Japan's Productivity Paradox

Japan's Productivity Paradox

December 2015
Simon Cox   |   Investment Strategist, BNY Mellon Investment Management, Asia Pacific

Once seen as the crucible of hi-tech approaches to improving productivity, Japan is now better known for its ageing society and persistently anaemic inflation. Under prime minister Shinzo Abe’s latest reforms, however, that could be set to change.

PREPARED FOR PROFESSIONAL CLIENTS ONLY

Productivity – doing more with less – is the ultimate source of prosperity. This is particularly true in Japan. Because its working-age population is shrinking, its economic progress depends on getting the most out of each worker that remains. To students of productivity, however, Japan presents a paradox. It is both cutting-edge and hidebound; futuristic and nostalgic. It is simultaneously a land of impressive innovation and of baffling inertia, embracing the new but never quite surrendering the old. The classic example is, of course, the fax machine, which is widely used and highly evolved in Japan, even as it is edging towards extinction elsewhere.1

In September, Japan’s prime minister, Shinzo Abe, announced a bold target to increase Japan’s nominal GDP by about 20%.2 It was one of three new “arrows” of Abenomics, his campaign to revive Japan’s economy, complementing the original arrows of monetary stimulus, fiscal pragmatism and structural reform. To achieve this growth, Japan will have to defeat deflation, prevent the workforce shrinking too fast, and increase labour productivity (GDP per worker) by roughly 2% a year.3

figure 1

How feasible is that for a country like Japan? In its heyday, Japan’s manufacturers set about productivity improvement (or kaizen) with quasi-religious zeal. They pioneered new production techniques, organizing workers into tight-knit teams with the authority and incentive to iron out every kink and inefficiency in the manufacturing process. In recent decades, Japan has become a self-proclaimed “robotics superpower”, with about 300,000 industrial robots in use, almost a quarter of the global total, according to a report by the Headquarters for Japan’s Economic Revitalization.4 In some of its factories, sophisticated machines churn out manufactured goods with barely a worker in sight. And yet, measured across the economy as a whole, Japan’s labour productivity is surprisingly poor.

The Asian Productivity Organization (headquartered tellingly in Japan) calculates that the country’s GDP per worker is only two-thirds of the US level.5 Worse than that, it is now a full 20% below the equivalent figure in Taiwan, one of the “flying geese” that once belonged in Japan’s slipstream (according to the famous metaphor coined by Akamatsu Kaname, a Japanese economist in the 1930s). Part of the gap with Taiwan reflects the island’s long workweeks. But even when judged by output per hour, Japan compares unfavourably with Taiwan and much of Western Europe, let alone America and Singapore (see figure 1).

On the face of it, this is dispiriting. But it also has one encouraging implication. Because Japan’s productivity level is so low, it also has ample scope to grow. Japan’s progress need not depend on the painstaking work of pushing back the frontiers of knowledge. It can improve its productivity simply by adopting some tricks of the trade that other countries pioneered years ago. Indeed, Japan could increase its GDP by 20% merely by replicating the productivity performance of the European Union’s older members (i.e., the 15 countries in the EU before the May 2004 enlargement). Japan, accustomed to leading Asia’s flock, can fly in the slipstream of other nations for a while. It has become a “catch-up” economy.

In what ways does it need to catch up? Highly productive economies typically have ample stocks of human and physical capital. Japan already has both. Its workforce is unusually well educated, boasting the third highest proportion of university and college graduates in the OECD.6 Its 15-year olds also registered the third highest score in the 2012 PISA (Program for International Student Assessment) science tests7, which compare academic achievement across countries. It does not lack for raw brainpower.

figure 2

Nor does it suffer from a shortage of physical capital. According to the APO, Japan’s capital-output ratio is the highest in Asia: 3.8 compared with 3.1 in China, a country often accused of overinvestment, and 2.9 in Taiwan. Japan’s businesses also invest a relatively high proportion of the country’s GDP in research and development. Among OECD countries, only Swedish and Israeli firms invest more, relative to the size of their economies.

Japan’s problem is not, then, weak powers of invention or capital accumulation. Its shortcomings lie elsewhere: in its powers of adaptation. It lacks sufficiently sharp incentives to restructure corporations and industries to make the most of new technologies and fresh organizational thinking. Japanese firms spend heavily on software, for example.8 But, according to Kyoji Fukao of Hitotsubashi University and his co-authors, they hoard the unskilled “clerical” workers whom information-and-communication technologies (ICT) would normally render obsolete.9 Japan also underinvests in other kinds of “knowledge-based capital”, like firm-specific training, market research, brand-building and improved corporate decision-making, according to the OECD.

The OECD attributes this inertia partly to a lack of competition. In Japan’s overly regulated service industries, firms are sheltered from the market forces that would push them into making better use of labour and capital. Until recently, for example, Japan’s bricks-and-mortar pharmacies faced little competition from e-commerce, because regulations barred the online sale of many over-the-counter medicines. Those regulations have been largely lifted as part of Abe’s piecemeal structural reforms.

A lack of competitive “push” in Japan’s economy may, however, be less important than a shortage of demand “pull”. Japanese firms can get away with hoarding workers in unproductive jobs partly because those workers have few better options. Japanese unemployment may be low, according to the official statistics, but underemployment, as abundant anecdotal evidence attests, is rife, especially in Japan’s service sector. Every visitor to Japan notes the “elevator ladies”, who greet people in the foyers of high-end hotels, and the “baton men”, who stand guard by every set of road-repairs waving illuminated batons to warn drivers of the danger.10

If Japanese spending picked up, activity quickened, and hiring strengthened further, these workers might find more interesting and lucrative things to do with their time. Japan’s firms would then adapt to life without them—perhaps by employing the same labour-saving technologies that other countries embraced long ago.

Even Japan’s beloved fax machine might come under threat. In a more buoyant, demand-led Japanese economy, the additional labour required to service the machines and process faxed instructions might become costly. And if that cost were passed on to consumers, even the technologically challenged might discover they like online ordering after all.

 

1 The New York Times: ‘In High-Tech Japan, The Fax Machines Roll On’, 13 February 2013.

2 The Japan Times: ‘Abe aims arrows at new targets with three fresh goals for “Abenomics,” 20% rise in GDP’, 24 September 2015.

3 CAO: ‘Economic and Fiscal Projections for Medium to Long term Analysis’, 12 February 2015.

4 Meti: ‘Japan’s Robot Strategy’, 10 February 2015.

5 APO: ‘APO Productivity databook’, 2015.

6 OECD Economic Surveys, Japan April 2015.

7 OECD Economic Surveys, Japan April 2015.

8 OECD Economic Surveys, Japan April 2015.

9 IAO: ‘The Structural Causes of Japan’s Lost Decades’, accessed 17 November 2015.

10 See “Bending Adversity” by David Pilling.

BNY Mellon Investment Management is an investment management organization, encompassing BNY Mellon’s affiliated investment management firms, wealth management organization and global distribution companies. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and may also be used as a generic term to reference the Corporation as a whole or its various subsidiaries generally.

This information is not investment advice, though may be deemed a financial promotion in non-U.S. jurisdictions. Accordingly, where used or distributed in any non-U.S. jurisdiction, the information provided is for Professional Clients only. This information is not for onward distribution to, or to be relied upon by Retail Clients. For marketing purposes only. Any statements and opinions expressed are as at the date of publication, are subject to change as economic and market conditions dictate, and do not necessarily represent the views of BNY Mellon or any of its affiliates. The information has been provided as a general market commentary only and does not constitute legal, tax, accounting, other professional counsel or investment advice, is not predictive of future performance, and should not be construed as an offer to sell or a solicitation to buy any security or make an offer where otherwise unlawful. The information has been provided without taking into account the investment objective, financial situation or needs of any particular person. BNY Mellon and its affiliates are not responsible for any subsequent investment advice given based on the information supplied. This is not investment research or a research recommendation for regulatory purposes as it does not constitute substantive research or analysis. To the extent that these materials contain statements about future performance, such statements are forward looking and are subject to a number of risks and uncertainties. Information and opinions presented have been obtained or derived from sources which BNY Mellon believed to be reliable, but BNY Mellon makes no representation to its accuracy and completeness. BNY Mellon accepts no liability for loss arising from use of this material. If nothing is indicated to the contrary, all figures are unaudited. Any indication of past performance is not a guide to future performance. The value of investments can fall as well as rise, so investors may get back less than originally invested. Not for distribution to, or use by, any person or entity in any jurisdiction or country in which such distribution or use would be contrary to local law or regulation. This information may not be distributed or used for the purpose of offers or solicitations in any jurisdiction or in any circumstances in which such offers or solicitations are unlawful or not authorized, or where there would be, by virtue of such distribution, new or additional registration requirements. Persons into whose possession this information comes are required to inform themselves about and to observe any restrictions that apply to the distribution of this information in their jurisdiction. The investment products and services mentioned here are not insured by the FDIC (or any other state or federal agency), are not deposits of or guaranteed by any bank, and may lose value. This information should not be published in hard copy, electronic form, via the web or in any other medium accessible to the public, unless authorized by BNY Mellon Investment Management. Issuing entities. This information is approved for Global distribution and is issued in the following jurisdictions by the named local entities or divisions: Europe, Middle East, Africa and Latin America (excl. Switzerland, Brazil, Dubai): BNY Mellon Investment Management EMEA Limited, BNY Mellon Centre, 160 Queen Victoria Street, London EC4V 4LA. Registered in England No. 1118580. Authorised and regulated by the Financial Conduct Authority. • Switzerland: Issued by BNY Mellon Investments Switzerland GmbH, Talacker 29, CH-8001 Zürich, Switzerland. Authorised and regulated by the FINMA. • Dubai, United Arab Emirates: Dubai branch of The Bank of New York Mellon, which is regulated by the Dubai Financial Services Authority. This material is intended for Professional Clients only and no other person should act upon it.• Singapore: BNY Mellon Investment Management Singapore Pte. Limited Co. Reg. 201230427E. Regulated by the Monetary Authority of Singapore. • Hong Kong: BNY Mellon Investment Management Hong Kong Limited . Regulated by the Hong Kong Securities and Futures Commission. • Japan: BNY Mellon Asset Management Japan Limited. BNY Mellon Asset Management Japan Limited is a Financial Instruments Business Operator with license no 406 (Kinsho) at the Commissioner of Kanto Local Finance Bureau and is a Member of the Investment Trusts Association, Japan and Japan Securities Investment Advisers Association. • Australia: BNY Mellon Investment Management Australia Ltd (ABN 56 102 482 815, AFS License No. 227865). Authorized and regulated by the Australian Securities & Investments Commission. • United States: BNY Mellon Investment Management. • Canada: Securities are offered through BNY Mellon Asset Management Canada Ltd., registered as a Portfolio Manager and Exempt Market Dealer in all provinces and territories of Canada, and as an Investment Fund Manager and Commodity Trading Manager in Ontario. • Brazil: this document is issued by ARX Investimentos Ltda., Av. Borges de Medeiros, 633, 4th floor, Rio de Janeiro, RJ, Brazil, CEP 22430-041. Authorized and regulated by the Brazilian Securities and Exchange Commission (CVM). The issuing entities above are BNY Mellon entities ultimately owned by The Bank of New York Mellon Corporation. BNY Mellon Company information. BNY Mellon Cash Investment Strategies is a division of The Dreyfus Corporation. • Investment advisory services in North America are provided through four different SEC-registered investment advisers using the brand Insight Investment: Cutwater Asset Management Corp, Cutwater Investor Services Corp, Pareto New York LLC and Pareto Investment Management Limited. The Insight Investment Group includes Insight Investment Management (Global) Limited, Pareto Investment Management Limited, Insight Investment Funds Management Limited, Cutwater Asset Management Corp and Cutwater Investor Services Corp. This information does not constitute an offer to sell, or a solicitation of an offer to purchase, any of the firms’ services or funds to any U.S. investor, or where otherwise unlawful • BNY Mellon owns 90% of The Boston Company Asset Management, LLC and the remainder is owned by employees of the firm. • The Newton Group (“Newton”) is comprised of the following affiliated companies: Newton Investment Management Limited, Newton Capital Management Limited (NCM Ltd), Newton Capital Management LLC (NCM LLC), NCM LLC personnel are supervised persons of NCM Ltd and NCM LLC does not provide investment advice, all of which is conducted by NCM Ltd. Only NCM LLC and NCM Ltd offer services in the U.S. • BNY Mellon owns a 20% interest in Siguler Guff & Company, LP and certain related entities (including Siguler Guff Advisers LLC). Issued as at 12.11.2015. GE111 — 12.05.2016. T3364 11/15