2 014
SpecialEdition48
4
Special Features

Regional Integration and Cultures in theAge of Knowledge Creation–The Story of the Tower of Babel Revisited–
Masahisa Fujita, President, RIETI

Multilateralizing
21st Century Regionalism
Richard E. Baldwin,
Professor, International Economics,
the Graduate Institute, Geneva
2013 in Review:

Overlooking RIETI’s activities andresearch findings
Introduction of the 9 Research Programs48
2014 Special Edition
1

Contents

Chairman’s Statement
About RIETI

Special Features
President s lecture2

Regional Integration and Cultures in theAge of Knowledge Creation−The Story of the Tower of Babel Revisited−
Masahisa Fujita, President, RIETIBBL seminar

8

Multilateralizing 21st Century Regionalism
Richard E. Baldwin,
Professor, International Economics, the Graduate Institute, Geneva

2013 in Review:
Overlooking RIETI s activities and research ﬁndings
Symposium
14“The Science of Japanese Personnel Management−Rethinking employment systems in the era of globalization”

Essays and Columns
15“Reduced policy uncertainty and the Japanese economy”
Masayuki Morikawa, Vice Chairman & Vice President, RIETI

18“What We Can Learn from the History of Government Debt”
Arata Ito, Fellow, RIETI

22“Is the negative impact of FDI real? Empirical evidence from Japan”
Ayumu Tanaka, Research Associate, RIETI

Research Digest
24“Re-estimating the Rate of Deflation in Japan”
Tsutomu Watanabe, Faculty Fellow, RIETI

29“Cohort Size Effects on Promotion and Pay”
Daiji Kawaguchi, Faculty Fellow, RIETIIntroduction of the 9 Research Programs
36
38
40
42
44
46
47
48
49

International Trade and Investment
International Macroeconomics
Regional Economies
Technology and Innovation
Raising Industrial and Firm Productivity
New Industrial Policy
Human CapitalSocial Security, Taxation, and Public Finance
Policy History and Policy Assessment

What is RIETI Highlight?
RIETI’s public relations magazine “Highlight” is published quarterly, featuring RIETI’s most recent activities with the objectiveof disseminating research outcomes to a wider audience. This special edition has been edited in English in order to reach ourinternational readers.

Chairman s Statement
In 2013, we saw an indication of gradual improvementin the global economy. The economy in the eurozone
began to pick up even as the grave debt crisis continued.
The U.S. economy expanded enormously toward theyear end due to a lively stock market and robust personal
consumption.
The Japanese economy also grew rapidly in 2013,
partly backed by the gradual improvement in the global
economy, but due largely to Abenomics—a set ofdynamic economic policies which include bold monetaryand financial policies and growth strategies.
However, Abenomics is not a panacea for therevitalization of Japan’s economy as its policies andstrategies aim to support and restore the private sector’svitality. It means that only when the private sector’svitality is revived will we succeed in reinvigorating
Japan’s economy. Therefore, whether or not Abenomics
can invigorate Japanese firms will draw full attention
throughout this year.
As a policy think tank that conducts research to makepolicy proposals, the Research Institute of Economy,
Trade and Industry (RIETI) has been implementing thethird medium-term plan (fiscal 2011 to fiscal 2015).
Under the plan, we place emphasis on the following
Three Priority Viewpoints: i) incorporating growth of
the world economy, ii) developing new growth areas,
and iii) creating new economic and social systems forsustainable growth, which we invariably bear in mind
when proceeding with research activities.
We continued to focus on the Three Priority Viewpoints
in 2013, and actively conducted research and hosted
symposiums on a variety of issues such as the quake
revival, corporate competitiveness, human capital, tradeand currency, and innovation, while examining overseas
and domestic economic circumstances and the effects of
Abenomics.
For 2014, invariably centering on the Three Priority
Viewpoints, we will continuously engage in performing
critical and in-depth analyses that are linked to theeconomy and industry. Over and above this, we will
endeavor to conduct research and hold symposiums in
response to trends in the economy both domesticallyProﬁle2011-Present Chairman, RIETI
2004-2011
Senior Managing Executive Officer & Chief Economist,
Mizuho Research Institute, Ltd
2001-2011
Regular Commentator of World Business Satellite (TVTokyo)
2000
Chief Economist & General Manager, Research
Department, Head Office, IBJ
1999
President, Banque IBJ (France) S.A.
1975
Joined Industrial Bank of Japan, Ltd. (IBJ)
His works are as follows: Nihon no Toppako (Japan’s Breakthrough),
Tokyo Keizai Inc., 2011; Sekaikeizai: Rensasuru Kiki (Global Economy:
Chain-reaction Crisis), Toyo Keizai Inc., 2009; Chugoku Jinmingen no
Chosen (Challenge of China’s Yuan), Toyo Keizai Inc., 2004; Nihon
Keizai no Risuku Shinario (Risk Scenarios for the Japanese Economy),
Nihon Keizai Shimbun, Inc., 2004

and abroad, and enhance research collaborations withJapanese and foreign policy think tanks.
In our research activities, RIETI also focuses on
disseminating our various research findings. We havebeen managing and providing databases to the public
on the economy, industry, and social issues which are
related to our research areas. We will constantly strive to
be engaged more deeply in such activities in 2014.
In the special edition of the RIETI Highlight Vol. 48,
our notable research findings and activities conducted
in 2013 are unveiled and discussed under the title,“Review in 2013: Overlooking RIETI’s activities andresearch findings”—not only our research programs but
also symposiums and seminars, and popular content
such as “Research Digest” and columns. We hope that
this special edition will be helpful in spreading ourresearch activities and findings and in deepening theunderstanding of trends in the global economy.

Atsushi Nakajima
Chairman, RIETI
About RIETI
RIETI, an incorporated administrative agency, was founded in April 2001 as a government-affiliated policy research institute with acertain degree of independence from the administrative authorities. RIETI endeavors to analyze and research various policy issues
from a medium- to long-term perspective, thereby accumulating the necessary knowledge to formulate and recommend policy
options.

RIETI Highlight 2014 Special Edition 1

President’s lecture
Keynote lecture at the 53rd European Regional Science Association Congress

Regional Integration and Culturesin the Age of Knowledge Creation—The Story of the Tower of Babel Revisited—
Masahisa Fujita
President & Chief Research Officer, RIETI
Professor, Konan University
Adjunct Professor, Institute of Economic Research, Kyoto University

Palermo, Italy in August 2013, Masahisa Fujita, a leading economist in the field of spatial economics andPresident and Chief Research Officer of RIETI, delivered a keynote lecture entitled “Regional Integration andCultures in the Age of Knowledge Creation—The Story of the Tower of Babel Revisited—” at the 53rd European
Regional Science Association (ERSA) Congress. ERSA is the supranational association of national regional
science across Europe. Its members are academics, policy professionals, and researchers who are interested inspatial economics and planning, regional and local development, and related issues. Fujita addressed that thefundamental resource in the Brain Power Society is the individual’s brain power, and that diversity would play avital role in creation of new knowledge and development of innovation.
he purpose of my presentation is to give you
an overview with regard to the importanceof diversity and culture in the sustainable
development of the global economy based on innovationand the creation of new knowledge throughout the world.
I will speak on this in connection with the main themeof the congress of ERSA, namely, “Regional Integration:
Europe, the Mediterranean and the World Economy.”
In the light of globalization concerning production andtrade of traditional goods, no one would disagree that thelower the transport costs are, the greater is the efficiency.
However, in the light of the development of the Brain
Power Society, in which the creation of new knowledge
or innovation has become the major activity of mostcountries and regions throughout the world, can we saythat for the production and transfer of “knowledge”
broadly defined, the lower the communication barriers
are, the better is the outcome? In other words, is paradisefor the Brain Power Society a world of effortlesscommunication with no communication barriers?
The advantage of Europe is that so many diverse cultures,
languages, and people are gathered in a relatively small
region, which can enhance the development of Europe.
Therefore, the motto of the European Union (EU) is“United in diversity.” In general, much as it is true that
distance, space, and multiple languages erect barriers
to communications, each region could develop its own
unique culture and knowledge.

2 RIETI Highlight 2014 Special Edition

Why are diversity and culture
important for the Brain Power
Society?
The fundamental resource in the Brain Power Societyis the individual’s brain power, namely, the knowledge
in our brains. However, two brains that are exactly
alike do not yield any synergy. Similarly, in thecontext of interregional and international cooperation
for innovation, diversity in culture creates synergy ininnovation activity.
There is an old adage that tells us, “With three ordinary
persons together, splendid ideas will come out.” Thiscan be set into practice when the three persons aredifferent from each other in terms of their knowledge
composition—new knowledge creation is attributable
to the fusion of different knowledge through a common
one. Despite the fact that these persons have sufficientdifferences in their knowledge composition when theymeet for the first time, if they continue working together
for too long, then their common knowledge expands
relatively while the differential knowledge of each
person shrinks gradually, and thus the synergy becomesincreasingly less. Eventually, “after three ordinary persons
meet for three years, no splendid ideas will come out.”
During the 1980s, the Japanese economy had been
growing rapidly, and some people expected that theJapanese economy would surpass the U.S. economy soonand become the number one in the world. At that time,
I was teaching at the Wharton School at the University

ProﬁleAccording to the Book of Genesis in the Bible, once
upon a time, somewhere in the Mesopotamian region,
there was a powerful empire that spoke a single language.
However, people there became too uppity and arrogant,and they started building a giant tower reaching toward
heaven, thus challenging God. God became angry andconfounded their language by introducing many different
languages and scattered them upon all the face of the
Earth, with each region speaking a different language. In
terms of this story, I would like to pose a question: Was ita punishment or a blessing in disguise? Or, is it true thatthe world with a single culture can outweigh the world
with many regions with different cultures?
In investigating this question, I pose a related question

Diversity and creativity
̶soft evidences
There are some soft evidences about the importance ofdiversity for creativity. One of them is an interestingarticle on Japanese culture by Yoko Tawada, aninternationally renowned writer.
Tawada, who won the Akutagawa Prize and Tanizaki
Prize in Japan, the most prestigious literature prizes
in Japan, as well as the Lessing Prize and the Goethe
Medal in Germany, was born in Tokyo but also lived
in Germany for 26 years, writing both in Japanese andGerman. In the article, she answered, “While I was inJapan, nothing evolved from it, neither curiosity nor
desire, I never thought much about my own culture; it’s
the difference between the two cultures that made me
productive, not the Japanese culture as such.”
It is interesting to compare the episode of Yoko Tawada
to the effects of the shinkansen on Japan. The shinkansen
opened in 1964, when the Tokyo Olympics were held,and contributed much to making Japanese culture
homogeneous. Partly because of it, Japan eventuallybecame monopolar, not only in terms of politics,
business, and the economy, but also culturally dominatedby Tokyo. Has the shinkansen contributed to enhancing
the creativity of the Japanese society?
RIETI Highlight 2014 Special Edition 3

Introduction of the 9 Research Programs

In the early 1990s, what Japan, which became one of the
top countries in terms of per capita gross domestic product(GDP), needed was a more diverse group of people for
exploring the cutting edge of the knowledge frontier andinnovation. On the contrary, however, too much close
communication among Japanese people made them too
homogeneous for the purpose of cutting edge innovation.
How can we resolve the fundamental antinomy between
the short-run effect and the long-run effect in knowledge
cooperation? The story of the Tower of Babel might give
us a clue to solve this problem.

on information communications technology (ICT).
Does ICT really enhance knowledge productivity? The
development of ICT, without doubt, has greatly enhanced
the transfer speed of knowledge and information. On
the other hand, each person has a limitation in absorbing
new information and knowledge, and it is not obvious
whether the development of ICT will advance ordiminish the creativity of people.

2013 in Review

of Pennsylvania, and people there were wondering what
would be the secret of Japan’s success. One answer
to this is the so-called “nominication,” or learningby drinking. People working in companies in Tokyo
often go drinking together after work, and keep talking
and communicating through sake or wine over a long
evening. When Japan was in the process of catching up
to the United States and European economies, I believe
nominication contributed to Japan’s success to a large
extent.

Special Features

Masahisa Fujita’s expertise includes urban and regional economics,
regional development, spatial economics, and international economics.
He obtained his Ph.D. in regional science from the University ofPennsylvania in 1972. Prior to his current position, he was a professor
at the Department of Economics, University of Pennsylvania (1994–95)
and a professor at the Regional Science Department, University ofPennsylvania (1986–94). He is a member of the American Economic
Association, the Japanese Economic Association, the EconometricSociety, and the International Regional Science Association. Selectedpublications include: The Economics of East Asian Integration (writtenwith Ikuo Kurosawa and Satoru Kumagai, Edward Elgar, 2011);
Economics of Agglomeration (written with J F Thisse, Cambridge
University Press, 2002); The Spatial Economy (written with P Krugman
and A Venables, MIT Press, 1999); Urban Economic Theory, Cambridge
University Press, 1989; and others.

President’s lecture
There are about 36 million people living in theTokyo Metropolitan area, which is by far the biggest
agglomeration of people in a single metropolitan area inthe world. A survey shows that from 1982 to 2000, thetotal number of patent applications in Japan increased
steadily, but since 2000, it has started decreasing steadily,
while Tokyo’s share in the applications kept increasing
until 2008, and finally started decreasing just recently(Fig. 1). This suggests that excessive concentration ofknowledge workers and cultural activities in Tokyo
has been causing the Japanese people to become toohomogeneous in terms of their knowledge composition,
which in turn has caused the knowledge productivity of
the Japanese people as a whole to decline. Indeed, thenumber of Japan’s patent applications was at the top in
the world until 2005, but it started declining in 2002.
In contrast, the United States, China, and Korea havebeen growing rapidly in terms of patent applications. In
particular, the United States surpassed Japan in 2006, andChina is now at the top in 2011.
Figure 1: Tokyo concentration and patent applications in Japan

Share of Tokyo in patent applications(By courtesy of Professor Nobuaki Hamaguchi at Kobe University)
0.53
0.52

2008

2010
1985

0.51
1983

2011
2005

0.5
0.49

1996

1982

0.48
0.47
0.46
2000002000
250000300000350000 400000
National total in patent applications

Furthermore, there is an interesting change in the shareof each major country in the international papers with
American co-authors (papers written under the coauthorship of Americans in the United States and nonAmericans residing outside of the United States) over thelast 10 years. The United States is the largest international
hub of academic activities today. It is not surprising that
English-speaking countries such as England and Canada
have high shares. Interestingly, Germany also maintains
a strong academic connection with the United States.
In contrast, the Japanese academic connection with theUnited States has been declining relatively, indicatingthat the Japanese academic society is becoming relatively
insular. On the other hand, the share of papers coauthored with Chinese scholars is increasing as fast as
China’s GDP growth (Fig. 2).

4 RIETI Highlight 2014 Special Edition

Figure 2: The share of each country in the international
papers with American co-authors(%)
14

England

China

12

Germany
Canada10
France
8
Japan

6

4
1999-2001

07-09

08-10

09-11

Source: The Ministry of Education, Science and Culture, Japan, May 2013

In a study by Professors Fritch and Graf from Jena
University in Germany, two representative research cities
in the former East and West Germany were compared.
Each city has a population of about one million people
with an elaborate network of research cooperation
within the city or region. In comparing the cities, thelinks between the research institutions in each city
are much denser in East Germany. According to the
traditional explanation of the importance of knowledgenetwork density in research productivity, East German
cities should have higher productivity. The actual result
nevertheless is exactly the opposite. In terms of percapita patent registration, West German cities have about
twice as many as that of East German cities. The denseinternal linkage means the linkage with the outside
world is rather weak, which is the opposite state of West
German research cities. Their findings indicate that wider
research cooperation can raise productivity.
Moreover, Ottaviano and Peri in a 2006 paper compared
U.S. cities and concluded that, in terms of their wages,
U.S.-born citizens are more productive in a culturally
diversified environment. Similarly, Bellini, Ottaviano,
and others compared European regions in terms ofcultural diversity and economic performance. They
demonstrated the positive correlation between diversity
and productivity and that higher diversity brings about
higher productivity.
Another good example of the importance of diversity
for creativity is the data on the National Institute forMaterial Science (NIMS) in the research town of
Tsukuba in Japan. NIMS has the largest number offoreign researchers—about 600. In 2004, NIMS was
designated as a center for young researchers. Then, in
2007, it was designated as the International Center for
Materials Nanoarchitectonics (MANA). Since then,
NIMS has made great efforts to increase the number offoreign researchers. The proportion of the number offoreign researchers, which, at the start of 2001, was lessthan 4%, now is approaching 25% (Fig. 3).
Figure 3: Share of foreign researchers at NIMS

20

2011

15
10
5
2001

ICYS

MANA

H
13

.4
H
14
.4
H
15
.4
H
16
.4
H
17
.4
H
18
.4
H
19
.4
H
20
.4
H
21
.4
H
22
.4
H
23
.1

0

Programs: MANA=International Center for Materials Nanoarchitectonics;
ICYS=International Center for Young Scientists
Source: Ariga and Urao, “Productivity enhancement of a research institutethrough the contribution of foreign researchers,” Science & Technology Trends
No.127, January-February 2012, Ministry of Education and Science

Table 1: World ranking in terms of citations in materials
science

Institute
Citation
1 Max Planck Society 25739
2 Tohoku Univ.
23891
3 MIT
18568
4 UC Santa Barbara 17338
5 Penn. State Univ. 15503
6 Chin. Acad. Sci. 15101
7 Univ. Cambridge 14977
8 Kyoto Univ.
13301
9 Osaka Univ.
12575
10 Russ. Acad. Sci. 12556…
10474
18 NIMS

Recent 5 years（Jan. 2007 to Jan. 2011）
Institute
Citation
Chin. Acad. Sci.
45576
Max Planck Soc
16318
MIT
11514
11266
NIMS
Natl. Univ. Singapore 11209
Tsing Hua Univ.
10436
Tohoku Univ.
10291
Georgia Tech.
9463
Ind. Inst. Tech.
9459
Univ. Manchester
9197

Source: Ariga and Urao, “Productivity enhancement of a research institutethrough the contribution of foreign researchers,” Science & Technology Trends
No.127, January-February 2012, Ministry of Education and Science

My recent research work on modeling the dynamics ofthe Brain Power Society focuses on how the diversityof knowledge workers and the local culture develops
endogenously, furthermore, how it is related with thegrowth rate of knowledge in the whole society and,
consequently, with the growth rate of world economy.
Among these questions, I concentrate on how thediversity of knowledge and local culture affects thegrowth rate of knowledge in the whole society.
I have conducted a joint research on the question above
with Marcus Berliant at Washington University in St.
Louis, and “Knowledge Creation as a Square Dance on
the Hilbert Cube” is the first paper we have co-authored.
The next paper represents the fusion with the endogenous
growth theory and the dynamics of knowledge diversity.
And recently, we extended this single-region model to a
multi-region model, introducing culture and diversity inknowledge creation.
The square dance was very popular in the era of the Wild
West in the United States. Square dancing in principle
requires eight people. Each person dances with his/herpartner and then quickly exchanges partners. There is avariety in the formations of eight persons. I have recently
written three papers with Marcus Berliant. After all, we
met only for three or four weeks per year. I worked withother people for the rest of time while Marcus Berliant
also worked with other people. Thus, we are essentially
RIETI Highlight 2014 Special Edition 5Introduction of the 9 Research Programs

11 years before being
designated as ICYS/MANA（Jan. 1994 to Dec. 2004）

Modeling the dynamics of the Brain
Power Society

2013 in Review

As a result, NIMS has become one of the leading
research institutions in the world in terms of citationsin the field of material science. Before starting the realpromotion of inviting foreign researchers, between 1994
and 2004, it was ranked 18th in terms of citations inmaterials science. After promoting internationalization,
inviting many young foreign researchers, its ranking
in terms of citations between 2007 and 2011 moved to
the fourth place (Tab. 1). Furthermore, among the top
31 papers at NIMS, 24 were written collaboratively
by Japanese researchers and foreign researchers.
This represents a good example in showing how thediversification of knowledge workers has increased
productivity in a research institution.

Special Features

Share of foreign reseachers (%)

25

The issue of “cultural exception” is becoming a
stumbling block in recent EU-U.S. trade talks. In June
2013, France successfully lobbied the EU to exclude
cultural industries such as film, music, and televisionfrom the EU-U.S. trade talks. The United Nations
Educational, Scientific and Cultural Organization(UNESCO) also reaffirmed the sovereign right ofgovernments to adopt measures to protect and promote
the diversity of cultural expressions. It is understandable
that many countries want to protect their own culturalindustries against big countries. However, the study on
the global music consumption and trade since 1960 torecent years carried out by Ferreira and Waldfogel at
the University of Pennsylvania shows that, contrary to
growing fears about large-country dominance, substantial
bias towards domestic music exists. They conjecturethat the rapid development in ICT over the last half
century helped the consumption of domestic music morethan for foreign music. The important policy issue is
how to enhance the creativity of cultural industries ineach country or region, not how to protect them against
foreign exports. When every country and region becomes
more creative in the promotion of its own culture, theentire world would become richer culturally.

President’s lecture
performing international square dancing in developing
new papers, which is very typical in regional science andeconomics.
The figures from Peter Gordon’s recent paper (2013)indicate that most people in regional science are square
dancing in developing new papers. Among the papers
published recently in the Journal of Regional Science,about 60% are collaborative papers. Moreover, amongsuch papers published in 2010 and 2011, 45% are based oninternational collaboration, and about 30% are written byauthors in different cities (Figs. 4 and 5). Over and above
this, in the American Economic Review in 2012, 82% of
the papers were co-authored, and in Quarterly Journal
Economics in 2012, 88% of the papers were co-authored.
Figure 4: Journal of Regional Science author locations, 19592011 percentage of collaborative papers
(%)
70

60

50

40

1
10

-1

1
20

00

-0

1
20

90

-9

1
19

19

80

-8

1
-7
70
19

19

59

-6

3

30

States) have the same number of knowledge workers
or researchers. As knowledge workers and researchers
in the same regions can easily communicate, intrainteraction is very dense. Because of the traveling timeand cost, however, interregional research cooperation is
not easy between the two regions.
Furthermore, there is much weaker knowledge transferfrom region B, or the United States, to region A, orJapan, and vice versa. Few Japanese people read
American newspapers and watch American television. If
we take two typical persons in region A, their common
knowledge is relatively large. The same applies to region
B.
In contrast, if one person is taken from region A andregion B respectively, then naturally their common
knowledge is relatively much smaller. This means that,within each region, the common knowledge is large
while internationally or interregionally differential
knowledge is large. For creating incremental innovations,each region can achieve it within itself utilizing its
large common knowledge. When it comes to exploring
the cutting edge of the science frontier such as new
biotechnology and real new software, diversity inknowledge workers is essential. In this case, international
cooperation becomes very important because eachregion has a different culture, and there is large diversity
between regions. In this way, the existence of spatial
barriers in communications will contribute to enhancing
the productivity of knowledge creation for the wholesociety.

Figure 5: Types of collaboration (4 categories)（%）
100

The story of the Tower of Babelrevisited

90

45.1%

80
70
60
50

29.4%

40
30

5.9%

20

19.6%

10
0

1959-63 1970-71 1980-81 1990-91 2000-01 2010-11
Diﬀerent countries
Same city

Diﬀerent cities (Same country)
Same Institution

Source: Peter Gordon (2013), Annals of Regional Science 50, 667-84

Formalizing such an academic square dance in the realworld will account for the basic idea of our culture
and diversity model in the case of two regions. It is
assumed that both region A (Japan) and region B (United
6 RIETI Highlight 2014 Special Edition

Reconsidering the story of the Tower of Babel,before the expulsion from the paradise of effortlesscommunication, all of the 2N people were in one empire,enjoying effortless communication. In this context,
so much common knowledge is being accumulated,
and the capacity for absorbing common knowledge incomparison to the creativity of each person becomes
relatively important. Assuming that this capacity is
sufficiently large, as a consequence, the equilibrium
point in the paradise of effortless communication is
given in the red point in the figure, meaning much lower
productivity than the bliss point.
■ Phase 1
God expelled 2N people from the paradise and divided
them into two regions. Each region has N people and adifferent language. Just after the expulsion, not muchhappened because they still inherit the same culture.
Given this situation, since the interregional cooperation
decreases productivity, people in each region cooperate
only internally. Furthermore, interregional knowledge

■ Phase 2
In which the interregional difference in knowledge
composition becomes large enough so that the
productivity in the interregional cooperation becomescomparable to that in the intraregional cooperation. In
the situation of Phase 2, each person in each region uses
a certain proportion of time not only for intraregional
knowledge cooperation, but also for interregional
knowledge cooperation. Therefore, each person canaccumulate both effectively large common knowledge
within the same region and large differential knowledge
between the two regions. As a consequence, they can
gradually move upwards both in intraregional andinterregional productivity.

Are towers abhorrent to us? The tower constructed by asingle empire might be no good for us. On the contrary,
it is delightful to let hundreds of towers bloom all over
the world, with each tower representing a unique local
culture. Indeed, led by the Leaning Tower of Pisa, acountless number of wonderful towers have been built
throughout the world. Animals can also build towers, andone ant species, for instance, can build an approximately
7-meter high anthill. I like the tower made of humanbeings, and there is such tower in Tarragona, Spain,
which represents a real human collaboration.
Finally, words from the epilogue of the famousbook by August Lösch, Die räumliche Ordnung derWirtschaft [Spatial Order of Economy] are cited here:“If everything occurred at the same time there would
be no development. If everything existed in the sameplace there could be no particularity. Only space makes
possible the particular, which then unfolds in time. Only
because we are not equally near to everything; only
because everything does not rush in upon us at once; only
because our world is restricted, for every individual, for
his people, and for mankind as a whole, can we, in our
finiteness, endure at all. Space creates and protects us inthis limitation. Particularly is the price of our existence.”■ Phase 3
They eventually reach the highest point in terms of theinterregional productivity, which is called the “New
Eden.” At this stage, every person achieves much higher
knowledge productivity than in the original effortlesscommunication paradise. Therefore, the growth rate ofknowledge in the whole society at the New Eden is muchhigher than that in the original effortless communication
paradise.

This example shows that, by breaking one region into two,
the whole society can achieve a remarkable improvementin knowledge creation over the one region case. This canhappen even when the interregional cooperation is rather
costly.

From the left, Prof. Roberto Lagalla of the Rector of the University of Palermo;
President Fujita; Prof. Fabio Mazzola of the University of Palermo; Andrés
Rodríguez-Pose, the president of ERSA for the next term

Let us recall our original question: Was the expulsion
from the paradise of effortless communication to a
multiregional, multilingual, and multicultural world apunishment or a blessing in disguise? The results of ourmodel suggest that it was the latter.
RIETI Highlight 2014 Special Edition 7

Introduction of the 9 Research Programs

In Phase 2, interregional knowledge diversity as well as
intraregional knowledge diversity increases gradually.
This is because interregional interactions take place
in a particular manner. Providing that, for example,
Japanese economists work together with their Americancounterparts, the former is not working equally withevery economist in the United States. In practice,
American economists and Japanese economists form
many different groups, such as the Harvard group,
Yale group, Chicago group, Stanford group, and soforth, in which they closely work together becauseof group externalities. Within the same group, they
enjoy strong group externalities, while intergroup
externalities are relatively weak. Since all economists
are divided into a large number of groups, for instance,
Japanese economists also develop heterogeneity among
themselves. This is why the interregional cooperation
also promotes the intraregional knowledge diversity.

2013 in Review

Conclusion: Let hundreds of towers
bloom

Special Features

spillover is naturally weak. Therefore, sooner or later,
each region develops its own culture.

BBL seminar

Multilateralizing 21st Century
Regionalism
Richard E. Baldwin
Professor of International Economics, the Graduate Institute, Geneva

Brown Bag Lunch (BBL) seminars are held during lunch hours. RIETI invites Japanese and foreign guest
lecturers and provide a venue for candid exchange of opinions on a variety of policy issues, transcending
industry-government-academia boundaries. On July 4, 2013, Richard E. Baldwin, Professor of International
Economics at the Graduate Institute, Geneva, gave his presentation on “Multilateralizing 21st Century
Regionalism” in the seminar. A novel framework for thinking about the costs and benefits of multilateralizing
various deep provisions were suggested in the presentation.

oday’s presentation will cover several key topics
in relation to multilateralizing regionalism.
The first section will explain how 20th century
and 21st century globalization are different and why
this means that 20th century and 21st century trade aredifferent. Following this, I will look at how and why
20th century and 21st century regional trade agreements(RTAs) are different. Finally, I come to the key point.
Since 20th and 21st century RTAs are different,
multilateralization of 20th and 21st century RTAs must
be viewed differently. The main messages are that it
is erroneous to consider multilateralizing 21st century
regionalism (MR21) in the same light as multilateralizing
20th century regionalism (MR20). Having made thispoint, I admit immediately that I do not have all of theanswers. More research is needed—specifically withregard to the legal content of the various 21st century
RTAs around the world and the economic impact of thevarious provisions in them.

Traditional view of globalization
The standard way of understanding globalization atpresent is that a slow transition from a state of “notrade”—or autarky in economics jargon—to one ofcompletely free trade. There are two key points in thistraditional conceptualization of globalization. First, it
is mostly about trade costs. Second, globalization canbe viewed as a single process that has—with some
important setbacks—been shifting the world from nearautarky before the Industrial Revolution to something
approaching free trade. I assert that globalization is
actually two distinct processes. The traditional view—
with its focus on trade costs—was right up until thelate 1980s or early 1990s. After that time, however,globalization should be considered as driven in part by a
new process—although the traditional trade-cost process
is still in effect.

8 RIETI Highlight 2014 Special Edition

Globalization as three cascading
constraints
To explain this, it is useful to conceptualize globalization
as governed by three constraints—not one. Before theIndustrial Revolution, production and consumption
were spatially bundled due to three types of costs: thecost of moving goods, ideas, and people. In the preglobalized world, all three costs were very high, thus
almost everything that was consumed in each village wasmade in the same village. This meant that the world was
effectively broken down into village economies, eachof which consumed almost all of its own production.
The traditional view of globalization considers only the
reduction in the cost of moving goods. The other two
constraints also matter, but before turning to that, it isworth reminding you of the traditional globalization
perspective.

First unbundling: Relaxing thetransportation constraint
The first real shock came with the Steam Revolution.
This produced a radical drop in the cost of transporting
goods due to the development of steam-powered ships
and trains. The cost of moving ideas became easier withtelegraph and telephone, yet both remained extremely
expensive. The cost of moving people was also stillhigh and time-consuming. In a paper I wrote in 2006,
I refer to this period in time as the “first unbundling,”that is to say, lower costs of moving goods allowed forthe spatial unbundling of production and consumption.
Once shipping goods over long distance became feasible,
scale economies and comparative advantage reshaped
the world’s economic geography. Industry concentrated
in some countries and products were sold all over theworld.

Professor Baldwin answered questions from seminar participants.

The next big step came with a revolution in informationand communications technology (ICT). This relaxed
the communication constraint by radically lowering
the cost of moving ideas. This, in turn, led to what I
called the “second unbundling” in my 2006 paper. Moredirectly, this meant that the factories themselves could
be unbundled. Complex manufacturing processes could
be broken down into several stages and organized froma distance. In other words, the ICT revolution allowed
manufacturing to be offshored.

Critical diﬀerences between the ﬁrst
and second unbundling
The main difference between the first and second

Implications for trade
Now I will turn to the implications of these changes
for trade. In the 20th century, goods were bought andsold across borders, and trade was relatively simple.
In the 21st century, trade flows became more complex,
and supply chain linkages were developed. This led
to a reliance on each stage of a supply chain working
smoothly and efficiently, much like a widely-dispersed
factory. As tangible and intangible assets are now
exchanged all over the world, property rights havebecome a necessity for 21st century trade. 21st century
trade is clearly significantly different from 20th century
RIETI Highlight 2014 Special Edition 9Introduction of the 9 Research Programs

Second unbundling: Relaxing thecommunication constraint

2013 in Review

The separation of production and consumption, however,
did not make the world flat in economic geographyterms. Indeed, it was quite the opposite. Being able tosell to the world market favored firms that could achieve
vast scale economies. These new industrial processes,
however, were radically more complex than the old preglobalization processes—think of the contract between a
blacksmith’s shop and a modern steel foundry. What thismeant was that the second and third constraints became
binding. In order to reduce communication and face-toface costs, production was concentrated in factories andindustrial districts. Thus, even as production dispersed
globally, it clustered locally. This local clustering
had very little to do with the cost of moving goods. It
occurred due to the cost of moving ideas and people.
In short, relaxing the transportation constraint led
to a dispersion of activity internationally, but, as thecommunication and face-to-face constraints continued tobind, production was clustered at the sub-national level.

Two critical changes
occurred when the ICT
revolution related the second
constraint. First, managerial,
marketing, and technicalknow-how that used tomove only inside firms within a single nation was now
moving internationally. This led to extremely rapid
industrial growth in the handful of developing countries
which received the offshored stages of production. This
is why the impact of the second unbundling was so
different than the first. The technology “transfers” that
we always thought to be very important for development
was now happening. But it was not a “transfer”—
it was organized inside global value chains (GVCs),
most of which were by multinational firms from theUnited States, Japan, and Germany. The recent sudden
expansion of developing industry in such countries hascome about due to the moving of ideas across borders, as
opposed to how industry grew after the first unbundling.
Trade was previously used for the purpose of selling
goods. However, it is now more important as a meansof producing goods. The second big change is that wehave to start thinking of know-how as firm-specific, notnation-specific. Before the ICT revolution and the boom
in offshoring manufacturing, it was convenient to thinkof a nation’s technology as bundled together with its
labor. Now that offshoring is easy, we see that a nation’s
technology is actually controlled by its firms, and thesefirms can now choose to combine their high technology
with low-wage labor abroad.

Special Features

unbundling lies in the natureof the cross-border flows.
In the first unbundling, it
was mostly goods crossing
borders. In the second
unbundling, many of theflows of goods, ideas, people,
training, and investment thatused to happen only inside
factories now occurred acrossborders.

BBL seminar
ProﬁleRichard Edward Baldwin has been a professor at International
Economics at the Graduate Institute, Geneva since 1991, a part-time
visiting research professor at the University of Oxford since 2012,
Policy Director of CEPR since 2006, and Editor-in-Chief of Vox since
he founded it in June 2007. He was Co-managing Editor of the journal
Economic Policy from 2000 to 2005, and Programme Director of
CEPR’s International Trade programme from 1991 to 2001. Before
that he was a Senior Staff Economist for the President’s Council of
Economic Advisors in the Bush Administration (1990-1991), on leavefrom Columbia University Business School where he was Associate
Professor. He did his PhD in economics at MIT with Paul Krugman. He
was visiting professor at MIT in 2002/03 and has taught at universities
in Italy, Germany and Norway. He has also worked as consultant
for the numerous governments, the European Commission, OECD,
World Bank, EFTA, and USAID. The author of numerous books andarticles, his research interests include international trade, globalization,
regionalism, and European integration. He is a CEPR Research Fellow.

trade—not merely a continuation—as know-how andideas are now a significant part of supply chains.
Another related yet significant factor involves thedevelopment of 20th century trade over time. In thelate 1980s, production sharing and so-called “verticalspecialization” trade within Europe, the United States,
and Canada was common, but little of this occurredNorth-South. However, over the last 20 years, there has
been a shift to North-South production sharing, including
Asian nations. Yet, North-South production sharing has
not been developing to the same degree across all sectors,
and, in fact, growth in trade has mostly developed in thefields of electrical and mechanical machinery.
There are a number of factors to consider in how thisunderstanding of 21st century trade could affect policy.
Rather than considering simply one aspect of trade suchas free trade agreements (FTAs), it is crucial that all
trade disciplines are considered together as a package.
Before starting on this line of reasoning, I should notethat I believe that the case of China is quite different. A
different set of rules apply to China since it can use its
huge internal market as a lever to encourage offshoringeven without providing legal assurances that come withdeep RTAs.

Implications for trade policy
Due to its different nature—in particular its close
association with production sharing—21st century
trade requires different disciplines than did 20th
century trade. These can be broken down into two maincategories. The first is supply-chain disciplines. Theseare essential for connecting the geographically dispersed
stages of production. They include not only liberal
trade policy barriers but also excellent transportation
services, guaranteed business mobility, and guaranteedcommunication services. Rather than thinking of supply10 RIETI Highlight 2014 Special Edition

chain disciplines in terms of lowering tariffs in order tosell more, thinking in terms of ensuring that each partof the chain can work smoothly and efficiently together
may be more beneficial.
The second category of 21st century trade disciplines
are offshoring disciplines. These refer to protectionof companies’ tangible and intangible assets that they
have placed abroad. This ranges from factors such as
international investment to application protection oftechnology abroad and the local availability of businessservices. Looking at 21st century trade as being different
from 20th century trade shows that these factors are alsoa part of modern trade which must be taken seriously as
disciplines in their own right.

Trade policy as a package
Supply-chain and offshoring disciplines work best when
packaged together. In relation to this, 21st century RTAs
represent a convenient package. High-tech firms findsuch packages favorable and are willing to offshore
some of the manufacturing jobs. In turn, developing
nations that wish to join GVCs are generally willingto make certain concessions to be able to do so. Deep
RTAs appear to be the solution in moving forwardwith 21st century multilateralizing of regionalism. The
World Trade Organization (WTO) had issues with the
Doha Development Agenda (DDA), and 21st century
regionalism has developed consequently through the
explosion of growth in bilateral investment treaties(BITs), deep RTAs, and unilateral liberalization indeveloping nations.
To introduce some basic statistics, the WTO databasereveals that the number of RTAs began to increasesignificantly from around the mid-1990s. The numberof related offshoring and supply-chain provisions in
RTAs started to accelerate rapidly from around 1989,

Concrete examples of 21st century
disciplines

In summary, the traditional 20th century view ofregionalism is that RTAs of FTAs are specificallyrelated to tariff preferences, with a simple concept ofpolitical economy. However, 21st century regionalism
is more closely related to disciplines which underpin
second unbundling. Therefore, it could be argued thattraditional analysis is insufficient and irrelevant for 21st
century regionalism. It is now more appropriate to utilize
regulation-economics as opposed to tax-economics inanalyzing current 21st century regionalism. Furthermore,
the basic political economy is different in 21st century
regionalism than it was in 20th century regionalism.
In 21st century regionalism, interest groups between
countries are very diverse. Developing countries tend to
aim to satisfy national industrialization strategies throughFTAs, whereas in advanced economies, FTAs tend tosatisfy the development of GVCs.

Multilaterizing 21st century
regionalism
Having laid out the differences between the first andsecond unbundling and the associated types of trade
and trade policy (what I called 20th century trade and21st century trade), I turn now to the multilaterizing
21st century disciplines that are embedded in 21st
century RTAs. Let us start, however, by recalling what
multilateralization of 20th century RTAs involved.

A key distinction between shallow and deep RTA
provisions is that the latter is non-discriminatory, or atleast much less obviously discriminatory. And this isby their very nature—not by policy design. At the heartof this lower degree of discrimination is the difficult ofascertaining the nationality of companies, services, andintellectual property in today’s interconnected world.

With regard to supply-chain disciplines in RTAs,
examples include customs cooperation, beyond WTO
GATS liberalization, FTA of industrial goods, and visa
disciplines. Examples of offshoring disciplines include
TRIMS, GATS, TRIPS, competition policy, IPRs,
investment, movement of capital, and the approximationof laws. As GATS is mentioned as both a supply-chain

Nowadays, it is difficult to pinpoint specificallywhere the value-added originates or the nationalityof companies. Of course, we all know that Sony
Corporation is a Japanese company, but when it comesto the North American Free Trade Agreement (NAFTA),
Sony USA is largely treated as a U.S. company as far as
Mexico and Canada are concerned. This also applied toMultilateralizing regionalism in the 20th century focusedon extending tariff preferences, rules of origin, and rulesof cumulation in order to reduce discrimination. The
concept of multilateralization was to go from bilateral
to multilateral agreements in gradual steps, eventuallyleading to worldwide free trade. 21st century RTAs still
include a similar concept, but they also revolve arounddeeper disciplines that support global supply chains.

RIETI Highlight 2014 Special Edition 11

Introduction of the 9 Research Programs

Japan’s RTAs in the WTO database tells a slightly
different story from those of the United States. Japan
has a much higher percentage of visa and asylum-related
RTAs, with a similar percentage of movement of capitaland investment provisions. The United States and Japan
in particular use RTAs to underpin value chains. The
value chains of the EU tend to be within the EU itself,
and it does not have to sign such deep agreements as do
Japan and the United States. As a result, it may have amuch less clear interest in underpinning GVCs through
RTAs, as the EU represents the ultimate RTA in itself.
A pattern can be seen by investigating RTAs conductedby all countries in the world. The categories of visa andasylum, movement of capital, intellectual property rights(IPRs), investment, and competition policy have thehighest rate of RTAs in the world as a whole, and it iseasy to imagine that they are the most strongly related tothe current GVCs.

2013 in Review

In order to discuss more specifically the meaning of 21st
century regionalism, the agreements which have beensigned by the United States, Japan, and the European
Union (EU) should be mentioned. In looking at thefrequency of each provision in the United States in the
WTO database, preference is clearly given to those which
are both mentioned in WTO 1.0 along with having deeper
RTAs in place. Examples of this include tariff cuts,
Trade Related Aspects of Intellectual Property Rights(TRIPS), Trade Related Investment Measures (TRIMS),
the General Agreement on Trade in Services (GATS),and public procurement. In terms of provisions which
are not included in the WTO such as visa and asylum,
movement of capital, and labor market regulation,
there is actually a percentage of U.S. agreements which
include such provisions as well. In the United States,
a high percentage of bilateral agreements include themovement of capital and are legally enforceable.

discipline as well as an offshore discipline, it would be
beneficial to research which aspect of GATS matches
each discipline.

Special Features

and the number of BITs started to rise rapidly sincearound 1988. In the mid-1990s, developing countries
started unilaterally lowering tariffs. This information
paints a picture of 21st century regionalism as one ofdeep agreements, BITs, and unilateral liberalization.
Developing countries have made their economies morebusiness-friendly, although this is difficult to document
prior to 2005.

BBL seminar
capital as banks tend to operate on a multilateral scale.
As a consequence, rules of origin on deep provisions are“leaky”—it is difficult to write an RTA provision on, forexample, rights of establishment that limits the benefit tocompanies from the signing countries.
As a consequence, RTA provisions are fundamentally
non-discriminatory. When two countries sign a FTA, it
is not necessarily discriminatory toward other countries.
In fact, such an agreement could even benefit othercountries. As an example, the adoption of the euro was
originally expected to lead to an increase in trade within
Europe but a reduction in trade outside of the eurozone.
However, the introduction of the euro led to an increasein trade both inside and outside of the eurozone as it
became easier for the countries outside of the eurozone
to do business with nations which all use the same
currency. Rather than being discriminatory, the adoptionof the euro could more accurately be described as slanted
multilateral liberalization. Many 21st century RTA
provisions arguably have similar features and effects.
Another aspect of multilateralizing regionalism inthe 21st century is that preference margins in the realworld are actually very small. In looking at the tariff
preferences of the 20 largest economies in the world, alarge number of them have more than half of their tradeas duty free. Furthermore, when high tariffs of greaterthan 10% exist, they tend to be excluded from any FTA
in which the country is engaged. As a result, between
high tariffs being excluded from FTAs, which display
no preference, and multilateralism, where no preference
exists, preference margins are clearly smaller now thanthey were previously.
Recent estimates of trade creation and trade diversion
due to RTAs have provided some interesting empiricalevidence. In assessing them in relation to various trade
agreements around the world, it was found that a trendof positive trade diversion exists in the majority ofagreements. Of the few trade agreements which reflected
negative trade diversion, the figures were very low. Only
the Common Market for Eastern and Southern Africa(COMESA) and the Caribbean Community (CARICOM)
agreements had high percentages for negative trade
diversion, yet they also showed negative percentages for
trade creation at the same time. These agreements could
almost be thought of as anti-trade agreements as they
reduce trade both inside and outside of the affected area.
The South African Development Community (SADC)
represents an agreement which closely reflects theclassic 20th century view on regionalism, where thenumbers for trade creation are significantly positive andthose for trade diversion are negative. This view would
suggest that trade diversion is a problem issue, with tradecreation being desirable. However, the state of trade
diversion and trade creation in the SADC is generally
12 RIETI Highlight 2014 Special Edition

not reflected in the majority of other trade agreements.
This is due to tariff preferences not being high and trade
diversion and trade creation not being driven by market
access. This information could be used to argue against
the necessity of multilateralizing. However, based on thisevidence, it may be beneficial to cease viewing FTAs
simply in terms of trade diversion and trade creation. It
would be ideal if this evidence could be analyzed in moredetail in terms of comparing trade diversion and tradecreation in individual provisions of trade agreements
such as competition policy, investment, and GATS.
At present, there is a general lack of discrimination
technology for deep RTA provisions. Supply-chain
disciplines assure the rapid movement of goods, ideas,
people, and capital, and the goal of developing nations is
to foster supply-chain industrialization. Discriminationin trade agreements is not useful ordinarily. In otherwords, multilateralism is often embedded in deep RTAs.
This is also another factor which should be considered
in looking at multilateralizing 21st century regionalism.
Furthermore, the origin of discrimination in RTAs is alsodifficult to determine for services, capital, firms, andcommunication. Liberalization is also often embedded
in host nation regulations whose justifications exclude
discrimination. As an example, if the United States wereto get Colombia to change its labor laws, this would havean effect not only on the former, but also on any othernation conducting business with the latter.
More research needs to be conducted in a variety offields. Assessing the impact of various RTA provisions
on trade in goods, services, and investment throughusing the WTO database on provisions, the World Input
Output Database (WIOD) on parts and components, andthe data on foreign affiliates’ sales or employment tomeasure investment effects of various provisions would
all be beneficial. Analysis of the WIOD could be used tosee if trade in parts and components is affected by certain
provisions, which in turn would provide for a better
understanding of GVCs.

Another priority area would be to identify RTA
provisions with negative spillovers for third nations.
Perhaps there is a chance that certain investment
provisions or capital provisions have discriminatory
elements to them, and it would be very useful to pinpoint
exactly where such provisions exist.

In turn, high gains from having regional rules would
lead to hub and spoke regionalism, and high gains fromglobal rules would result in unilateral adoption of rules at
low cost, or mega-regional or global multilateralization
at high cost.
In conclusion, in order to move forward withmultilateralizing regionalism, finding agreement onminimum principles as in GATS, such as investment
disciplines, infrastructure service openness, and deeper
IPR disciplines is important. Furthermore, legal researchon how different are the deep provisions in existing
RTAs, and developing investment rules along with a
WTO trade facilitation package for customs cooperation
would also aid this process.

2013 in Review

The goal of 20th century multilateralizing regionalism
was to reduce discrimination. The goal of 21st century
multilateralizing regionalism is to realize network
externalities. At present, there are a few thousand BITs
in existence. Japan itself has about 30 BITs. It would be
simpler and more efficient to have only one BIT rather
than several. Realizing such a network externality would
lead to a more predictable environment, and it would
also make it easier for developing countries to join suchagreement. This entails a trade-off of determining an
optimal level of harmonization and multilateralization.
The downside of multilateralization is that diversityof situations and preferences between nations favor
bilateral agreements instead, yet network externalities
and sales economies favor multilateralization at higherthan-bilateral-level. It is essential to determine what
elements should be multilateralized and to what extent.
For example, if harmonization was low cost and low

In cases of harmonization with high cost and low gain,such as the legal alcohol limit for driving, it would besensible to maintain national rules.

Special Features

At this stage, it would also be good to start to search
for network effects of RTAs. Most current research ison a bilateral level, although evidence shows that evenbilateral agreements have an effect on a multilaterallevel. This, in turn, could lead to a better understandingof what could be gained from multilateralizing FTAs.

gain, it would be a non-issue. However, if it is low costand high gain, it could lead to a unilateral adoptionof regional rules. As an example, the HarmonizedCommodity Description and Coding System (HS) of
the past meant that every country had its own systemof trading classifications. Over time, it was deemedsensible and beneficial for countries to share the sameclassification system, thus this was developed and adopted
unilaterally. This system allows for differences between
countries below the six-digit level and is an example ofharmonization at a certain level, which is also low cost.

Question & Answer Session

Q

Is there any hard empirical evidence showing that
foreign direct investment and BITs are related?

It is surprisingly difficult to show that BITs are related
to foreign direct investment. Part of the problem appears
to be that foreign direct investment is measured in terms ofcapital flows.

A

Korea has signed some very deep trade agreementswith the United States and the EU. The TPP could
possibly look similar to those. If the TPP turns out to be
multilateralized, it would surely be a success worldwide.
Regarding FTA negotiations in Japan, the underlying
commercial logic of GVCs is fundamentally asymmetric. With
this in mind, the International Supply Chain Agreement (ISCA)
seems to be a good institutional vehicle for multilateralizing
FTAs in Japan and Asia.

A

Just to be clear, I actually do not think that the FTA
between the United States and Korea should be used
as a template. Rather, if I were to guess how I imagine aJapanese TPP would turn out, it would be similar to the U.S.Korea FTA. Regarding the TTIP, it appears that it will not
be easy to complete because a similar thing has been tried
before. The EU and the United States have been discussing
similar issues for about 60 years. There still has not beenmuch of an evolution on hard issues in both the United Statesand Europe, unlike in Japan. I think that it is not likely that
the TTIP will be completed if the TPP is not. In order for the
TTIP to be successful, it would surely need the full supportof people like David Cameron and Angela Merkel. Yet, it isunclear as to how much an agreement on making the TTIP
would lead to regulatory convergence. There is some hope inthat the globalization of production has led to a certain degreeof standardization in parts and components. However, thefact that the TTIP is referred to as an agreement, rather than apartnership, is in itself revealing about its nature.

A

RIETI Highlight 2014 Special Edition 13

Introduction of the 9 Research Programs

In terms of multilateralization, how important do
Q you feel the Trans-Pacific Partnership (TPP) is? Also,
what do you feel should be the guiding principles of FTA
negotiations in Japan?

You mentioned the FTA agreement between the
United States and Korea as a possible template for
the TPP. What is your view on the prospects of a potential
Transatlantic Trade and Investment Partnership (TTIP)
between the EU and the United States, particularly in thearea of rules and regulations?

QSymposium

The Science of Japanese Personnel Management—Rethinking employment systems in the era of globalizationn July 12, 2013, the international symposium
entitled “The Science of Japanese Personnel
Management—Rethinking employment
systems in the era of globalization” was held. In order tomaintain or improve competitiveness in the integrating
global markets, a growing number of Japanese firms
facing saturated domestic markets have been revising
their personnel policies that were formed during theera of high growth. Changes in the legal environmentsin the areas of non-standard employment, extension of
the mandatory retirement age, work-life balance, etc.
are also pressing the reform. How are such changes
affecting the way people work and the way workforces
are being managed? Researchers from the Institute ofSocial Science of the University of Tokyo and RIETI
have been analyzing personnel data in order to shed lighton the relationship between personnel policies and the
behaviors of employees and managers.

through the panel discussion among economists from both
Japan and the United States, we investigated important
human resource management policy issues faced by
Japanese firms and explore desirable personnel reforms.

Panelists in session● Program ● (see: http://www.rieti.go.jp/en/events/13071201/handout.html)
13:00

Opening Remarks
Hiroshi Ishida
Director, Institute of Social Science, The University of Tokyo
Welcoming Speech
Makoto Ogawa
Deputy Director-General for Labour and Human Resources,
Economic and Industrial Policy Bureau, METI

13:15 - Keynote Speech
A Personnel Economics Approach to Productivity
14:00
Enhancement
Edward P. Lazear
Jack Steele Parker Professor of Human Resources Management andEconomics, Stanford University / former Chairman of the U.S.
Council of Economic Advisors
14:00 - Presentation
Global Talent Management for Japanese
14:20
Companies in Developed and Emerging Markets
Alec R. Levenson
Senior Research Scientist, Center of Effective Organization,
University of Southern California
A keynote speech by Professor Edward P. Lazear

In this symposium, we shared some of our findings
as well as discussed many related issues with leading
economists including Edward P. Lazear, Jack Steele
Parker Professor of Human Resources Managementand Economics, Graduate School of Business,
Stanford University, who has contributed enormously
in forming the field of personnel economics, which
studies employment systems quantitatively. He alsodelivered a keynote speech entitled “A Personnel
Economics Approach to Productivity Enhancement,”
in which Professor Lazear expounded on his view
about correlation between productivity and personnel
practices through personnel economics. Following the
keynote speech, Alec R. Levenson, Senior Research
Scientist, Center of Effective Organization, Universityof Southern California, gave his presentation concerning
talent management for Japanese firms in the global
market. Furthermore, Takao Kato, Professor, Colgate
University / Visiting Professor, Institute of Economic
Research, Hitotsubashi University, and Hideo Owan,
Faculty Fellow, RIETI / Professor, Institute of Social
Science, The University of Tokyo, presented findings
from their research project, “Economic Analysis of
Human Resource Allocation Mechanisms within the
Firm: Insider econometrics using HR data” (www.rieti.
go.jp/en/projects/program/pg-07/008.html). Finally,
14 RIETI Highlight 2014 Special Edition

14:40 - Research Report
Lessons from the Personnel Data Repository
15:30
Project
Takao Kato
Professor, Colgate University / Visiting Professor, Institute of
Economic Research, Hitotsubashi University
Hideo Owan
Faculty Fellow, RIETI / Professor, Institute of Social Science, The
University of Tokyo
15:30 - Presentation
Toward the Diversity of Regular Employees
15:50
Under the Polarization of the Japanese Labor
MarketKotaro Tsuru
Program Director and Faculty Fellow, RIETI / Professor, Graduate
School of Business & Commerce, Keio University
15:50 - Presentation
Expanding Work Opportunities for Women and
16:10
Support for Work-Life Balance: The roles ofmanagers
Hiroki Sato
Professor, Interfaculty Initiative in Information Studies and Instituteof Social Science, The University of Tokyo
16:30 - Panel Discussion
Challenges in Personnel Management for
17:55
Japanese Firms in the Era of Globalization
Panelists (in alphabetical order):Edward P. Lazear
Alec R. Levenson
Hideo Owan
Hiroki Sato
Kotaro Tsuru
Moderator:
Daiji Kawaguchi
Faculty Fellow, RIETI / Professor, Faculty of Economics,
Hitotsubashi University
17:55 - Closing Remarks
Atsushi Nakajima
18:00
Chairman, RIETI

Essays and Columns

Special Features

Reduced policy
uncertainty and theJapanese economy
Masayuki Morikawa
Vice Chairman & Vice President, RIETIReduced policy uncertainty can contribute to a country’s economic growth. This column highlights thenegative influence of policy uncertainty and political instability on the growth of Japan. A survey showsthat international trade and tax polices pose the greatest uncertainty on Japanese companies. The column
concludes with a discussion of the mechanism via which uncertainty affects corporate behavior.

Many hurdles remain, however, and the Japanese
government is faced with difficult policy decisions on
a range of issues in which there are conflicts of interest
among the Japanese people. In particular, it must:■ Lay out a clear path toward fiscal sustainability;■ Reform the social security system; andPolitical stability and economic growth■ Negotiate the Trans-Pacific Partnership (TPP) andA series of empirical studies have shown that politicalinstability and frequent changes in governments havea negative impact on the national economy (Aisen and
Veiga 2013). According to these studies, the economic
impact of political stability is quantitatively massive,
far exceeding those of major growth policies, such as
trade liberalization and corporate income tax cuts. Thus,
there is a good possibility that the outcome of the Houseof Councilors election in July 2013, where the rulingcoalition parties won the majority of seats, will serve as asignificant driver of Japan’s economic growth.

other economic partnership agreements (EPAs).
Whether or not the end to the divided Diet dispels theuncertainty over the future course of economic policies
is a key determinant of the success or failure of thegovernment’s efforts to motivate companies to takepositive actions.

Negative inﬂuence of policy uncertainty
Various research attempts have been made to examine
the economic impact of uncertainty (Bloom 2009,
Carrière-Swallow and Céspedes 2013). In particular, it
has been found that policy uncertainty has a substantial
negative impact on the real economy, such as the GDP,equipment investment, and employment (Baker et al.
2013).
Uncertainty about future economic policies andregulations has a significant influence on corporate
management decisions with respect to medium- tolong-term investment in equipment, research anddevelopment, business expansion overseas, humancapital, and so forth. For instance, a country’s corporate
taxation rate affects the cost of capital—a key element
in determining the profitability of investment. Labor
market regulations—such as those for employment
protection, temporary agency workers, and workers hired
RIETI Highlight 2014 Special Edition 15

Introduction of the 9 Research Programs

When the two chambers of the parliament are controlled
by different parties, or when the opposition controls
the legislature under the presidential system, decision
making on important policies is bound to be stalled or
postponed. The recent “fiscal cliff ” in the U.S. is a wellknown example. In Europe, the government changes inthe eurozone countries increased uncertainty over the
fiscal policy, resulting in the instability of the euro. In
Japan, political power was transferred from the Liberal
Democratic Party (LDP) to the Democratic Party ofJapan (DPJ) four years ago, but the LDP regained
control through the general election in December 2012.
However, the Diet had been in a flux until summer 2013.
During these government changes, certain economic
policies, such as those related to tax, social security, andthe labor market, have fluctuated.

2013 in Review

hile the effects of the “three arrows” of theJapanese Abenomics policy mix—boldmonetary easing, flexible fiscal policy, andthe growth strategy—have attracted worldwide attention,
reduced policy uncertainty is also expected to contributeto the country’s economic growth by stimulating longterm investments in the private sector.

Essays and Columns
on fixed-term contracts—affect the cost of employment.
The social security system, which involves costs tocompanies in the form of employers’ contributions, hasa similar impact. Meanwhile, the government’s policy
for the TPP and other trade issues results in changes in
the costs of international trade and direct investment,
thereby affecting corporate decisions regarding businessexpansion in the global market. Since such investment isirreversible in nature and involves substantial adjustment
costs, a wait-and-see strategy could be a rational choicefor companies if the future course of policy is uncertain.
Therefore, greater uncertainty about the future has adetrimental effect on investment and employment.

Which speciﬁc policies have createduncertainty?
However, most studies conducted to date have primarily
analyzed the impact of macroeconomic uncertainty, andresearch delving into individual government policies
and regulations has been scarce. In response to thisgap in the research, we conducted an original survey of
publicly listed Japanese companies to find out which
specific policies have created uncertainty, the impactsof such uncertainty on management decisions, the typesof management decisions that are strongly affected byuncertainty, and so forth. In what follows, I would liketo outline the key points of our findings (see Morikawa
2013 for details).
■ First, we asked respondents to indicate the degree of

uncertainty they feel over the future course of various
types of government policies and regulations, suchas tax policy, social security system, labor market
regulations, corporate law and regulations, andinternational trade policy.
The results show that international trade policy poses
the greatest uncertainty to Japanese companies, followed

sequentially by the social security system, environmental
regulations, tax policy, and labor market regulations (seecolumn (1) of Tab. 1).
■ Second, we asked to what extent their management

decisions are affected by such uncertainty.
We found that uncertainty about tax policy has thegreatest impact on corporate management decisions
with nearly half of the respondents indicating that their
management decisions are “significantly affected” bythem. International trade policy and environmental
regulations followed with the ratio of those “significantly
affected” by their uncertainty at around 30%, and,
subsequently, labor market regulations, corporate law
and regulations, and social security system at around
20% (see column (2) of Tab. 1).

Mechanisms behind the negative inﬂuence ofpolicy uncertainty
Uncertainty could affect corporate behavior in a broad
range of activities, including:■ Equipment investment■ Innovation■ Mergers and acquisitions■ The hiring of new employees

Thus, we asked what type of management decisions
are significantly affected by policy uncertainty. Cited
by roughly two-thirds of the respondents, equipment
investment is found to be most affected by uncertainty,
followed by decisions regarding entry into, orwithdrawal from, overseas markets; cited by nearly halfof the respondents; and then decisions on the hiring of

Table 1: Economic policy and regulatory uncertainty and impact on business management (%)(1)High degreeof uncertainty(2)Signiﬁcantly
aﬀected

1

Tax policy

13.5%

47.1%

2

Social security system

39.1%

19.7%

3

Business licensing system

7.6%

15.5%

4

Labor market regulations

11.1%

23.5%

5

Environmental regulations

15.2%

27.6%

6

Land use and zoning restrictions

4.9%

10.7%

7

Consumer protection laws and regulations

5.9%

9.7%

8

Corporate law and regulations

9.7%

22.6%

9

International trade policy

50.4%

30.2%

Source: The Survey on the Outlook of the Japanese Economy and Economic Policy by RIETI. The survey was conducted from February 2013 to March 2013.

16 RIETI Highlight 2014 Special Edition

Table 2: Management decisions signiﬁcantly aﬀected by policy uncertainty (%)

Equipment investment

65.9%

2

R&D investment

14.6%

3

ICT investment

4.5%

4

Advertizing

3.5%

5

Entry into or with drawal from overseas market

47.0%

6

Organizational restructuring (M&A, etc.)

24.0%

7

Hiring of regular full-time employees

27.5%

8

Hiring of non-regular employees

11.8%

Special Features

1

Source: The Survey on the Outlook of the Japanese Economy and Economic Policy by RIETI.

permanent full-time employees and on organizational
restructuring (see Tab. 2).

Concluding remarks

Political Instability Affect Economic Growth?”
European Journal of Political Economy , Vol. 29,
March 2013, 151-167.
■ Baker, Scott R, Nicholas Bloom, and Steven J
Davis, “Measuring Economic Policy Uncertainty,”
unpublished manuscript, 2013
■ Bloom, Nicholas, “The Impact of Uncertainty Shocks,”
Econometrica , Vol. 77, No. 3, 2009, 623-685.
■ Carrière-Swallow, Yan and Luis Felipe Céspedes,“The Impact of Uncertainty Shocks in Emerging
Economies,” Journal of International Economics ,Vol. 90, No. 2, 2013, 316-325.
■ Morikawa, Masayuki, “What Type of Policy
Uncertainty Matters for Business?” RIETI
Discussion Paper, No. 13-E-076, 2013.

ProﬁleMasayuki Morikawa is the Vice Chairman and Vice President,
RIETI. He joined the then Ministry of International Trade andIndustry (MITI) in 1982 and has held a variety of positions at the
Ministry of Economy, Trade and Industry (METI), including as
the Director of the Macroeconomic Affairs Division, Industrial
Structure Policy Division and the Deputy Director-General of
the Economic and Industrial Policy Bureau. He holds a Ph.D. ineconomics from Kyoto University. His area of expertise includes
economic policy, industrial structure, and productivity analysis. His
works include: “Demand Fluctuations and Productivity of Service
Industries,” Economics Letters, Vol. 117, No. 1, 256-258, 2012;“Productivity and Survival of Family Firms in Japan,” Journal of
Economics and Business, Vol. 70, November-December 2013, 111125; “Economies of Density and Productivity in Service Industries:
An Analysis of Personal Service Industries Based on EstablishmentLevel Data,” Review of Economics and Statistics, Vol. 93, No.1, 2011,179-192; “Labor Unions and Productivity: An Empirical Analysis
Using Japanese Firm-Level Data,” Labour Economics, Vol. 17, No.
6, 2010, 1030-1037. His more publications and papers are on: http://
www.rieti.go.jp/users/morikawa-masayuki/index_en.html

RIETI Highlight 2014 Special Edition 17

Introduction of the 9 Research Programs

These findings suggest that the predictability of
government economic policies and regulations is a
critical factor in making long-term investment decisions.
Improving the predictability of policies and regulations
would significantly help revitalize the economy. Greater
political stability will lead to the improved performanceof the Japanese economy, putting an end to the prolonged
stagnation■ Aisen, Ari, and Francisco José Veiga, “How Does2013 in Review

We then conducted a regression analysis to explain therelationship between policy uncertainty and the expectedsales growth rate of companies. The dependent variable
is the expected medium-term sales growth rate, andthe main explanatory variable is the measure of policy
uncertainty taken from the survey. After controlling
for the industry characteristics and the trend growth
rates of the individual companies, we found that policy
uncertainty over tax policy, labor-market regulations,and environmental regulations has statistically andeconomically significant negative effects on the expectedsales growth.

References

Essays and Columns

What We Can Learn
from the History ofGovernment Debt
Arata Ito
Fellow, RIETI

Two big pieces of news about Japan’s fiscal conditions made major headlines within a week in early August
2013. First, the government put forward the Medium-term Fiscal Plan on August 8, 2013. Then, on the very
next day, came the Ministry of Finance’s announcement that the government debt topped one quadrillion
yen for the first time ever at the end of June 2013.

any people may be starting to worry about thenation’s fiscal future. As they try to decipher
the government’s fiscal reconstruction plan,
it would be useful to have a deeper understanding of thecharacteristics observed in government debt trends in thepast.
Government officials, such as those at the Cabinet Officeand the Ministry of Finance who collect and analyze debt
data over a long-term period, have in-depth knowledge
about such characteristics. However, raw data andmaterials used for such analysis are not released to the
public (Note 1), and it is not easy for ordinary people toaccess such data.
Thus, in a bid to be of help for those who are keenlyinterested in the long-term trends of the government debt,
I would like to introduce some of the interesting aspectsof Japan’s public debt trends based on the data I havecollected and compiled from various sources for research
purposes.

Government debt trends over the past 100
years and beyond
Figure 1 shows the changes in Japan’s government
debt from 1885 to 2011 as a ratio to the gross domestic
product (GDP) (Note 2). Government debt includes not
only that owed by the central government but also that
owed by municipal governments (prefectures, cities,
wards, towns, and villages) (Note 3).
The gross government debt-to-GDP ratio, which has had
ups and downs over the period, has experienced threeconspicuous upward trending periods, namely, the mid1900s; from the latter half of the 1930s to the first halfof the 1940s; and from the 1990s to date. The first andsecond uptrends were due to a temporary increase in
18 RIETI Highlight 2014 Special Edition

fiscal deficits resulting from the issuance of war bonds
to finance the Russo-Japanese War and World War II
respectively.
Figure 1: Government debt-to-GDP ratio
2.5

2

1.5

1

0.5

Net debt
0

Gross debt

1880 1895 1910 1925 1940 1955 1970 1985 2000 2015

In the third and ongoing uptrend, the gross government
debt-to-GDP ratio has been rising rapidly—though not as
sharply as in the first two—and sustainably. This meansthat the rise is attributable to structural factors, namely,
chronic fiscal deficits, making a striking contrast with thefirst two uptrends. In fiscal 2011, the ratio came close to
2.2, exceeding by far the highest record before the end ofWorld War II, 1.7, posted in fiscal 1944.
Some scholars are critical about the use of gross debt asa measurement of the size of debt. They claim that net
debt, calculated as the total amount of debt outstanding
less the total value of financial assets held, should beTable 1: Decomposition of changes in the debt-to-GDP ratio
Note: Figures in the table denote the per-year average during the sample period. Plus ﬁgures for the primary balance represent a deﬁcit and minus ﬁgures show a surplus.

Change indebt-to-GDP
ratio[2]+[5]Contribution of ﬁscal balanceContribution of nominal GDP growth[3]+[4]Contributionof primarybalance deﬁcit

Contributionof debt
service

Period1886-1905

[1]

[2]

[3]

[4]

[5]

[6]

[7]

1.1%

2.6%

1.7%

0.9%

-1.5%

-0.6%

-0.8%

1906-1916

-4.1%

-1.2%

-3.2%

2.0%

-2.9%

-1.3%

-1.7%

1917-1944

4.5%

8.5%

6.8%

1.8%

-4.0%

-0.9%

-3.1%

1945-1948-46.3%

2.7%

2.0%

0.7%

-49.1%

6.2%-55.2%

1949-1986

0.6%

2.1%

1.0%

1.1%

-1.5%

-0.9%

-0.6%

1987-1990

-2.0%

1.0%

-2.2%

3.2%

-3.0%

-2.4%

-0.5%

Contributionof real GDP
growth[6]+[7]

Contributionof inﬂation

6.0%

6.3%

3.8%

2.5%

-0.3%

-0.9%

0.6%

2006

-0.1%

0.8%

-1.0%

1.8%

-0.9%

-2.1%

1.2%

2007-2011

7.6%

5.7%

3.7%

2.0%

2.0%

0.0%

1.9%

used as a measurement because economic entities usually
hold financial assets—such as cash and deposits—as well
as debt. For the purpose of comparison, both gross andnet debt ratios to GDP are plotted in Figure 1. We cansee that they generally follow the same trend though theydiffer in the level.

3

In Table 1, the change in the government debt ratio
in each upward or downward trending period is
decomposed into contributing factors. In the periods
that saw a significant rise in the ratio, as indicated by a
big plus figure in the second column, the government
ran a large fiscal deficit without exception, providing
supporting evidence for the characteristic mentioned
in the preceding section. Interestingly, however, thetable shows that the downward trending periods did
not necessarily coincide with a fiscal surplus. Or, more
precisely, it has been rather rare for them to coincide.
Needless to say, lowering the government debt ratio is oneof the largest policy challenges for Japan. Looking into
Figure 3: Decomposition of changes in debt-to-GDP ratio
during downward trending periods

15

Debt service
Primary balance (plus ﬁgure indicates a deﬁcit)
Inﬂation

10

Real economic growth
Change in debt-to-GDP ratio

5

0

2.5
2
1.5

-5

-10

1
0.5

-40

0
-60
1680 1720 1760 1800 1840 1880 1920 1960 2000

1906-1916
Post-Russo-Japanese
War period

1945-1948
Post-WorldWar Ⅱ period

1987-1990
Bubble period

RIETI Highlight 2014 Special Edition 19

Introduction of the 9 Research Programs

Figure 2: Government debt-to-GDP ratio of the United States
and the United Kingdom

Characteristics seen in the downward trends
in the government debt ratio2013 in Review

Figure 2 shows the gross government debt-to-GDP
ratios of the United States, the United Kingdom, andJapan. Both the United States and the United Kingdom
experienced a temporary sharp rise in the ratio during
the two world wars. However, with the end of war, theupsurge was followed by a slow but steady downtrend
in each case but more conspicuously in the period
subsequent to the end of World War II, in which the grossgovernment debt-to-GDP ratio eventually returned to thepre-war level in both countries. Japan also experienced
a slow but steady downtrend from the latter half of the
1900s through the first half of the 1910s following theend of the Russo-Japanese War. However, the downtrend
following the end of World War II was sudden andsteep, a phenomenon not seen in the United States andthe United Kingdom at any time over the past several
hundred years of their history.

Special Features

1991-2005

Essays and Columns
what happened in the past downward trending periods
might give us hints as to how we can and should tackle
this formidable challenge. Figure 3 visually illustrates
the characteristics observed in some of the downward
trending periods based on the numbers in Table 1.
In the period following the Russo-Japanese War, alarge primary balance surplus—i.e., current revenue
less current expenditure excluding debt service—andsustained high economic growth on a nominal basis werethe major contributing factors. The government backthen implemented fiscal stimulus measures while, at thesame time, maintaining strict discipline. This represents a
successful case scenario for achieving a reduction in thegovernment debt ratio by the best mix of fiscal reform
measures and economic growth measures.
In contrast, the downtrend in the government debt ratio
following the end of World War II was a result of asudden fall in the yen’s value which caused prices tosoar and hence led to a sharp increase in nominal GDP
growth. As indicated by the fact that the real GDP growthduring this period of time was a contributing factor for
an increase in the government debt-to-GDP ratio, thereal economy was in a terrible state. This represents oneof the worst case scenarios for reducing the government
debt ratio.
The latter half of the 1980s resembled the period
following the Russo-Japanese War in that economic
growth and a primary surplus were the main contributors
to the decline in the government debt ratio, but themargin of decline was smaller due to a smaller primary
surplus. As Table 1 shows, Japan’s government debt ratio

fell only marginally in 2006. Both a marginal primary
surplus that year and deflation that started in the second
half of the 1990s contributed to this result.
As such, real GDP growth, inflation, and primary
surplus are major contributing factors to a decline
in the government debt-to-GDP ratio. If Japan is tolower the ratio, currently at a record high level, in an
orthodox approach, it has no option but to make steadyand continuous efforts to generate an adequate primary
surplus on a sustainable basis. This is an importantlesson from the history of government debt. Following
the end of World War II, both the United States and theUnited Kingdom eventually succeeded in bringing down
their high government debt ratios by making steady andcontinuous efforts to generate a primary surplus year
after year over a long period of time.
In a bid to address the issues surrounding the first of
the three contributing factors, or as a way to enhance
Japan’s real economic growth potential, the governmentof Prime Minister Shinzo Abe is vigorously promoting
economic structural reform under its growth strategy
dubbed as the “third arrow” of Abenomics. Meanwhile,in an attempt to end deflation and thus attain the second
contributing factor, the Bank of Japan is taking boldmonetary easing measures, which constitutes the “firstarrow” of Abenomics. Lastly, in order to tackle problems
inhibiting the achievement of a primary surplus or thethird contributing factor, the government is committed tohalving the primary deficit to GDP ratio by fiscal 2015
from the level in fiscal 2010 and turning the balance intoa surplus by fiscal 2020, as set out in the Basic Policies
for Economic and Fiscal Management and Reform

Figure 4: Future outlook on the debt-to-GDP ratio
Size of primary surplus as apercentage of GDP
1%

2%

3%

4%

2.8

2.3

0.8

A projected range ofthe debt-to-GDP ratio
under various primarydeﬁcit scenarios＋ ＋ ＋

A projected range of thedebt-to-GDP ratio based on theassumption that the government
achieves its primary balance goals,
with the red circles representing
the median value

1.3

＋ ＋ ＋

＋ ＋ ＋

1.8

0.3
2008

2009

2010

2011

2015

2020

2060

Note: In 2060, the squares indicate the debt-to-GDP ratio calculated based on the assumption that the gap between the interest rate and the economic
growth rate for the year will be about one percentage point, while the plus marks signify the debt-to-GDP ratio calculated under the assumption that sucha gap is almost zero. Three consecutive marks̶either squares or plus marks̶ plotted for each scenario are the 1st, 2nd, and 3rd quantiles of the debt
ratios obtained from 100,000 simulations.

20 RIETI Highlight 2014 Special Edition

endorsed by the Cabinet in June 2013.

Notes
Future outlook of the government debt-toGDP ratio

Some market participants cast doubt even on thepossibility of the government achieving its goal for the
first milestone period through fiscal 2015. A country’s
primary deficit can be decreased by an increase in tax
revenue resulting from economic growth as well as bydiscretionary policy measures such as tax hikes andspending cuts. The latter holds the key to reducing andeventually eliminating Japan’s primary deficit because,
as discussed above, the ongoing increase in government
debt is chronic and structural in nature.

ProﬁleArata Ito has been a fellow at RIETI since 2013, and:2012 Project Academic Support Specialist, Graduate School of
Economics, The University of Tokyo;
2009 Research Associate, Institute of Economic Research,
Hitotsubashi University.
His works are as follows: “A New Monthly Index of Real Economic
Activity in Japan,” The University of Tokyo, 2012 (in Japanese);“Fiscal policy switching in Japan, the US, and the UK,” (with
Tsutomu Watanabe and Tomoyoshi Yabu) Journal of the Japaneseand International Economics, Vol. 25, No. 4, 2011, 380-413;“Measuring Tax Multipliers in Japan,” (with Tsutomu Watanabe andTomoyoshi Yabu) In Ihori, Toshihiro (Ed), Fiscal Policy and Social
Security, Keio University Press, Tokyo, 2010, 143-177 (in Japanese).

RIETI Highlight 2014 Special Edition 21

Introduction of the 9 Research Programs

The Medium-term Fiscal Plan is expected to be revisedand finalized after Prime Minister Abe makes the final
decision on whether or not to raise the consumption
tax in April 2014 as scheduled. The focus of attention
now is whether the Abe government can come up witha convincing set of concrete and effective measures
to fundamentally change Japan’s fiscal and economic
structure which is chronically dependent on debt.

3. In addition to debt held in the central
government’s general accounts and local
governments’ ordinary accounts, some partsof debt held in the central government’s
special accounts and local governments’ publicmanagement business accounts are included ingovernment debt. Specifically, debt held in thoseaccounts classified into General Government
in the System of National Accounts (SNA) is
included in government debt. As for the central
government, debt within the Special Accountfor Social Infrastructure Improvement and theSpecial Account for Energy Measures is treated asgovernment debt, but debt in the Special Accountfor Fiscal Investment and Loan Program Funds is
not included in government debt. As for municipal
governments, debt in Public Management
Business Accounts is counted as government debt.

2013 in Review

The eventual goal of the government’s fiscal policy is
to decrease the government debt ratio. Suppose that the
government achieves its goal of turning the primarybalance into a surplus by fiscal 2020 and continues
to generate a surplus in the years thereafter. Then,considering that the level of future debt ratios differs
depending on the assumed difference between the interest
rate payable and economic growth rate in the future, thegovernment debt ratio would be brought below the 2011
level in 2060 provided that an annual primary surplus ofat least 3.5% of GDP is to be generated over the period
from the latter 2020s until 2060. Bringing the ratio
further down to 1.0 would take another 30 years or more
based on the most conservative scenario.

2. Figure 1 does not include any graph representing
the amount of debt outstanding because it is not
appropriate as a measurement of the size of thedebt burden as explained as follows: Consider two
households A and B, each holding 20 million yen
in debt, and suppose that household A earns anannual income of four million yen and household
B 12 million yen. In this case, the burden of
repaying the same amount of debt is much heavier
for household A than for household B. As such,it is more appropriate to measure the size of thegovernment debt in relative terms, i.e., as a ratio
to GDP, rather than in terms of absolute amount.

Special Features

Plotted in Figure 4 are projected ranges for the net
government debt-to-GDP ratio based on several different
scenarios for future primary deficits. It shows that the net
government debt would remain high as a ratio to GDP
even if the goal of achieving a primary surplus by fiscal
2020 is fulfilled. But the pace of rise in the debt ratio
would be significantly slower than that over the period
from 2002 to 2011. On the other hand, if the government
fails to fulfill its goal, the debt ratio may top 2.5 times.

1. Some international organizations conduct analysis
from a similar viewpoint. For instance, see theOctober 2012 issue of the World Economic
Outlook by the International Monetary Fund(IMF).

Essays and Columns

Is the negative impactof FDI real? Empiricalevidence from Japan
Ayumu Tanaka
Research Associate, RIETI

Policymakers fear the negative employment effects of foreign direct investment. This column provides recent
empirical evidence on FDI and domestic employment. The results show that FDI has positive effects on
domestic employment. Furthermore, our new empirical research finds a non-negative relationship between
Japanese firms’ foreign activities and their suppliers’ domestic employment.

The government subsidizes firms which establish newplants inside Japan. Following the earthquake thegovernment provided additional financial support forfirms. The Ministry of Economy, Trade and Industry(METI) provided subsidies reaching approximately 300
billion yen ($3.85 billion) to 510 firms to remain in the
country.

he Japanese government is concerned about theso-called “hollowing out of manufacturing,”
referring to the negative effects of FDI on
domestic employment. A typical story is described below.
“Japanese firms face severe competition with firms in
low-wage Asian countries such as China, Korea, andTaiwan. Many Japanese firms, therefore, establish theiroverseas subsidiaries in low-wage countries, which
results in the manufacturing workers in Japan losing theirjobs. To protect them, it is necessary for the government
to subsidize Japanese firms.”

Before examining whether these policies are adequate,
we investigate whether or not FDI has a negative
employment effect.

Empirical evidence from Japan
In the 2000s, the fear of hollowing out grew among
policymakers for many reasons, including a strong yen
and a high corporate tax rate. After the Great East Japan
Earthquake in 2011, an electricity supply problem also
arose due to the shutdown of the nuclear power plants,
which exacerbated the fear of hollowing out.

Several empirical studies investigate the employment
effects of FDI and offshoring. Most studies have foundeither positive or non-negative employment effects(Note 1).

Figure 1: Impact of FDI on the log of employment in manufacturing (Tanaka, 2012)

Outcome: log employment

0.2
Starters
0.171

0.177

0.15
0.136

Non-Starters
0.1
0.086
0.05
0.040
0

-1

0.055

0.052

2

3

0.015

0.007

0.000
-2

0.044

0

1

Relative time
Note: The relative time is zero for the year when FDI is initiated. The vertical axis represents the change from t-2 in the log of
employment. The red and blue lines represent ﬁrst-time investors and the matched control group, respectively.

22 RIETI Highlight 2014 Special Edition

My recent study examines the employment effects of
FDI using comprehensive firm-level data from the Basic
Survey of Japanese Business Structure and Activities(METI, 2001–2008). I compare firms that initiated FDI
to those that did not using propensity score matching(PSM).

The results indicate that the impact of FDI on employment
in the Japanese manufacturing industry in the 2000s was
positive rather than negative. The positive employment
effects of FDI are accompanied by positive effects onexports and domestic sales by the parent firms in Japan.
This suggests that the relationship between domestic andoverseas activities by Japanese firms is complementary.

Policy implications

Authors’ note: Tanaka (2012) and Ito and Tanaka(2013) are outputs of a project on international tradeand investment undertaken by the Research Institute of
Economy, Trade and Industry (RIETI).

■ Barba Navaretti, Giorgio, Davide Castellani, andAnne-Celia Disdier, “How does Investing in Cheap
Labour Countries Affect Performance at Home?”
Oxford Economic Papers , Vol. 62, No. 2, 2010,234–260.
■ Castellani, Davide, Ilaria Mariotti, and Lucia
Piscitello, “The Impact of Outward Investments
on Parent Company’s Employment and Skill
Composition: Evidence from the Italian Case,”
Structural Change and Economic Dynamics , Vol.
19, 2008, 81–94.
■ Desai, Mihir, Fritz Foley, and James Hines,“Domestic Effects of the Foreign Activities of U.S.
Multinationals,” American Economic Journal:
Economic Policy , Vol. 1, No. 1, 2009, 181–203.
■ Hijzen, Alexander, Sebastien Jean, and Thierry
Mayer, “The Effects at Home of Initiating
Production Abroad: Evidence from Matched FrenchFirms,” Review of World Economics , Vol. 147,
2011, 457–483.
■ Ito, Keiko and Ayumu Tanaka, “Expansion ofOverseas Production and the Impact on Employment
in Domestic Supporting Industries: An Empirical
Analysis Based on Buyer-Supplier Transaction
Relationships,” mimeograph, 2013.
■ Tanaka, Ayumu, “The Effects of FDI on Domestic
Employment and Workforce Composition,” RIETI
Discussion Paper, No. 12-E-069, 2012.
■ Wagner, Joachim, “Offshoring and Firm
Performance: Self-selection, Effects on
Performance, or Both?” Review of World
Economics , Vol. 147, 2011, 217–247.
■ Yamashita, Nobuaki and Kyoji Fukao (2010),“Expansion Abroad and Jobs at Home: Evidence
from Japanese Multinational Enterprises,” Japanand the World Economy , Vol. 22, 88–97.

ProﬁleAyumu Tanaka has been a research associate at RIET since 2013,
and was a fellow at RIETI in 2010. His works include: “Firm
Productivity and the Number of FDI Destinations: Evidence from a
Non-parametric Test,” Economics Letters, Vol. 117, No.1, 1-3, 2012;“The Causal Effects of Exporting on Japanese Workers: A FirmLevel Analysis,” RIETI Discussion Paper, No. 12-E-017, March 2012,
1-27; “Multinationals in the Services and Manufacturing Sectors: A
Firm-level Analysis using Japanese Data,” RIETI Discussion Paper,
No.11-E-059, July 2011, 1-44.

RIETI Highlight 2014 Special Edition 23

Introduction of the 9 Research Programs

Empirical evidence does not support the hollowing
out of manufacturing or a negative employment
impact of FDI on the Japanese manufacturing industry.
Rather, FDI shows positive employment effects. The
implication is that policy which lowers firms’ incentives
to invest abroad is not adequate for increasing domestic
employment.

References

2013 in Review

Another study I conducted with Keiko Ito (Ito and Tanaka
2013) sheds light on the impacts of FDI on domestic
suppliers. We identified the transaction relationshipamong Japanese firms using a database provided by
Teikoku Databank and constructed a firm-level databasewhich contains basic information on Japanese firms andtheir foreign subsidiaries and domestic suppliers. Our
results show that, on average, Japanese firms’ foreign
activities are positively — or at least non-negatively —related to their domestic non-multinational suppliers’
employment. This new finding implies that firms that
supply their products to multinational firms can enjoy
positive employment effects.

1. Barba Navaretti et al. (2009) find such a result
for Italy and France, Castellani et al. (2008) forFrance, Desai et al. (2009) for the U.S., Hijzen etal. (2011) for France, Yamashita and Fukao (2010)
for Japan, and Wagner (2011) for Germany.

Special Features

Figure 1 shows the average employment growth of FDI
starters and non-starters in the Japanese manufacturingindustry. The FDI starters’ average employment growthrate is 17.7%, while that of the FDI non-starters is
5.1%. Therefore, the estimated average effect of FDI on
employment is 12.6%.

Note

Research Digest

DP: 12-E-075

How Fast Are Prices in Japan Falling?
Satoshi Imai, Chihiro Shimizu, Tsutomu Watanabe

http://www.rieti.go.jp/jp/publications/dp/12e075.pdf

Re-estimating the Rate ofDeÀation in Japan
Tsutomu Watanabe
Faculty Fellow, RIETI
Professor, Graduate School of Economics, The University of Tokyo

While Japan has been undergoing deÀation over a long period of time, the corresponding rate has been fairly
moderateʊabout 1% annually. This situation differs from the price plunge observed in the United States
during the Great Depression before World War II, a well-known case of deÀation in a developed country.
Given this inexplicable phenomenon of “moderate deÀation,” it is not surprising that some people overseas
have been questioning the reliability of Japan’s price statistics, particularly the consumer price index (CPI).
To answer their questions squarely, Professor Watanabe, a faculty fellow, and his co-authors conducteda veri¿cation of the statistical reliability of the CPI prepared by the Ministry of Internal Affairs andCommunications (MIC) through such means as trying to reproduce the CPI using an enormous volume ofpoint-of-sale (POS) data. Furthermore, based on a comparison of the reproduced CPI with the price index
calculated according to the U.S. practice, a cautious attitude is essential in the judgment as to whether or not
to overcome deÀation.

ʊThe original title of the paper is “How Fast Are
Prices in Japan Falling?” Could you tell us yourpurpose for writing this paper?
In Japan, deflation has been continuing since the mid1990s. While this is obviously a major problem not only
for Japan but also for the global economy, the CPI showsthat the deflation rate has been about 1% every year, or
about 2% at the highest during the most rampant periods.
Although there have been a very limited number ofcases of deflation in a developed country, one suchcase occurred in the United States during the Great
Depression in the 1930s, where an annualized 7% priceplunge was observed. Compared to this, the present
deflation in Japan can be considered as a moderate pricedecline continuing over a very long period. The fact thatdeflation has not been so rapid in Japan while people
have claimed that the country has been suffering froma stagnant economy for more than a decade is drawing
close attention among researchers and businesspersons
overseas as well as domestically.
The cause of this phenomenon has been discussed foryears by policymakers and researchers. Their views vary,
among which there is a skeptical view regarding thereliability of Japan’s price statistics themselves, claimingthat “the deflation rate is only apparently low due to theinaccuracy of the CPI calculation by the MIC.” This
perspective seems to be prevalent, particularly in Europe
and the United States.
Thus, while deflation in Japan has been moderate, we
intend to identify whether this inexplicable phenomenon
24 RIETI Highlight 2014 Special Editionof moderate deflation, in which there have been sluggish
price falls, is attributable to statistical issues or otherfactors.
ʊWhat methods did you adopt to verify thereliability of the statistics?
There are two possible methods for verifying thereliability of the statistics themselves. One method
is to review each data point used for the preparationof the CPI by the MIC and examine whether theyare appropriate. However, it is difficult for external
researchers to access easily the details of the data andthe statistics actually used for the CPI preparation. Evenif such in-depth information was available, it would be
difficult to determine their validity.

Analysis based on sales-related information
amounting to 3.6 billion data entries over 10yearsʊIs it challenging to prepare a new price index?
In fact, we tried to calculate the price index a few years
ago, but gave up during the process. The MIC has been
publishing its CPI preparation methods, but the detailsof each method involve many technical issues which are
not described in the text. We proceeded with this task
while confirming the issues step by step by contacting
the MIC, but unfortunately we had to discontinue theprocess because the task was too complicated and timeconsuming.

Of course, it was not certain at the start of the researchʊWhat data did you use?
For the reproduction of the CPI, we had to collect alarge volume of consumer shopping data. The POS data
used in this research was jointly compiled by Nikkei
Digital Media, Inc. and the University of Tokyo. Thisdataset is the sum of data collected on more than 200,000
commodity items sold at some 200 supermarkets acrossthe nation between 2000 and 2010. These items mainly
include food products, beverages, and other nondurable
consumer goods (general merchandise such as shampoo),and the sales information was summed up through theso-called POS system.

2013 in Review

However, given the current situation in which researchers
and businesspersons in Europe and the United States
have publicly expressed their skepticism about thereliability of Japan’s CPI in overseas academic meetings,
we considered it beneficial for not only researchers but
also policymakers to verify the reliability of Japan’s CPI
using data other than that used by the MIC. Thus, we
continued to approach the MIC for its cooperation.

Mr. Imai, a co-author of the paper, is in charge ofconsumer price-related systems in the Statistics Bureauof the MIC. It is unusual for researchers and the person
who is actually preparing the statistics to work jointlywith all of their proprietary information disclosed to eachother as we did in this research. In this regard, the factthat our collaboration was very successful is a valuable
achievement for similar analyses in the future.

Special Features

For the second method, we aim to prepare a price index
of our own in consideration of the MIC methods for CPI
preparation while using a data source that is different
from that used for the CPI prepared by the MIC.

as to whether the final results would be favorable to
the MIC, given the academic nature of the research.
Obviously, it was not an option to carry out analyses
that were biased in order to obtain the cooperation of
the MIC. However, we have successfully obtained thecooperation of the relevant department of the MIC bysharing the view that “it is necessary in the first place toinvestigate the actual conditions.”

In 2009, for instance, we surveyed 260 supermarkets and
230,000 items. The total number of data entries added
up to 422 million in 2009, and reached 3.6 billion overthe entire research period. However, both the numberof stores and items have been partially replaced (Tab.

Table 1: Status of item replacement at the 103 stores

Number ofitems newly
released

Number of
items
discontinued

Proportion of
items newly
released

Proportionof items
discontinued

2000

203,563

̶

̶

̶

̶

2001

208,164

57,52652,925

0.276

0.254

2002

217,139

66,03557,060

0.304

0.263

2003

206,172

51,696

62,663

0.251

0.304

2004

222,486

74,65558,341

0.336

0.262

2005

224,705

62,15859,939

0.277

0.267

2006

242,669

80,361

62,397

0.331

0.257

2007

254,887

78,06065,842

0.306

0.258

2008

268,541

89,55775,903

0.333

0.283

2009

256,824

75,49587,212

0.294

0.340

RIETI Highlight 2014 Special Edition 25

Introduction of the 9 Research Programs

Number ofitems sold at the
103 stores

Research Digest
Figure 1: Year-on-year changes in the price index estimated by the U.S. methods

Average (of 78 times of sampling and estimation by the U.S. methods)
CPI published by the Statistics Bureau, MIC
Estimate by the MIC methods
0.05
0.04
0.03
0.02
0.01
0
-0.01
-0.02
-0.03
-0.04

Table 1 shows that approximately 30% of the items
were replaced every year. In 2009, for example, 75,495
new items were added while 87,212 existing items werewithdrawn. The proportion of about 30% is greater thanthat in foreign countries, suggesting that marketable
items are being replaced every year to a considerable
extent.
Some items are typically consumed over a long periodof time, such as sweet adzuki-bean jelly from a longestablished Japanese confectionery company, whereas
others are continually being replaced with new items,
such as instant noodles. Unless such replacement foreach item is accurately identified in the process of priceresearch, the resulting prices may vary widely. We also
wanted to examine the degree of the impact of such
replacement.

Preparing a consumer price index on our
own to verify the reliability of the CPI
ʊCould you tell us the details of the analyses?

26 RIETI Highlight 2014 Special Edition

1
.0

7
10
20

.0

1
.0
20

09

7
09
20

.0

1
.0
20

08

7
08
20

.0

1
07
20

.0

7
07
20

.0

1
06
20

.0

7
06
20

05

.0

1

1). The number of stores that continued in cooperating
throughout the research period was 103, and the total
number of items sold there was 203,000 in 2000, andsubsequently increased to 256,000 in 2009.

20

.0

7
.0
20

05

1
04
20

.0

7
.0
20

04

1
03
20

.0

7
.0
20

03

1
02
20

.0

7
02

.0
20

01

01
20

20

.0

1

-0.05

Using the enormous volume of data collected, we tried
to reproduce the MIC’s CPI in accordance with its CPI
preparation methods. In parallel with this task, we also
performed a total of 64 patterns of analyses based on the
MIC methods while modifying these methods stepwise
to determine, as a simulation, whether the results would
differ depending on such modifications.
Finally, given the substantial criticism from overseas,
particularly from the United States, regarding thereliability of Japan’s statistics, we tried to prepare a priceindex using data obtained in accordance with the methods
used by the U.S. Bureau of Labor Statistics (BLS), whichis responsible for the country’s preparation of the CPI.
Mr. Imai is of course familiar with the practice of CPI
preparation as an MIC official with responsibility over it,
and he is also knowledgeable about the methods of the
U.S. BLS. This was a great help to us in advancing the
research.
ʊHow were the results?
In the first task of reproducing the price index inaccordance with the MIC methods, the CPI was preparedusing a different data source that was very similar to one
published by the MIC. This suggests no problem with thedata and procedures used in this research in terms of the
reproducibility of the CPI.

line), compared with that using the MIC methods (redand green lines), shows lower prices for the most recent
months although it is basically tracing a similar trend (Fig.
1). Figure 2 was created focusing on this difference.
To put it simply, the primary difference between the U.S.
and the MIC methods lies in the method of sampling.
According to the U.S. methods, items to be includedin the price data differ for each research study because
they are randomly sampled each time the research is
conducted. This method of sampling is superior in that it
lowers the risk of eliminating marketable items from theresearch, but involves certain variation in the results due
to its probabilistic nature.

Finally, the results of the use of the U.S. BLS methods
also follows a similar trend to that resulting from the useof the MIC methods, except for the details (Fig. 1).

Special Features

As for the second task of performing analyses while
modifying the current MIC methods stepwise, althoughretailers such as supermarkets, for example, often
hold special sales events, “special sales prices” are notincluded in price data unless they continue for at least
eight days according to the MIC methods for calculating
the CPI. Some people see this practice as a problem;
therefore we made it a rule to include such prices in
the price data if they continue for at least three days.
The result, however, showed no significant differencecompared to that of the first task.

Let me focus on the consumer price increase rate of 1%,
which was the target set by the Bank of Japan (BOJ) for
its monetary policy. Supposing a 1% price increase isachieved by the MIC methods, how is the inflation rateestimated using the U.S. methods? As shown in the graph,the inflation rate based on the U.S. methods is nearly zero,or 0.1%, on average, but ranges from -0.5% to +0.5%.
That is, when the inflation rate is 1% based on the MIC
methods, it varies between -0.5% and +0.5% within the
80% confidence interval according to the U.S. methods.

As shown in this graph, the annualized deflation ratein Japan is about 2% to 2.5% at the highest level eventhough it was estimated using different methods, andno deflation has occurred that is comparable to the
7% to 8% price plunge in the United States during theGreat Depression. In short, the MIC methods for CPI
preparation involve no significant statistical error.
ʊWhere does the difference between the MIC andthe U.S. methods lie?

Figure 2: Inﬂation rates by the MIC and the U.S. methods

2013 in Review

In other words, even if a 1% price increase is estimatedby the MIC methods, the probability of a price increase

The price index estimated using the U.S. methods (blue

0.010

0.005

0.000

-0.005-0.010-0.015-0.020-0.010-0.005

0.000

0.005

0.010

0.015

0.020

0.025

Inﬂation rate using the MIC methods (year-on-year basis)

RIETI Highlight 2014 Special Edition 27

Introduction of the 9 Research Programs

Inﬂation rate using the U.S. methods (year-on-year basis)

0.015

Research Digest
or decrease is 50-50 according to the U.S. methods.

A cautious stance is essential in judgments
or actions with regard to exit from deﬂation
ʊWhat policy implications can be derived from theseresults?
We would like to emphasize the necessity of paying
heed to these differences due to the statistical methods indiscussions on the inflation rate required to end deflation.
As shown in Figure 2, even if the inflation rate estimatedby the MIC methods is +1%, it is highly likely thatthe rate estimated by the U.S. methods would remain
negative.
In order to ensure that price changes are positive, theinflation rate must be at least +2% when estimated using
the MIC methods. At this level, the rate will be positive
even if it is estimated using the U.S. methods.
Utmost care should be taken in making judgments andtaking action to pull out of deflation. It is recommended
that various measures to combat deflation be retracted after
price changes estimated by the MIC methods reach +2%.

Professor Watanabe showed a daily price index.

since May 2013 and is also linked to RIETI sites, it ispossible to monitor the daily fluctuations in prices suchas those in foreign exchanges.

ʊThe BOJ policy target was an inÀation rate of
1% when this paper was written, and the target
rate was raised to 2% following the start of the new
government.

While such data as a daily price index has also beendeveloped by Google Inc. as well as the Massachusetts
Institute of Technology (MIT) in the United States, theycalculate their price indexes based on price informationcollected through the Internet. Our trial is primarily
characterized by the fact that it is based on actual datacollected from as many as 300 stores.

As suggested by the analysis results, we thought thatan inflation rate of 1% as estimated by the current MIC
methods was too low for the target and should be raised
to 2%. We finished the paper with the hope that thiswould be proposed, and the target which I considered
preferable was actually set by the newly-elected
government and the BOJ. In this respect, their response
was satisfactory.

With a strong interest in prices, I have been studying thisthrough various cross-sectional methods. For instance,
I conducted a study on the pricing process using atypical price comparison site Kakaku.com in 2008, andanalyzed price rigidity using rent data in 2009 (*1). I
hope to undertake new types of studies in the future
by effectively using the above-mentioned data andindicators.

The frequency of publishing price data
should also be daily rather than monthly
ʊCould you tell us about your future studies?
As it is referred to as a barometer of the economy,
the CPI, which was the research subject this time, isconsidered as a critical indicator in effectively managing
economic policies. Unfortunately, the CPI published by
the MIC is on a monthly basis. Thus, we tried to preparea daily price index using the POS data in the research.
By designing a system to transfer all price informationcollected from 300 stores to my study during the nightof the same day, the “price index of yesterday” can beobtained the following day. Price information includes
special sales data under this system, which, in thiscontext, is close to the U.S. practice. As the price index
has been published on the University of Tokyo website
28 RIETI Highlight 2014 Special Edition

ProﬁleTsutomu Watanabe has been a professor at the Graduate Schoolof Economics, the University of Tokyo since April 2011. He was aprofessor at the Institute of Economic Research, Hitotsubashi University
from 2002 to 2011, and took up an associate professor position at thesame institute from 2002 to 2011. He was also an economist at the Bankof Japan from 1982 to 1999. His expertise is in monetary policy andprice dynamics. His recent works include: Satoshi Imai and Tsutomu
Watanabe, “Product Downsizing and Hidden Price Increases: Evidence
from Japan’s Deflationary Period,” Asian Economic Policy Review, Vol.
9, No. 1, 2014, 69-89; Jessie Handbury, Tsutomu Watanabe and David
E. Weinstein, “How Much Do Official Price Indexes Tell Us about
Inflation?” NBER Working Paper No. 19504, October 2013; Takayuki
Mizuno and Tsutomu Watanabe, “Why Are Product Prices in Online
Markets Not Converging?” PLoS ONE 8(8): e72211. doi:10.1371/journal.
pone.0072211. Published 28 August 2013;

Footnote*1 see: http://www.rieti.go.jp/jp/publications/dp/09e044.
pdfResearch Digest

DP: 13-E-029

Cohort Size Eﬀects on Promotion and Pay:
Evidence from personnel data
Shota Araki, Takao Kato, Daiji Kawaguchi, Hideo Owan

http://www.rieti.go.jp/jp/publications/dp/13e029.pdf

Cohort Size Effects on Promotion
and Pay
Faculty Fellow, RIETI
Professor, Department of Economics, Hitotsubashi University

Unemployment among young people has posed a major problem to several countries. The International
Labour Organization (ILO) estimates worldwide unemployment for 15-24 year olds at 12.6% for 2013,
with the rate remaining above 12% through 2018. As regular full-time positions are in short supply during
the economic downturn, there has been an increased proportion of non-permanent workers. Professor
Kawaguchi and his co-authors have investigated how tough economic times impact the way Japanese large
companies treat those who are fortunate enough to have secured regular employment with them.

Special Features

Daiji Kawaguchi

In this study, the authors have carried out an econometric analysis on detailed personnel data from twolarge Japanese manufacturers, for the purpose of testing the relevance of tournament theory as it applies togroups of employees concurrently entering the company as new college graduates (cohorts). Results indicatethat individuals in smaller entering groups enjoy relatively better chances of promotion. While conventional
wisdom holds that traditional Japanese employment customs are weakening, the authors suggest that theevidence that each cohort participates in its own separate tournament indicates that some economicallyjusti¿able practices remain in place.

Who competes in the promotion contest?
ʊIn your paper, you point out that the purpose of
the paper also includes elucidating the promotion

mechanisms in Japanese ¿rms…
Within labor economics, tournament theory is one wayof conceptualizing how companies decide on whom topromote. According to the theory, you have a series ofcontests, where the losers drop out until only a winninggroup—the prize winners—remains. Since each contest
is won by the superior player, this is indeed a method
for evaluating relative merit. This approach also has one
clear advantage: it filters out external factors such as
RIETI Highlight 2014 Special Edition 29

Introduction of the 9 Research Programs

The worldwide financial crisis of 2008 drove up
unemployment among the young to levels that, despitesome differences in severity from country to country,
drew international concern. A young person’s failure tofind a job can have long-term consequences; once you get
derailed, it can be difficult to get back on track. Japan, ofcourse, has been in a long-term slump, dating back to thecollapse of the bubble economy. Professor Yuji Genda
and his colleagues at the University of Tokyo have been
conducting research into unemployment among theyoung since the mid-1990s—beginning shortly after
the bubble ended—and have demonstrated that, when
economic conditions are ailing, higher percentagesof new workers find themselves in non-permanent
employment. This is knowledge that we have alreadyacquired from prior work. So then, what about the
young people who have managed to obtain a permanent
position at a big firm anyway—how are they treatedafter they are hired? We assumed that the number of newentry workers is low in the fragile economy—that is, thecohort size is small. Does the small cohort size affectthe young employees’ opportunities for promotion? This
question drew our attention, and we looked into it.

2013 in Review

ʊPlease tell us how you became involved in this lineof research and the particular issues which you aretrying to address.

Research Digest
the state of the economy, which, when bad, can impede
everyone’s performance. One problem with the theory,
however, is that it is not clear exactly who is competingwith whom within the company. For this reason, there
has not been much econometric analysis of theory as
it directly relates to firms; instead, the analysis itself
has typically been based on sports scenarios and othersituations where the contestants are very clear, and theoutcomes have been often invoked to examine business
management.

among competitors seem to be a reasonable way toapproach the issue in practice, since it eliminates
performance differences that might result from moreor less experience, or more or less time in on-the-job
learning. Our paper presents an econometric analysis ofdetailed company data, toward the goal of validating ourhypotheses.

Obviously, however, an analysis that applies to sports
does not necessary apply to business. We therefore
wanted to use actual company data to test directly thetheory. We were still left with the problem of identifying
the contestants in the competition. Our hypothesis wasthat the employees who entered at the same time would
become the competitors; within a cohort, comparisons

The 2010 study by Kwon, Milgrom, and Hwang
stimulated our research. Using personnel data from
American and Swedish companies, their paper analyzed
how economic conditions at hiring time affected future
promotions. The results suggested that employees whoentered during good times were promoted more quickly.
One can think of a reason for this—compared to sluggish

ʊWas there any prior research that you were looking
at?

Figure 1: Size of entry cohort of Manufacturing Company A (white-collar workers)

120

Cohort size

100
80
60
40
20
1990

1995

2000

2005

2010

2005

2010

Cohort year

Figure 2: Size of entry cohort of Manufacturing Company B (white-collar workers)

Cohort size

300
250
200
150
100
50
1990

1995

2000

Cohort year

30 RIETI Highlight 2014 Special Edition

Access to detailed personnel data

We used personnel data from two large Japanesemanufacturers with many employees in Japan. Bothcompanies granted access to 20 years of detailed data—from 1991 to 2010. We were able to see how many
graduates they hired each year, the ratio of both genders,

By looking into trends over 20 years, which is a relatively
long period, we were able to take note of some distinct
features—such as a rapid drop in the number of new hiresthat occurred in the mid-1990s (see Figs. 1 and 2).
In general, it is quite difficult to get access to this type of
in-depth information. Fortunately, we received a favorable
response after approaching the software company
that manages the personnel information for these twocompanies. These two companies also gave us permission
to analyze their personnel records for academic purposes.
Individual names were removed from the data, of course,
along with other information that would make it easy toidentify the actual subjects. On our side, we also took
considerable care to maintain security. In particular, after
placing the data onto RIETI’s servers, we never offloaded
them while analyzing and arranging the dataset; weaccessed and operated on them entirely through RIETI’s
remote access system, which was set to allow access only
to authorized users working from authorized computers.
We were well protected against leaks, and this is one of
the reasons why we were granted access.
As I mentioned earlier, there are only a few cases—
anywhere in the world—where an econometric analysis
has been carried out directly on this type of personnel
data. And in the few cases that do exist, data wereof limited quality—data from failed companies, forexample, or data obtained through business consultants2013 in Review

ʊIn your paper, you indicated that you were able toaccess data that are usually off-limits. What data did
you use?

the ages of the new hires, the schools from which they
graduated, and their track records over the subsequent
years: qualifications, wages, and bonuses.

Special Features

economic times, there appears to be an increase in
the number of challenging and desirable jobs within acompany at good times, which could possibly bring future
success. But we were skeptical of this reasoning. These
results applied to the United States and Sweden, but did
not seem to mesh with the circumstances of Japanesefirms. In the United States and Sweden, for example,
there are open and fluid labor markets for different types
of work, and it is fairly easy to move from one company
to another. In Japan, however, there is a tendency to stayand develop one’s career within a firm. Thus, there seems
to be a fundamental difference in the characteristics of theorganization between the two. In the case of a Japanese
firm, the availability of managerial positions—and ofdesirable jobs—would presumably be relatively lessaffected by external business circumstances and otherexternal factors. If this is true, then what variables inparticular would in fact affect the promotion rates? Our
idea, as mentioned earlier, was that the cohort size—thenumber of new hires entering together—would have alarge effect. So we set out to look at that.

Table 1: Eﬀect of cohort size on work qualiﬁcations

Ordered Probit Model with school dummy variables; survey of 1991‒2010 college graduates in white-collar employment

Coeﬃcients

Manufacturing Company B

Coeﬃcients

Cohort Size (10 persons)-0.0342(0.0033)

Cohort Size (10 persons)-0.0019(0.0008)

Females-0.511(0.0432)

Females-0.818(0.0118)

Tenure1.0728(0.0081)

Tenure0.3466(0.0033)(Tenure)2/100-2.771(0.0392)(Tenure)2/100-0.6998(0.0215)

Pseudo R2

0.59

Pseudo R2

0.27

N

85539

N

81952

Note: Number in parentheses is standard deviation.

RIETI Highlight 2014 Special Edition 31

Introduction of the 9 Research Programs

Manufacturing Company A

Research Digest
was 24. According to the data, the individuals in thesmallest cohort enjoyed approximately twice the chancefor promotion to a given level (called “Grade 3” in ourstudy) compared to their counterparts in the largest
cohort. Moreover, each decline of one standard deviation(27.7 individuals) in the cohort size corresponded to afour-percentage point jump in the promotion rate. Resultsfor Company B showed the same trends, although they
were less pronounced. The data also show that cohort
size has a bigger effect on bonuses than on wages. Thisfinding suggests that, within Japanese firms, bonuses
have the characteristics of the “tournament prizes” asposited by tournament theory.
ʊWhy do cohorts compete internally?

Professor Kawaguchi said that there was correlation between cohort sizeand promotion opportunities.

associated with the researchers. In this regard, our study
is significant in that we were able to obtain and utilize
comprehensive information from successful, established,ongoing companies.

Small cohort size generates opportunities
for promotion

In Europe and the United States—and certainly in thelatter—there is a strong connection between a company’s
internal labor market and the economy’s external labormarket, as indicated by the relative frequency with which
employees move from company to company. Because
capable employees are readily poached by other firms,
a company that wishes to retain talent needs to evaluate
its employees by capability and offer promotions
accordingly. In Japan, however, the labor market ismuch less fluid. Companies guarantee long-term
employment, and workers develop knowledge and skills
while traversing their careers internally. Indeed, someresearchers have noted that the wage curve for Japanesecompanies—the curve associating wages with age—hasbeen flattening out in recent years; in any case, the curveis still much steeper than that of American companies.

ʊWhat were the results of your analysis?
For both companies, we found that the greater cohort
size had a negative effect on one’s chances of promotion.
This suggests that the individuals within each cohort arecompeting among themselves for promotion; in otherwords, the cohort is engaged in its own tournament.
The findings also indicate that a small cohort size isadvantageous to workers in terms of promotions. Under astagnant economy, companies hire fewer new graduates,
so cohort size falls—improving the prospects of those
who get hired, compared to those who do not. An
additional factor to consider, however, is that the better
promotion rate may in part be attributable to the greater
average capability of the people in the smaller cohort.
Because tough economic times reduce job opportunities
throughout the economy, companies have the chance torecruit relatively more capable applicants; and this may
be the reason for the cohort’s faster advance. For thisreason, we filtered out the effect that university quality
has on graduate promotion rates, such that we could
better isolate the effect of cohort size itself.
For Company A, the largest cohort size—namely, thegreatest number of yearly new hires during the 19912010 period we studied—was 124, while the smallest
32 RIETI Highlight 2014 Special Edition

This is apparently why promotion mechanisms at
Japanese companies function differently than those at
U.S. companies. In particular, comparative evaluation in
Japan tends to focus on people within the same cohort.
By comparing within the cohort—namely, by directlycomparing those individuals who have worked the same
number of years—the company can more easily assess
real differences in skills; the comparison, as a result,is more transparent. I would say that this approach isone of the pillars of Japanese employment practice. It
is true, of course, that the Japanese economy is caught
up in major changes, and that many distinctive Japaneseemployment practices are fading. Even so, this cohortbased evaluation approach survives, because it remains
an efficient way to screen and motivate workers.

Necessity for studying trends for employees
who join in mid-careerʊWould you get different results if you examineddifferent companies?
Personnel management practices might be different incompanies that are heavily oriented toward merit-based
appraisals—where they might put less focus on individualcohorts. Results might also have been different if we
studied companies in other types of enterprise—service
companies or entertainment companies, for example.

ʊIf the likelihood of promotion is more dependent oncohort size than on differences in capability, does it
seem somewhat unfair or not?

In Japan, where the proportion of turnover is smaller
than that in the United States, it is likely that the way
a company handles its human resources would have adecisive influence on the firm’s performance. Thus, one
crucial issue is to identify the standards used to decideon which employees get the important jobs. In thisstudy, we showed that people beginning their careers at
two large Japanese manufacturers, when competing for
promotion, are largely in competition with the othersin their own cohort. So, as a company makes decisions
about promotions, where does it place the greatest
weight? Presumably, the company must refer to a wide
range of information when making these decisions.
When considering a person for a promotion, for example,
it might assess according to evaluations from superiors
or use a numerical performance score which is calculated
by using some specific method. Our feeling is that thequality of the school from which one graduated plays
a relatively important role in the early years; but thatas time goes by and the employee gains experience,
the weight shifts more toward on-the-job performance.
There has not yet been much research in this area, in part
because the relevant data has been difficult to obtain. We
think this is the topic that should be addressed next.

ʊWhat type of political implications do your ¿ndings
suggest?
When it comes to landing a job in tough economic times,
a wide gap opens up between those who are fortunate
enough to find something, and those who are not. Our
results suggest that the gap is even greater than we might
have thought, since the fortunate job finders also enjoy
above-average rates of promotion. To put it another way,
hard times seem to magnify the unfairness. Companies
cannot control the economy. When the external
environment worsens—when the economy weakens—
they have no choice but to cut down on hiring; and,as a result, it will have a heavy impact on the labormarket in the short run. This in turn will bring about
an increase in the number of non-permanent workers,

ProﬁleDaiji Kawaguchi has been a professor at the Faculty of Economics,
Hitotsubashi University since 2013. He was an assistant professor at
the Graduate School of Humanities and Social Sciences, University ofTsukuba from 2003 to 2005, and an assistant professor at the Instituteof Social and Economic Research, Osaka University from 2002 to
2003. His recent works are as follows: Hirokatsu Asanno, Takahiro Ito
and Daiji Kawaguchi, “Why Has the Fraction of Nonstandard Workers
Increased? A Case Study of Japan,” Scottish Journal of Political
Economy, Vol. 60, 2013, 360–389; Daiji Kawaguchi and Yuko Ueno,“Declining Long-Term Employment in Japan,” Journal of the Japaneseand International Economies, Vol. 28, 2013, 19-36; Daiji Kawaguch and
Tetsushi Murao, “Who Bears the Cost of the Business Cycle? LaborMarket Institutions and Volatility of the Youth Unemployment Rate,”
IZA Journal of Labor Policy, Vol. 10, Article 10.

RIETI Highlight 2014 Special Edition 33

Introduction of the 9 Research Programs

Importance of Consistent Macroeconomic
Management

ʊPlease let us know something about your next
research topics.

2013 in Review

In our study, we covered people who had not beenworking very long at their companies. While themaximum employment length among our samples
from the two companies was 20 years, the average forCompany A employees was only 6.5 years, and for
Company B employees, 7.6 years. This is a point which
I particularly want to stress. If we were to look at people
who are really building up a career and moving up into
top positions, then we would expect to find that they
were in competition with people hired somewhere near
the same year they joined the firm, but not necessarily inthe same cohort.

Special Features

In addition, we need to review studies focusing on
companies where many employees enter in mid-career.
When an individual with 10 years of experience entersthe firm, for example, questions are raised; where do they
get positioned in the company, and against whom are theyevaluated when considering promotions. Many individuals
in this category are involved in quite specialized work;
therefore, many of them do not fit the picture of employees
who compete within their own cohorts. In the light of
this, there must be some other methods of evaluating
them, and we need to elucidate them. One of the coauthors of our paper—Hideo Owan, RIETI Faculty Fellow
and a professor at the University of Tokyo—is working
with others on a RIETI project already underway in thisarea, entitled “Economic Analysis of Human Resource
Allocation Mechanisms within the Firm.” We lookforward to seeing their findings.

with negative long-term consequences for everyone
involved. If we want to prevent this type of problem,
we need macroeconomic policies that maintain a stableeconomy. As far as monetary policy is concerned, there
are numerous discourses on what the goals should be.
Looking to the United States, we see that the Federal
Reserve Board monitors both the inflation rate and theunemployment rate when deciding on how to act. The
Bank of Japan, in contrast, does not maintain clear goals
with respect to labor market indicators. From my pointof view, they should be giving these indicators a great
deal of weight. In particular, I think policymakers needto devote serious thinking to the employment conditions
for young people.

INTRODUCTION OF
THE
RESEARCH
PROGRAMS
Under the third medium-term plan (fiscal

established. With each Research Program

2011 to fiscal 2015), RIETI makes it its

representing a set of interrelated policies,

mission to undertake theoretical andaltogether they will cover a broad range

empirical research to create a grandof policy areas. Several Research Projects

design for putting the Japanese economy

are to be conducted under these nine

on a growth path and solidifying

Research Programs. Depending on thesustainable growth in the future. To thisprogress we are able to make in the nineend, we will proceed with research

Research Programs or the potential

activity by always keeping in mind thenecessity to explore new research areas

following three Priority Viewpoints

due to changing economic conditions, we(1. Incorporating growth of the world

will either alter or add to our current

economy, 2. Developing new growthresearch programs as needed.

areas, and 3. Responding to changes insociety and creating new economic andIn the current special edition, we willsocial systems for sustainable growth) on

introduce you our leading researcheconomic and industrial policies. Basedachievements from the nine researchon the three Priority Viewpoints, nine

programs.

Research Programs have been

34 RIETI Highlight 2014 Special Edition

Three Priority Viewpoints on economic and industrial policies:
i. Incorporating growth of the world economy;ii. Developing new growth areas; andiii. Responding to changes in society and creating new economic and social
systems for sustainable growth.

Research Programs

International Tradeand
Investment

International
Macroeconomics

Regional
Economies

Technology
andInnovation

Raising Industrial
and Firm
Productivity

New Industrial
PolicyHuman CapitalSocial Security,
Taxation, andPublic Finance

Policy History
and Policy
Assessment

Special Projects

Research Process
To further improve on the quality of research, RIETI ensures that at least three discussion fora
are organized for each research project through workshops and symposiums, where Japaneseand foreign experts and policymakers participate to deepen the research.

Brainstorming
workshop

Midtermworkshop

Launching of a
new research
project

Deepening thestudy andre-matchingvarious researchinterests

Discussion
paper/policy
discussion
papers seminars
Deepening theanalysis ofindividual papers

Final reportingand international
symposiums,
workshops
and seminars
Dissemination ofresearch ﬁndings

RIETI Highlight 2014 Special Edition 35

International Trade and Investment
Program Director: Ryuhei Wakasugi, Faculty Fellow, RIETIThe growth of Japan’s economy is inseparable from changes in the global economy. This program, focusing
on the relationship between the globalization of firms (i.e., exports and overseas production) and growthof the Japanese economy, will study R&D and innovation of globalizing firms, international technology
transfer, employment, and industrial clusters from theoretical and empirical perspectives, together
with studying international trade and investment rules (i.e., the WTO and regional trade agreements)
empirically and from both legal and institutional perspectives. Furthermore, it also will study the impacts
on firms and industries of the external shock of the Great East Japan Earthquake, changes in production
networks and the structure of trade following recovery, and the effects of restrictive energy and material
supply on structural changes in the Japanese economy.

Introduction of Discussion Papers (DPs) published under the Program
DP Title

Why Did Manufacturing Firms Increase the
Number of Non-regular Workers in the 2000s?
Does international trade matter?
Author(s)Release Date
Research
Project
DP No.
URL

Toshiyuki Matsuura (Keio University)
April 2013
Study of the Creation of the Japanese
Economy and Trade and Direct Investment
13-E-036
www.rieti.go.jp/jp/publications/dp/13e036.pdf

This paper examines whether there is any link between
export openness and the temporary workers ratio at
firms. First, we investigate the effect of export openness
on sales volatility using Japanese firm-level data. Next,
we examine whether firms will increase the numberof temporary workers as their sales volatility changes.

Finally, we calculate to what extent changes in thetemporary workers ratio are attributable to the sales
volatility that is caused by exporting. We find statisticallysignificant evidence that a foreign demand shock throughexports affects the sales volatility at the firm level andthat increases in the sales volatility induce the extensive
use of temporary workers. Indeed, we find that thosefirms that incur a higher fixed employment cost makeextensive use of temporary workers when the sales
growth volatility rises. However, quantitative evaluationof the effects of exporting on the temporary workers
ratio shows that the magnitude of these effects is quite
small. We conclude that the impacts of firms’ exporting
status and export share on the temporary workers ratio
are statistically significant but economically negligible
in size. Thus, it is not appropriate to attribute the cause
of increases in the temporary workers ratio to increased
foreign shocks that occur because of exporting.

Figure: The growth rate of GDP, exports, regular workers andtemporary workers
(%)
15.0

DP Title

On Biased Technical Change: Was
technological change in Japan electricitysaving?

10.0
5.0

Author(s)Release Date
Research
Project
DP No.
URL

0.0
-5.0
-10.0
Regular worker
Temporary worker
GDP
Export

-15.0
-20.0
-25.0
2002

2003

2004

2005

2006

2007

2008

2009

Source: GDP and export are obtained from the System of National Accounts(Cabinet Office), and the number of regular workers and temporary workers comefrom the Census of Manufacturers (METI).

36 RIETI Highlight 2014 Special Edition

Hitoshi Sato (Fellow, RIETI)
September 2013
Study of the Creation of the Japanese Economy andTrade and Direct Investment
13-E-077
www.rieti.go.jp/jp/publications/dp/13e077.pdf

Since the Great East Japan Earthquake, electricity
generation has declined in Japan, and electricity prices
have allegedly increased. The literature on biased
technical change suggests that such electricity supply
constraints may induce a biased technical change. This

Table: Cost share decomposition (2000‒2007)
Electricity /Sectors

Changein share

Price
eﬀect

Food & Beverage
Textiles & Leather

0.80

0.01

−0.54

0.14

1.20

0.40

−0.02

−0.61

0.19

0.84

Wood

0.12

0.11

−0.19

0.01

0.19

Paper

0.13

0.34

−0.69

0.25

0.22

Rubber & Plastic

−0.98

0.01

−0.52

0.20

−0.66

Chemicals

−9.39

0.10

−2.97

0.14

−6.66

−3.13

−0.01

−1.81

0.18

−1.48

Primary Metals

−2.42

−0.07

−1.07

−0.16

−1.12

Metal Products

−1.57

0.06

−1.43

−0.02

−0.18

Machinery

−0.25

0.06

−0.46

0.14

0.00

Electrical Products

−0.85

0.27

0.77

0.01

−1.90

−0.15

−0.07

0.09

0.04

−0.22

−0.07

0.02

−0.16

−0.02

0.09

1.09

0.00

−0.07

0.30

0.86

−0.14

0.03

−0.05

−0.05

−0.07

Transportation

1.13

−0.26

0.12

0.09

1.19

Energy /Sectors

Changein share

Scale
eﬀect

Price
eﬀect

Food & Beverage

2.71

0.02

2.06

−0.07

0.69

Textiles & Leather

1.13

−0.06

1.01

−0.03

0.21

Wood

0.77

−0.11

0.76

0.00

0.13

Paper

−0.36

−0.45

4.05

−0.56

−3.40

Nonmetallic
Mineral Products

Transportation
Equipment
Construction
Wholesale & Retail
FinanceTechnical
change Residual

0.00

0.89

−0.20

−0.70

39.49

−0.48

21.20

−0.51

19.28

7.43

−0.02

11.10

−0.89

−2.76

Primary Metals

2.86

−0.03

6.90

−1.21

−2.81

Metal Products

0.22

−0.07

1.37

−0.24

−0.85

Machinery

0.42

0.01

0.77

−0.06

−0.30

Electrical Products

1.65

−0.07

1.91

−0.08

−0.11

0.31

−0.05

0.53

−0.05

−0.11

Transportation
Equipment

Release Date
Research
Project
DP No.
URL

Banri Ito (Fellow, RIETI)
Xu Zhaoyuan (ERI-DRC, State Council of China)
Naomitsu Yashiro (Consulting Fellow, RIETI)
September 2013
Study of the Creation of the Japanese Economy andTrade and Direct Investment
13-E-081
www.rieti.go.jp/jp/publications/dp/13e081.pdf

This study empirically examines the role ofagglomeration in enabling firms to begin exporting, usinga large dataset of Chinese firms. Knowledge spillover
caused by the agglomeration of exporters can reduce theinitial cost of export, thereby lowering the “productivity
cut-off” required to export. A parametric estimation ofan export entry model indicates that the agglomerationof incumbent exporters contributes significantly toexport participation, although its magnitude is limited.
These spillover effects are generated not only by the
agglomeration of exporting foreign invested firms (FIFs),
but also, more importantly, by that of indigenous Chinese
exporters. In fact, the agglomeration of exporting FIFs
only contributes to the export entry of FIFs, yet has anegative impact on indigenous Chinese firms’ export
participation.
Figure: Knowledge spillover eﬀects of agglomeration of ﬁ rms
on export entry
0.0025The minimum
The maximum

Indigenous ﬁrms
0.002

Construction

1.33

0.31

1.60

−0.13

−0.45

Wholesale & Retail

2.24

−0.02

2.00

−0.39

0.65

Finance

0.26

0.00

0.27

0.00

−0.01

Transportation

13.06

1.39

21.00

−0.80

−8.53

0.0015FIFs
0.001

0.00050

ExportstatusTotal Employee
factorproductivity

Wage

ExportstatusTotal Employee
factorproductivity

Wage

Note: Each figure indicates marginal effects provided by the estimationof the Probit model using the number of exporting fi rms in the same
industry and region as explanatory variables. Export status is a dummy
variable that indicates whether or not to export in the previous year. Its
maximum (1) indicates knowledge spillover effects by agglomerationof experienced exporters, and its minimum (0) indicates those by nonexporters.

RIETI Highlight 2014 Special Edition 37

Introduction of the 9 Research Programs

0.00

Chemicals

Mineral Products

Author(s)Technical
change Residual

Rubber & Plastic

Nonmetallic

Does Agglomeration Promote theInternationalization of Chinese Firms?

2013 in Review

Scale
eﬀect

DP Title

Special Features

paper explores the extent to which the technical change inJapanese industries is biased, using a system of translog
cost share equations where electricity and non-electricenergy are separately treated as inputs. Using Japaneseindustry data over the 1973-2008 period, our findings
confirm that technical change has been energy-saving but
not electricity-saving in many industries, and that it tends
to be labor-saving and capital-using. As a result, factor
prices are much more important than technical change asa determinant of electricity’s cost share.

International Macroeconomics
Program Director: Takatoshi Ito, Faculty Fellow, RIETI

Amid rapidly advancing globalization, there is a need to consider how the Japanese economy should takeon growth in emerging markets and realize balanced, sustainable growth within Asia. In addition to
studying institutional infrastructures such as the role of a currency basket in the Asia region, this program
also will analyze various issues related to exchange-rate pass-through and the choice of invoice currencies
from both macroeconomic and corporate-level perspectives. Furthermore, it also will advance research
spanning fields such as international trade and macroeconomics, international finance, macro finance,
corporate foreign-exchange risk management, and corporate finance. We will endeavor to propose ideal
macroeconomic policies for fiscal reconstruction, particularly their influence on exchange rates, as well as
analyze the long-term deflationary mechanism and explore ways of overcoming it.

Introduction of Discussion Papers (DPs) published under the Program
DP Title

Figure 1: Choice of invoice currency and ﬁ nancial hedges

Exchange Rate Risk Management of Export
Firms: New ﬁndings from a questionnaire
surveyHigh Yen
Invoicing
32.9%
No
22.1%

Author(s)Takatoshi Ito (Faculty Fellow, RIETI)
Satoshi Koibuchi (Chuo University)
Kiyotaka Sato (Yokohama National University)
Junko Shimizu (Gakushuin University)
Release Date
April 2013
Research Project Research on Exchange Rate Pass-ThroughDP No.
13-E-024
URL
www.rieti.go.jp/jp/publications/dp/13e024.pdf

In this paper, we present new findings of Japanese firms’
exchange rate risk managements based on a questionnaire
survey sent to all Tokyo Stock Exchange listed firms
in 2009. Using their responses, we conduct empiricalanalysis to investigate the relation between respective
risk management tools including the choice of invoicecurrency and the price revision strategy (pass-through).
Results show the following: first, firms with higher
sales and greater dependency on foreign markets more
actively engage in currency hedging including financial
and operational hedging. Second, Japanese firms use
both financial and operational hedging complementarily.
Third, U.S. dollar invoicing is supported by bothfinancial and operational hedging. Fourth, yen-invoicing
substitutes for both financial and operational hedging.
Fifth, pass-through also substitutes for financial
hedging. These findings indicate that Japanese firms
use operational hedging, financial hedging strategies,
and pass-through policies depending on their choice ofinvoicing currency.

Yes
53.5%

ForwardTransaction

No
46.5%

Yes
77.9%
Others
67.1%
Figure 2: Choice of invoice currency and operational hedges
High Yen
Invoicing
32.9%
No
49.7%

Yes
14.1%

Marry
&
Netting

No
85.9%

Yes
50.3%
Others67.1%
Note: Firms with more than 75% of yen invoicing share are classified into “Highshare of yen invoicing” and other fi rms into “Others.” The outer circle shows the
choice of invoice currency. The inner circle shows the answer of hedges.

38 RIETI Highlight 2014 Special Edition

DP Title

DP Title

Industry-speciﬁc Exchange Rate Volatility
and Intermediate Goods Trade in Asia

The Sophistication of East Asian Exports
Author(s)Figure: Asian triangular trade: 1995-2010
500a) Intra-regional trade of intermediate goods

400
300
200
100
1995

1997

1999

2001

2003

2005

2007

2009

b) Finished Goods Exports to the World

1,200

Figure: The frequency of Japanese, Korean, Chinese, andVietnamese exports based on the sophistication of the
products exported
50
Korea

Vietnam

Japan
40

China
30

20

10

0

5,000 10,000 15,000 20,000 25,000 30,000 35,000
Product Sophistication Index

1,000
800

Note: The figure represents the share of each country’s exports at different levelsof product sophistication. Product sophistication is calculated using the method of
Kwan (2002).
Source: CEPII-CHELEM database and calculations by the authors

600
400
200
0
1995

1997

1999

2001

General Machinery
Electrical Machinery
Precision Instruments

2003

2005

2007

2009

Oﬃce Machinery
Communication E.Q.
Transport E.Q.

Note: Amounts of both intra-regional trade (USD billion) and fi nished goods
exports to the world (USD billion) are calculated using the total machinery
exports in 10 Asian economies: China, Indonesia, India, Japan, Korea, Malaysia,
the Philippines, Singapore, Thailand and Taiwan. The machinery exports are
based on the ISIC 2-digit classification that ranges from 29 to 34. The “world” inFigure b is defi ned as the all countries except the above 10 Asian economies.
Source: Authors’ calculation based on the OECD STAN database

RIETI Highlight 2014 Special Edition 39

Introduction of the 9 Research Programs0

Hausmann, Hwang, and Rodrik (2007) found thatcountries that export more sophisticated products tend
to subsequently grow more rapidly. We examine thesophistication of Asia’s exports using Hausmann etal.’s and Kwan’s (2002) measures. Japan remains thetechnology leader in Asia, but not in the world. In 2012,
Japan’s exports competed with those of South Korea andTaiwan and were complementary with those of China andthe Association of Southeast Asian Nations (ASEAN).
South Korea and Taiwan competed intensely with eachother but less so with China and ASEAN, while ASEAN
countries competed extensively with each other. Given
the high levels of competition and cooperation among
East Asian countries, greater exchange rate stability
in the region would reduce export volatility among
competitors and facilitate trade among comrades.

2013 in Review

This paper empirically analyzes the effect of exchange
rate volatility on intra-Asian trade of intermediate goods
at an industry level by constructing a new dataset of theindustry-specific bilateral real exchange rate. As the final
processed exports are destined for countries outside the
Asian region, both the exchange rate and world demand
are considered as a possible driving force in the crossborder fragmentation and processing trade. It is foundthat, in contrast to the recent studies, the exchange rate
impact on intra-regional trade differs across industries.
The exchange rate volatility has negative and significant
effects only on the general machinery industry anda part of the electric machinery industry with moredifferentiated products, even when taking into accountthe world’s demand for the final processed exports. Thesefindings are supported by various kinds of exchange rate
volatility in the short- and long-run. Our empirical results
suggest that the different impact of the exchange rate
volatility across industries is tied to the characteristics oftraded goods in respective industries.

Release Date
Research
Project
DP No.
URL

Willem Thorbecke (Senior Fellow, RIETI)
Hao-Kai Pai(Research Assistant, RIETI)
November 2013
East Asian Production Networks and Global
Imbalances
13-E-092
www.rieti.go.jp/jp/publications/dp/13e092.pdf

Special Features

Kiyotaka Sato (Yokohama National University)
Junko Shimizu (Gakushuin University)
Nagendra Shrestha (Yokohama National University)
Shajuan Zhang (Yokohama National University)
Release Date
April 2013
Research Project Research on a Currency Basket
DP No.
13-E-031
URL
www.rieti.go.jp/jp/publications/dp/13e031.pdf

Percent of the Total Value of Each Country s Exports

Author(s)Regional Economies
Program Director: Nobuaki Hamaguchi, Faculty Fellow, RIETIThis program will study urban, rural, and industrial growth viewing the regions of Japan in thecontext of the global economy, and using this to develop policy recommendations and other outputs.
Specifically, it will analyze, both theoretically and empirically, matters such as formation of domestic andinternational regional systems through market mechanisms, the mechanisms of enterprise clustering, andthe relationship between economic growth and urbanization, considering regional policies that would
be desirable from the perspectives of national economic growth and maximizing policy effects, and also
researching the optimal sizes of regional blocs and communities. Additional study will look at the ideal
forms of the supply chains of Japanese firms and the recovery of areas affected by the Great East Japan
Earthquake. Furthermore, the ideal management strategies for outstanding small and medium-sizedenterprises utilizing regional resources and other advantages will be studied as well.

Introduction of Discussion Papers (DPs) published under the Program
Table 1: Cumulative percentage of ﬁ rms by region

DP Title

Role of Hub Firms in GeographicalTransaction Network
Author(s)Release Date
Research
Project
DP No.
URL

Yukiko Saito (Fellow, RIETI)
September 2013
Inter-organizational and Inter-inventors Geographical
Proximity and Networks
13-E-080
www.rieti.go.jp/jp/publications/dp/13e080.pdf

In this study, we investigate the role of geographicalproximity in an inter-firm transaction network and therole of hub firms on geographical spread of regional
impact. By using inter-firm micro transaction data of over
800 thousands firms, we found that indirect transaction
is geographically dispersed mainly due to a few hub
firms, although firm’s direct transactions mostly occur
within geographically narrow areas. More precisely,
median distance between indirect transaction partners(partners’ partners) is 255km, which is much larger thanthat between direct transaction partners (29km). In a
counterfactual transaction network without hub firms,
whose transaction relations are no less than 100, median
distance between indirect transaction partners is reduced
to 70km, thereby suggesting the important role of hub
firms in a geographical transaction network. We confirm
this suggestion through an analysis of regional impact of
the Great East Japan Earthquake.

Tier 0Tier 1

Tier 2Tier 3

Total

1.8%

5.1%

56.7%

90.5%

Hokkaido

0.0%

2.3%

60.2%

95.8%

Tohoku

16.6%

33.6%

82.0%

96.7%

Kanto

0.0%

2.7%

58.2%

89.5%

Chubu

0.0%

0.8%

51.6%

90.6%

Kinki

0.0%

1.2%

54.2%

88.0%

Chugoku/Shikoku

0.0%

0.5%

47.2%

90.1%

Kyushu

0.0%

0.3%

42.8%

88.3%

Table 2: Cumulative percentage of ﬁ rms in counterfactual
network without hub ﬁ rm
Tier 0Tier 1

Tier 2Tier 3

Total

1.8%

4.0%

20.3%

55.9%

Hokkaido

0.0%

1.3%

19.8%

65.2%

Tohoku

16.6%

27.3%

56.6%

81.2%

Kanto

0.0%

1.9%

19.8%

55.2%

Chubu

0.0%

0.6%

13.8%

54.4%

Kinki

0.0%

0.8%

14.0%

49.5%

Chugoku/Shikoku

0.0%

0.4%

11.5%

48.9%

Kyushu

0.0%

0.3%

9.8%

44.9%

Note: Tier 0 fi rms are defi ned as fi rms in the earthquake-affected areas, Tier 1
fi rms are defi ned as Tier 0 fi rms’ partners, Tier 2 fi rms are defi ned as Tier 1 fi rms’
partners, and Tier 3 fi rms are defi ned as Tier 2 fi rms’ partners.

40 RIETI Highlight 2014 Special Edition

DP Title

Localization of Collaborations in Knowledge
Creation

Author(s)Author(s)Release Date
Research
Project
DP No.
URL

Andrew B. Bernard (Tuck School of Business at Dartmouth)
Toshihiro Okubo (Keio University)
August 2013
Studies on the Structure of Japanese Economic
Space and Japanese Supply Chains Sustaining
Growth Under Globalization and Disaster Risks
13-E-069
www.rieti.go.jp/jp/publications/dp/13e069.pdf

Release Date
Research
Project
DP No.
URL

This study investigates the localization of knowledge
exchange behavior by using data on inter-establishment
collaborations in Japanese patent applications. Using
distance-based methods, we obtain the following
results. First, inter-establishment collaborations are
significantly localized at the 5% level, with the rangeof localization at approximately 100km. Second, theextent of collaboration localization was stable during
1986-2005 despite the extensive developments in
information and communications technology facilitating
easy communication between remote researchers.
Third, the extent of collaboration localization is muchlarger in inter-firm collaborations than in inside-firm
collaborations. Furthermore, in inter-firm collaborations,the extent of localization is larger in collaborations
with firms having only one research establishment. As awhole, inter-establishment collaborations are localized
and stable, and localization occurs to complement firmborder effects, especially with regard to small firms.
Figure: Relative densities of inside-ﬁ rm and inter-ﬁ rm
collaborations

.8

3.5
3

inter-ﬁrm
.6

2.5
2

inside-ﬁrm

.4

1.5
1

.2

0.5

add

drop=add

0

12

80

-2

12

56

80

0
064

0-

64

0
32

32

0
-8

-4

60

0-

.6

80
-1

.4

16

drop

40

.2

20

20
0-

0

0

0

0

Distance (kｍ）RIETI Highlight 2014 Special Edition 41

Introduction of the 9 Research Programs

Figure: Add and drop rates across products2013 in Review

This paper explores the role of multi-product plants
and product switching in the Japanese manufacturingsector. While a substantial body of work has exploredthe importance of the extensive margins of plant entry
and exit in employment and output flows, only recently
has research begun to examine the adjustment acrossproducts within establishments and its importance forplant and aggregate output and employment flows.
Using a novel, annual plant-product dataset covering
all Japanese manufacturing plants with more than four
employees from 1992 to 2006, we provide the firstevidence on the role of multi-product plants in theJapanese manufacturing sector and how the productmix and the plant mix have changed over time. Unlike
previous studies, we are able to track annual changes
in the product mix. The period covers a major decline
in manufacturing activity, and we show that the mixof products and output shifted strongly toward larger
multi-product plants that are part of multi-establishment
manufacturing firms.

Hiroyasu Inoue (Osaka Sangyo University)
Kentaro Nakajima (Tohoku University)
Yukiko Saito (Fellow, RIETI)
August 2013
Inter-organizational and Inter-inventors Geographical
Proximity and Networks
13-E-070
www.rieti.go.jp/jp/publications/dp/13e070.pdf

Special Features

DP Title

Multi-Product Plants and Product Switchingin JapanTechnology and Innovation
Program Director: Sadao Nagaoka, Faculty Fellow, RIETIThe sources of innovation are the creation of new knowledge and its exploitation to solve real-world
problems. This program will develop original data on innovation process with a view toward improving
our understanding of such processes, including the surveys of inventors in Japan, North America, andEurope, and will conduct analysis from a global perspective so as to contribute to evidence-based policy
formation conducive to technology development and innovation. Specifically, the program will analyze
a broad range of issues, such as an assessment of intellectual property systems such as patent systems,
knowledge transfer and mobility of people across organizations, university-industry cooperation, technicalstandards for innovation, collaboration in innovation, corporate organization and industrial organization
to promote innovation, and international comparison of entrepreneurship.

Introduction of Discussion Papers (DPs) published under the Program
DP Title

Entrepreneurship and Human Capital:
Empirical study using a survey ofentrepreneurs in Japan

curriculum activities experienced at universities andfacilitating employees to develop broad professional
experiences.
Figure: The numbers of samples by entrepreneurship phase

Author(s)Release Date
Research
Project
DP No.
URL

Ryota Baba (Booz & Company (Japan) Inc.)
Kazuyuki Motohashi (Faculty Fellow, RIETI)May 2013
Empirical Studies on the International Comparison ofOpen Innovation
13-E-049
www.rieti.go.jp/jp/publications/dp/13e049.pdf

Entrepreneurship activities are low in Japan, and it isoften discussed that possible reasons are the lack ofventure capital and a rigid labor market. However, it israre to find a study that analyzes the human capital aspectof entrepreneurs based on a large scale sample survey.
In this study, the characteristics of the human capital ofentrepreneurs, such as education and job experience, areanalyzed based on a survey of entrepreneurs conducted
by RIETI in 2012. The entire process of entrepreneurshipis divided into three phases—(1) planning, (2) execution,and (3) achieving success in business—and thedeterminants of each step, not only the education andjob background, but also personal relationships with theentrepreneur and his/her personality, are investigated.
It is found that broad experiences while attending
universities such as extra-curriculum activities are an
important factor at the planning and execution stage. In
contrast, broader job experiences but within a limited
number of companies can explain the probability ofentrepreneurship success well. Therefore, promotionof entrepreneurship activity in Japan including forminga spin-off company requires both a variety of extra42 RIETI Highlight 2014 Special Edition

PHASE1PHASE2

PHASE3success /failure1-10
scaling

startbusiness
1501
Peopleplannednotstarted2201
People700
PeopleAllsamplesnotplanned7023
People5822
PeopleDP Title

Evolution of Standards and Innovation

Author(s)Release Date
Research
Project
DP No.
URL

Masayo Kani (Tezukayama University)
Kazuyuki Motohashi (Faculty Fellow, RIETI)
April 2013
Empirical Studies on the International Comparison ofOpen Innovation
13-E-033
www.rieti.go.jp/jp/publications/dp/13e033.pdf

Figure: Innovation strategy on new product development
process

Author(s)Reiko Aoki (Faculty Fellow, RIETI)
Yasuhiro Arai (Kochi University)
Release Date
September 2013
Research Project Standard Policy for Innovation
DP No.
13-E-075
URL
www.rieti.go.jp/jp/publications/dp/13e075.pdf

We present a framework to examine how a standard
evolves when a standard consortium or firm (incumbent)
innovates either to improve the standard or to strengthen
the installed base which increases switching cost.
By investing also in technology improvement, bothinvestments make it more difficult for another firm
(entrant) to introduce a standard. Our analysis shows thatthe incumbent’s strategy will differ according to whether
the technology is in its infancy or if it has matured,
but the existing standard will never be replaced by theentrant. Stability of a standard consortium standard has
dynamic benefits in that it prevents replacement by anentrant. The incumbent deters entry when the technology
is in its infancy but allows entry and co-existence of two
standards when the technology is mature. This implies
that dominance of a single standard even for wellestablished technologies suggests some market powerby the incumbent. Our results also indicate that superior
technology will never be sufficient to overtake anexisting standard.
Figure: Stage two (Bertrand competition) equilibrium

v1-SInternal
development(N=1199)

Acquiringexternaltechnology(N=436)

Regime Ⅱ
Standard
Replaced

Regime Ⅲ
Co-existence

3t

Not
acquiring(N=642)

Regime Ⅰ
Standard
Upgraded

Regime Ⅳ
Co-existencev00Technology
partner=Business
partner(N=288)3t

Technology
partner≠Business
partner(N=148)RIETI Highlight 2014 Special Edition 43

Introduction of the 9 Research Programs

New product development(N=1390)

External
development(N=168)2013 in Review

There is a growing trend of open innovation in the
new product development process, while technology
insourcing has not been investigated very well ascompared to technology outsourcing in empiricalliterature. In this paper, we examine the factors that
determine whether to acquire external knowledge andhow to assimilate it in the process of new productdevelopment by using novel dataset at the productlevel, conducted by RIETI in 2011. We distinguishwhether technology partners are also business partners
such as suppliers or customers, and show their distinct
patterns. In the case that technology partners are notbusiness partners, patents play an important role inmoderating transaction costs in the partnership, while
co-specialization of technology and its complementary
assets with partners is found for cases in which
technology partners are also business partners.

Special Features

DP Title

Determinants of Demand for Technology in
Relationships with Complementary Assets inJapanese Firms

Raising Industrial and Firm Productivity
Program Director: Kyoji Fukao, Faculty Fellow, RIETI

The aim of the program is to measure industry- and firm-level productivity and its determinants for Japanand various East Asian countries and to conduct research on policies aimed at raising productivity. At theindustry level, the program—in addition to updating and expanding the Japan Industrial Productivity (JIP)
and China Industrial Productivity (CIP) databases in collaboration with Hitotsubashi University—will
construct an industrial productivity database by prefecture for Japan and examine the impact of the recent
earthquake on regional economies and policies for reconstruction. At the firm or establishment level,
employing micro-data from government statistics and corporate financial data in Japan and abroad, theprogram will research the following: productivity differentials between firms, the impact of globalization,
how changes in demand affect corporate performance, policies for raising productivity in the service
sector, and productivity dynamics from an international perspective—including productivity differentials
between Japanese, Chinese, and Korean firms—as well as other related issues.
At the industry and firm level, the program will measure investment in intangible assets such as researchand development, software, in-house training and organizational structure—all of which are importantsources of innovation and productivity growth—and will examine the economic effects of such investments.
Introduction of Discussion Papers (DPs) published under the Program
DP Title

The Eﬀects of Birth Weight: Does fetal origin
really matter for long-run outcomes?
Author(s)Release Date
Research
Project
DP No.
URL

Makiko Nakamuro (Keio University)
Yuka Uzuki (National Institute for Educational Policy Research)
Tomohiko Inui (Faculty Fellow, RIETI)
April 2013
Research on Measuring Productivity in the Service
Industries and Identifying the Driving Factors for
Productivity Growth13-E-035
www.rieti.go.jp/jp/publications/dp/13e035.pdf

effect of birth weight on later educational and economic
outcomes. The most important finding is that birth weight
has a causal effect on academic achievement at aroundthe age of 15, but not on the highest years of schoolingand earnings.

DP Title

Competition, Productivity Growth, andStructural Change
Author(s)This paper investigates whether birth weight itself causes
individuals’ future life chances. By using a sample oftwins in Japan and controlling for the potential effects
of genes and family backgrounds, we examine theTable: Empirical results (twin-ﬁxed eﬀects)

Independent
variables

Dependent
variables

Student
HighestPrivateRanking
Years of Earnings
Middle Performance
College
Schooling
School (Age 15)

Birth weight (/100g)

0.050＊ 0.210＊ 3.138(0.029) (0.108) (3.090)-0.077(0.170)0.065(0.071)

Log (birth weight)

0.112＊ 0.575＊＊ 7.326(0.066) (0.249) (7.149)-0.137(0.417)0.177(0.161)

Non‐LBW(Low birth weight)

0.053＊(0.030)0.099(0.088)5.659＊(3.055)-0.146(0.162)-0.042(0.072)

Observations(of twin pairs)

1,257
(641)

2,206
(1,138)

918
(736)

2,234
(1,144)

1,832(1,032)

Note: 1. The numbers in parentheses are heteroskedasticity - robust standard
errors and clustering at the family level.
2. ** and * represent 5% and 10% significance level, respectively.
Source: Authors’ calculations

44 RIETI Highlight 2014 Special Edition

Release Date
Research
Project
DP No.
URL

Takeo Hori (Aoyama Gakuin University)
Taisuke Uchino (Research Associate, RIETI)May 2013
Decomposition of Economic Fluctuations for Supply
and Demand Shocks
13-E-041
www.rieti.go.jp/jp/publications/dp/13e041.pdf

Extending the endogenous growth model proposedby Young (1998), we construct a two-sector growthmodel that explains the observed pattern of structuralchange. Unlike existing studies, we assume neither nonhomothetic preferences nor exogenous differential inproductivity growth among different sectors. Our key
assumption is that any two goods produced by firms
in a sector are closer substitutes than those producedby firms in other sectors, which gives rise to an
endogenous differential in productivity growth among
different sectors. When the two composite goods arepoor substitutes, the share of employment graduallyshifts from the sector with a low markup to that witha high markup. To test the validity of the prediction of
our model, we also estimate industry-level total factor

Figure 1: Correlation between markup and TFP growth

0.02

0

-0.02

-0.04
-0.4

-0.2

0
0.2
Markup (period-average）

Observations

0.4

Fitted values

Does the Stock Market Evaluate Intangible
Assets? An empirical analysis using data oflisted ﬁrms in Japan
Author(s)Tsutomu Miyagawa (Faculty Fellow, RIETI)Takizawa Miho (Toyo University)
Kazuma Edamura (NISTEP)
Release Date
June 2013
Research Project Study on Intangible Assets in JapanDP No.
13-E-052
URL
www.rieti.go.jp/jp/publications/dp/13e052.pdf

Following Corrado et al. (2009), we measure intangible
assets at the listed firm level in Japan. Compared tothe conventional Tobin’s Q, the revised Q including
intangibles is almost 1 on average, as suggested by Hall
(2000 and 2001). The standard deviation of the revised
Q is smaller than that of the conventional Q. Estimation
results based on Bond and Cummins (2000) show that
greater intangible assets increase firm value. In particular,
in the IT industries, on average, Tobin’s Q is higher thanthat in the non-IT industries, and the stock market reflects
the value of intangibles in the IT industries. These results
suggest that the government should adopt policies that
promote investment, including intangibles in the IT
industries, and change in the industry structure in Japan.

2013 in Review

TFP growth (period-average)

0.04

DP Title

Special Features

productivity (TFP) growth and markup using Japanesefirm-level panel data. The empirical results show anegative correlation between estimated markup and longterm TFP growth, and a positive correlation between
the growth of industrial labor input and markup, which
supports our theoretical results. Finally, in contrast to
the previous studies of structural change that consider
competitive economies, we study the socially optimal
allocation and characterize the optimal tax policies.

Figure: Density of Tobin s Q
1

0.04
0.8
0.02
0.6

0

0.4

-0.02

0.2

-0.04

0

-0.4

-0.2

0
0.2
Markup (period-average）

Observations

0.4

Fitted values

0

1

2

4

Revised Tobin s Q

68Conventional Tobin s Q

Note: The vertical axis indicates Density, and the horizontal axis indicates Tobin’s
Q.

Notes: Markups, TFP growths, and labor input growths are measured as
deviations from their respective means. Observations with markup significantly
lower than 1 at the significance level of 5 percent are removed.

RIETI Highlight 2014 Special Edition 45

Introduction of the 9 Research Programs

Growth in the number of employees (period-average)

Figure 2: Correlation between markup and labor input growth

New Industrial Policy
Program Director: Hiroshi Ohashi, Faculty Fellow, RIETI

Leading nations appear to have ventured into the formulation of strategies and policies that promote boththeir own domestic industries and companies in the global markets. This program will conduct researchon formulating industrial policies in the aftermath of the Great East Japan earthquake with a view toward
resolving issues being faced by the Japanese economy. It will take into consideration the roles played byproduct innovations, while also looking into the perspectives of, for example, environmental, energy, andresource policies, competition policy, as well as agricultural policy.
Introduction of Discussion Papers (DPs) published under the Program
DP Title

DP Title

Stochastic Macro-equilibrium andMicrofoundations for Keynesian Economics

Disguised Protectionism? Environmental
Policy in the Japanese Car Market

Author(s)Release Date
Research
Project
DP No.
URL

Hiroshi Yoshikawa (Faculty Fellow, RIETI)May 2013
Issues Faced by Japan s Economy and Economic
Policy Part II: Population decrease, sustained growth,economic welfare
13-E-039
www.rieti.go.jp/jp/publications/dp/13e039.pdf

In place of the standard search equilibrium, this paper
presents an alternative concept of stochastic macroequilibrium based on the principle of statistical physics.
This concept of equilibrium is motivated by unspecifiable
differences in economic agents and the presence of all
kinds of micro shocks in the macroeconomy. Our model
mimics the empirically observed distribution of laborproductivity. The distribution of productivity resulting
from the matching of workers and firms depends
crucially on aggregate demand. When aggregate demandrises, more workers are employed by firms with higher
productivity while, at the same time, the unemployment
rate declines. The model provides a micro-foundation forKeynes’ principle of effective demand.
Figure 1: Dynamics of creation and destruction of potential jobs
The number of potential job sites (in log)

Author(s)Taiju Kitano (Hitotsubashi University)
Release Date
June 2013
Research Project Basic Research for a New Industrial Policy
DP No.
13-E-059
URL
www.rieti.go.jp/jp/publications/dp/13e059.pdf

The U.S. government criticized Japanese environmental
policies, which promoted eco-friendly car (eco-car)purchases via measures such as tax exemptions andsubsidies, as disguised forms of protection by arguing thatthe fuel economy standard for the subsidy qualification
was designed to be more beneficial to domestic firms. This
paper examines Japanese environmental policies from2005-2009 to assess whether or not they were adequately
formulated from an environmental perspective. The
analysis compares the outcomes between the actual fueleconomy standard for subsidy qualification introduced inJapan and an alternative standard suggested by the U.S.
government. Simulation results based on the structural
econometric model of multi-product oligopolisticcompetition show that although both alternative and actual
standards are comparable for the average fuel economy of
new cars sold, the former is inefficient in improving thefuel economy because it requires much larger subsidies
to achieve the same average fuel economy level as that of
the latter.
Figure 2: Stochastic macro-equilibrium
The number of employed workers

Aggregate demand D or β

Reservation
wages μPool of unemployment

Productivity (in log)

Note: Both productivity and the number of potential job sites are in the natural
logarithm. The straight line as drawn in the figure means that the distribution of
productivity is power-law.

46 RIETI Highlight 2014 Special Edition

The level of productivity

Human Capital
Amid the rapid aging of its society, intensifying global competition, and recovery from the Great East Japan
Earthquake, utilizing its human resources is a significant key to Japan maintaining and strengthening its
economic dynamism and increasing its growth potential, as a nation relatively lacking in natural resources.
This program will carry out multifaceted, comprehensive research on measures for strengthening humancapital and human resource capabilities, from a full life-cycle perspective including ideal labor market
systems to increase worker incentive and ability, early childhood education through higher education,
human-resources development in employment years, and utilization of elderly human resources.

Special Features

Program Director: Kotaro Tsuru, Faculty Fellow, RIETIIntroduction of Discussion Papers (DPs) published under the Program
DP Title

DP Title

Cohort Size Eﬀects on Promotion and Pay:
Evidence from personnel data

Dynamics of the Gender Gap in the
Workplace: An econometric case study of alarge Japanese ﬁrm

Author(s)DP No.
URL

Figure: Size of entry cohort of Company A, college-graduate
white collar
120

Cohort size

100

80

60

40

20
1990

1995

2000
Cohort year

2005

Release Date
Research
Project
DP No.
URL

Takao Kato (Colgate University)
Daiji Kawaguchi (Faculty Fellow, RIETI)
Hideo Owan (Faculty Fellow, RIETI)May 2013
Economic Analysis of Human Resource Allocation
Mechanisms Within the Firm: Insider econometrics
using HR data
13-E-038
www.rieti.go.jp/jp/publications/dp/13e038.pdf

This paper provides new evidence on the nature andcauses of the gender pay gap using confidential personnel
records from a large Japanese manufacturing firm.
Controlling only for the human capital variables that are
typically included in the standard wage function results
in a substantial gender pay gap—16% for unmarried and
31% for married ones. However, additionally controllingfor job level, skill grade, hours worked, and number of
dependents almost eliminates the “unexplained” gender
pay gap. We estimate various models of promotion rates
and additionally find that (i) there is a statistically andeconomically significant correlation between the hours
worked and the odds of promotion for women but not formen; (ii) maternity carries a substantial career penalty(up to a 20-30 percentage-point fall in future earnings),
especially for college graduate women; and (iii) the
maternity penalty can be avoided by promptly returningfrom parental leave and not reducing work hours after
returning. As such, our evidence points to the importanceof women’s ability to signal their commitment to work
(or the level of family support they receive)—throughworking long hours and taking shorter parental leave—
for their career advancement.

2010

RIETI Highlight 2014 Special Edition 47

Introduction of the 9 Research Programs

This paper provides econometric evidence on thecohort size effect in promotion and pay using detailed
personnel records of all workers who joined two large
manufacturers in Japan during the period 1991-2010. We
find that entering the labor market when the economy
is in a bad year and joining firms with fewer colleagues
increase the probability of promotion and pay. Ourfinding implies that the cohort can be a reasonable proxy
for the contestant pool.

Author(s)2013 in Review

Release Date
Research
Project

Shota Araki (Hitotsubashi University)
Takao Kato (Colgate University)
Daiji Kawaguchi (Faculty Fellow, RIETI)
Hideo Owan (Faculty Fellow, RIETI)
April 2013
Economic Analysis of Human Resource Allocation
Mechanisms Within the Firm: Insider econometrics
using HR data
13-E-029
www.rieti.go.jp/jp/publications/dp/13e029.pdf

Social Security, Taxation, and Public Finance
Program Director: Mitsuhiro Fukao, Faculty Fellow RIETI

Japan has to maintain its economic dynamism in the face of its rapid aging population and low fertility
rate. This program will carry out multifaceted, integrated research on Japan’s social security system,
taxation, and public finance. The research subjects include (1) an analysis of comprehensive panel data on
the elderly, (2) possible reforms to the social security and taxation systems, (3) a proposal for combining
carbon taxes and investment subsidies in energy conservation, (4) optimal fiscal policy measures forreconstruction from the recent earthquake, economic recovery, and fiscal consolidation, and (5) new formsof public services, including the “third sector.”
Introduction of Discussion Papers (DPs) published under the Program
DP Title

DP Title

Stability of Preference against Aging and
Health Shocks: A comparison between Japanand the United States

The Future of Long-term Care in Japan

Author(s)Author(s)Release Date
Research
Project
DP No.
URL

Hideki Hashimoto (The University of Tokyo)
Hidehiko Ichimura (Faculty Fellow, RIETI)
Satoshi Shimizutani (Consulting Fellow, RIETI)
August 2013
Toward a Comprehensive Resolution of the Social
Security Problem: A new economics of aging
13-E-068
www.rieti.go.jp/jp/publications/dp/13e068.pdf

Release Date
Research
Project
DP No.
URL

Satoshi Shimizutani (Consulting Fellow, RIETI)July 2013
Toward a Comprehensive Resolution of the Social
Security Problem: A new economics of aging
13-E-064
www.rieti.go.jp/jp/publications/dp/13e064.pdf

This paper reviews a decade of implementation of the
public long-term care insurance (LTCI) program in Japan,
which is now experiencing unprecedented pressure
from its rapidly aging population. This overview of the
program’s features focuses on the incentive mechanisms
and diversity, and examines official future projectionsof LTCI costs and their accompanying assumptions. It
also includes the discussion of possible reforms for the
LTCI program, with an emphasis on the micro aspects of
LTCI, as evidenced by the Japanese Study on Aging andRetirement (JSTAR).

This study explores stability of preference against aging
and health shocks. Contrary to a vast amount of literatureassuming that risk attitude is unchanged over time, we
utilize JSTAR (Japanese Study of Aging and Retirement),
which provides longitudinal data on the middle aged
and elderly comparable with the Health and Retirement
Study (HRS)/English Longitudinal Study of Ageing(ELSA)/Survey of Health, Ageing and Retirementin Europe (SHARE), to examine how aging and past
health experiences systematically affect risk attitude.
We find that while there is empirical evidence that aging
gradually causes individuals to be more risk averse,
health shocks do not seem to affect risk preference
systematically.

Table: Distribution of two types of questionnaires in JSTAR wave 1 to detect irrational response.

Risk attitude to 10% gain

Risk attitude to 20% gain
1

2

3

4

5

6

7

8

9

10

11

Total

1
2
3
4
5
6
7
8
9
10
11

26.86
4.24
1.49
1.12
0.74
0.45
0.15
0.15
0.07
0.15
0

1.34
2.6
2.16
1.19
0.97
0.37
0.3
0.3
0
0.15
0

1.19
0.97
2.53
4.46
2.08
1.04
0.52
0.07
0
0.22
0

0.52
0.45
0.52
3.13
3.35
1.93
1.04
0.89
0.22
0
0

0.3
0.15
0.15
0.67
3.42
3.13
1.12
0.37
0.37
0.3
0.07

0.22
0.07
0.07
0.07
1.04
2.68
1.71
1.86
0.07
0.22
0.07

0.15
0.07
0.07
0.07
0
0.45
0.97
1.04
2.16
0.74
0.07

0.07
0
0.07
0.07
0.07
0
0.15
0.74
0.15
0.67
0

0.07
0
0
0
0
0
0
0.07
0.45
0.3
0

0.07
0
0
0
0.07
0.07
0.07
0.07
0.07
2.46
0.22

0.07
0
0
0
0
0
0
0
0
0
0

30.88
8.56
7.07
10.79
11.76
10.12
6.03
5.58
3.57
5.21
0.45

Total

35.42

9.38

13.1

12.05

10.04

8.11

5.8

2.01

0.89

3.13

0.07

100

Violation of motononicity

48 RIETI Highlight 2014 Special Edition

Violation of local concavity

Policy History and Policy Assessment
The objective of this program’s research is to review and assess trade and industrial policy chiefly over theperiod from 1980 through 2000, as it looks at Japan’s economy, society, and trade and industrial policies atthe end of the 20th century.
At the same time the final two decades of the 20th century were a time of significant changes in Japan’s
economy and society, they also were a time of very major real and organizational changes in trade andindustrial policy. This research will attempt to make clear how changes in trade and industrial policy at
the turn of the century were effected, based on activities including assessment of the recognition of policy
issues over the preceding quarter-century, choice of policy means in response, and their results.

Special Features

Program Director: Haruhito Takeda, Faculty Fellow, RIETIIntroduction of Discussion Papers (DPs) published under the Program
DP Title

DP Title

Political Economy of Trade Liberalization:
The case of postwar Japan

Eﬀects of Industrial Policy on Productivity:
The case of import quota removal during
postwar Japan

Megumi Naoi (University of California, San Diego)
Tetsuji Okazaki (Faculty Fellow, RIETI)
Release Date
November 2013
Research Project Historical Evaluation of Industrial Policies
13-E-090
DP No.
URL
www.rieti.go.jp/jp/publications/dp/13e090.pdf
Author(s)Author(s)This paper attempts to provide a systematic analysis on
the effects of industrial policy in postwar Japan. Amongthe various types of Japanese industrial policy, this paper
focuses on the removal of de facto import quotas throughthe foreign exchange allocation system. Analyzing a panelof 100 Japanese manufacturing industries in the 1960s, wefind that the effects of the quota removal on productivity
were limited—the effects were significantly positive, buttime was required before they appeared. On the other hand,the effects of tariffs on labor productivity were negative
although insignificant. One possible reason for this isthat the Japanese government increased tariff rates before
removing the import quotas and maintained high tariff rates
afterward. As a result, the effects of the Japanese industrial
policy in the 1960s might be smaller than widely believedin the Japanese economic history literature.

Figure: Changes in trade liberalization rate

Figure: Distribution of tariﬀ rates
(%)
30.0

(%)
100

1960.490

1961.4

25.0

80
70

20.0

60
50

15.0

40
30

10.0

20
10

5.0

0
1960 1961 1962 1963 1964 1965 1966 1967 1968 1969(%)

Source: White Paper on International Economy and Trade, 1970

0
0

1-5

6-10 11-15 202530

35 40-45 50

Over
50
(%)

RIETI Highlight 2014 Special Edition 49

Introduction of the 9 Research Programs

How did the postwar newer democracies, whose
governments faced pressure from both vested special
interests and voters, achieve trade liberalization?
Exploiting the case of trade liberalization in Japan in the
1960s, this paper addresses this question. Because thebenefits and costs of trade liberalization are unequallydistributed among the population, generating winners
and losers, trade liberalization is inherently a highly
political issue. The Japanese government and the Liberal
Democratic Party (LDP) leaders used two tactics to build
a coalition of legislators for trade liberalization. Whilethey used sequencing of liberalization to buy off support
from the legislators of the Upper House, they relied onside payments for the legislators of the Lower House.
This strategy choice was consistent with the differencein the sizes of the electoral districts between the Upper
House and the Lower House.

2013 in Review

Kozo Kiyota (Faculty Fellow, RIETI)
Tetsuji Okazaki (Faculty Fellow, RIETI)
Release Date
November 2013
Research Project Historical Evaluation of Industrial Policies
DP No.
13-E-093
URL
www.rieti.go.jp/jp/publications/dp/13e093.pdf

http://www.rieti.go.jp/en/
Research Institute of Economy, Trade & Industry,IAA