Information Technology and the New Globalization: Asia’s economy today and tomorrow (Summary)

NAKAJIMA Atsushi (Chairman, RIETI)

Today's RIETI symposium, "Information Technology and the New Globalization: Asia's economy today and tomorrow" is organized by RIETI and held jointly with the Japan Productivity Center and the Hitotsubashi Institute for Advanced Study, in conjunction with the Fourth Asia KLEMS Conference, which is scheduled to be held in Tokyo.

Asia KLEMS is a framework that has been established to follow up World KLEMS, a project designed to build an international database that allows for conducting international productivity comparison. World KLEMS is participated by economists around the world and led by Professor Dale W. Jorgenson of Harvard University, who is going to give a keynote speech at this symposium. Asia KLEMS is part of the global framework and its key participants from Japan include not only RIETI but also Professor Kyoji Fukao, program director and faculty fellow at RIETI and professor at the Institute of Economic Research, Hitotsubashi University, who will take the podium at today's symposium.

Needless to say, improvement of productivity is a principal source of economic growth. In particular, given the rapid pace of aging and birthrate decline in Japan and major Asian countries such as China and South Korea, productivity improvement is now the top priority issue to be solved for continuous and sustainable growth.

Under these circumstances, in order to develop policies that are effective to stimulate economic growth, it is necessary to accurately identify the reality of productivity in industries and companies through the development and analysis of database like KLEMS, which I referred to a moment ago, while understanding the effects of the use of IT, innovation, and globalization on productivity.

Under the theme of IT in Asia and new globalization, this symposium will be run by leveraging the results of the Asia KLEMS Conference. While placing the viewpoint of productivity at the core, we will welcome participants from overseas, including Richard E. Baldwin, who is a professor at the Graduate Institute, Geneva and the president of the Centre for Economic Policy Research (CEPR), as well as Professor Lawrence Lau of the Chinese University of Hong Kong. Professor Baldwin is the world's top expert on international trade and economy and leads discussions about the changes brought about by IT and new globalization to the world's economy or trades. Professor Lau developed the first econometric model of China and has extensive knowledge and wisdom about Chinese and East Asian economies.

Participants from Japan include Toshitaka Sekine, director-general, Research and Statistics Department, Bank of Japan, and Professor Kozo Kiyota, research associate at RIETI and a professor at the Keio Economic Observatory and Graduate School of Economics, Keio University. These participants will bring a wider scope of view to the panel discussion, which will focus on Asia's economy today and tomorrow.

I strongly believe that the up-to-date reports from these world authorities and their panel discussion will further enhance your knowledge and wisdom.

Dale W. JORGENSON (Samuel W. Morris University Professor, Harvard University)

We are all familiar with Japan's two lost decades. Since the beginning of the 1990s, there has been little economic growth and no productivity growth. Japan's policy response to the lost decades is the theme of my lecture. Prime Minister Shinzo Abe announced a second phase of Abenomics as an attempt to deal with long-term issues, opportunities of new globalization, and the role of IT. Japan is a laggard in the application of IT and has underinvested in this the central engine for innovation in the world economy.

The spread of global economic activities and value chains has taken on enormous momentum in the last two decades. With the collapse of Japan's bubble in 1991, a new international order emerged with India and China overtaking Japan on the list of the world's largest economies. In fact, China became the world's largest economy in 2014.

Japan's response to the new world order: Abenomics

This change in the world order provoked a response by Japan by Prime Minister Abe called Abenomics. The first phase of Abenomics is characterized by the three arrows of aggressive monetary policy, flexible fiscal policy, and growth strategy. In early 2016, the prime minister initiated a search for new economic policy built on the perceived successes of the first phase of Abenomics.

I was chosen to provide advice on the new phase of Abenomics. My recommendations were to revitalize the Japanese economy by stimulating productivity growth. I identified non-manufacturing sectors protected from international competition as the primary focus. The reformulation of Abenomics was completed with the economic policy called "Growth Strategy 2017," which I will refer to as the second phase of Abenomics.

Issues facing the Japanese economy

First, Japan's productivity growth has stagnated in a period when technologies have evolved more rapidly than in any period of economic history. Second, Japan is confronted by a serious demographic crisis with a fall in the labor force and a declining population. The third challenge is that government revenues will rise in relation to the gross domestic product (GDP) to finance needed expenditure and support an aging population.

First phase of Abenomics

The traditional Japanese approach to growth was to subsidize favored industries, which created large companies that stifle competition. Abenomics aims to drill down through policies that sustain cartels, stifle competition, and eliminate incentives to invest in new technologies. The first reform was in agriculture to diminish the influence of agricultural cooperatives and to participate in trade agreements. Second, efforts are being made to increase competition in the highly regulated electric and gas utility sector, but doing so has been complicated by the Fukushima Daiichi nuclear accident. The third would be to stimulate competition by eliminating bedrock regulations in various industries.

The productivity gap between the United States and Japan at the aggregate level for the entire economy was 15%. Japanese industries with striking productivity gaps include the sectors of agriculture, energy, finance/insurance, other services, and wholesale/retail trade. These five sectors account for the entire productivity gap between Japan and the United States. Deregulation of these industries is necessary to stimulate competition and improve innovation and investment in IT. Japanese labor laws need revision to resolve the inefficient allocation of a shrinking labor force. Trade agreements can also play an important role in a growth strategy.

Abenomics 2.0: Growth Strategy 2017

When I met with the prime minister and his cabinet, my recipe was simple: Japan has to end productivity stagnation through a productivity revolution by promoting competition. The new face of Abenomics was then created based on three principles. The first is to boost productivity. The second is to drive innovation and trade. The third is to energize corporate activities.

As for boosting productivity, the first action is to reform the traditional work style, meaning reforming of the labor market. The second is to invest in human resources. The third is to embrace diversity in the labor force, or utilizing the elderly and women. However, where is the aforementioned drilling down to stimulate competition in cartelized industries in order to increase productivity?

As for driving innovation and trade, the first objective is to provide personalized medical care. The second is to have better distribution services for business emulating Amazon or Alibaba. The third is to increase productivity in infrastructure. The fourth is to promote the development of financial technology. However, specific talk about trade, services, and industries identified as lacking in productivity were all omitted.

The third principle is to energize corporate activities through corporate tax reductions, by strengthening investor confidence, and to drive inward foreign investment to facilitate technology transfer.

Conclusion

In order for the Japanese economy to exploit ongoing IT developments, there must be competition to drive investment and innovation. This seems to be a key missing part of Abenomics 2.0. The second arrow of the first phase of Abenomics should be abandoned for energetic reform and restoring fiscal balance through a shift of taxation away from investment toward consumption. A growth strategy should be focused on adapting to the changing world economy and the development of global value chains. We need concrete demonstrations of initiatives to improve productivity in Japan, which was precisely what generated widespread support for the first phase of Abenomics.

Richard E. BALDWIN (President of CEPR, Professor of International Economics, Graduate Institute Geneva)

Today, I'd like to broaden the way you think about globalization. Let's begin with a definition: globalization is what happens when goods, ideas, people, services, and capital move from one nation to another. The driving force behind the international flows of these things is arbitrage. Whether it is goods, services, ideas, people, or capital, things tend to flow from where they are abundant and thus cheap to where they are scarce and thus expensive. When thinking about trade in goods, this arbitrage is called "comparative advantage."

In my 2016 book, The Great Convergence, I argue that the global nature of globalization has changed in recent decades. In 1990, G7 countries accounted for about 70% of manufacturing output; that percentage has fallen to below 50% as China, Korea, India, Poland, Indonesia, and Thailand increased their share of manufacturing. The change in G7's share of GDP share was equally dramatic, with G7 countries accounting for 67% in 1993 and 46% in 2014.

Rethinking globalization

The traditional mental model for thinking about globalization is trade theory—in particular variants on David Ricardo's theory of comparative advantage. I think that did a good job of explaining how globalization worked from its earliest start around 1820 right up to 1990. But although comparative advantage still matters, there is a new form of globalization going on.

To understand this, I invite you to suspend your disbelief and ask yourself the question, "What if globalization were driven by knowledge flows, not trade flows?" Suppose that everything is made from know-how and labor, trade costs and barriers have not changed since 1990, and in that same year "pipelines" opened that allowed firms to move know-how across borders. Assume the pattern of pipelines to be the United States connected to Mexico and China, Germany to China and Poland, and Japan to China. In the 20th century, competition was done either with high-tech and high-wages or low-tech and low wages. However, with the pipelines, G7 country companies can take their know-how and combine it with low-wage labor abroad. The manufacturing that used to be competitive in G7 countries because their technological edge outweighed high wages would be moved to high technology and low wages. This would cause a rapid shift of knowledge (and therefore manufacturing) from G7 countries to the factory economies connected by the pipelines. Knowledge pipelines led to an information and communications technology (ICT) revolution.

Three costs that constrain globalization and the great convergence

I would like to combine the idea of globalization as knowledge with the traditional view of globalization to form a broader perspective on globalization. There are three costs that form three constraints on globalization: trade costs, communication costs, and face-to-face costs. The steam revolution and Pax Britannica lowered trade costs without much affecting the other two costs. Low trade costs made high-volume trade feasible and comparative advantage made it profitable. The steam revolution unbundled production and consumption, which is when specialization started. As markets expanded globally, production clustered locally to reduce communication costs, not trade costs. Micro-clustering fostered innovation and ignited the bonfire of innovation and modern growth in G7 countries.

However, high communication costs meant G7 innovations stayed in G7 nations and know-how imbalances appeared. Pre-globalization knowledge between the rich and poor nations were fairly even. Afterwards, most of the knowledge was in the rich countries. That led to the "great divergence" where poor countries stayed poor and formerly rich countries such as China and India became poor. This was because trade costs came down, but communication costs did not. The ICT revolution lowered the cost of moving ideas and made offshoring feasible, while vast wage differences made it profitable. "New globalization" is information crossing borders. This is what led to the "great convergence" where countries such as China and India have started to reclaim their share of GDP as the G7's share of GDP drops.

Explaining the rise of anti-globalization

The first cause of anti-globalization is that the new globalization breaks the monopoly that G7 labor had on G7 know-how. Technology developed in G7 countries was moved offshore. This broke the social contract between companies and workers. Second, new globalization affects economies with a finer resolution. As an example, in old globalization, international competition happened at the level of completed products, such as Japanese cars entering the U.S. market. In new globalization, international competition happens at the level of individual jobs. This is no longer team Japan versus team United States, but rather the United States getting mixed up with Japan. This makes it hard to understand what is going on. These combined two factors led to economic anxiety, fragility, and disenfranchisement in G7 nations. The impacts of new globalization are more sudden, more individual, more unpredictable, and more uncontrollable. Any worker could lose their job next regardless of the skills they possess.

Future of globalization

Although I started with the negatives of globalization, these changes are probably going to allow people to better leverage their know-how. Thinking about the future, I would like to speculate about whether globalization will advance or retreat in the next five years. I think the next step of globalization is going to be more disruptive. Face-to-face costs remain high, and two-thirds of the people in rich countries who work in the service sector have not yet experienced globalization or automation.

However, technological advances in the next five years could make it feel like foreigners are actually working in your office through advanced communications, not travel. Imagine if instantaneous machine translation of spoken communication becomes commonplace and eliminates language barriers. Telepresence systems already exist today where you can feel like everyone is in the same room. Telepresence and instantaneous translation would allow for highly-paid professional jobs to move abroad. Telerobotics would allow for the offshoring of manual jobs or even surgeons. A maid in the Philippines could work a robot cleaning hotel rooms in London. Telemedicine would allow doctors to work on patients anywhere in the world. Although these technologies are currently expensive and clunky, exponential technological growth will make them affordable and convenient in short order. The future is moving so fast that science fiction is starting to look a lot more like science and a lot less like fiction.

Lawrence J. LAU (Ralph and Claire Landau Professor of Economics, The Chinese University of Hong Kong)

In the long run, whether or not there is economic growth or stagnation is not likely to be constrained by supply but will depend on the growth of aggregate demand. There is no sign of satiation in many economies. The demand for public goods remains very high, but they are not adequately supplied under the current conditions. The enhanced possibility of capital-labor substitution is favorable for the Japanese economy. Therefore, the substitution of labor by capital is the right thing to do. The advances of IT are so powerful that they will bring us closer to the day when it is possible to have "from each according to his ability and to each according to his need."

KIYOTA Kozo (Research Associate, RIETI / Professor of Economics Keio Economic Observatory and Graduate School of Economics Keio University)

If we look at the global value chain (GVC) income in Asia, we can see that there is a consistent decrease in Japan and Taiwan. On the other hand, a remarkable increase has been observed in the manufacturing industry in China, India, and Indonesia. In the Japanese manufacturing sector, the capital-labor substitution has led to a decrease in the number of jobs. Offshoring has only a marginal influence on the domestic employment. However, concern is voiced over the productivity decline in the Japanese manufacturing sector as a whole, which has resulted from the shutdown of highly productive domestic production sites. Attention should also be paid to the fact that the introduction of new technologies will change people's working style.

SEKINE Toshitaka (Director-General, Research and Statistics Department, Bank of Japan)

Against the backdrop of a labor shortage, we do not observe significant increases in wages and the general level of prices. Under these circumstances, Japanese companies are trying to improve their productivity through their voluntary initiatives. This has a positive effect on the government's ongoing labor market reform, but at the same time will exert a temporary downward pressure against the prices through the decrease in the real wage gaps. However, this will not last forever, and the mechanism designed to achieve the 2% inflation target remains intact. When making these considerations, it is very important to measure the productivity in an accurate way.

MORIKAWA Masayuki (Vice Chairman & Vice President, RIETI)

In the past six years, a significant increase was seen in the volume of Japanese service exports while its merchandise exports grew at a very modest pace. This allowed the entire Japanese economy to improve its productivity through the resource reallocation effect. High productivity is often seen in manufacturers without plants, companies with large headquarters functions, and firms making use of IT. The fourth industrial revolution is a cornerstone of Abenomics' Growth Strategy 2017. However, the service industry is more aggressive than the manufacturing industry in terms of the use of big data, and companies engaged in global market have a positive view of the impact of artificial intelligence (AI). In addition, it is likely that there is a complementary relationship between AI and high-skilled labor rather than a substitutive one.

Fukao:
If there is a free flow of knowledge and capital beyond national borders, how Japan can raise the level of the affluence? How should we reform the education systems or what kind of knowledge accumulation is important? Also, there are issues such as cyber security, economic systems including site-seeing assets, and so on. In order to have a more affluent society, what can we do? At the same time, could you please comment on the presentations by the four panel members?

Baldwin:
The importance of quality in absolutely everything is done in Japan. This edge of the Japanese way of doing things was limited to the manufacturing sector because only goods could cross borders; however, exporting this excellence through the service sector will expand; that is an opportunity to take account of.

Professor Lau commented on the substitutability of capital and labor. Artificial intelligence (AI) does not replace all of the employees because somebody has to supervise people, and the supervisor's productivity does not gone up, thus his wage should not go up. Therefore, I am not really sure that this whole snapback will work, but if you cast the whole thing as either capital or labor, it is a temporary deviation to capital and will snap back. Since AI is infinitely reproducible, whoever can control and use it the best will win everything. I think the nature of this technology will fundamentally encourage inequality.

Fukao:
Professor Jorgenson earlier said that the quality of labor is high in Japan, but it is not necessarily utilized effectively. How can wages in Japan be raised in general? Also, what is the concrete direction we should realize in labor reform under Abenomics?

Jorgenson:
The manufacturing sector in Japan from the point of view of productivity is very healthy, but the challenge is in the service sectors. It is important to try to limit this drag on productivity that is due to inappropriate government policy that has focused attention on limiting entry into certain key sectors that turn out to be those that are important in international trade.

What is needed is a clear focus, an identification and targeting of the industries where this is a problem and drilling down to the bedrock of regulations that are holding back productivity growth. That will make it possible for Japan to play a leadership role as the way that Apple Inc. has played in smartphones for example. The key to enhancing incomes in Japan and enabling Japan to take advantage of the opportunities are being created through this very rapid globalization process that Professor Baldwin described.

Lau:
AI and robotics increase the substitutability between capital and labor. The isoquant will change because it becomes flatter between capital and labor. We focus on substitution and the real wage rate, but we should also look at the cost of computing or AI relative to the wage rate. The wage rate is not going to go up because the cost of computing and AI has come way down. I am very happy to see that the rising productivity in the service sector in Japan, but Japan needs to create jobs that cannot move away. As Paul Samuelson predicted, the factor price equalization is actually happening.

Morikawa:
Graduate students will not be easily substituted by new technologies not because they have high expertise in their work, but rather they have malleable skills. In terms of policy, investment for education is important and, among all, improving the quality of the teachers is imperative. Paying more for newly hired teachers will prevent them from taking up another higher-wage job. Regarding the basic income, it is important to establish a safety net, and, also, it is necessary to think about negative income tax systems.

Sekine:
Japan can maintain the affluence only by increasing productivity. Needless to say, the government has to work on the growth strategy in the labor market. Also, it is important to work on deregulation and introduce more competition. Further, companies' responses to labor shortages are also important. The tighter labor market conditions have induced them to raise their productivity. If we continue to have a high-pressure economy, the potential growth of Japan's economy would be boosted through the improvement of the productivity, and this could be driven by these corporate responses.

Kiyota:
If AI and robots are different from traditional capital, we should be cautious in thinking about this substitution. In order to estimate the elasticity of substitution between AI/robots and labor inputs, however, we need their price data. As for the impact of globalization on employment in Japan, the impact of outward foreign direct investment would be negligible. Some people say both trade and the technology change affect expansion of wage gaps, but others say the effect of technology change is stronger than trade. For now, globalization does not seem to have significantly negative effects on the wage gaps in Japan. However, in the United States, a study found significantly positive effects of globalization on increasing executive compensation. It may be necessary to focus more on a small percentage of people who are benefiting from globalization.

Fukao:
Thank you. I would like to shift my attention to the companies. What kinds of policies are needed to invigorate Japanese companies, for example, reduction in corporate taxes?

Jorgenson:
As a consequence of the aggressive monetary policy of the Bank of Japan, the devaluation of the yen was finally successful and a very important macroeconomic barrier to Japan's successful access to the world market, including the benefits of globalization and participation in global value chains was removed. That has increased trade in services relative to manufacturing. Also, we need to consider labor market reform. There is a great opportunity for increased efficiency and increased utilization of the highly skilled Japanese labor force. The enormous investments that have been made in human capital in Japan have led to the very high quality of labor force that it currently enjoys.

Morikawa:
One regulation we need to focus on is the occupational licensing system in the service industry. It is desirable moving from licensing to certification or to having graded licenses, for example, allowing the hygienist to do some of the dentist work or the nurse to do some of the doctor's work. Deregulating the occupational licensing system is important in terms of increasing productivity in the service industry.

Sekine:
The exchange rate is a sensitive issue, but the Bank of Japan acknowledges that it is one of the important transmission channels, although the Bank does not aim at a specific level. Monetary policy should be conducted in accordance with domestic necessities so as to support economic activity and ensure price stability of each country. Now, I want to hear from Mr. Morikawa about the utilization of big data. Unlike U.S. corporate managers who recognize the importance of big data especially to manage blue-collar workers, Japanese corporate managers seem to be reluctant to utilize big data. I think this is an issue that we need to address.

Morikawa:
In the United States, many companies utilized the IT revolution to change the businesses, but Japanese companies tend to worry excessively about compliance infringement. It may inhibit them from taking risks.

Kiyota:
According to the data introduced at the RIETI symposium in 2015, Japan was ranked 196th out of 199 countries in terms of the stock of the inward foreign direct investment relative to GDP. The regulation and language barrier do not fully explain this; this is about the uniqueness of Japan. Against the backdrop of labor shortage, we do not observe significant increases in wages. Japanese outward foreign direct investment is increasing, but Japanese companies have 32 trillion yen of internal reserves within foreign affiliates as of the end of 2015. Why are they not coming back to the Japanese workers?

Fukao:
I would like to go back to what was mentioned by Mr. Morikawa first. In terms of ICT advancement and new globalization, China is the largest beneficiary which is followed by India. For further advancement of Asia, what kinds of policies are needed?

Baldwin:
When the outsourcing started in 1985-1986, the wage difference was 40 to 1 between Japan and China. The success of Asia, especially in manufacturing, was this combination of high tech and low wages. Between 1985 and 2000, there were no free trade agreements in East Asia, but after China approached the Association of Southeast Asian Nations (ASEAN) for a free trade agreement, the domino effect happened in Asia. Unfortunately, the Trans-Pacific Strategic Economic Partnership Agreement (TPP) is stalled currently. Right now, it seems like it might be Japan that is keeping it going. The Regional Comprehensive Economic Partnership (RCEP) will also be useful. Even keeping the TPP going will continue to be a good thing. Those are the things that we can do to continue Asia's success.

Lau:
East Asian industrialization started in Japan, but as Japanese wage rate went up, labor-intensive industries moved successively to lower-cost locations such as Hong Kong, then Taiwan, then South Korea, then Southeast Asia, and Mainland China when it opened to the world in 1978. All of these economies adopted some form of export promotion policy rather than import substitution. This was facilitated by the favorable exchange rate for Japan. Similarly, Taiwan and China had large devaluations of their currencies. In addition, we need to look at Samuelson's idea of factor-price equalization more carefully. Factor price equalization under globalization is a way of viewing this.

Jorgenson:
I agree with Professor Baldwin on the importance of free trade agreements and the proliferation. In East Asia, all of the IT products have been grouped under a free trade agreement. It has had the most important impact in moving IT to the lowest cost producer, by and large, China, but that is now moving on to other parts of East Asia. This is a graphic illustration of a creative response to a particular situation in the fact that information about IT is difficult to contain, and therefore flows across international boundaries, leading to a free trade agreement in the production and trade that facilitates international integration through value chains.

The free trade agreement regarding a commodity is that it is not necessary to think in terms of the TPP, something that is in agreement among countries, that we need to be more creative than that, and it seems that Japan has a very sophisticated approach to this. That is going to be a very important positive force in making use of the developments that we have been discussing here having to do with robotics and AI.

Baldwin:
AI should stand for almost intelligent not artificial intelligence because the thing does not think. I read a story about AlphaGo. The research started by giving it 30 million board positions. It divided itself in half and played itself at computer speed for six months, learning from its mistakes. It went very well and beat the world's best player. However, if the board is changed from 19 to 19 to 20 to 20, it would have lost completely because it did not really know how to play strategically. As for the Japanese uniqueness, if you had a whole series of secret immigrants who came in and took over Japanese service sector jobs, the output was going up, labor productivity did not seem to be going up, and the wages most certainly were not going up. I wonder if the very nature of AI as pattern recognition only is not understanding some of those, but I will leave that as speculation.

Jorgenson:
The way that the literature and global value chains have evolved, it has emerged that there are three regional centers of global value chain development: North America, Asia, and Europe. The United States is now reexamining its policy toward integration within North America. Asia is taking advantage of this lack of leadership in North America, but I also think that the same thing is true in Europe. The great German reform that took place before the current government came to power has motivated and powered a lot of the development of global value chains within Europe, which has been a great success. However, when you look at the bottom line, it turns out that Asia has gained the comparative advantage in the development of global value chains.

Fukao:
Our session has now concluded. Thank you very much.