Regional Perspectives on Economic Revitalization: Promoting industries with earning power

Faculty Fellow, RIETI

Japan's population peaked in 2008 and has been on a decline since. It is concerning that some municipalities, particularly those in rural regions, may fall into a downward spiral where a decrease in the population would lead to a contraction in the local economy and deterioration in public services, which in turn would cause a further decrease in the local population. In December 2014, the government endorsed a long-term vision for the vitalization of towns, people, and jobs (Cabinet decision on December 27, 2014), setting forth its basic policy to achieve regional revitalization, in particular, for local nonmetropolitan regions by bringing about a virtuous cycle of job creation and population growth.

In many local municipalities across the country, substantial works are already underway to develop a vision for a desirable population size in the future and comprehensive strategic plans for its realization, as the plans established within the current fiscal year would be reflected in the central government's decisions on the amount of rural vitalization subsidies to be provided to local municipalities in the coming fiscal year. However, it is no easy task for municipalities to come up with concrete plans on how to maintain their population levels when the nationwide population is in decline. Also, they will be required afterwards to report on the outcome of plan implementation for each strategy with hard figures.

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A review of municipalities' economic development plans implemented in the past reveals that what have been the most seriously lacking among the local authorities are objective data-based evaluation indicators and the knowledge and experience required to interpret them. Evaluation indicators share a similar aspect with key performance indicators (KPIs) which local municipalities are required to include in their comprehensive strategic plans. Both indicators are aimed at providing a quantitative picture of the impact of policy measures on the local economy. For that, local-level input-output tables are necessary, but to create such tables needs enough time, costs, and know-how. In order to help local municipalities with their quantitative policy evaluation, the central government has developed and made available some analytical tools, including the Regional Economy and Society Analyzing System (RESAS), for municipal governments to utilize.

The fundamentals to maintaining the local population are the formation of income-generating industries, the provision of sufficient job opportunities, and the constructing economic structural linkages among them. This means that understanding regional economies requires two perspectives, namely, what industries bring in income to local economies from outside sources and what industries offer job opportunities to the local residents. Municipalities need to develop a clear understanding of their respective economic structures if they are to come up with comprehensive strategic plans that are viable and effective.

In investigating the structure of the local economy, it is helpful to divide industries into two types.

The first type comprises those that cannot be sustained without the physical presence of people and businesses, i.e., those that require a sizable population and a cluster of businesses. Examples of this include personal service providers (e.g., retail shops, restaurants, real estate agencies, and hospitals) and business service providers (e.g., maintenance and inspection companies, accounting firms, advertisement agencies, and information processing service providers). Since those industries are dependent on the local presence of people and businesses for their survival, they are called the "derived sector" or the "non-basic sector."

The second type comprises those that can operate with or without a concentration of population and/or businesses. Most of their customers are from outside their region. Manufacturers' plants and factories as well as location-based industries such as agriculture, forestry, fishery, and mining are included in this type. Since those industries are dependent on natural conditions (natural stock) and are not derived from the internal market, they are called the "basic sector" or the "export sector."

Advancement in information and communications technology has enabled some service industries to make their way into the basic sector. For instance, online retailers as well as businesses offering ideas, design concepts that can be embodied in physical form, or other services that can be provided in a set of packages have the potential to become an export industry. Meanwhile, when we focus on the flow of money, basic sector industries can be defined as those capable of earning income from outside their region. In contrast, non-basic sector industries circulate money within the region.

What is important in understanding a regional economy is that a local economy with only industries that serve the local market cannot be sustained. Regions without industries that obtain earnings from outside the region are destined to decline eventually. Indeed, many of the regions with a declining population are also experiencing a decline in basic sector industries or those earning income from outside the region.

To be sure, even without any earnings from outside, it is possible to circulate money on local demand. However, such an economy would run out of steam in due time. Earning money from outside sources is prerequisite to the sustainability of the regional economy.

It is known both theoretically and empirically that the size of the non-basic sector is determined by the size of the sector. The basic to non-basic ratio defines this causal relationship. The larger the value of the ratio, the greater is the knock-on effect of the basic sector on local employment. In other words, if we can determine the size of the basic sector in a certain municipality, we can estimate the size of its population.

In the Keynesian effective demand model, demand such as investment and exports has an impact on income. In contrast, an economic base model focuses on how much impact revitalization in the basic industry, a positive supply-side effect, has on local employment (population).

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Suppose that the number of basic sector employees increased by 1,000 in a municipality where the ratio of non-basic sector employees to basic-sector employees is one to four. This would translate into an additional 5,000 jobs and, assuming two family members per worker, a population increase of 10,000.

Thus, a municipality whose plan calls for "increasing the local population by 1,000 in the next 15 years by promoting the development of new industries" would have to generate 100 new jobs in the basic sector. This helps assess the adequacy of the plan. For instance, some of those 100 new jobs would have to comprise experts specialized in various fields. Comprehensive strategic plans should spell out the types of human resources that should be secured (developed or imported) to work in specific industries, rather than simply discussing the size of the population.

In order to identify industries constituting the basic sector, local-level input-output tables that show inter-industry and inter-regional transactions would provide a direct path. However, since only some municipalities provide such tables, we have to resort to an indirect approach, using location quotients (LQs), which is an alternative measure based on more easily accessible data on the number of employees. An LQ is an industry's share local employment indexed to the industry's share of nationwide employment as one. For instance, if the LQ of a particular industry in a municipality is 2.0, the concentration of that industry in the municipality is twice as great as the national average.

However, since this does not reflect the existence of international trade, I have developed a modified LQ, which is obtained by multiplying the LQ by Japan's self-sufficiency ratio for respective industries. Applying the modified LQ as a measurement enables a more accurate identification of industries that constitute the basic sector in each municipality. Industries with an LQ greater than 1.0 are net exporters and capable of earning income from outside their region.

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The figure illustrates the earning power and employment capacity by industry in the city of Imabari, Ehime prefecture, with the logarithmic value of the modified LQ (earning power) measured along the horizontal axis and an industry's share in local employment (employment capacity) along the vertical axis. All values are calculated by industries at the two-digit level of the Japan Standard Industrial Classification (JSIC). The greatest income earner for the city is the water transport industry, which reflects the strong presence of coastal shipping companies, followed by a series of manufacturing industries such as the petroleum products industry. Furthermore, some of those industries also have a significant employment capacity, as exemplified by the transportation equipment manufacturing industry, which signifies the concentration of shipbuilding enterprises, and the textile products manufacturing and wholesale industries that include towel manufacturers and wholesalers. All of this highlight the necessity of promoting the development of diverse basic sector industries and linking them to job-creating industries.

Figure: Earning Power and Employment Capacity of the City of Imabari

Figure: Earning Power and Employment Capacity of the City of Imabari
Source: Ministry of Internal Affairs and Communications, "Economic Census for Business Activity" (2012) and "Economic Census for Business Frame" (2009)

Here, if we define employees with a modified LQ greater than 1.0 as those belonging to the basic sector, the basic to non-basic ratio for Imabari is 3.22. Meanwhile, the ratio of workers to the total population of the city is 1:2.25. Thus, according to the economic base model, an additional 100 jobs in the basic sector would increase Imabari's population by about 950.

Being a relative index, the LQ is useful in identifying industries with a comparative advantage, but it is problematic in that the absolute size of an economy is not taken into consideration. Still, the fact remains that the LQ offers an easy and effective means for municipalities to identify where their bread and butter come from.

The Ministry of Internal Affairs and Communications (MIC) is now preparing charts illustrating the correlations between basic sector industries (earning power) and job-creating industries (employment capacity) to make them available for public use under the government's "open data" initiative. It is expected that utilizing such charts together with the RESAS in a mutually complementary manner will enable municipalities to reflect a more objective assessment of their economic realities into their comprehensive strategic plans for regional revitalization.

>> Original text in Japanese

* Translated by RIETI.

May 26, 2015 Nihon Keizai Shimbun

June 29, 2015