Contribution by Information Technology to U.S. and Japanese Economies is Equal

Senior Fellow, RIETI

Dale W. Jorgenson
Professor, Harvard University

Although Japan's information technology is said to have lagged behind that of the U.S. throughout the "lost decade," or so the 1990s are referred to, if one harmonizes the statistics for that era from both countries, the contribution by IT to growth rate can be seen to be the same. The gap that did exist in growth rate can be explained by two primary factors: the failure of demand to absorb the increased supply that was brought about by improved efficiency, and a shortage of labor input (prompted by a decline in employment). Furthermore, as regards the future of the Japanese economy these issues are still relevant.

How did Japan's economy differ from that of the U.S.?

Japan's average economic growth rate fell massively from 4.1% in the 80s to 1.4% in the 90s. Looking at more recent trends, the growth rate for the first three months of this year essentially stuck at zero, and the economy still trudges along. In marked contrast to Japan, the U.S. economy prospered throughout the 1990s, especially in the latter half of that decade when the accelerated economic growth, supported by an increase in productivity arising from investment in IT, came to be called the "new economy."

Following the sudden global depression of the IT industry, the U.S. growth rate did fall in 2000, but according to the Bureau of Labor Statistics the stream of productivity was still as strong as ever. When the dot-com bubble collapsed, skepticism surrounding the new economy spread, but there was at least no change in the effect the IT revolution was having in rising productivity.

A paradigm representing the speed of IT innovation was expressed by Moore's Law, which states that the density of transistors in semiconductors will double every 18 months. Drawn on by this overwhelming rate of technological innovation, the technical advantages offered by computers and telecommunication equipment continue to expand. The ascent of vibrant productivity that could be seen in the U.S. was owing to these technological advances and vigorous IT investment in the corporate sector.

Throughout the latter half of the 1990s, innovation picked up in pace. According to the International Technology Roadmap for Semiconductors (ITRS), the aforementioned rate at which the density of transistors in semiconductors was increasing had been set before 1995 at a base level of doubling every 24 months, but was soon corrected to the rate of doubling every 18 months. Also, it was midway through this decade that the Internet suddenly came to be widely available.

The authors analyzed in what way the Japanese and U.S. economies changed at this turning point halfway through the 1990s. Comparing the average annual rate of U.S. labor productivity in the years 1973-1995 with that of the years 1995-2000, a rise of 0.74% can be seen.

An increase in labor productivity can be broken down into two components: an increase in the amount of capital stock per individual laborer (what is called "capital deepening," that is to say capital input per hour worked) and a rise in total factor productivity (TFP equals the sum total of all contributions to productivity other than that by capital and labor). IT capital (capital stock pertaining to computer hardware, software and telecommunication equipment) contributes a 0.50% share to the rise in capital deepening. If this is added to the 0.24% contribution by IT capital to the rise in TFP, the resulting figure is 0.74%, and thus it can be concluded that all growth in U.S. labor productivity in the second half of the 1990s can be explained solely by IT.

So what about Japan? The kind of speed of technical innovation in IT expressed by Moore's Law should be seen in Japan as well. If this is the case, then it would be natural to expect that Japan, like the U.S., also experienced the phenomenon that was the new economy. But, according to a report by the Organisation for Economic Co-operation and Development (OECD) Japan was slower than the U.S. in its introduction of IT, and was held back as a result.

However, the OECD report uses the official statistics of each country as a base, without performing any adjustments to harmonize the methodology of them. So, in order to properly assess the comparative influence of IT on economic growth between Japan and the U.S., the authors first developed a database of comparable data. Although the GDP statistics of both countries abide by 93SNA (System of National Accounts, standards laid down by the UN in 1993), several discrepancies in the application of the concept exist between them. Above all, when performing analyses on IT the following two points must be observed.

Japan undervalues IT investment

First of all, the definitions of "software" in Japan are different from in the U.S. Only custom made software are treated as capital investment when Japan's GDP is calculated. In contrast, U.S. GDP calculations not only treat custom made software as capital investment, but also packaged software, and software developed in-house; thus by comparison estimations of capital investment in IT, based on Japan's official GDP statistics, come to be undervalued. Given that investment into these different sorts of software was some ¥4 trillion in 2000, the authors calculate that close to 1% of GDP has come to be underestimated.

Secondly, there are pertinent problems associated with deflators for IT equipment. As innovation strides ahead, so do model changes in the hardware catalog become more frequent. As a result of this, the index used is calculated by means of regression analysis performed on the upgraded part using the computer's wholesale price index and consumer price index (the Hedonic index). Even though the U.S. uses the same process in performing its estimations, the resulting index is heavily influenced according to the type of regression analysis model employed.

If one compares the official U.S. and Japanese computer-related statistics, the rate of falling prices that was experienced from 1995 to 2000 can be seen to be twice as fast in the U.S. as it was in Japan. It is thought that differences in the method of compiling statistics are exerting an influence here. Furthermore, if the rate of falling prices is smaller, then the growth of essential investment also becomes smaller, and the growth contribution by IT comes to be undervalued.

The authors corrected these discrepancies in the statistics and carried out a comparison of the growth accounting decomposition between Japan and the U.S. (see graph). Firstly, the contribution by IT capital to economic growth in both countries in the latter half of the 90s was approximately the same - about 1%. That is to say, the opinion held up until now that Japan was lagging behind the U.S. in IT investment is based entirely on differences in calculation of national statistics.

Furthermore, a growth in TFP in the second half of the 90s can be seen even in Japan, just the same as in the U.S. In this way, although there was an enormous difference between the growth rate of the Japanese and U.S. economies in the 90s on a macro level, this difference cannot be found regarding the capital deepening of IT capital nor in the growth of TFP.

What explains this difference between the two countries is non-IT-related capital stock and labor input. Labor input, in particular, shows a minus contribution to growth in Japan throughout the 90s. The cause of this can be attributed to the fact that although the supply structure was becoming more efficient, demand was not rising to meet it.

Advances in efficiency made by adapting downsizing strategy as seen in the restructuring of private firms, should not be the way to cope with this situation. What is crucial is an improvement in productivity achieved through the increase of output brought about by technological innovation - the development of new products and so forth. Effective from this year, Japan expanded tax incentives for research and development. Japan's failure to sufficiently implement these kinds of policy measures, to promote private-sector innovations, during the 1990s may be one reason behind the lack of economic growth throughout the decade.

Graph: Economic Growth Decomposition

Stimulation of Demand and Countermeasures for the Declining Birthrate

If the process for calculating Japan's growth rate for the latter half of the 90s is harmonized to U.S. methods, an annual rate of about 2.1% is given, half of which can be explained by a growth in IT investment. In other words, the acceleration in the rise of Japan's productivity was for the most part supported by innovation in IT.

However, because the climb in productivity is so dependent on IT innovation, whether it is sustainable or not will be the biggest issue. As for the semiconductor integrated circuits, which are leading innovation in this field, the development of various component technologies has become more difficult, and there is the view that there will be a slowdown in pace to the speed seen in the days before 1995. Telecommunications are suffering from a similar problem, and although the bandwidth is expanding geometrically, the development of contents for it shows signs of reaching a bottleneck. Should IT innovation decelerate, its efficacy in propping up the long-term growth rate will become weaker, through the decline in productivity of the macro-economy.

Moreover, in all consideration of Japan's future growth rate, the state of labor input is of utmost importance. The estimations of the National Institute of Population and Social Security Research claim that Japan's labor force will reach a peak of 68,700,000 people in 2005 and then decrease to 62,600,000 by 2025. This annual decrease in the population of about 0.5% will push the economic growth rate down by 0.3 percentage points. By contrast, using the figures of the U.S. Department of Commerce's Census Bureau as base from which to estimate, increasing labor input in the U.S. will have the effect of pushing the country's GDP up at a rate of about 1% per year.

Of course, the fall in Japan's labor force has, as one of its primary causes, the unique feature of the mid-50s baby boomers who will depart from the working population over the next 10 to 20 years. In the long-term, the declining birthrate is the big issue. Thus, in planning the expansion of labor supply, it is necessary to address with thorough consideration the at-first-glance conflicting issues of women's job participation and countermeasures to prevent the declining birthrate. Furthermore, while an increase in productivity is necessary to compensate for the downsizing of labor supply, because of this the simultaneous strengthening of the labor supply and the promotion of demand-arousing innovation are absolutely crucial.

>> Original text in Japanese

* Reprinted from the Keizaikyoshitsu column of the Nihon Keizai Shimbun, July 3, 2003. No reproduction or republication without written permission of the author and Nihon Keizai Shimbun.

July 3, 2003 Nihon Keizai Shimbun

August 22, 2003