RIETI Report July 2008

Productivity in the Japanese Service Sector

Productivity has proven a difficult area to quantify. The RIETI co-produced Japan Industrial Productivity (JIP) Database has provided valuable data for researchers in Japan and abroad on this vital area of the modern Japanese economy and enabled comparison with other countries. As Japan increasingly becomes a service-oriented economy, interpretations of the JIP and other data have found the country's service sector productivity lagging that of other industrialized economies. But is productivity in the Japanese service sector as low as some may believe? What other approaches are suitable for assessing productivity? And what are the motivations for continuing to seek ways to boost productivity? RIETI Fellow KATO Atsuyuki is exploring these areas.

This month's featured article

Productivity in the Japanese Service Sector

KATO AtsuyukiFellow, RIETI

Dr. Kato joined RIETI as a Fellow in June 2007. His areas of expertise include economic growth, trade, and development, and productivity analysis. He received his Ph.D. in Economics from the University of Essex with a dissertation on "Income Convergence, Productivity Growth, and Trade in China." He also earned an M.Sc. in Economics from the School of Oriental and African Studies (SOAS) of the University of London and an M.A. and B.A. in Economics from Waseda University. His policy discussion paper, "Survey of Productivity in the Service Sector" was recently published.

Fellow Column

Is Japanese Service Industry Productivity Actually Low?

KATO Atsuyuki

In recent years debate has grown on the productivity of service industries. In Japan, where the service sector accounts for more than 70% of the (nominal 2006) GDP and the population is aging rapidly while the fertility rate declines, improving service industry productivity is imperative to ensuring sustainable economic growth. Thus, as a key policy issue the government, as well as scholars and members of the business community, are keenly discussing how this improvement can immediately take place. Beneath these discussions often lies the perception that Japanese service industries are lagging behind those in other industrialized countries (particularly the United States) in their level and growth rate of productivity. It is typically argued that these productivity gaps need to be eliminated by pushing forward regulatory reforms and promoting effective use of information technology. But while regulatory reform and IT use are undoubtedly important, is the productivity of Japanese service industries actually low relative to those in the U.S. and other industrialized countries?

Indeed, international comparisons of labor productivity show that Japan's service sector productivity ranks near the bottom among industrialized countries. One such comparison, published by the Japan Productivity Center for Socio-Economic Development, had Japan ranked 19th among the 30 member countries of the Organisation for Economic Co-operation and Development (OECD) --the lowest among the Group of Seven (G7) major economies-- in the productivity of all industries in 2006, despite being ranked third among OECD countries in manufacturing sector productivity. According to Wolfl (2003), analysis by industry type also shows that the growth rate of Japanese wholesale/retail, financial, and rental industries substantially decreased in the 1990s compared to the 1980s. This was in sharp contrast to the U.S., where remarkable expansion of these industries served as the driving force behind relatively high economic growth. Based on these official statistics, the productivity of Japanese service industries should be judged as low.

However, it is difficult to accurately identify "quantity of production" and therefore even more difficult to accurately measure productivity. Output for services traded in markets can be obtained based on the sales figures of companies providing the services. However, incidental services provided for free are not included in this output despite actually being produced, which may result in underestimates in the quantity of production and level of productivity. Also, overestimation and underestimation of productivity are quite likely to occur due to the extreme difficulty in including control variables such as a deflator and purchasing power parity (PPP) that accurately reflect differences in quality.

The shift from a manufacturing-based to a service-based economy materializes not only in the form of increased shares of conventional service industries but also as a transformation of core manufacturing and other non-service industry business segments into service businesses. Japan is generally thought to have relatively high manufacturing sector productivity while service sector productivity remains low. However, this may indicate that service production by industries solely engaged in service businesses has been inefficient but service production within the manufacturing sector has been highly efficient. But is this perception reasonable?

These observations suggest that sensitive discussion is needed to uncover whether the productivity of Japanese service industries is in fact low. In the future, studies verifying the efficiency of service production should be conducted while ensuring, as much as possible, application of uniform conditions. Deflators need to be developed based on detailed quantity and price data that properly reflect differences in quality, and there needs to be expansion of statistics covering service industries.

It is certainly not clear at the moment whether re-measurement incorporating all these factors would result in higher Japanese service industry productivity. The re-measurement results may turn out barely different from the originals in terms of aggregate data, with plus and minus effects offsetting each other. Or the productivity figures resulting from the re-measurement could turn out lower than the current level. However, even if re-measurement leads to the conclusion that Japanese service industry productivity is not particularly low relative to other countries, the importance of improving productivity would not be diminished. Needless to say, service sector productivity improvement is the prime engine for Japan's long-term economic growth regardless of its position relative to other countries.

Wölfl, A. (2003), "Productivity Growth in Services Industries: An Assessment of Recent Patterns and the Role of Measurement," OECD Science, Technology and Industry Working Papers, 2003/7, OECD Directorate for Science, Technology and Industry

*Translated from the original Japanese column published in RIETI Highlight, vol. 20, 2008

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