Are Pro-productivity Policies Fit for Purpose?

New technologies, old challenges: Slowing growth in a technologically accelerated world

Today, in many advanced economies—and particularly in Japan—growth in employment and total hours worked has plateaued or even declined. Since GDP growth equals the sum of labor input and productivity gains, future economic growth must now rely almost entirely on productivity improvements. While this trend began to show in Japan several decades ago, it is no longer unique to Japan, as nowadays many European countries are beginning to experience the same structural shift.

At the same time, societies find themselves surrounded by rapid technological progress, with AI being the most recent example, without yet seeing clear productivity gains. This recalls Robert Solow’s famous observation from the 1980s: “We see computers everywhere except in the productivity statistics.” The question now is whether this pattern is being repeated or whether the world is entering a new phase where technology may help address broader issues such as aging populations, climate change, and geopolitical shifts.

Technology also brings challenges, including job disruption and societal risks. It is time to ask whether the productivity policies of the 1980s–2000s remain adequate, or whether a new policy framework needs to be developed.

The G20 countries: slow leaders, lagging growers, and the stagnating rest

Currently, the only country among the G20 countries that continues to see accelerating productivity growth is India. All others, including the EU, are experiencing a slowdown. To analyze this trend, the G20 economies were grouped into three categories: the “leading but slowing” (advanced economies such as the G7 and Australia), the “lagging but growing” (countries like India, China, Turkey, Indonesia, and, in historical context, South Korea), and the “muddling through” groups (including Russia, South American economies, and Saudi Arabia), which have shown stagnant or inconsistent productivity gains.

Although emerging economies continue to contribute positively, their growth is also slowing, primarily due to China’s economic deceleration. Advanced economies are the primary source of the global productivity decline, having sharply reduced their contributions since the 2000s.

Labor productivity levels also vary widely across the G7. While the United States has pulled ahead, countries like Germany, France, and Japan have stagnated in recent years, especially since the pandemic. Japan’s lower productivity per hour partly reflects longer working hours rather than less output per worker, which is another issue that needs to be addressed.

Why regions and demand matter for productivity growth

Importantly, productivity gaps also exist among different areas and regions within countries. In places like the United Kingdom and the EU, regional disparities in productivity levels have widened. Long-term stagnation has created “low productivity traps” in some areas, where isolated investments, for example in infrastructure, are insufficient to affect meaningful change. Addressing these requires coordinated improvements of several areas such as infrastructure, education, healthcare, and transport.

Regional disparities are central to understanding productivity slowdowns. Without regionally balanced growth, metropolitan areas may advance while other regions fall behind, creating not only economic gaps but also political fragmentation.

The role of demand and supply

Productivity debates often focus on supply-side policies, such as training and infrastructure, but demand-side factors are equally important and tend to be frequently overlooked. Countries like Japan, with aging populations and weak post-crisis demand, show how insufficient demand can limit productivity growth. Long-term shifts, such as rising demand for public and personal services, also play a significant role, especially in aging societies. Additionally, amid the current geopolitical environment, going forward, new public spending on defense and security may become economically significant depending on their implementation.

On the supply side, outdated regulations, ineffective competition policy, and low diffusion of new technologies are key obstacles. Despite technological advances, productivity gains are concentrated in a few “superstar” firms, while many smaller businesses do not benefit to the same degree. Poor measurement of these developments adds another layer of complexity.

Overall, no single solution exists to address all these issues at once. Reacting to the productivity slowdown requires a broad and coordinated set of policies.

Cross-regional growth scenarios

Looking forward, trends show a diminishing contribution from labor input, especially in Japan and parts of Europe, making productivity growth more important than ever for sustaining GDP. In the United States, strong GDP growth over the past decade has been supported by an expanding labor force—driven by high levels of immigration and a culture of long working hours. However, these factors are expected to slow in the coming years, especially if immigration policies become more restrictive. Looking ahead, if U.S. productivity continues to grow at the same pace as it did from 2012 to 2023, economic growth will hover around 1.5%. To maintain recent GDP growth rates, productivity will need to rise to just under 2%. Achieving the higher growth levels seen in the 1990s and early 2000s would require an even stronger productivity increase to above 2%. While the United States may currently be hitting that mark, the key question is whether such gains can be sustained over time.

The challenge is even greater in Europe, where hours worked are expected to decline, similarly to Japan’s long-term trend. To match the growth rates of the 1990s, European productivity growth would need to exceed 2.5%. Japan, already in a lower-growth equilibrium due to a shrinking labor force since the 1990s, has been growing at just over 1%. Maintaining that pace might seem feasible, but given the scale of the challenges ahead, it will not be sufficient. Across all regions, future GDP growth will depend on a significant acceleration in the growth of productivities. In many cases, this could mean doubling current productivity growth rates. While Japan may not require a full doubling, a substantial improvement is still needed.

Policy imperatives and foundations

A policy framework that outlines the main drivers of productivity growth, which can be grouped into three categories, could be used to address this. The first includes the direct drivers: investment in physical and human capital, technology, innovation, and structural transformation which boost overall productivity. The second group comprises the indirect drivers—well-functioning markets and institutions that ensure investments are channeled efficiently. These include financial, product, and labor markets, along with regulatory and competition frameworks. Regional allocation of resources is also emphasized here. The third category highlights the role of internationalization. In a global economy, policies that support trade, foreign direct investment, and migration help optimize the use of resources and enhance productivity across borders for the benefit of all parties involved.

Another important part of pro-productivity policies are the underlying foundations—macroeconomic, fiscal, and structural—as well as the importance of governmental coordination. Productivity improvements require collaboration across ministries, and also between central and regional governments. The evolving complexity of the global environment also demands more flexible and capable public institutions to formulate and implement effective, context-specific policy mixes.

Policy priorities vary depending on a country’s stage of development. Early-stage economies focus on boosting private investment and basic education, while middle-income countries emphasize investment quality, infrastructure, and more advanced education. Advanced economies must navigate the complexity of intangible assets, innovative financing and lifelong learning. Industrial policy, once focused on building new sectors, now increasingly targets upgrading existing economic activities and encouraging structural change.

Business dynamics are also key as many economies face a slowdown in productivity due to insufficient turnover among firms. Efficient resource allocation and modern financing mechanisms, including venture capital and ESG finance, are becoming more important. At the same time, globalization and trade openness remain as vital as ever, but emerging industrial policies bear the risk of fragmenting global markets and undermining international cooperation. Immigration policies and institutional capabilities also play a role in sustaining productivity.

A comparative analysis of the United Kingdom and South Korea illustrates how policy approaches evolve across development stages. South Korea followed a typical path from early-stage to middle-income stage policies but has struggled to fully shift toward advanced-stage strategies. The United Kingdom, on the other hand, has implemented several counterproductive policies in recent years, including the elimination of its industrial strategy and Brexit-related disruptions.

Ongoing research across the G20 is examining national policy mixes in more detail. Early findings suggest that innovation policies often focus too narrowly on technological frontiers, while diffusion and absorption are under-addressed. There is growing emphasis on investment-related policies considering sustainable green growth and intangible investment, but their concrete impacts of productivity remain unclear. Meanwhile, competition and resource allocation policies often lag behind.

Recent developments in Europe and the United Kingdom point to a resurgence of industrial policy focused on vertical strategies—targeting specific sectors such as manufacturing and high tech. However, challenges remain, especially in designing policies for service industries. Moreover, insufficient attention is given to place-based strategies that account for regional disparities. Translating industrial strategy into effective regional policy remains a key issue for achieving broad-based productivity gains.

On Japan’s evolving approach to economic and industrial policy

Japan’s new industrial policy, as outlined in METI’s Third Report of the Committee for New Direction of Economic and Industrial Policies, acknowledges the need for both horizontal and vertical policy approaches. The policy emphasizes innovation, wage growth, sustainable development, and improved living standards, aligning with these broader goals. However, the policy’s breadth raises concerns, particularly the inclusion of 15 sectors—more than in other countries like the United Kingdom—which could dilute focus. While Japan’s policy is comprehensive, including important sectors such as healthcare and nursing services, there is a risk that overloading the policy with too many priorities may lead to lessening its overall impact.

Effective industrial strategy should prioritize key sectors and link them to broader productivity-enhancing policies. A clear set of priorities is essential for guiding businesses towards productivity growth. The evolution of pro-productivity policies should also be adaptive, as past strategies may no longer be relevant today, particularly in light of advancements in technology and structural changes. Japan should aim to refine its approach by focusing on the elements that drive productivity while learning from other nations’ experiences. Ultimately, there is no single “golden model.” Instead, a combination of strategies based on context is needed for future success.

Reimagining pro-productivity policies in a rapidly changing world

In sum, while productivity is a topic of great importance, there are good reasons why there is no one single ministry or department dedicated to it, as many ministries are involved in developing policies that drive productivity, including ministries responsible for education, health, international relations, and transport and infrastructure. As the world is constantly changing, when thinking about how to address productivity issues, aspects such as new technologies, aging societies, geopolitics, and geoeconomics must be factored in to assess whether the existing mix of policies employed to drive productivity is still appropriate or not.

Given this situation, many countries—including Japan, with its “New Direction for Economic and Industrial Policy” approach—are currently thinking about new ways to reimagine industrial policy. However, while industrial policy is indeed of great importance, there are other aspects that also need to be considered when it comes to pro-productivity policies. Governments must ask themselves what policies are needed in order to respond to the issues that the global community is facing today.

Comment

METI’s Third Report of the Committee on New Direction of Economic and Industrial Policies was brought up. RIETI is involved in creating the next version of this report. Several issues were raised regarding items that the report lacks. Out of all of these issues, what would be the most important one for present-day Japan?

It is true that appropriate pro-productivity policies depend on the development stage of the respective economy, as well as the international economic environment and emerging technologies. The world has changed greatly and is still continuing to change at a quick pace. One particular challenge for Western countries, including the United Kingdom and Japan, is the issue of economic security and protectionism. How can collaboration and promotion of free trade be carried out in order to ensure that free trade and foreign direct investment can continue in this age of economic decoupling? What about the roles of the Global South, China, and the United States under the new Trump administration? What policies are needed to leverage the benefits of emerging technologies, such as AI and robots?

We are hosting the World KLEM conference on March 28, so since Professor Bart van Ark has been a leading figure in the World KLEMS initiative along with the late Dale Jorgenson, ideas for new initiatives that could enhance research on emerging and urgent productivity policy issues are also of great interest.

Bart VAN ARK:
Looking at the 15 industries selected by Japan, steel and chemicals are well-developed industries that may need to change their strategy, but does the government need to play that role? Looking back at history, industrial policy has often focused on protecting old industries rather than creating space for new industries that are taking on the role of trying to deal with future challenges. If the mission going forward is going to be about climate, digitalization, health, and global security, then industries related to batteries, pharma, as well as health care and nursing services will be crucial. Another important industry is tourism, but is government intervention necessary for its development? Having serious discussions about where the government needs to play a role in addition to the business community is necessary.

We are living in a complex world shaped by globalization, and the more collaboration we can seek, the better. As opposed to Europe, which has the advantage of the European Union being a large economic space that could open up more potential if it were to become a single market, Japan is challenged in this regard. Creating an economic area to maximize the benefits of trade by collaborating with Korea, Taiwan, and other economies in South and Southeast Asia would be a step forward.

Regarding new research, several good data sets are now available, such as the IMF’s New Industrial Policy Observatory (NIPO) database or the OECD’s Quantifying Industrial Strategy (QuIS) database. These datasets can help to frame how industrial policies can contribute to driving economic growth and development, creating a significant opportunity for research going forward.

Q&A

Q:
Regarding the reasons behind productivity slowdown listed in your slides, how did you define short-term and long-term?

Bart VAN ARK:
If a short-term problem continues long enough, it becomes a long-term problem. Short-term issues are related to specific events, which are often shocks that have immediate impacts on demand. Examples would be the global financial crisis or the COVID-19 pandemic. On the other hand, underlying forces such as demographics are clearly a longer-term issue. The interaction of these different factors is also important. In general, in the case of short-term issues, policy intervention usually brings immediate results. Meanwhile, long-term investment is much more difficult because the effects will not be observed immediately. While we are currently confronted with geopolitical challenges, the underlying sources of slow productivity growth have a long-term nature, meaning that it is very difficult to convince policymakers and electorates that those issues need to be addressed.

Q:
What about the integration of pro-productivity policies into overall policy? The Japanese government declared 2022 to be a start-up year, promoting start-ups and unicorn companies that contribute to innovation. However, the simultaneous provision of zero-zero loans led to the survival of companies with low productivity, so-called zombie companies. This was the result of different policies existing at the same time. What would be a good example from other countries for integrated policy approaches?

Bart VAN ARK:
Industrial policy should not only focus on creating new economic activity but also on removing unproductive economic activity. There is a risk of policy capture by vested interests of those businesses that want to protect themselves, which results in resources being locked up. Governments need to make choices, allow business dynamism to increase, and let companies fail, if necessary—particularly in an economy with labor shortages. A clear narrative around productivity is also crucial because it is not an easy topic to address with the electorate. Many people do not know the meaning and importance of productivity, or they associate the term with working harder for less pay, or even job losses. Government and business leaders alike must focus on clear communication about the benefits for society. They must also address concrete questions about how those people and companies that are not benefiting from pro-productivity policies can be supported, and also factoring in regional components.

Q:
During a recent visit to Washington DC, many people pointed out to me that U.S. productivity outperformed other countries, especially following the COVID-19 pandemic. What are the reasons behind this phenomenon?

Bart VAN ARK:
During the COVID-19 pandemic, the United States raised its level of productivity by responding in a way that is typical for the United States, meaning that many people lost their jobs, especially in industries with low productivity such as hospitality and other personal services. At the same time, digitalization and working from home spread. Starting in 2020 and 2021, Biden’s stimulus policies also had an impact, leading to more investments, raising labour productivity, in particular. However, now, the cyclical effect that was observed at that time is not playing a big role anymore. There is a 40% probability that the United States has moved into a high-productivity growth regime, meaning that the stimulus has helped to adopt AI and other technologies. This would put the United States on a significant path forward and outstrip other countries. But there is also a 60% chance that this is not the case due to various factors such as the current trade tariff policy. It remains to be seen how this will play out, but for now it seems to have been a temporary uptick, meaning that this exceptionalism of the United States is not as exceptional as it appears to be.