2006・5
Special Post Office, Privatization and Universal Service Obligation Costs

Fumitoshi Mizutani
Shuji Uranishi

Special Post Office, Privatization andUniversal Service Obligation Costs*
FUMITOSHI MIZUTANIKobe University
Graduate School of Business Administration
2-1 Rokkodai, Nada-ku, Kobe, 657-8501, Japan
E-mail: toshi@kobe-u.ac.jp

SHUJI URANISHI
Fukuyama Heisei University
Faculty of Business Administration
117-1 Miyuki-cho Kami Iwanari, Fukuyama, 720-0001, Japan
E-mail: uranishi@heisei-u.ac.jp

Abstract
By using the empirical method, this paper analyzes Japan’s “special” post office and evaluates
universal service obligation (USO) costs. With empirical analysis, we obtained the following results.
First, the cost of the special post office is about 9.8% higher than that of the “ordinal” post office.
Second, USO costs are about 348 billion yen, accounting for 17.3% of total revenues generated by ordinal
postal services. Also, approximately 81% of total prefectures are creating deficits.

Third, if the special

post office were abolished, USO costs would be reduced to 273 billion yen. Last, even with theprivatization of the Japan Post, USO costs are still large at 251 billion yen.

These results imply that

reorganization of the post office network will be necessary.

1. Introduction
In October 2007, following several years of confusion, Japan Post, a public corporation created in
2003, will be privatized.

Even before he assumed the premiership in 2001, Prime Minister

Koizumi began pushing for the privatization of the Japanese Post Office, asserting that postal
services could be provided more effectively by the private sector than by the existing public
corporation.

In 2005, amid strong objections from within his own Liberal Democratic Party,

Koizumi proposed privatization laws regarding the Japan Post.

When his proposals were rejectedby the Diet, Koizumi dissolved the House of Representatives and turned to voters to test the level of
support for his privatization plan.

While those in government had rejected his privatization

initiative, the result of the referendum was a show of clear voter support for postal reform.
There were several objections to the privatization of the Japan Post, including the concern*

Part of this study is supported by a research fund from the 21st century COE program and a research
grant from the Ministry of Education and Science.

1that if Japan Post were privatized, the universal service provided by the post office would not be
maintained, especially that postal services would be eliminated in rural areas. Postmasters of special
post offices were most vocal in their objections to privatization.
This paper focuses on the special post office and universal service obligation. Within
Japan Post, there have been two different organizations, the ordinal post office and the special post
office. The ordinal post office is directly owned by the public agency but the special post officemight be loosely defined as a “franchisee” of the Japan Post.

The origins of the special post officecan be traced to 1871, when the post office system began as a result of the help of local influential
people.

From the beginning, the behavior of the special post office seems different from that of theordinal public sector.

In our previous study, Mizutani and Uranishi (2003), we found that the

introduction of competition did not improve efficiency in the public agency (the Post Office),
although much research claims that a competitive environment is important (see for example,
Yarrow (1986), Kay and Thompson (1986), Bishop and Kay (1989), Vickers and Yarrow (1991)).
The lack of improvement in efficiency in the public agency shown in our results might be caused by
the existence of the special post office. This study will investigate the following points.
the cost of the special post office really the same as that of the ordinal post office?

First, isSecond, many

people objected to the privatization of the Japan Post on the grounds that privatization would weaken
or destroy the universal service obligation.

How big must universal service obligation costs be inorder to maintain current service prices?

Third, by how much will universal service obligation

costs be reduced if the special post office is abolished?

If we assume that the privatization of theJapan Post will produce the same results as the privatization of the Japan National Railway, howmuch will universal service obligation cost?
The structure of this paper is as follows.
special post office.

First, we explain the postal system and theIn this section, the origin of the special post office and managerial

characteristics of the special post office are discussed.

Second, as background information, we

explain the privatization scheme of the Japan Post which was recently passed in the Diet.

Third, inorder to assess the cost difference between the special post office and the ordinal post office, thevariable cost functions of the postal services are estimated.

In this section, we estimate twodifferent cost functions for different functional types of post office--the collection and delivery(C&D) type of post office and the non-collection and delivery (non-C&D) type of post office.
Fourth, universal service obligation costs are estimated.

In this section, we estimate three cases ofuniversal service obligation costs: (i) the current situation, (ii) the abolishment of the special post
office, (iii) post-privatization with the abolishment of the special post office.
our results and overall conclusions.

2

Finally, we present

2. The Postal System and the Special Post Office
2.1 Service Range of the Japan Post and the Current Mail Situation
The Japan Post, which became a public corporation on April 1, 2003, provides three main
services: (1) ordinal postal services such as letters and parcels; (2) postal savings; and (3) postal life
insurance.

Each of these three activities is a self-supporting system, which means that theoperating costs of each are covered by its user fees, etc., without financial support from the General
Account. Although the postal savings and postal life insurance sectors make profits, ordinal post
services created deficits in 2002.

For example, in 2002, ordinal postal service costs for providing

letter and parcel delivery were 2,189.8 billion yen, while ordinal postal revenues collected from thesale of stamps and postcards were 2,167.3 billion yen, producing a deficit of 22.5 billion yen.
Ordinal postal services can be classified into various types, including delivery ofindividual letters and post cards, delivery of periodicals such as newspapers and magazines, anddelivery of non-commercial printed material such as academic prints.

Table 1 shows the majorclassification of mail items.

Table 1. Trend in Mail Volume

FiscalYear

Parcel Delivery Service

International Mail Service(million items)(million items)

Mail
Service(billion items)

Post OfficePrivateShare of

Outgoing

Incoming

Carrier

Post Office

mail

mail

1993

24.5

150

1,245

10.8%

129

217

1994

24.0

143

1,328

9.7%

124

241

1995

24.8

148

1,434

9.4%

123

281

1996

25.5

161

1,530

9.5%

128

301

1997

25.8

163

1,617

9.2%

131

309

1998

25.9

155

1,833

7.8%

119

279

1999

26.1

154

2,357

6.1%

113

292

2000

26.9

155

2,574

5.7%

106

298

2001

26.7

162

2,654

5.8%

99

287

2002

26.2

166

2,751

5.7%

91

269

‘02/’93

1.07

1.11

2.21

0.53

0.71

1.24

Source: Japan Post (2003, p.66)

3

Japan Post deals mainly with ordinal mail such as letters and cards, items which havediminished in number after a peak in 2001.

Private carriers have also begun to enter this market

since deregulation, making it difficult for Japan Post to monopolize the market.
competition is threatening Japan Post in the parcel delivery market.

More serious

Since the entry into the market

of Yamato parcel delivery service in 1976, the parcel delivery market has been dominated by thishugely successful private carrier.
well.

Japan Post is losing share in the international delivery market as

The imbalance between incoming and outgoing mail pushes the cost structure upward.

2.2 Kinds of Post Offices
Post offices in the Japanese postal system can be classified into three kinds bymanagement form and two kinds by functional form.

First, as for management form, there areordinal post offices, special post offices and summary post offices.
directly owned and operated by the Japan Post Public Corporation.

The ordinal post office is

Its buildings and facilities are

owned by the Japan Post Public Corporation, and its employees are public employees.

The special

post office, in contrast to the ordinal post office, could be considered a kind of franchisee of theJapan Post Public Corporation, with its buildings generally owned by the postmaster of the post
office or some other private citizen and rented by the Japan Post Public Corporation for the purposeof providing postal services.

Although the postmaster of the special post office is a public

employee, it is customary for the postmaster’s offspring to inherit his job when he retires.

A moredetailed description of the special post office will be presented in the next section.

Last, thesummary post office is one which has been contracted out to the private sector.

The Japan Post

Public Corporation engages a contractor who operates the summary post office in a rented part of an
office building, for example.
As for the functional form of the post office, there are two kinds of post offices: thecollection and delivery post office (the C&D post office) and the non-collection and delivery post
office (the non-C&D post office).

Figure 1 shows the system of post services in Japan.

The C&D

post office’s role is the collection and delivery of letters and parcels to users and regional centers inthe system.

On the other hand, the non-C&D post office only accepts letters and parcels.

Thus, the C&D post office can be characterized as a distribution center of postal items
while the non-C&D post office resembles a retail shop serving residential areas by providing postal
services.
Table 2 summarizes trends related to each kind of post office since 1998.
ordinal post offices are C&D type post offices.

First, most

In 2002, of 1,310 ordinal post offices, the C&D

type accounted for 96%. Second, special post offices comprise two types, the majority being
non-C&D but with about 19% being the C&D type.

Another feature of the Japanese postal

situation is that there are an extremely large number of post offices.

4

In 2002, there were 24,752

post offices, making post offices the most numerous type of public facility in the nation. According
to Japan Post (2003), there is on average a post office at every 1.10 km interval, while other public
facilities are not as numerous (e.g. elementary schools (1.1km), police station (1.4km), national andpublic hospitals (4.0km), fire stations (2.3km).

Another puzzling feature of the postal system inJapan is that the number of the summary post offices, which operate at lower cost, has decreased
while the number of more expensive C&D type post offices has increased

Transport（Inter-region）

Delivery Post Office(Regional Center: Ordinal)
Transport
Receive (C&D)

Delivery Post Office(Ordinal / Special)

DeliveryCollection

Mail Post

Non Delivery
Post Office(Ordinal / Special)

Summary
Post Office

Receive (Non-C&D)

User (Sender)

User (Receiver)

Figure 1. The System of Post Service in Japan

Table 2. Kinds of Post Office and Numbers of Post Office
Kind of
Ordinal Post OfficeSpecial Post Office
Management
Form
Summary Post
OfficeKind ofC&D Post
Non-C&DC&D Post
Non-C&D
Functional
OfficePost Office
OfficePost Office
Form
1998
1,257
54
3,656
15,176
4,589
1999
1,256
51
3,651
15,227
4,579
2000
1,257
51
3,641
15,275
4,550
2001
1,257
51
3,627
15,307
4,531
2002
1,260
50
3,563
15,3784,501‘02/’98
1.00
0.93
0.97
1.01
0.98
Note: C&D Post Office (Collection and Delivery Post Office), Non-C&D Post Office(Non-Collection and Delivery Post Office)Source: Japan Post (2003, p.36)

5

2.3 Origin of the Special Post Office
The modern Japanese postal service system began in 1871, after its founder, Hisoka
Maejima, visited the UK and observed the postal system there.

However, because of the budget

constraints of the National Government, it was difficult to establish a modern post office network ina short period.

The government called on regional influential people to cooperate by lending theirland, for example, or parts of their estates to be used as post offices, in return appointing theselandowners postmasters.

Many regional influential people cooperated with the government out ofthe patriotic conviction that a postal service system was necessary in order to create a modern
Japanese society.

Through the efforts and cooperation of its founders and supporters, a nationwide

postal service network was completed in about three years (Tanaka, 2004).

By 1872, 21 post

offices had been established by the government, but the number of post offices established by theprivate sector was an astonishing 1,138 (Ministry of Posts and Telecommunications, 1971 and 1991).
Thus, the privately established post offices were dominant from the very earliest days of the post
network in Japan.

These private post offices established by regionally influential people were thefirst of what are now called “special” post offices.
After going through many changes, post offices began to be classified into three types.
The third class of post office categorized in 1886 became what is now the special post office.

In

1941, the classification of the three types was revised, and post offices were reorganized into twoclasses.

The first and the second class became ordinal post offices and the third class became thespecial post office.

2.4 Characteristics of the Special Post Office
Surely, the special post office has played an important role in the establishment of themodern Japanese postal system.

In the early days of the postal system, there were many cases inwhich postmasters went so far as to donate their private assets to the public.

Since then, the special

post office has displayed several unusual characteristics that distinguish it from other organizationsin the general public sector.

In this section, we will describe the characteristics regarding threeimportant issues: (i) appointment of the postmaster, (ii) building and facilities, and (iii) management
system.

Appointment of the Postmaster of the Special Post Office
Postmasters of special post offices are appointed in a different way from postmasters ofordinal post offices. Although both are government officials, the postmaster of an ordinal post
office is "a general postal administration official," in other words a national civil servant appointed
postmaster in the course of an official government career.

6

On the other hand, although thepostmaster of a special post office is a government official, he is appointed from outside the ranks ofgeneral career government officials.

Whereas nowadays vacant positions for postmaster of a

special post office are theoretically open to the public, there has customarily existed, and in practicethere still exists to some extent, a closed system whereby vacancy information is not made public,
and it often remains obscure how postmasters at special post offices are replaced. While there arecases nowadays in which an unrelated person is appointed as postmaster of a special post office,especially in large cities, the appointment system still lacks transparency and most postmasters
continue to be those who have inherited the job from their parents.

This system has been criticizedby many who consider it unfair, unprofessional, and feudalistic.
Postmasters of special post offices have several advantages over postmasters of ordinalpost offices. For example, retirement age is 65 for special post office postmasters but 60 for
general post office officials (Segawa, 2005).

Furthermore, a special post office requires at least 8.9

million yen only for the salary of the postmaster but at a summary post office of the same size, only
4.2 million yen is needed for all expenses (Segawa, 2005).

Buildings and Facilities of the Special Post Office
The second characteristic of the special post office is that, while all buildings housing
ordinal post offices are owned by the Japan Post Public Corporation, even now there are many cases
in which buildings housing special post offices are privately owned.

Many of the special post

offices in fact double as residences for the postmaster owner, and a substantial number of special
post offices are located in heritable property.
For example, there were 18,942 special post offices by the end of March, 2003.
special post offices, only 1,436, or 7.6%, were owned by Japan Post.

Of theseOn the other hand, thenumber of special post offices in which the buildings are rented by Japan Post from private owners is
17,506, or 92.4%.

Of these 17,506 post offices, cases in which buildings are owned by thepostmaster himself number 5,788, or 33.1% (Harada, 2004).

Presumably, the percentage of post

offices with postmaster ownership is higher in the countryside. Because the private owners of thebuildings of the special post office can expect stable rental revenues from the publicly owned Japan
Post, continued public ownership of the Japan Post is apparently in their best interest .
There have been complaints that rental fees paid to special post office owners may exceed
the market price, and because the Post Office has not published detailed information disclosing
rental cost, it is natural that there is suspicion. Quite recently, according to the Nihon Keizai
Shinbun (2006), rental fees paid by the Japan Post Public Corporation were on average 4.75 million
yen per special post office.

If this estimate is correct, it would indicate a monthly rental fee ofabout 396 thousand yen, certainly in most cases considerably higher than the market price.

7

Management System
Human resource allocation for the special post office is decided by Japan Post.

The

running expenses of the post office are also determined by its size. A postmaster of a special post
office cannot allocate employees or decide running expenses himself.

And because the financial

independence of the postal service is judged from the point of view of the entire postal system,
theoretically it does not matter to Japan Post whether each individual special post office’s
management is efficient. An individual post office has no incentive to run efficiently, regardless ofwhether it is a special or an ordinal post office. Furthermore, most special post offices are small1.
There are 13,698 special post offices with less than five employees, accounting for 72.5% of thetotal.
Another distinctive feature of the special post office is that there was until recently acategory of expense which applied only to it.

Originally intended to be used to cover the expenseof lighting, fuel, or equipment, the “watashikiri-hi” (free-use allowance) was provided annually topostmasters of special post offices.

There were no restrictions on the use of this money or

requirements that its use be accounted for.

The amount of “watashikiri-hi” was about 91.2 billion

yen for the entire postal system, or an average of about one million yen per postmaster in 2000
(Tanaka, 2004).

However, according to Segawa (2005), postmasters serving as regional section

chiefs received much higher amounts of “watashikiri-hi.”

Although the post office has an audit

system, categories of expenses such as “watashikiri-hi” create room for vagueness and inefficiency
in the postal service.

In 2003, the “watashikiri-hi” was abolished after many complaints about its

lack of transparency.

3. Privatization of the Japan Post
3.1 Pros and Cons of Privatization
The law for the privatization of Japan Post was passed in October, 2005, and theorganization is slated to become private in April, 2007.

Before its ultimate success, however, thelaw requiring the privatization of Japan Post was rejected in the House of Councilors in August after
having passed in the House of Representatives.

To establish support for his initiative, Prime

Minister Koizumi dissolved the House of Representatives and held a snap election, winning alandslide victory for the LDP and vindicating his plan for postal reform, which subsequently passed
both houses without resistance.
1

According to Tanaka (2004, p.126), at the end of March, 2003, the size distribution of the special post
office is as follows: 2-person-employee (2,363 post offices, 12%), 3-person-employee (4,049 post office,21%), 4-person-employee (4,265 post office, 23%), 5-person-employee (3,014 post office, 16%),
6-person-employee (1,143 post office, 6%), 7-person-employee (739 post office, 4%), 8-person-employee(3,36 post office, 18%).

8

There were several reasons put forward for the privatization of Japan Post.

First, many

services provided by Japan Post are already being performed by the private sector.

The savings(postal savings) service offered by the post office does not significantly differ from that at privatebanks.

Insurance (postal insurance) is also provided by private insurance companies.

Even forordinal postal services, the private sector is involved to some extent. For example, parcel delivery
services are provided by private companies.
private companies.

Periodicals and mail documents also are delivered by

The only item limited to Japan Post is personal messages.

Second, while Japan Post as a whole is not creating deficits, most post offices are creating
deficits, especially in the countryside.

As we mentioned before, post offices are spaced even more

densely than elementary schools, with most post offices being special post offices, more expensive
to maintain than the other two kinds of post offices in Japan.

Privatization would mean that Japan

Post would be free to reform expensive, inefficient, perhaps superfluous special post offices.
Changing them into summary post offices might be an option.
Third, money the government makes through postal savings is used for investment inspecial corporations.

For example, the government uses money from government investment andloan programs, notably the postal savings business, to construct highway networks through theagency of the Public Highway Corporation.

The amount of postal savings is huge, supplying

special corporations with a flood of investment money, many of it inefficiently channeled into theconstruction of unnecessary highways or other public works projects. This activity, often criticizedas contributing to environmental degradation, has been cited as one justification for the privatization(or the elimination) of postal savings.
On the other hand, many people oppose privatization (e.g. Tanaka (2004), Takigawa(2004)).

Objections have been heard from postmasters of special post office and union members ofJapan Post, who offered several reasons why Japan Post should not be privatized.
objection was that universal service will not be maintained.

The biggest

In rural areas, the post office is often

the only financial institution, so that with the privatization of the Japan Post, the service level in rural
areas might be reduced.
Others oppose privatization because they believe that public ownership is necessary.
Services provided by the post office are not limited to only what might be called postal services.

In

rural areas, post offices provide some services which would be otherwise difficult to obtain, having
made agreements with municipal governments to provide patrons with official documents such as
resident cards and tax payment proof documents.

Opponents of privatization claim that theprivatized post office cannot provide such governmental services.

93.2 Privatization Scheme
The privatization scheme taken by the government has several characteristics, the first ofwhich relates to the organizational structure of the postal services.

In 2007, the Japan Post will be

reorganized into one stock holding company and four postal service providing companies. The
four postal providing companies are the following: the post office company which holds the post
office buildings; the postal service company; the postal savings company; and the postal life
insurance company.

The post office company will provide postal customer services bycontracting-in from the three other companies.

These four companies will be owned by the Japan

Post stock holding company.
Second, the privatization procedure will be carried out in two steps.

The first step iscreating five new private companies in 2007: one stock holding company and four postal service
providing companies.

The first step is considered a transition period toward full privatization.

Shares of the stock holding company will be owned by the government.

This transition period will

last until the year 2017, when the second step of privatization will begin.

During the second stage,

all shares of both the postal saving company and the postal life insurance company will be sold tothe private sector.

Therefore, only the post office company and the postal service company willremain within the Japan Post group.

At the second step, two thirds of the shares of the Japan Post

stock holding company will be sold to the private sector.

Therefore, the Japan Post will continue tobe regulated by the government as a partially privatized company, a special corporation underJapanese law.
Third, in order to maintain regional local services, the “Social and Regional MaintenanceFund (Shakai Chiiki Koken Kikin)” will be established.
trillion yen (about $US 8.5 billion).

This fund is expected to be about one

The main source of revenue for this fund will come from theproceeds of the sale of stock shares of the postal saving company and the postal life insurancecompany.

The post office company and the postal service company will use the revenues from thisfund in the capital market to maintain postal services in local areas.

4.
4.1.

Effect of the Special Post Office on Costs
Cost Model
The main purpose of this section is to evaluate whether the special post office causes thecost structure to increase.

Many researchers claim that the special post office, because it has no

incentive to reduce costs, has a tendency to push the post office’s cost upward.

Furthermore, thespecial post office might have higher costs than the ordinal post office due to an easier environment
for rent seeking behavior.

Publicized scandals regarding the relationship between politicians andpostmasters might provide insight into possible unnatural influences on cost structure.

10

In thissection, we will evaluate whether the special post office in reality has higher cost than the ordinalpost office, by estimating the cost function of the postal service.

In this study, we distinguish two

kinds of activity in the ordinal postal services: the collection and delivery activity (C&D) and thenon collection and delivery activity (non-C&D).

As we explained before, because post offices inJapan are distinguished by activity of postal services and the cost structure of these activities isdifferent, the collection and delivery type (C&D) post office and the non-collection and delivery type(non-C&D) post office are formulated differently.

Therefore, we separately specify the costfunction of each post office.
First, we consider two functional types of post office, the C&D post office and thenon-C&D post office.

For the functional type of post office-i (i = C (the C&D post office), NC (thenon-C&D post office), the cost functions for each post office consist of output (Yi) and two input
factor prices: labor, material and service (wLi, wMi).

Furthermore, for collection and delivery

activity in rural areas, the mail volume would be smaller and that fact affects the cost structure of the
C&D post offices.

Therefore, we include a variable for rural ratio (R) in the cost function of the

C&D post office.

Finally, as the cost structure of the special post office might be different fromthat of the ordinal post office, we also include a variable for the ratio of special post office (S) in thecost function of the C&D post office.

It is worth noting that we wished to include a summary post

office in these functions but there was no data available for this type of post office, so that we wereforced to exclude the summary post office.

Finally, as most non-C&D post offices are special post

offices, we do not include the ratio of special post offices in the cost function of the non-C&D post
office2.

As a functional form, we employ a Cobb-Douglas cost function3:
lnVCC = αC + αYlnYC + βLClnwLC+ βMClnwMC + γRlnR + γSlnS(1)lnVCNC = αNC + αQNClnYNC + βLNClnwLNC + βMNClnwKNC .

(2)

The outputs treated in the C&D type post office are classified into four categories (seeFigure 1): (1) mail directly received from senders, (2) mail collected from posts, (3) mail transported
to other post offices, (4) mail delivered to individuals.

Of course, the ratio of these activities also

affects the cost structure of the C&D post office, even if the post office has the same mail volume of
output.

Therefore, we specify the output measure for the C&D post office as the hedonic formulaof total treated mail items (QC), the ratio of received mail from senders (HR), the ratio of collected

2

In FY2002, in the category of the non-C&D post office, the number of special post offices was 15,378.
On the other hand, the number of ordinal post offices was only 50. Therefore, the special post office inthis category accounts for 99.7%.
3
As a functional form, the translog cost function is better because it has fewer restrictions than the
Cobb-Douglas cost function. However, because of a problem with sample size, we use the
Cobb-Douglas cost function.

11

mail items (HC), and the ratio of mail delivered to individuals and transported-out (HD) as follows:
lnYC = lnQC + ηRlnHR+ ηClnHC + ηDlnHD .

(3)

On the other hand, the non-C&D post office has customer service activity only.
consider only the total volume of mail received from customers.

Therefore, we

And the output measure (YNC) isequal to the total volume of mail (QNC).
We estimate these two cost functions with the full information maximum likelihood(FIML) method by substituting equation-(3) into equation-(1).

In these models, we impose therestriction on input factor prices such that Σi βiC = 1, Σi βiNC = 1 (i = L (labor), M (material)) and do
so on output characteristic variables such that Σj ηj = 1 (j = R (receive), C (collection), D (delivery
and transport-out)).

4.2.

Data

Our main data sources are annual statistics issued by the national government, except for data
related to postal service expenses, which was obtained mainly from two sources, the Regional
Profit and Loss Statement of the Post Office and Statistics on Postal Services. Although theformer source is not published, we obtained the data directly from the Japan Post.
source is annually published by the Japan Post.

The latter

Data related to the definition of rural areas was

obtained from the Government Reports issued by the Ministry of Internal Affairs andCommunications.
The basic unit for the analysis in this study is the prefecture.

We collected data for three

years from 2000 to 2002. Because there are 47 prefectures in Japan, the total sample size for the
analysis is 141 observations.
Although the basic unit for the analysis is the prefecture, some data such as postal
expenses and input factors are not available on a prefecture-basis because these are reported on a
postal administrative division-basis.

Therefore, we converted some data from the postal

administration division-basis to the prefecture-basis. The correspondence of the postal
administration division to each prefecture is shown in Table 3.
The conversion method from the postal administration division to each prefecture is asfollows.

First, we allocate the postal service expenses based on the number of post offices in eachprefecture, because these numbers were available.

However, the costs of a post office vary by its

functional type (the C&D or the non-C&D post office) and by its administrative type (the ordinalpost office or the special post office).

For example, according to test calculation results obtained by

the Japan Post in 2005, the postal service expenses of the C&D post office are about 3 to 8 times

12higher than the expenses of the non-C&D post office in each prefecture. Therefore, we consider thetypes of post office for the allocation of postal service expenses.

In this study, based on the resultsof Japan Post, we converted division-based postal service expenses to prefecture-based postal
expenses.

Table 3. Postal Administration Division and Prefecture
Postal Administration Division
Prefecture
Hokkaido
Hokkaido
TohokuAomori, Iwate, Miyagi, Akita, Yamagata, Fukushima
Kanto
Ibaragi, Tochigi, Gunma, Saitama, Chiba, Kanagawa, Yamanashi
Tokyo
Tokyo
Shinetsu
Niigata, Nagano
Hokuriku
Toyama, Ishikawa, Fukui
Tokai
Gifu, Shizuoka, Aichi, Mie
Kinki
Shiga, Kyoto, Osaka, Hyogo, Nara, Wakayama
Chugoku
Tottori, Shimane, Okayama, Hiroshima, Yamaguchi
Shikoku
Tokushima, Kagawa, Ehime, Kochi
KyushuFukuoka, Saga, Nagasaki, Kumamoto, Oita, Miyazaki, Kagoshima
Okinawa
Okinawa

Second, in order to obtain the average wage, it is necessary to know the numbers of
employees of post offices in each prefecture.

However, this data is not directly available so that we

had to estimate the numbers of employees.

It is a fact that the common expenses of the three major

postal services (ordinal postal services, postal savings and postal insurance) of the Japan Post areallocated by the numbers of employees, we use common expenses as the weight for the calculationof number of employees. Therefore, we converted the total number of employees to a prefecturebase, according to the percentage of the common expenses of each prefecture.
Last, we define capital costs as the total of depreciation costs, interest payments, and othercapital related costs in the analysis of the universal service obligation costs. But the data which we
obtained is also added up for the whole postal service.

We use the numbers of the ordinal post

offices in each prefecture for the allocation of capital costs.

The biggest ratio in repayment assets

of a postal service are the buildings of post office and those of ordinal post offices owned by theJapan Post.

4.3.

Definition of Variables

The variables used for the estimation of variable cost function are defined as follows.

And thestatistics of these variables are shown in Table 4 and Table 5. First, the variable cost (VCi, i = C(C&D), NC (non-C&D)) is the sum of labor costs and material and service costs.

Energy costs,

which would be incurred mainly for gasoline for trucks and motorcycles, are included in materialand service costs.

13

Table 4 Statistics of Used Variables : C&D Type Post Office

24,511

Standard
Deviation
26,6296.46881.06504.3147

11.462952.8050

47.3676

13.8489264.3676

1,415,044
0.2601
0.06130.6786
0.26200.72202,716,491
0.03180.02280.02340.18940.1979170,701
0.16100.01520.60390.0001
0.0941

18,275,900
0.38090.10910.72990.71950.9200-0.78630.03780.63300.8438-0.21370.03780.15620.3670

Variable
VCC

Variable Cost

wLC

Labor PricewMC

Material Price

QC
HR
HC
HD
R
S

OutputReceived Ratio
Collection Ratio
Delivery Ratio
Rural Ratio
Special PO Ratio
Share of Labor
Cost
Share of Material
Cost

S(L)
S(M)

Mean
million yen
million yen per
employeemillion yen per
officethousand piece-

Table 5 Statistics of Used Variables : Non-C&D Type Post OfficeStandard
Variable
Mean
Deviation
VCNC Variable Cost
million yen
2,829
2,812
million yen
wLNC Labor Price
14.0661
1.9198per employee
million yen
wMNC Material Price
1.45590.3429per office
thousand
QNC
Output34,62747,738piecesShare of Labor
S(L)0.82350.0340
Cost
Share of MaterialS(M)0.17650.0340
Cost

Minimum

Maximum

4,393

176,006

Minimum

Maximum

677

19,0666.744018.2291

0.96673.0762

6,995

294,082

0.62680.86720.13280.3732

As for output measure, we use the total number of post items (Qi).

This measure consistsof mail-post items and parcels received, collected, transported and delivered to recipients.

While

the role of non-C&D post offices is only to receive mail from customers, the C&D post offices
engage in all kinds of activities related to mail--receiving, collecting, transporting and delivering.
Therefore, in the cost function of the C&D post office, we define the output variable as the implicit
output index (Y) instead of mail volume.

As we explained before, in order to avoid estimation bias

based on different kinds of output, we include four kinds of variables of output characteristics: theratio of received mail (HR), the ratio of collected mail items (HC), the ratio of mail delivered toindividuals and transported-out (HD).

The ratio of received mail is the ratio of the number of mail14

items directly received from senders to the total number of mail items.

The ratio of collected mailitems is defined as the ratio of the number of collected mail items to the total number of mail items.
The ratio of mail delivered to individuals and transported-out is defined as the ratio of the number ofmail items delivered to individual households and transported to other regions to the total number ofmail items.
We defined two kinds of input factor prices.
average annual salary per employee.

First, labor price (wLi) is defined as theThis is obtained by dividing annual labor costs by permanent

employees. Material and service price (wMi) is obtained by dividing material and service
expenditures by the number of post offices.

As we mentioned before, energy expenditures areincluded in the expenditures.
Two kinds of institutional variables are defined.
of universal geographical condition.
each prefecture.

First, rural ratio (R) is used as a measure

The measure is defined as the ratio of rural municipalities in

The definition of a rural municipality is based upon the rural area law.

Second,the special post office ratio (S) is defined as the ratio of the number of special C&D post offices tothe total number of C&D post offices. As we explained before, the office buildings of special post
offices are privately owned and the headquarters of the Japan Post rent their buildings from thespecial post office.
As noted in the previous section, we define the capital costs of postal service. However,
we do not include capital costs in this cost model because the cost functions estimated in this study
are variable costs of the C&D post office and the non-C&D post office.

Most items of capital costs

are costs of repayment assets such as office buildings. As only ordinal post offices own their own
buildings, their cost structure would be different from that of special post offices.

Therefore, it is

not appropriate to include capital costs and to assume the same capital price for these types of post
offices.

4.4.

Estimation Results of Cost Function
We estimate two kinds of cost functions shown in equation-(1) and (2) simultaneously.

In

addition, we substitute the output characteristic function into the cost function of the C&D post
office beforehand, shown in equation-(3).

The estimation method is full information maximum

likelihood (FIML) for all cost functions. As for cases of estimation, we estimated three cases
according to selection of institutional variables.
The estimation results for these three cases are summarized in Table 6.

Thegoodness-of-fit in the regression is acceptably high for all models. As for the required properties in
the cost function, first, homogeneity conditions in input factor prices are satisfied, because we
imposed restrictions on the cost models. Second, as for monotonicity conditions, it is necessary

15

that the cost function is a non-monotone decreasing function in both output and input factor prices.
The monotonicity conditions are evaluated by checking the partial derivative of the cost function
with respect to output and input factor prices. And it is necessary that the partial derivative is notnegative (i.e.,∂lnVCC /∂lnQC > 0,∂lnVCNC /∂lnQNC > 0,∂lnVCi /∂lnwi > 0).

In our test

results, these conditions are satisfied.

Table 6. Estimation Results: Estimate and Standard Error
Case
Model
αC
αY
C&D

ηR

Post OfficeηC

Cost Function

ηD
βLC
βMC
γR
γS
R-squared
Sample size
αNC

Non-C&D

αQNC

Post Office

βLNC

Cost Function

βMNC
R-squared
Sample size

Case-1Model 1C
10.2866***(0.0393)0.5741***(0.0391)
0.2035(0.5247)
0.3416**(0.1505)
0.4549(0.6308)
0.8287***(0.0796)0.1713**(0.0796)0.0193(0.0257)
0.2011(0.1312)0.8762141
Model 1NC
8.0216***(0.0244)0.7220***(0.0253)
0.6298***(0.0431)0.3702***(0.0431)0.8995141

Case-2Model 2C
10.2501***(0.0431)0.5384***(0.0353)- 0.0526(0.5346)0.3503**(0.1529)0.7023(0.6280)0.8646***(0.0852)
0.1354(0.0852)
0.0412*(0.0238)--0.8699141
Model 2NC
8.0210***(0.0238)0.7206***(0.0241)0.6252***(0.0452)
0.3748***(0.0452)
0.8996141

Case-3Model 3C
10.2837***(0.0401)
0.5850***(0.0317)0.2692(0.4760)
0.3401**(0.1528)0.3907(0.5873)
0.8450***(0.0782)
0.1550**(0.0782)--0.2643***(0.0988)0.8756141
Model 3NC
8.0221***(0.0249)
0.7233***(0.0252)
0.6385***(0.0429)
0.3615***(0.0429)
0.8994141

This table indicates some interesting results. First, the coefficients in output measure areless than one.

This implies that economies of scale exist in each post office.

coefficient of the C&D post office is less than that of the non-C&D post office.

Moreover, theThis implies that

more economies of scale exist in the C&D post office than in the non-C&D post offices.

16

These

results support the findings of previous studies such as Panzar (1993), Cazals et al. (1997) andBradley and Colvin (1995), who assert that the main source of scale economy in postal service isderived from mail delivery.
Second, the coefficients of both the rural ratio and the special post office ratio show thepositive sign. Although each of them is statistically insignificant in Case 1, the coefficients of these
institutional variables are both positive and statistically significant in Case 2 and Case 3. Thisimplies that if the Post Office has more rural areas and more special post offices, then costs go up.
One important finding is that the special post office has a cost disadvantage over the ordinal post
office, as many people have claimed.

The special post office’s cost is about 20% higher than thatof the ordinal post office.

5.
5.1.

Estimation of the USO Cost
Definition of Universal Service
In this section, we estimate the universal service obligation (USO) cost and evaluate

whether or not universal service can be maintained.
reasons.

USO costs are estimated here for the following

First, when policy options for the reform of postal services are discussed in Japan, USO

costs are recognized as important, but almost no one has shown the magnitude of USO costs forJapanese post offices.

Second, we obtained information showing that the special post office hashigher costs than the ordinal post office.
USO costs be affected?

If we abolish the special post office system, how will

Third, having been passed into law, privatization is inevitable.

much will privatization reduce USO costs?

By how

We will explore these issues.

A measurement of the USO cost is obtained by net avoidable cost (NAC) approach, as we
explain later. As for the definition of the USO, in this study generally we follow the definition ofCrew and Kleindorfer (1998).

The USO is not defined specifically based on types of service (e.g.

cards, letters, parcels) or limits of services (e.g. number of deliveries, price of services)

In fact,

according to our survey of previous studies, no one has clarified what kind of services or what
service level should be defined as universal service. It is natural that universal service levels
cannot be defined because the purpose of each country’s post office itself is to provide universal
service, as IPTP (2000) points out.
Crew and Kleindorfer (1998), however, define the USO as a requirement on the incumbent
Post Office to provide ubiquitous service at a uniform price. Rodriguez and Storer (2000) define it
as a provision of ubiquitous minimum quality services to all (national) customers at a uniform,
affordable set of prices, which entails the subsidization of services to some customers.

Similarly,

Castro and Maddock (1997) define the USO cost as where the avoidable cost of the carriage of aletter on a given path exceeds the price charged, the net difference is the cost of the CSO for the17letter.

Thus, we define the USO cost as the sum of deficits derived from the provision of thecurrent service levels at a uniform price in a deficit-making area.

5.2.

Estimation of the Universal Service Obligation Cost
There are two different approaches that have been taken to estimate the USO cost. One is

the net avoidable cost (NAC) approach and the other is the entry pricing (EP) approach. The NAC
approach is based on the estimated avoidable cost, which the operator is able to avoid when it does
not provide service only for a deficit-making area.

In this approach, the total amount of deficit in

the deficit-making areas, in which the uniform price could not cover the average incremental cost ofproviding services, is defined as the USO costs.

Originally this approach was developed in thetelecommunications industry but has also been applied to the postal service industry.

For example,

Castro and Maddock (1997) used this method to estimate the USO cost of the Australia Post.
On the other hand, in the EP approach, the USO cost is defined as the decrease of the
profit in profitable regions after competition is introduced.

Universal services are maintained bycross subsidies from profitable regions to deficit-producing regions. Therefore, in this method, theUSO cost is measured by profits taken over by the new entrant in the profitable region. As an
example of this method, there are studies of Bradley and Colvin (2000) for the USPS of the UnitedStates and Robinson and Rodriguez (2000) for the Post Office of the United Kingdom.

However,

one big problem with this method concerns the difficulty of measuring the competitive environment.
Surely, the results of the USO cost vary according to how the competitive environment is set up.
In this study, we use the NAC approach to measure the USO cost. As we mentioned
above, the USO cost obtained by the EP approach is greatly influenced by how the competitiveenvironment is set up.

In the current Japanese postal service network, it is not easy to set up acompetitive environment.

For example, it is necessary to analyze the current competitiveenvironment for delivery services such as small parcel delivery because private companies actuallycompete with the Post Office in this market.
the cost function.

5.3.

Furthermore, we can employ the estimation results of

For these reasons, we choose the NAC approach as the measurement method.

Estimation Procedure of the Universal Service Obligation Cost
In this section, we will explain the estimation procedure of the USO cost.

As weexplained before, the USO cost used here follows the definition by Castro and Maddock (1997),
whereby “the avoidable cost of the carriage of a letter on a given path exceeds the price charged, thenet difference is the USO cost for that letter.”In this study, instead of “path,” we take the “region.”

After we classify “deficit regions” and “profitable regions” by judging whether the unit cost per
piece exceeds the uniform tariff, we consider the total loss of “deficit regions” as the USO cost.

Asfor postal services, in this study, we take all kinds of ordinary mail (e.g. letters, cards and published18

items such as periodicals) and parcel goods.

The USO cost of postal service is estimated in five

steps, following a study by Uranishi (2004).

(1) Step 1: The definition of total cost
First, we define the total cost of each area as follows:
TC = Σ i VCi + Σj FCj(4)

The total cost of each area (TC) is calculated as the sum of variable cost (VC i) of post type i ( i = C(Collection and delivery), NC (Non-collection and delivery).

These variable costs are estimatedusing econometric methods. As for fixed costs, there are three components, which are capital cost
(FCK), common expense parts of the three post business (FCCC) and administration expenses of theregional headquarters (FCAD).

The administration expenses of the regional headquarters are for the

purpose of management and control of the postal network.

We include such costs in the total costof each region(2) Step 2: Obtain the calculated value of total costs
In step 2, we determine the calculated value of total costs by using the estimated costfunctions shown in the previous chapter.

Without using the estimated cost functions, we can obtaineach area’s total costs by simply using observed total costs.

However, the observed total costs

might include abnormal values in a specific year. Therefore, in this study, we use a calculated
value of total costs.

First, we obtain the calculated variable costs of each area, by substituting

numbers for each area for all explanatory variables into the variable cost function. And then adding
the fixed costs of each area to the calculated variable costs, we can obtain the calculated total costs.
That is, that the output of mail volume, input factor prices and other institutional or geographicalfactors in each area are controlled to obtain the variable costs.

(3) Step 3: Obtain the average total cost and the uniform tariff of the postal service
In this step, the average total cost of the postal service of each area and the uniform tariffof the postal service are obtained.

First, the average total cost of postal service of each area isobtained by dividing the total costs, shown in equation –(4), by the total output of each area (Q).
As for the uniform tariff (p), we use the average revenues per output as the uniform tariff.
That is, the uniform tariff is defined as dividing total postal service revenues (TR) by total output (Q).
In fact, as the Japan Post provides several kinds of services such as letters, cards, and parcel delivery
services and each individual service has its own uniform tariff.

However, as we treat a single

output model in this study, we divide postal service revenues by a single output measure.

19

Singleoutput measure (Q) is calculated based on Mizutani and Uranishi (2003).

(4) Step 4: Define the profit-making and the deficit-making areas
The unit profit of each area (π) is expressed as the difference of the uniform tariff and theaverage cost of the output (π = p – AC).

The profit-making areas and deficit-making areas are

identified by the unit profit of each area.

The deficit-making area is identified by showing thenegative unit profit as follows.
The profit-making areas if π >0 in a area
The deficit-making area if π <0 in a area(5) Step 5: Estimation of the USO cost
The USO cost (CUSO) is defined as the total sum of deficits of the deficit-making areas asfollows.
CUSO = Σm (πm Qm)(5)

m: deficit-making area (πm < 0, m ∈ n)n: number of total areas

5.4.

The Estimation of USO Costs and Policy Effects on USO Costs
In this section, we will evaluate how much the USO costs, by following the procedure

which we explained in the previous section.
the postal service in 2002.

The base case (Case 1) shows the current situation of

Furthermore, we will estimate two more cases: the case of theabolishment of the special post office (Case 2) and the case where privatization is carried out alongwith the abolishment of the special post office (Case 3).
For these cases, we will estimate the USO costs by following the procedure shown in theprevious section.

In order to estimate the USO costs, we make some assumptions.

The important

assumptions taken here are as follows.
First, in the case where the special post office is abolished (Case 2), we assume the costsof the post office are reduced by 20.1%, an assumption based on the result of cost model-1C insection 4.

In the variable costs of the special post office, rental fees for buildings are included.

Although based on Japan Post’s report, the amount of rental fees of buildings paid for the special
post office comprises about 10.3% of cost reduction, leading us to assume that the abolishment effectof the special post office is 9.8%4.

4(The true effect of abolishing the special post office) = (the effect of the special post office in the cost20Second, we did not distinguish the managerial forms of the non-C&D type post office inthe cost estimation because the number of non-C&D type ordinal offices is so low.

In thisestimation of the USO costs, we assume that the abolishment of the non-C&D type of special post
office can also attain the same cost reduction of 9.8%.
Third, we assume that privatization also could reduce the cost of the post office.
Although ownership is not the only factor relevant to efficiency, much empirical evidence supports
the assertion that privatization attains productive efficiency (e.g. see Tittenbrun (1996)).

The

numerical information used here is followed by our econometric study on the privatization of theJapan National Railway (see Mizutani and Uranishi (2005)).

Although Mizutani and Uranishi(2005)’s study pertains to the railway industry, there are similarities between the privatization of theJapan Post and that of the Japan National Railways.

For example, at the first step, the ownership of

the reformed organization remains in the public sector, although the management of the organization
becomes more like that of a privately owned company.

Furthermore, services which are considered

non-marketable are supported by the government through the establishment of a special fund.
Based on Mizutani and Uranishi (2005)5, as a rough approximation of the effects of the privatizationof Japan Post, we consider it acceptable to assume that the privatization effect is a 2.56% cost
reduction in the first year and that the reduction rate thereafter declines annually.
The estimation results of the USO costs are summarized in Table 7. First, the current costof the USO is about 348 billion yen, which accounts for about 17.3% of the total revenues of the
postal service.

Many people have observed that many areas (prefectures) are showing deficits, andindeed 38 areas are deficit-making.

Thus, in the postal service division, about 9 profitable areas

support many deficit-making areas in order to maintain the USO.
Second, when the special post offices are replaced by the ordinal post offices, the USO
costs become about 273 billion yen, as Case 2 shows.
Case 1.

That is a 21.5% reduction compared withIn Case 2, the share to total revenues of the postal services also decreases to 13.5%.

Thus,

the abolishment of the special post office reduces the USO costs considerably.
Last, the effects of privatization are shown in Case 3. As operating costs are reduced due
to privatization, the USO costs are also reduced. However, the effects seem not large: the USO
costs are about 251 billion yen, which represents only an 8% reduction, compared with Case 2.
Furthermore, the deficit-making areas do not change much, compared with Case 2.

The reduction

effects based on Mizutani and Uranishi (2005)’s study are almost ending at about 12 years after
privatization.

function) – (the effect of the rental fees paid to the special post office) = 20.1% - 10.3% = 9.8%
5
From Mizutani and Uranishi (2005)’s result, if other conditions are fixed at the sample mean, theprivatization effect on the variable cost is obtained as follows: ∂lnVC/∂R = -0.0280 + 0.0024R, where
VC: variable cost, R: time trend after privatization. The reduction rate of VC is diminishing and it turns
to zero 12 years after privatization.

21

Table 7. The Effects of Special Post Offices on the USO Cost in 2002 (Real Value: Base Year =2000)
Case 1:Case 2:
Case 3:
Base Case
Abolish Special Post
Privatization with no
Officespecial post office
USO cost
348,469
273,429
251,462(million yen)
Share of USO cost to
17.3%
13.5%
12.5%
total revenue
Numbers of
9 (19.1%)
10 (21.3%)
12 (25.5%)
profit-making areas
Numbers of deficit38 (80.9%)
37 (78.7%)
35 (74.5%)
making areas

6. Concluding Remarks
The main purpose of this paper was to analyze the special post office and evaluate themagnitude of universal service obligation costs.

In our previous study, Mizutani and Uranishi(2003), we found that the introduction of competition did not contribute to efficiency in the publicagency (the Post Office), although many researchers have asserted that the competitive environmentis important. Our unusual finding might be due to the existence of the special post office.

Fromempirical analysis, we obtained the following results. First, the cost of the special post office isabout 9.8% higher than that of the ordinal post office. Second, the USO costs are about 348 billion
yen in the current situation.
services.

The USO costs account for 17.3% of total revenues of ordinal postal

Furthermore, about 81% of total prefectures are classified as deficit-making areas.

Third, if we abolish the special post office, the USO costs will be reduced to 273 billion yen. Last,even if privatization of the Japan Post achieves the improved performance seen in the case of theJapan National Railway, the USO costs will still be large at 251 billion yen.

The special post office

was usuful in the beginning in creating an extensive Japanese postal network, but their role may beunnecessary in a modern Japan.

Our results imply that a reorganization of the Japan Post will benecessary.

[2006.2.27

745]

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