, MFP growth has significantly declined compared to the 1980s.

MFP is a proxy measure of technological innovation. This includes technological innovations generated by R&D investment as well as growth in human capital and corporate capabilities. These factors are referred to as intangible assets. While intangible assets are registered as expenses, it is important to view them as investments that have a bearing on corporate value and assess them as capital.

Intangible assets account for 27% of U.S. economic growth since the second half of the 1990s. Software investment and firm-specific skills account for the majority of these intangibles. We could not confirm that growth in IT capital was directly impacting growth in MFP. But an impact was being made on MFP via intangible assets.

To boost productivity growth, it is necessary to eliminate inefficiency in individual enterprises and to bring them up to best practices. The promotion of inter-firm competition, development of small- and medium-sized enterprises (SMEs), and investment in education play an important role in this process.

It is also important to move the frontier of best practices outward. This requires R&D investment and improvements in human capital aimed at promoting and facilitating innovation. The acceptance of human capital from overseas is also effective.

Intangible assets play a key role in this process. In particular, the presence of entrepreneurs capable of making decisions on investing in intangibles is important. An environment needs to be developed to provide adequate incentives to such entrepreneurs. At the same time, the regulatory environment must be conducive to the exit of firms from the market.

Services are highly local in nature but expanding services into other geographic markets needs to be explored.

Business dynamics (the birth and death of firms) is playing an increasingly important role. In particular, business dynamics has a major impact on innovation. The exit of low-productivity firms facilitates the redistribution of resources to high-productivity firms. Market ability is critically important in the functioning of this process.

In particular, the retail industry needs to be analyzed. One reason is that the retail industry is playing a larger role in the economy than manufacturing. The U.S. is far ahead of Japan in labor productivity and the retail industry is growing rapidly in the U.S. This also needs to be analyzed.

In the U.S., large-scale chain retailers are investing intensively in IT and are achieving high growth rates in both productivity and employment. Analysis of past data reveals the following. New firms achieve higher productivity than continuing establishments, and the exit of low-productivity establishments contributes importantly to productivity growth. This is consistent with the tendency for small-scale retailers to exit the market and to be replaced by the entry of chain stores with high productivity.

The development of chain stores requires tools for communicating over distances. Today, IT is being used for this purpose.

The U.S. has a very large number of retail establishments, 12% of which belong to large-scale chains. Unlike the manufacturing sector, the data show that older large-scale retailers are creating a lot of employment. On the other hand, small-scale retail establishments start to shed jobs if they fail to grow within a few years of their establishment.

This can be attributed to the greater success of large firms in integrating their IT investments into their organizations. This has been instrumental in generating higher returns.

Store-level microdata were used to compare retailers in Japan, the U.S., and the UK. The findings indicate that between 1997 and 2002, Japan had a greater number of retail establishments than the U.S., while the average number of employees per establishment was lower in Japan than in the U.S.

A comparison of birth and death rates of retail establishments shows no significant difference among the three countries. However, Japan has a lower level of new entries. Furthermore, in the case of Japan, new entrants tend to be large-scale establishments.

A comparison of continuing establishments indicates that employment growth rates are higher in the U.S. than in Japan and the UK. In Japan, new entrants tend to be large. Resource re-allocation through market exit is functioning most effectively in the U.S., followed by the UK and Japan.

Land use restrictions exist in the UK whereby the establishment of large-scale suburban retail stores is frowned upon. Some research results indicate that this has had a negative impact on British productivity.

It is necessary to compile detailed statistics on birth and death rates of firms and to measure what Joseph Schumpeter called "creative destruction." It is also necessary to measure the impact of technology shocks and macroeconomic shocks on business dynamics.

Q: Why did Japan have strong TFP growth between 1980 and 1995? In particular, would it not be difficult to explain the high rate of productivity growth in the service sector based on the discussions we have heard so far? Also, would it not be difficult to explain why economic growth decelerated in the mid-1990s?

A: The share of intangible assets in the total economy was low during the 1980s and 1990s. It is necessary to analyze other factors that affect economic growth. Productivity growth rates in service industries were not low during the first half of the 1990s. However, the characteristics of IT were quite different at that time. Japan's failure to keep up with the change in the characteristics of IT (downsizing) can be considered to be a reason for the deceleration of economic growth.

A: Japan's economic growth during the 1980s was still in the catch-up phase with the U.S. and Europe. During this period, economic growth was affected by the growth of non-IT investment.

Q: If entrepreneurial and management principles are important, is it sufficient to measure business assets based on financial statements?

A: When microdata are used in analysis, intangibles are measured by subtracting tangible assets from corporate value. Management capability, human capital and various other values are included in this.

Q: As companies become increasingly multinational, does this not mean that management pays less attention to the interests of their country and more attention to the interests of shareholders? In this environment, how can consistency with the JIP database be maintained?

A: When a company invests overseas, parts of its activities will not be covered by JIP. However, the JIP supplementary tables make it possible to grasp the overseas investments and activities of companies. By combining the JIP data and the supplementary tables, it is possible to measure the impact on productivity.

Q: Are there any cases where intangibles become non-performing assets? Would the problems related to the compensation system of the central bureaucracy be included in such a category?

A: The ratio between tangible and intangible assets is lower in Japan than in the U.S. The background to this is that Japan has overemphasized tangible assets and has failed to maintain a balance between the two. A good example of this is that the ATMs installed by financial institutions are inconvenient to use.

A: Accurate measurements will allow us to measure the returns on intangible assets. This will enable us to understand how intangible assets are assessed in the market.