Japan's Low Labor Productivity: The gap with the U.S. and complex causes

Vice President, RIETI

Concern over productivity is mounting as the labor shortage in Japan becomes more serious. Japan's labor productivity level is about two-thirds that of the U.S. and the lowest among the G7 countries. The productivity gap with the U.S. has remained nearly flat since the beginning of the 1990s and continues to exceed 30%.

In terms of average hourly wages as well, Japan is two-thirds that of the U.S. In other words, macro-economically, productivity and wages are nearly in equilibrium, meaning that Japanese wages are not too low.

As there are various kinds of economic value that are not captured by gross domestic product (GDP), productivity and economic welfare (a nation's degree of economic satisfaction) are not synonymous. Comparing standard of living, including leisure time, health, and level of equality, some studies indicate that the disparity between Japan and the U.S. shrinks to less than 20%, and some calculations put the two countries at roughly the same level. However, this does not change the fact that productivity is a fundamental factor that determines wages for workers and economic prosperity.

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Why is Japan's productivity low? A lot of research has been done, but no single definitive factor has been found to explain the Japan-U.S. productivity gap.

The amount of capital, including machinery and equipment, strongly affects the measure of labor productivity, but there is no significant difference in the capital coefficient (capital stock/GDP) for the major industrial countries. In other words, low equipment spending and capital in Japan is not a cause of the gap in labor productivity.

Japan's GDP, the numerator in labor productivity, is converted into dollars using the relative level of prices in the two countries—that is, purchasing power parity (PPP)—and so the trend toward a weak yen exchange rate in recent years is also not the cause. If anything, since Japan's rate of inflation has been low, PPP since the 1990s has consistently moved in the direction of a stronger yen, acting in the direction of increasing Japan's level of GDP in dollar terms.

However, international comparisons of labor productivity are not free from a variety of measurement errors. PPP is calculated based on the cost of goods and services in each country, but the accuracy of those calculations is limited. Services in particular, which account for a large share of the economy, are often of different quality even if they appear the same, making price comparison extremely difficult.

According to recent research, correcting for the fact that the quality of services in Japan is higher than that in the U.S. increases Japan's productivity by about 10 percent. However, this still does not reverse the conclusion that Japan's labor productivity is substantially lower than the U.S.

There is also a deep-rooted view that productivity per hour is low in Japan because of long working hours. However, no matter which productivity indicator—per worker or per working hour—is used, there is hardly any difference in Japan's position.

Taking U.S. productivity as 100%, the figure plots productivity per worker along the horizontal axis and per hour along the vertical axis. The solid line is the linear approximation and the dotted line is the 45-degree line. Japan is positioned on these lines. Caution is necessary in such matters as the fact that the denominator for calculating productivity per hour is the number of all workers, which includes part-timers, and the fact is that the scope of workers covered by statistics and the definition of working hours differs by country. Nevertheless, looking at the average, Japan is not an outlier from the international standard.

Figure: Labor productivity in OECD countries (2017)
Figure: Labor productivity in OECD countries (2017)
Note: Index with the U.S. as 100%
Source: Prepared by the author based on the OECD's productivity database

Countries above the 45-degree line, such as Denmark, Germany, and Norway, have relatively high productivity per hour. The higher a country's income level, the higher the value of leisure time, which reduces working hours. On this point, the U.S. could be described as an exceptional country where working hours are long in spite of its high income level.

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In recent years, the shortening of working hours is being promoted as part of work style reform. Excessive overtime is harmful to health, which includes mental health, and likely works against productivity. However, leaving aside extremely long working hours, research results from inside and outside Japan relating to working hours and productivity are not unform; it is not a simple relationship in which the more working hours are reduced, the more productivity increases.

Likewise, the relationship between work-life balance and productivity, when viewed empirically, is correlative but not causative. Emphasis is placed on productivity enhancement through work style reform, but it is impossible to connect the two. Nevertheless, as there is also no evidence that reducing working hours and improving work-life balance has a negative effect on productivity, these are issues that should be addressed from the simple perspective of benefiting workers.

Reducing labor inputs that are not connected directly to production, such as by paring down needless meetings and internal approval procedures, improving work plans, delegating decision-making authority, and revising rarely useful internal rules, is effective for increasing productivity of day-to-day corporate operations. On this point, it is important to continually improve the way work is carried out. The substance of such improvement is a problem to be addressed for the management of each workplace, but government policy, including excessive regulation and "administrative guidance," also has an impact.

Equal pay for equal work is also a pillar of work style reform. Improving the treatment of non-regular workers is undoubtedly an important issue, but since wages reflect productivity, it is impossible to raise their wages without improving productivity. According to the author's analysis, the level of wages of part-time workers is almost completely consistent with their productivity. On average, it is not the case that the wages of part-time workers are held down to a low level relative to their productivity. In order to raise the productivity and wages of non-regular workers, the right approach to take includes education and training in relevant skills and HR/labor management that encourages personal development.

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After accounting for matters such as measurement error, capital intensity, and working hours, why is Japan's labor productivity low? There is a lot of anecdotal conjecture as well as irrelevant arguments including that Japanese consumers think services are free, or that competition is too intense in Japan.

One also often hears comments that Japan is bad at business administration, but that argument is difficult to support. Looking at the results of the World Management Survey, which quantitatively compares the quality of management in firms from different countries, the average for Japanese firms is among the highest, alongside the U.S. and Germany, and much higher than the UK and France.

Generally, the top-two engines of productivity enhancement are technological innovation and improvement in the quality of the workforce, and undoubtedly these will continue to be the pillars of policies to improve productivity. However, Japan's R&D intensity is higher than that in the U.S., and according to international comparisons of academic ability and skills, the quality of Japan's human capital is top level. In other words, it is difficult to explain the Japan-U.S. productivity gap based on these factors.

A lot of research that has analyzed the causes of income level disparity among countries shows that the differences in the efficiency of resource allocation strongly affect nationwide productivity. From this perspective, Japan's low dynamism of renewal in the sense of increase in the market share of productive firms and shrinkage of unproductive firms might be a relatively important factor. Matters such as barriers to global competition, costs of geographical movement of workers and firms, government regulation, and protection of existing small and medium enterprises are related to this point.

What is to be done? As I set out in my recent book, Productivity: Misconceptions and Realities, through past research we have learned many things about what raises productivity and what drags it down.

Corporate investment in education and training, for example, contributes greatly to productivity. In light of the experience of the IT (information technology) revolution, enhancing investment in complementary intangible assets such as education and training will be important for future productivity growth in service industries that use new general-purpose technology such as AI (artificial intelligence).

As an example of a negative factor, excessive regulation of land use inhibits optimal geographical allocation of people and firms, which is known to push nationwide productivity down. It is important to capitalize on the advantages of urban agglomeration.

Although there is no conclusive policy to bridge the productivity divide between Japan and the U.S., persistent efforts must be made to remove the downward factors on productivity by utilizing evidence to achieve marginal productivity gains.

>> Original text in Japanese

* Translated by RIETI.

March 5, 2019 Nihon Keizai Shimbun

May 13, 2019

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