Prepared for the IIPS Symposium on

Upcoming Changes in Japanese Society and theFuture Shape of the Nation
Tuesday, 6 December 2005TokyoSession 2

Japan’s Future Economic CompetitivenessBarry P. Bosworth
Senior Fellow, Economic Studies Program
The Brookings Institution, Washington D.C.

Japan’s Future Economic CompetitivenessBarry P. Bosworth
Senior Fellow, Economic Studies Program
The Brookings Institution, Washington D.C.
To the visitor from abroad, it sometimes seems that Japan is beset by an
overwhelming number of economic problems. Japan’s economic problems have also
aroused concerns—both governmental and popular—in the United States. Whereas
the US took an optimistic view of Japan during the 1990s, it recently seems to beadopting a slightly too pessimistic view.
The problems confronting Japan, such as its aging population, are undoubtedly
serious. It is predicted that Japan’s workforce will shrink by approximately 18 percent
by the year 2030. An additional problem is the cost of pensions and health care. It isalso forecast that the dependency rate among the elderly will have increased byaround 50 percent by 2030. In addition, Japan’s budget deficit, which stands at 8
percent of its GDP, is the worst among the nations of the OECD. The US budget
deficit is also a topic of some debate; compared to Japan’s budget deficit, however, it
probably constitutes less of a problem. With respect to the balance of payments,
Japan’s outstanding sovereign debt has ballooned to 150 percent of GDP.
It must be pointed out, however, that the Japanese economy is coping effectively
with these problems. In particular, the author is extremely impressed with Japan’s
responses in the field in which he is engaged in collaborative research with Japanese
research organizations—for example, with the way in which Japan is dealing with theproblem of pensions for the elderly. Ten years ago the pension system appeared
completely unsustainable. Over the intervening ten years, Japan has modified it invarious ways and, within a five-yearly review framework, has converted it into asystem that has a chance of survival. Now that Japan has slashed pension payments,
the ratio of outlay on pensions to GDP is no longer so high in comparison with othercountries. It can probably be said that the pension problem has been virtuallyresolved.
Japan is also exemplary for the share of its elderly population that continue towork past retirement age. In the United States the question of the extent to which oldpeople will have to continue working is the focus of considerable attention in relation
to the question of health care costs. Japan currently manages to restrict health carecosts to around 8 percent of its GDP—astonishingly low compared to the UnitedStates figure of 15 percent. This is because less frequent surgical operations, costs areclosely regulated, and moderate wage levels can be maintained in the health careindustry.
Although the budget deficit problem is serious, there is light at the end of thetunnel. Japan is reining in government spending, but tax revenues are low incomparison with other countries. Essentially, taxes will have to be raised in order for
the issue of the budget deficit to be resolved.
Thus, despite the fact that Japan faces significant problems, it appears to have theresources to overcome them. Certainly, Japan’s ample human resources position it
well to respond flexibly to these challenges. In the end the problem is simply whetheror not the economy will continue to grow. Economic growth will mitigate or resolve1all of the problems outlined above. However, if the economy cannot grow, the aging
of society will have far-reaching effects. In light of these circumstances, the following
questions might be posed: why has the rate of growth of the Japanese economy been
so low over the past ten years, and how will it fare in the future?
Even among economists arguments are raging over these questions. Historically it
was difficult to find the relevant statistics (unlike in the United States); however, thishas changed considerably in recent years. Outstanding analysis of productivity in theJapanese economy has been carried out in the course of joint research by Hayashi andPrescott (2002), and more recently in joint research by Jorgensen and Motohashi(2005) and Fukao and others (2004). This research has shed light on why growth in
the Japanese economy has slowed down so much. After outstripping the US economy
in growth in the 1970s and 1980s, the Japanese economy rapidly went into aslowdown in the 1990s. According to the research carried out by Jorgensen andMotohashi, this was attributable to a reduction in the labor input. A combination of
two factors—a slower increase in the workforce population and declining working
hours—contributed greatly to the slowdown in overall growth. Furthermore, the IT
industry has made a substantial contribution. Although growth in the accumulation of
IT capital is not as rapid as in the United States, it would probably be fair to say thatthings are going reasonably well. In addition, total factor productivity growth, thecontribution of so-called technological progress to the growth rate, has also continued
at a reasonable rate, encouraging hope for the future.

Sources of Growth, 1973-2003
5Japan4United States

3TFP
IT Capital
Non-IT Capital
Labor

2
10-1
19751990

19901995

19952003

19731989

19891995

19952003

Jorgenson andMotohashi (2005)

The primary cause of the slowdown is evidently the labor input volume, as
exemplified by the number of hours worked. When the author first came to Japan in
the 1990s, the Japanese worker was the most industrious in the world. The UnitedStates and Sweden approached Japan’s level in this regard, but other countries had amuch shorter workweek.. In the 1190s, however, the basic number of hours worked
has declined substantially. Now the average Japanese worker does no more work than
the average American worker—an astounding turnaround. This phenomenon isparticularly striking in the manufacturing industry.

2

Hours of Work, Japan and theUnited States
Annual Hours per Worker
2200
2100
hours

2000
Japan

1900

United States

1800
1700
1600
1980

1985

1990

1995

2000

2005
OECD Productivity
Databaseyear

Why has the workweek declined? It may well be because of an increase in thenumber of companies and workers open to the idea of work-sharing in the face of thedecline in overall demand. Their willingness to share work probably motivated themto use work-sharing as a means to cope with the slowdown in economic growth.
However, this seems unlikely to continue in the future, and this phase seems alreadyto be coming to an end. The number of hours worked annually is leveling off, and thesituation may become akin to that in the United States. While the working populationin the United States is growing at an annual rate of approximately 1 percent, however,in Japan it is contracting by approximately 1 percent per annum. Thus, the overall
growth in the labor input will be much less than in the United States
Other research has reached similar conclusions to those of Jorgensen andMotohashi, and these results indicate that in the future overall labor productivity will
increase by 2 percent annually. Combined with a decline in the workforce, the overall
growth in GDP over the next ten years should average about 1.5 percent annually.
Competitiveness
There is a large gap in the productivity or efficiency between Japan’s global anddomestic enterprises. While Japanese companies that are engaged in activities in
global markets demonstrate extremely high levels of productivity, industries thatprovide goods and services to the Japanese domestic market are weak in comparison
with their counterparts in other advanced nations.
This is a major difference between Japan and the United States, and seems tostem from Japan’s predilection for protecting inefficient companies. As globalmarkets do not permit Japan this luxury, it is forced to adapt accordingly. Since
domestic markets are protected, there has been no need to raise productivity indomestic-oriented firms. In areas such as the service sector, however, conditions are
slowly changing and competitiveness is improving. This can probably be attributed to3deregulation. Also, in the past exports by the highly competitive manufacturingindustry were the major strength of the Japanese economy. Now domestic
non-manufacturing firms are beginning to improve their competitiveness as they
become exposed to various types of competition.
The Japanese manufacturing industry will be exposed to even fiercer international
competition in the future. Chinese and Korean companies are fighting to close the gapwith Japan, and as advances in communications technology facilitate overseas
production via outsourcing, Japanese companies are being forced to engage inrelentless cost-cutting.
There does not seem to be any need to increase immigration, since the export ofcapital and technology for overseas corporate activities will obviate the need toimport manpower. Instead of bringing manpower to Japan, Japanese companies
should make inroads into places where manpower is already congregated. In short, it
is likely that the trend towards overseas production will mushroom.
It is useful to compare Japan’s export shares and industrial structure to those ofother countries. In terms of exports, the United States still leads the world in market
share. With its colossal economy, the United States retains an enormous share of themarket; however, this has rapidly declined over the past four or five years. Japan’s
export share, which had seen a long unbroken upward trend, reached an overall peakin the 1990s and has been declining ever since. Of late, China’s rise has been
particularly noticeable.

Global Export Shares
14
pe rc e nt of tota l

12
10

Japan

8

Korea

6

China,P.R.

4United States

20
1980

1985

199019952000year

At the same time, the extent of Japan’s reliance on the manufacturing industry isevident when the Japanese manufacturing industry’s share of the overall workforce
and per-capita GDP are compared with those of other nations. Japan’s manufacturingindustry is enormous compared to those of other advanced nations. Since theservice-producing industries weight is known to increase as incomes rise, it can bepredicted that the Japanese manufacturing industry’s share of the workforce willprobably decline in the future. Considering which sectors of the domestic market are4

set to grow in the future, trends such as the manufacturing industry’s forays overseas,
especially in light of increased international competition, will naturally occur. Interms of the overall structure of Japan’s industry, the extent of its dependence on
industries targeting domestic markets will probably rise.

Employment Share in Manufacturing

Manufacturing share ofemployment

Average 1995-2001
0.25

DEU
JPN

0.2
0.15

USA

0.1
0

10,00020,00030,00040,00050,000GDP per capita, PPP

Japan’s ratio of investment in R&D to GDP is the third best in the world after
Sweden and Finland. Japan invests approximately 3 percent of its GDP in R&D.
Incidentally, the United States invests approximately 2.5 percent, and this percentage
is declining. By contrast, the ratio for Japan is rising, and Japan also has higheducational standards in international terms.
Japan’s net international investment position is 1.8 trillion dollars, whereas theUnited States is burdened with 2.5 trillion dollars of debt. No other nations comeclose in terms of debt or credit. With regard to the ratio of current account balance toGDP, approximately half of the current account balance is comprised of investment
earnings or so-called capital gains. As a creditor nation Japan also receives
extraordinary amounts of capital from abroad. This will undoubtedly continue toincrease in the future. The ratio of current account balance to GDP stands at around 4
percent but is likely to increase.

5Current Account/GDP
5capital income

p ercen t

4
3

trade balance
ca2
1
0-1
1980

1985

1990

1995

2000

2005

year

Summary
The relative predominance of the manufacturing industry will undoubtedly fade. Dueto severe workforce problems in Japan, the globally active manufacturing industry is
likely to raise its competitiveness by increasing its presence overseas. Meanwhile,industries that remain focused on Japan and target domestic markets will have to raise
their levels of production efficiency. It is likely that the entire industrial structure will
shift markedly towards the service industry and that greater emphasis will be placedon product development through advanced R&D. Japan is currently strong in R&D infields such as ICT (information and communications technology), environmental
science, and energy efficiency, and future investment will probably be focused inthese fields. Japan’s capacity for future growth resides in its ability to confront andovercome the increased competition. So far, Japanese companies are responding
extremely well. Deregulation and stimulation of participation by foreign companies
are likely to be crucial in maintaining this response.

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