On a New Growth Strategy: Japan must accelerate efforts to nurture human resources and technologies

Faculty Fellow, RIETI

Since the beginning of the 2000s, a "growth strategy" has been attracting much attention as the linchpin of Japan's economic policy. This can be taken as evidence that after experiencing years of economic stagnation, many Japanese people are now hoping for the kind of policies that would put the nation's economy on a stable growth course in the medium- or long-term horizon, rather than short-term economic stability. However, despite a series of policy packages that have been formulated and implemented under the name of a "growth strategy" to this day, we have seen no rapid improvement in Japan's economic performance over the years. In what follows, I would like to examine the New Growth Strategy endorsed by the Cabinet on June 18, to determine if this latest set of growth policies will be able to provide a viable roadmap for the Japanese economy, overcoming the shortcomings of earlier growth strategies.

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The biggest shortcoming of earlier growth strategies was their failure to properly review and have a clear understanding of how and why the Japanese economy remained in the doldrums for so long after the collapse of its economic bubble. In the past two decades, the Japanese economy grew at an average rate of about 1%, the lowest growth among advanced economies. As a result, Japan slipped sharply in the world ranking of national income per capita from fourth place in 1990 to 19th in 2008. In the end, although Japan managed to successfully catch up with advanced economies - i.e. the United States and European countries - by the end of the 1980s, it failed to keep up with the world economy in the past two decades.

Past growth strategies - all of them formulated on the assumption that Japan would be able to remain within the world's top 10 economies - were packed with just too many diverse policy measures. Given the weight of massive government debt burdens, Japan should not be able to afford such an across-the-board growth strategy. Regrettably, however, the latest growth strategy is no different from its predecessors, including a variety of eye-catching policies but based on an unrealistically optimistic estimate of the capacity of the Japanese economy.

Even more disturbing than such an all-round approach is the lack of consistency among the policies included in the New Growth Strategy. The strategy calls for achieving an average 2% real growth in the years through fiscal 2020 (April 2020 - March 2021) while at the same time generating some 5 million jobs in such sectors as the environment and energy, health, and tourism. The government's intention to promote domestic industries with technologies and hospitality catering to the needs and taste of Japanese people is commendable. But are these two goals - i.e. the goal of economic growth and the goal of job creation - consistent?

Suppose that the Japanese economy grows at 2% per annum in real terms in the next 10 years. This means that the size of the national economy would expand by 21% from 2010 to 2020. Meanwhile, the creation of 5 million jobs in the same period of time translates into an 8% increase by 2020 in the number of employed persons in Japan compared to the current total of 62 million. Now the rate of labor productivity growth, which is closely linked with per capita income growth, is generally calculated as a value equal to the rate of economic growth less the rate of employment growth. Then, Japan's labor productivity would have to increase by 13% in the next 10 years or at 1.2% per annum under the New Growth Strategy.

However, the annual growth of 1.2% is approximately same as the actual growth of Japan's labor productivity in the past 10 years, which is lower than what the U.S. and South Korea have recorded in the same period of time. Would such economic performance be enough to rebuild Japan into a strong economy?

Some people might say that the New Growth Strategy does not measure growth performance in terms of productivity. But productivity is one of the leading indicators measuring the long-term performance of a national economy and the problem with ignoring such a key indicator is obvious. Just imagine what the ramifications would be if we were to remove body weight from the list of health check-up items simply because we did not want to see the result.

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Human resources are an important factor of economic growth. However, when we consider human factors as a policy target, we should focus more on the "development of human resources," rather than simply minding the quantity of human resources, i.e. the aggregate number of employees. It is a welcome move that the New Growth Strategy has reexamined the roles and qualities of higher education from the viewpoint of enhancing human resources. At the same time, however, it should have discussed the roles and qualities of organizations, in terms of ensuring the "effective use of human resources" as a user and manager of human resources. Two separate studies - one conducted by a research group led by Professor John Van Reenen of the London School of Economics (LSE) and another conducted by a group of researchers including Professor Keun Lee of Seoul National University and myself under the auspices of the Research Institute of Economy, Trade and Industry (RIETI) - have found that companies are more likely to perform better when they invest in employee training and/or have a flexible personnel management system that facilitates the rapid promotion of individuals whose performance is highly rated.

Of course, it is difficult for a government to interfere with the organizational management of individual companies. And it is normally the case that any company having an unreasonably rigid management system will sooner or later be forced to exit the market. In Japan, however, the government has a track record of providing massive amounts of public funds to effectively bankrupt companies and declining industries.

By breaking away from this policy toward bankrupt companies and declining industries, the government will be able to induce companies to improve their organizational structure and management systems, while at the same time facilitating the transfer of labor from low productivity sectors to high growth sectors. Thus, if the growth and employment targets set forth in the New Growth Strategy have been determined with an eye on enhancing inter-company and/or inter-sectoral labor mobility through corporate metabolism, it can be said that the government has put forward consistent policy goals.

Some people would say that the government should be focusing its efforts on the promotion of business start-ups. Indeed, such calls were heard every time the economy took a downward turn, and the government responded by implementing various measures to support business start-ups. Yet, despite all those measures, Japan's business start-up rate has continued to decline instead of increasing.

The Global Entrepreneurship Monitor (GEM), an organization composed of individual scholars and think tanks, has been regularly conducting an assessment of entrepreneurial activity in various countries for international comparison. According to its report, Japan's entrepreneurial activity rate (or the percentage of individuals engaged in entrepreneurial activity in the sampled population) is the lowest among the 20 innovation-driven economies, mostly consisting of developed countries. One important factor behind this is the fact that among the same 20 economies, Japan has the highest "fear of failure" rate at 50%, that is, half of the sampled population indicated that fear of failure would prevent them from setting up a new business.

Because of this peculiar characteristic, Japan's innovation has been largely driven by the development of new and novel products by existing companies. In May 2010, Toyota Motor Corp. and its U.S. partner, Tesla Motors, Inc., announced a plan to jointly develop electric vehicles. Those two companies are symbolic of the stark differences between Japan and the U.S. as to who will drive next-generation innovation. While Toyota is the world's largest automobile maker, Tesla is a start-up company only founded in 2003.

Metabolism as a foundation for economic growth typically refers to a process in which new companies, such as Tesla, spring up and become a new innovation engine even if big and established companies, such as General Motors Co., go bankrupt. In Japan, however, the role of finding a new innovation engine has been fulfilled by established companies in the form of venturing into new business fields. For this very reason, it is critically important in Japan to facilitate metabolism within incumbents and motivate their continuous efforts to evolve into an organization capable of making the best use of people and technology. This indeed holds the key to Japan's future growth. In this regard, the long pending issue of corporate taxes, which are markedly higher than those in other comparable economies, must be addressed not only for the sake of attracting foreign businesses to Japan but also as a way to help companies accumulate human resources and technologies for future growth.

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However, even though there is an urgent need to nurture new growth industries, I have considerable doubts about the wisdom of the Bank of Japan's decision on June 15 to establish a new loan facility aimed at ensuring capital flows to growth industries. The role of the central bank is to maintain price stability and ensure the credibility of the financial system. Getting involved in growth policy is outside its jurisdiction. Indeed, Article 4 of the Bank of Japan Act stipulates that the BOJ must "always maintain close contact with the government and exchange views sufficiently, so that its currency and monetary control and the basic stance of the government's economic policy shall be mutually compatible." However, the intention of this provision is to ensure that the BOJ operates its monetary policy in a way that would hinder the government's economic policy objectives. It cannot be interpreted as requiring or allowing the BOJ to assume any part of the government role as a policy maker. Being confused about the division of roles and responsibilities between the government and the central bank in policy implementation, Japan may lose international confidence not only in its growth policy but also in its entire economic policy.

Now that Japan is just one of middle-class advanced economies, there is no magic strategy for growth. What is required of the government is to set a basic growth strategy that is clear-cut and understandable to everyone across the globe and, in line with that strategy, present policies can take advantage of the strengths of the Japanese economy.

>> Original text in Japanese

* Translated by RIETI.

June 25, 2010 Nihon Keizai Shimbun

September 13, 2010

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