RIETI Report June 2007

Accumulating Intangible Assets to Improve Productivity in the Service Sector

Japan has historically been able to maintain high levels of international competitiveness in the manufacturing sector. Yet productivity in the Japanese service sector, which employs more than 60% of the nation's workforce, lags far behind that of the United States and Europe. Raising productivity in the service sector is a critical element in bolstering productivity in the overall Japanese economy. At the RIETI Policy Symposium, "Productivity Growth in the Global Economy: Innovation in the Service Sector and the Role of Intangible Assets," the factors behind productivity differentials will be analyzed, primarily based on the results of "Productivity of Companies and Industries, and Japan's Economic Growth" project. Participants will also discuss how productivity can be improved in the service sector. We asked RIETI Faculty Fellow MIYAGAWA Tsutomu about the features and issues of this symposium.

This month's featured article

Accumulating Intangible Assets to Improve Productivity in the Service Sector

MIYAGAWA TsutomuFaculty Fellow, RIETI

Professor, Faculty of Economics, Gakushuin University

Dr. Miyagawa has been a Professor in the Faculty of Economics at Gakushuin University since 1999. He also served as a Visiting Professor (2001-'03) and Visiting Lecturer (2000) at the Economic Research Institute at Hitotsubashi University. In addition, he has held overseas research positions including: Visiting Researcher at the Centre for Economic Performance at the London School of Economics (2006), Fellow with the Economic Growth Center at Yale University (1988-'89), and Fellow with the Center for International Affairs at Harvard University (1987-'88). Dr. Miyagawa has also served as Director of the Nagoya Branch (1997-'99) and Senior Economist (1989-'97) at the Development Bank of Japan (formerly Japan Development Bank [JDB]) and Economist at the Economic Planning Agency (1982-'84). He obtained his B.A. in Economics from the University of Tokyo and Ph.D. in Economics from Hitotsubashi University. His areas of expertise are macroeconomics, Japanese economics, and Asian economic trends. His major works include: "Sectoral Productivity and Economic Growth in Japan, 1970-98: An Empirical Analysis Based on JIP Database" (with Kyoji Fukao, Tomohiko Inui, and Hiroki Kawai), in Growth and Productivity in East Asia, NBER Thirteenth Annual East Asia Seminar on Economics, (co-edited by Takatoshi Ito and Andrew Rose), The University of Chicago Press, 2004; "Productivity and the Business Cycles in Japan: Evidence from Japanese Industry Data," (with Yukie Sakuragawa and Miho Takizawa), The Japanese Economic Review, vol. 57, no. 2, 2006; and "The IT Revolution and Productivity Growth in Japan," (with Yukiko Ito and Nobuyuki Harada), Journal of the Japanese and International Economies, vol. 18, no. 2, 2004.

Interviews

RIETI Report: At the RIETI Policy Symposium held in July 2006, you delivered a presentation on "Determinants of TFP Growth and Potential Growth in Japan." What progress has been made over the past year? And what are the features of this symposium compared with last year's event?

Miyagawa: I spent the last five months of 2006 in London as a visiting researcher at the Center for Economic Performance of the London School of Economics. One of the participants in the RIETI policy symposium last year was Dr. Marcel Timmer of the University of Groningen in the Netherlands, one of the principal members of the EU KLEMS project. The main objective of the EU KLEMS project was to develop an international comparative database on measures of economic growth and productivity at the industry level, and the University of Groningen played a pivotal role. While I was in London, I contacted the team at the University of Groningen and modified the Japan Industrial Productivity (JIP) Database, so that it accommodated the standards for international comparisons. Dr. Kyoji Fukao and I had played a significant role at RIETI in the development of the JIP Database.

In March this year, the EU KLEMS project created the database, which can now be used to compare inter-industry productivity in 25 EU nations as well as the United States and Japan from 1970-2004. The database has been developed to ensure cross-country harmonization of the basic data and a major conference was held in Brussels to open it to the public. At this year's symposium, we will invite the University of Groningen's Dr. Bart van Ark, who spearheads the EU KLEMS project. We hope that he will use the database to make a presentation on the international position of Japan. Also, we will be reporting the results of the international comparative analysis of productivity we have been conducting using the EU KLEMS Database since March this year.

At the symposium last year, Dr. Dale Jorgenson delivered a report on the topic of "Japan's Potential Growth in a World Perspective." He spoke from the standpoint of the international position of Japan. At the symposium this year, we will make international comparisons of productivity based on more detailed data. I also believe that one of the achievements over the past year is that we are now better able to discuss in the context of international comparisons the issue of intangible assets such as human capital, knowledge capital, and organizational capital, as pointed out in the previous symposium.

RIETI Report: Your participation in the EU KLEMS project enabled you to make comparisons of productivity with the advanced economies of the U.S. and EU. What features stand out among the results of your analysis of the comparisons?

Miyagawa: One of the highlights was that we made a fresh discovery in the international comparisons of IT investments, the largest driving force behind the accelerated productivity growth in the U.S. in the late 1990s. Although I had thought that there had been a considerable buildup in IT investment since the second half of the 1990s in Japan also, I found that accumulated IT investment was far greater in the U.S. and major EU countries. Given that international comparisons of IT investments had conventionally been difficult to make, I see this as a significant achievement.

Another feature was the renewed confirmation that growth in productivity, especially total factor productivity (TFP), has been low in Japan since 1995 in comparison with the U.S. and major EU countries.

We also found that the relationship between IT investments and productivity varies from one country to another. An increase in IT spending does not necessarily raise productivity at a rapid pace. For example, in a comparison between the U.S. and the UK, the rates of increase in TFP differ even if the rates of growth in IT investments are almost on a par with each other. The difference may derive from disparities in the buildup of intangible assets, such as the development of the human capital and organizational reforms needed to take advantage of IT investments, and this finding has been receiving new attention.

RIETI Report: What about the comparison of inter-industry productivity in Japan with that in the U.S. and major EU countries? Also, why has the rate of productivity growth been low in Japan since 1995?

Miyagawa: It is now clear that Japan has lower productivity in the service sector than the levels found in the U.S. and key EU member states. There is a gap in the rate of productivity growth between Japan on the one hand and the U.S. and major EU countries on the other, and one of the main factors causing this difference is the low productivity in Japan's service sector. The accumulation of IT investments is particularly low in the distribution, transportation, and hotel industries. One of the factors behind the lower rate of productivity growth in Japan is that the use of IT investments lags that in, say, the U.S. This was also cited in the 2007 Economic Report of the President, which reported that spending on IT would lead to higher productivity only if it enabled the accumulation of intangible assets such as the development of human capital and organizational reforms, which underpin IT investments. While I was in London, I made an estimate of investments in intangible assets in Japan. Then, this May, I took part in an OECD workshop where estimates for Japan and for the U.S. and the UK were compared. The results of the comparisons indicate that the ratio of investments in intangible assets to GDP was lower in Japan than in the U.S. and UK. In addition, the ratio of investments in intangible assets to investments in tangible assets is much lower in Japan than it is in the U.S. Although these findings need to be examined in more detail, I believe that the accumulation of intangible assets is more important in the service sector than it is in the manufacturing sector, given that the former cannot rely on manufacturing technologies as can the latter.

RIETI Report: What is responsible for the great deal of attention paid toward productivity in the U.S?

Miyagawa: In the 2007 Economic Report of the President, productivity was addressed as a high priority issue. In the first overview section of the report, the importance of productivity in economic growth is pointed out, while Chapter 2 analyzes why productivity growth had been sustained for so long in the U.S. The productivity issue has a long history, and Dr. Robert Solow of the Massachusetts Institute of Technology, who won the Nobel Prize for Economics in 1987, published a bold and provocative paper called "Technical Change and the Aggregate Production Function" (Review of Economics and Statistics 39, August 1957) just 50 years ago, in which he asserted that one-third of the economic growth factors in the U.S. could be ascribed to the rate of technological progress. Since then, the rate of technological progress estimated by Dr. Solow's model has been called the Solow residual, and economists have been focusing their research on exactly what factors support one-third of U.S. economic growth. These discussions continue, and in my view only a few publications have had an impact comparable to the Solow paper. It is possible to consider the intangible assets I mentioned earlier to be one of the answers to the question raised by Dr. Solow.

The National Bureau of Economic Research (NBER), a nonprofit economic research organization in the U.S. where professors of economics and economists undertake research, holds a number of sessions for young economics scholars every summer. At this year's Summer Institute 2007, most sessions will deal with topics related to productivity, and we have been given the opportunity to present the results of our research at RIETI. Not only workshops like these, but a roundtable session on intangible assets is also scheduled. Since this year is the 50th anniversary of the Solow paper that triggered so much interest in productivity, Dr. Solow himself will be invited to participate in the roundtable session. So I would say that productivity is considered to be an economic issue warranting constant attention in advanced economies such as the U.S. and Europe, as it has yet to be fully resolved.

RIETI Report: In the symposium on June 22, how do you expect participants to discuss on improving productivity in Japan?

Miyagawa: As I have already noted, I would like to make the point that a more focused effort should be made to develop human capital and organizational reforms in step with new technologies, as an approach to improving productivity in the service sector. I also believe that Dr. van Ark will explain why the productivity growth in Japan's service sector is low from an international comparison perspective. I expect him to talk about the measures EU countries are taking to improve their productivity, as eliminating the productivity gap with the U.S. is regarded as a policy issue in Europe as it is in Japan. In addition, I think that Dr. Ron Jarmin of the U.S. Census Bureau will explain differences between Japan, the U.S., and the UK in the distribution industry as he has been comparatively studying its structure in Japan together with researchers from the UK and Japan. It is quite conceivable that the Japanese manufacturing sector competes so well internationally not simply because of its stellar manufacturing technologies, but also because it has an intangible asset in its world-class management capabilities. I hope that participants at this symposium will be able to develop a deeper understanding of strategies by which the service sector can grow in the global economy through greater management capabilities.

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