PDPRIETI Policy Discussion Paper Series 10-P-007

Service Sector Productivity in Japan:
The key to future economic growth
FUKAO Kyoji
RIETI

The Research Institute of Economy, Trade and Industry

http://www.rieti.go.jp/en/

RIETI Policy Discussion Paper Series 10-P-007
August 2010

Service Sector Productivity in Japan: The key to future economic growth*

FUKAO Kyoji
Hitotsubashi University and RIETI
Abstract
This paper aims to examine three issues: how bad the productivity performance in Japan’s
service sector has been; why it is important to accelerate TFP growth in the service sector;
and why TFP has stagnated in Japan’s service sector. The main findings of the paper are as
follows. First, TFP growth in the manufacturing sector is much higher than that in othersectors, although the manufacturing sector’s share is declining rapidly. For Japan, whose
population is in decline, productivity growth in the service sector is key for economic
growth. Second, TFP growth in ICT-using sectors declined substantially after 1995. Third,
accumulation of ICT assets in Japan was very slow in comparison with other developed
countries. Forth, the low level of intangible investment is probably one important cause of
the stagnation of TFP; another is that Japan’s service sector has fallen behind with regard toinvestment in ICT. Fifth, it seems that Japan’s low metabolism also impedes productivity
growth. Sixth, firms invest little in on-the-job training and off-the-job training for part-timeworkers, and the increase in part-time workers may have slowed down human-capital
accumulation. Seventh, it appears that Japanese firms have fallen behind in terms ofinternationalization and economies of scale.
Key words: service sector, total factor productivity, ICT investment, intangible
investment, productivity dynamics
JEL classification: L80, L90, O47, O53, J21
RIETI Policy Discussion Papers Series is created as part of RIETI research and aims tocontribute to policy discussions in a timely fashion. The views expressed in these papers aresolely those of the author(s), and do not present those of the Research Institute of Economy,
Trade and Industry.
*

This research was conducted as part of the project on “Japan’s Productivity and Economic Growth” at the
Research Institute of Economy, Trade and Industry (RIETI).

1. Introduction
As in other advanced countries, the share of the service sector in the economy has
been steadily increasing in Japan. This means that productivity growth in this sector
provides the key for Japan’s future economic growth. Yet, looking at actual trends
shows that productivity in this sector has stagnated for a long period. Against thisbackground, the purpose of this paper is to examine why this is the case, reviewing
previous studies on the issue and using industry level data of factor inputs andproductivity.
The structure of the paper is as follows. The next section looks at the productivity
performance of Japan’s service sector and compares it with other major countries. It also
discusses why service sector productivity is important for Japan’s future growth.
Section 3 then examines why productivity in Japan’s service sector has stagnated forsuch a long period, analyzing issues such as investment in information andcommunication technology (ICT), intangible investment, the natural selection
mechanism in the service sector, how the recent increase in part-time workers will affectproductivity, and average firm size in the service sector. Finally, Section 4 summarizes
the major findings of the paper.

2. Why is the Service Sector Important for Japan’s Future Growth?
From a supply-side perspective, there are three engines for economic growth:
increases in labor input, capital accumulation, and increases in total factor productivity(TFP).
Let us look at the trends in each of these components for Japan, starting with labor
input. Japan’s working age population, defined as those aged 15 to 64, grew rapidly
during the 1950s and 1960s. However, once the baby boomer generation had come ofage, the growth in the working age population declined rapidly. Specifically, while theworking age population grew by an average of 1.7% annually between 1955 and 1973
and still increased at a rate of 0.7% between 1973 and 1995, it has actually been
shrinking since then at an average annual rate of 0.3%.
Next, let us consider the role of capital deepening. This, in fact, accounted for muchof Japan’s rapid economic growth during the 1950s to early 1970s. However, as is wellknown, the marginal productivity of capital and the rate of return to capital tend to
decline over time as capital deepening continues, so that countries cannot maintain rapid
growth based on capital deepening forever. In fact, Japan’s rate of return to capital fell
substantially during the 1970s and then further during the 1990s and private sector

investment weakened. 2 Especially in the case of the manufacturing sector, capitalformation became so small that the net real capital stock recorded a decline between
2000 and 2002. These trends with regard to labor input and capital accumulation meanthat productivity growth is the key for Japan’s future economic growth.
Historically, labor productivity in Japan’s tertiary sector was not much lower thanin the secondary sector except during the period of rapid industrialization from
1947-1965. Figure 1 compares labor productivity (either nominal value added per
man-hour or nominal value added per worker) across sectors. The values are normalized
by dividing the productivity level of each sector by the productivity level of the primarysector.

Figure 1. Comparison of sectoral laborproductivity (primary=1)
6

5

4

3
Secondary
Tertiary2

10Notes:
Subsidiary occupations are taken account of for periods before the Second World War.
Data before 1965 are on a per worker basis. Data from 1973 are on a man-hour basis.
The primary sector consists of agriculture, fishery, and forestry. The secondary sector consists of mining, manufacturing andconstruction. The tertiary sector consists of all other sectors except imputed rent.
Sources:
Data for periods between 1885-1940 are from table 11 on page 31 of Saito and Settsu (2009).
Data for periods between 1947-65 are from Table 2.12 on page 41 of Ohkawa and Shinohara, eds., (1979).
Data for periods after 1970 are from the JIP Database 2009.

2

It is worth noting here that, among the OCED countries, only Japan and Korea experienced very
rapid capital deepening and a swift decline in the rate of return to capital. See Pyo and Nam (1999).
1

However, if we compare labor and total factor productivity growth in Japan’s
tertiary sector with that in the manufacturing sector, there is a huge difference. As
Figure 2 shows, TFP in Japan’s non-manufacturing sector (market economy3) grew by
only 23% in 1970-2006 (for an annual growth rate of 0.57%). On the other hand, TFP in
the manufacturing sector increased 2.8-fold in the same period (for an annual growthrate of 2.9%).4

Figure 2. TFP growth in manufacturing and non-manufacturing(market economy excluding imputed house rent), 1970-2006(1970 1)
3
Manufacturing

2.5

Non-manufacturing (market
economy, excluding house rent)

2

1.5

1

1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006

0.5

Source: JIP Database 2009.

3

The term “market economy” here means that education, medical services, government activities,
and imputed house rent are excluded.
4
In the 1990s and early 2000s, TFP growth in the manufacturing sector also stagnated. The sharp
decline in TFP growth in the manufacturing sector can be partly explained by the idling of capitalstock, which was caused by the recession in this period. However, even taking account of the decline
in the capacity utilization rate of capital, we obtain a similarly rapid declining trend in TFP growth in
the manufacturing sector.
2Despite the low productivity growth in the non-manufacturing sector (Figure 2), thelevel of labor productivity relative to the manufacturing sector, as seen in Figure 1, did
not decline drastically, because of the sharp increase in the relative price of
non-manufacturing output vis-à-vis manufacturing output.
As in other developed economies, the share of the manufacturing sector in Japan’s
economy overall is declining rapidly. As Figure 3 shows, the manufacturing sector
accounted only for 22% of Japan’s nominal GDP in 2002, while its share in terms of
employment was only 19%.

Figure 3. Share of the manufacturing sector in the macro-economy: JapanUS Comparison
Nominal value added of the manufacturing sector/nominal
GDP: Japan

0.4

Number of workers in the manufacturing sector/total
number of workers in the economy: Japan
Nominal value added of the manufacturing sector/nominal
GDP: US

0.35

Number of workers in the manufacturing sector/total
number of workers in the economy: US

0.3

0.25

0.2

0.15

2000

1995

1990

1985

1980

1975

1970

1965

1960

0.1
Sources: JIP 2006 and Council of Economic Advisers, Economic Report of the President , 2005.

3

Figure 3 also shows that de-industrialization in Japan accelerated twice during theperiod since 1970: after the first oil shock in the early 1970s, and then in the early 1990s
following the burst of the “bubble economy.” The second acceleration in
de-industrialization seems to have been caused by a decline in the domestic demand forinvestment goods and by the relocation of production through foreign direct investment.
In the 1990s, Japanese firms shifted production to other Asian countries (primarily the
ASEAN countries and China) in order to lower wage and other production costs. In thecase of the electrical machinery industry especially there was a sharp increase inoverseas production and a decline in domestic production and net exports in the period
1990-2003.
Since it is mainly large productive firms that invested abroad, this relocation of
production may well have led to the closure of productive establishments in Japan: only
44% of all the establishments which existed in 1990 survived until 2003 and not many
new establishments were opened during this period. As a result, the number of
establishments declined by 33%. It is important to note that even among establishmentswith the highest level of labor productivity in their respective industry, the survival rate
was not much higher: only 47% of establishments ranked in the top three deciles in eachof the 50 manufacturing sectors in 1990 survived until 2003.5
Judging from the fact that de-industrialization has proceeded even further in the
United States than in Japan (Figure 3), it seems likely that Japan’s manufacturing sector
will continue to shrink in the future. And with de-industrialization set to continue andthe total labor force shrinking, acceleration in service sector productivity growth isbecoming all the more important for Japan’s future economic growth.
Comparing Japan’s productivity performance with that of other countries, we findthat there is certainly a lot of room for improvement, both in manufacturing and inservices. Figure 4 shows sectoral TFP growth in the market economy for major
developed countries for 1980-1995 and 1995-2005. Japan experienced relatively high
TFP growth in the information and communication technology (ICT)-producing sector(electrical machinery, post and communication). However, the problem for Japan is that
TFP growth in ICT-using sectors, such as distribution services (retail, wholesale andtransportation) and in the rest of the manufacturing sector (i.e., excluding electricalmachinery), declined substantially after 1995. And these ICT-using sectors have larger
shares in the economy than the ICT-producing sector. The average share of labor input(hours worked) in the ICT-producing sector in Japan’s total labor input in 1995-2005
was 4.7%, while the labor input shares of distribution services and the rest of the5

See Fukao, Kim and Kwon (2008).
4

manufacturing sector were 23.4% and 16.8%, respectively.
This pattern differs substantially from that observed for the United States, which
experienced an acceleration in TFP growth not only in ICT-producing sectors but also in
ICT-using sectors. On the other hand, South Korea and most of the European countries
did not experience an acceleration of TFP growth in ICT-using sectors. In other words,
the ICT revolution in ICT-using sectors occurred only in the United States.

Figure 4. TFP growth in the market sector: by sector and by country

Manufacturing, excluding
electrical machinery

Other goods-producing
industries
3.0
2.0

-2.0

US

UK

Italy

FranceGermany

-1.0

Japan

0.0
Korea

US

UK

Italy

FranceGermany

1.0

US

UK

Italy

FranceGermany

Japan

Korea

198095
19952005

3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5

Japan

10.0
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0

Korea

Electrical machinery, post
and communication-3.0

Other goods producing industries

Distribution services

-3.0

-2.0

-1.5

US

Italy

UK

France-1.0Germany

US

UK

-1.0

Italy

-2.0

France-1.0Germany

-0.5
Japan

0.0
Korea

0.0

0.0
US

1.0
Italy

0.5

1.0
UK

2.0

France1.0

2.0

Germany

1.5

3.0

Japan

4.0

3.0

Korea

4.0

Japan

Personal and social services

Korea

Finance and business services

-2.0

-4.0

-2.5

-5.0

-3.0

Source: EU KLEMS Database, March 2008.

Next, Figure 5 compares sectoral labor productivity in Japan and the EU 15
countries (excluding Greece) relative to that of the United States. The figure also
provides a comparison for four factors that underlie differences in labor productivity,that is, differences in the quality of labor, differences in ICT capital service input per
man-hour, differences in non-ICT capital service input per man-hour, and differences in
the TFP level.
The figure shows that the labor productivity gap between Japan and the UnitedStates is larger in the non-manufacturing sector than in the manufacturing sector. Labor
5

productivity levels in Japan’s non-manufacturing sectors are generally less than 50
percent of the US levels. In the case of non-ICT capital service input per man-hour,Japan uses much more such input than the United States. With regard to labor quality,
there is not much difference between the two countries. The differences in laborproductivity are mainly caused by Japan’s low level of ICT-capital service input and low
TFP.6
Figure 5. PPP adjusted labor productivity, factor inputs, and TFP: Japan, EU and US comparison (2005, US=1)
Japan

EU 15 (excluding Greece)
1

2
1.8

0.9

2

1

1.8

0.9

1.6

1.6

ICT capital
service input
per manhour

0.8

0.8
1.4

1.4
0.7

1.2

0.6

1
0.8

0.5

0.6

0.7

1.2
1

0.6

0.8

0.5

Non-ICT
capitalservice input
per manhour

Quality of
labor

0.6
0.4

0.4

0.4
0.4

0.3

0.2

0.3

0.2

0.2
Personal services

Transportation

Finance and business services

Retail and wholesale

Primary sector, utilities and construction

Manufacturing, excluding electrical machinery

Electrical machinery, post and communication

Market economy

0
The whole economy

Personal services

Finance and business services

Transportation

Retail and wholesale

Primary sector, utilities and construction

Manufacturing, excluding electrical machinery

Electrical machinery, post and communication

Market economy

0.2
The whole economy

0

PPP adjusted
gross value
added perman-hour(right axis)

TFP (rightaxis)

Source: Inklaar and Timmer (2008).

Since ICT investment may contribute to innovation in production processes, thedifference in ICT-capital service input between Japan and the other countries is likely
one of the major causes of the stagnation of TFP in Japan.
We should note that it is very difficult to compare differences in the quality ofservices across countries and to measure PPP for services. For example, the quantity ofIn the case of finance and business services and personal services, ITC capital service
input per man-hour is not lower than in the United States. The differences in laborproductivity are caused by Japan’s low level of TFP.

6

6

truck transportation is basically measured as a unit of tonnage multiplied by kilometers
per man-hour (how much transportation in tonnage and distance was conducted by one
man-hour) and differences in quality, such as just-in-time delivery, are not taken account.
Similarly, in retail services, the length of business hours is not taken into account.
Measured productivity of German shops might be higher than that of Japanese shops
because German shops are only open until, say, 6 p.m. and customers adjust theirlifestyle accordingly.

3. Why Has TFP in Japan’s Service Sector Stagnated?
This section examines why TFP in Japan’s service sector has stagnated. According
to the analysis in the previous section, one “prime suspect” is the slower accumulationof ICT capital in Japan, and this section looks at this issue in greater detail. However,additional factors, which may have contributed to the stagnation of productivity inJapan’s service sector, such as slow accumulation of intangible capital, an insufficientnatural selection mechanism, are also considered.
Starting with the issue of ICT investment, Figure 6 compares the ratio of ICT
investment to GDP across the major developed countries. The figure shows that
accumulation of ICT capital was very slow in Japan. It seems that Japan did notexperience an ICT revolution in ICT-using sectors simply because it did not undertake
sufficient ICT investment.

7

Figure 6. ICT investment/GDP ratio in the major developed countries
14

12

Japan
Korea

10

US
UK

%

8

6

FranceGermany
Italy

4

2

0

Source: Fukao, Miyagawa, Pyo and Rhee (2009).

Why was Japan left behind in ICT investment? There are likely a number ofreasons. One possibly is that the ratio of custom software investment to packaged
software investment is much larger in Japan than in the United States. When Japanesefirms introduce ICT, such as an ICT system for customer services or the management of
information flows within the firm, they prefer custom software in order to avoid
business reorganization and the training of workers. This results in a smaller
productivity improvement from ICT investment. This example suggests that it isimportant to compare intangible investment in Japan with that in other developed
economies.
As Figure 7 shows, the investment/value added ratio in Japan has been much lower
than that in the United States. However, in this context it is interesting to note that
contrary to the case of intangible investment, Japan’s tangible investment/value added
ratio is much higher than that in the United States.

8

Figure 10-a. Japan

25

%

%

Figure 7. Intangible and tangible investment over value added ratio: Japan-US comparison

Figure 10-b. US

25

23

23

21

21

19

19

17

Intangible
Investment

15

Tangible
Investment

Intangible
Investment
Tangible
Investment

17
15
13

11

11

9

9

7

7

5

5
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005

13

Sources: Fukao, Miyagawa, Mukai, Shinoda, and Tonogi (2009). Original data for the US are taken from Corrado,
Hulten and Sichel (2005, 2006).

Next, Figure 8 compares the composition of intangible investment in Japan, theUnited States, and Britain. The figure suggests that, compared with the other two
countries, Japan invests a lot in R&D, most of which is conducted in the manufacturingsector, but very little in economic competencies such as brand equity, firm-specifichuman capital, and organizational structure.

9

Figure 8. Intangible investment
by category: share in total
intangible investment
100%
90%
80%

Computerized
information

70%
60%

Science andengineering
R&D
Other
innovative
property
Brand equity

50%
40%
30%
20%
10%
0%

Japan, US, 1998- UK, 2004
2000-05
2000
Sources: Japan: Fukao, Miyagawa, Mukai, Shinoda and Tonogi(2009), US: Corrado, Hulten and Sichel (2006), UK: Marrano and
Haskel (2006).

Table 1, which is based on Fukao, Miyagawa, Mukai, Shinoda and Tonogi (2009),
compares intangible investment by category in the manufacturing sector with that in theservice sector.7 During the period of 2000-2005, intangible investment/value added
ratio in the service sector was 9.5 percent, about one half of the corresponding ratio,
17.3 percent, in the manufacturing sector. This large gap is mainly caused by the factthat most R&D investment in Japan is conducted by the manufacturing sector. Figure 9shows the results of growth accounting with intangible capital by sector.8 We can see
7

In Fukao, Miyagawa, Mukai, Shinoda and Tonogi (2008, 2009), the service sector is defined as thewhole economy minus manufacturing, agriculture, forestry, fishing, mining, construction, and the
public sector.
8
We should note that, in this growth accounting, accumulation of human capital, except
firm-specific human capital, is not taken account of.
10that the contribution of intangible investment to labor productivity growth in the service
sector is on a declining trend and has been much smaller than that in the manufacturingsector. The low level of intangible investment is one important cause of the stagnationof labor productivity in Japan’s service sector.
Unfortunately, there are no estimates of intangible investment by sector for othercountries that are compatible with the estimates in Fukao, Miyagawa, Mukai, Shinoda
and Tonogi (2008, 2009).9 Therefore, it is premature to conclude that productivity
growth and ICT investment in Japan’s service sector lag behind those in other countries
because of Japan’s low level of intangible investment.

9

However, one such project is currently in progress at the Productivity Commission of theAustralian Government.
11

Table 1: Intangible investment by category in the manufacturing sector and the service sector
ManufacturingsectorServices
sectorComputerized information
Custom software
Packaged software

2000-2005(billion yen)
2,447
1,526
184

Ratio tovalue added(%)(2.09)(1.30)(0.16)

2000-2005(billion yen)
6,125
4,197
388

Ratio tovalue added(%)(2.37)(1.61)(0.15)

In-house software

510(0.45)

1,065(0.42)

Databases

226(0.19)

475(0.18)

Innovative property

13,316(11.22)9,161(3.55)

9,312(7.83)

1,052(0.40)

Mineral exploitation

0(0.00)

16(0.01)

Copyright and license costs472(0.41)

4,152(1.61)

3,531(2.98)

3,940(1.54)

Economic competencies

4,657(3.95)

9,292(3.59)

Brand equity

1,876(1.59)

3,477(1.33)

Firm-specific human capital584(0.49)

1,334(0.54)

Organizational structure

2,198(0.91)

4,480(0.36)

20,420(17.27)

24,577(9.51)

Science and engineering R&D

Other product development, design,
and research expenses

Total

Intangible investment/Tangible
investment
0.9
Source: Fukao, Miyagawa, Mukai, Shinoda, and Tonogi (2009)

12

0.5

Figure 9. Growth accounting with intangible capital by sector
Growth accounting withintangibles (Manufacturing sector)

Growth accounting withintangibles (Service sector)

5.00
4.00

5.00
Contribution of
TFP growth

4.00

3.00
2.00

3.00
Contribution of
intangible
capital

2.00

1.00
0.00

Contribution of
TFP growth

1.00
Contribution of
tangible capital

Contribution of
intangible
capitalContribution of
tangible capital

0.00

-1.00

-1.00

Growth rate oflaborproductivity

Growth rate oflaborproductivity

Source: Fukao, Miyagawa, Mukai, Shinoda, and Tonogi (2008).

Another possible reason for the stagnation of TFP in Japan’s service sector is thatthe natural selection mechanism is not working properly. An indication of this isprovided in Figure 10, which shows that start-up and closure rates of establishments inJapan are much lower than those in the United States. Further evidence is provided in
the study by Kim, Kwon and Fukao (2007), which, using firm level data for Japan’s
service sector, decomposes productivity dynamics in the periods 1997-1999 and2000-2002. Following Griliches and Regev (1995), the study decomposed changes in
the average labor productivity in a particular industry into the following four effects: thewithin effect, the reallocation effect, the entry effect, and the exit effect.
The results of that analysis are shown in Table 2. They indicate that in several
non-manufacturing sectors, such as construction and transportation, large negative
reallocation effects and exit effects on industry-level labor productivity growth can beobserved. In many industries, such as, business services, personal services,
advertisement, and information services, net entry effects (entry effects plus exit effects)
took positive values, but they were more than offset by the large negative values ofreallocation effects. Thus, it seems that Japan’s low metabolism also impedes
productivity growth in service sectors.

13

Figure 10. Start-up and closure rate of establishments: Japan-US comparison
Figure 4.2.Panel B. Closure rate:
Japan-US comparison %Figure 4.1.Panel A. Start-up rate:
Japan-US comparison %

14

14

12

12

10

10

8

8

6

6

4

4

2

2

0

0

All industries:
US

All industries:
Japan

Wholesale,retail andrestaurants:
Japan
Services: Japan

1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000

16

1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000

16

Note: Data are based on statistics from the employment insurance program of each country.
Sources: Small Business Administration, US Government (1998), Small and Medium Enterprise Agency, Ministryof Industry, Trade and Industry, Japanese Government (2001), and Study Group on “Industry Hollowing-out”
and Tariff Policy, Ministry of Finance, Japanese Government (2002).

Figure 2. Decomposition of changes in labor productivity in non-manufacturing sectors: Average valueof results for 1997－ 99 and results for 2000-02, annual values, %Industry nameLabor
productivity
growtha=b+c+d
Construction-4.80%
Wholesale
4.05%
Retail4.74%
Real estate
1.78%
Transportation-4.84%
Warehousing and other transportation related service -3.48%
Communication
36.83%
Electricity-1.11%
Gas, water and heat supply-3.93%
Hotels-0.23%
Broadcasting-10.19%Personal services
0.19%
Business services-0.32%
Information services-2.62%
Eating and drinking places
0.77%
Other services-0.30%
Advertisement-6.21%
Amusement
3.69%
Medical and care services and hygiene
0.23%
Source: Kim, Kwon and Fukao (2007).

WithineffectReallocation
effectNet entry
effectEntry effect

Exit effect

b
0.07%
1.59%
2.53%
1.85%
0.61%
0.72%
8.60%
6.88%
0.56%
1.75%
0.22%
0.36%
1.83%
-0.64%
0.49%
0.12%-2.64%
3.40%
0.94%

c
-5.03%
0.83%
1.02%-0.37%-3.91%-4.37%
25.56%-8.06%-5.35%-1.03%-15.38%-1.74%-2.78%-3.70%-1.15%
0.17%-9.85%-0.26%-0.06%

d=e+f
0.16%
1.63%
1.19%
0.30%
-1.53%
0.17%
2.67%
0.07%
0.86%
-0.95%
4.96%
1.58%
0.63%
1.72%
1.44%
-0.59%
6.29%
0.56%-0.65%

e
1.48%
1.33%
0.95%
-0.66%-1.80%-1.34%
1.11%
0.03%
0.98%
-2.08%
4.85%-0.13%-1.54%
0.49%-2.33%
0.99%
9.81%-1.73%-2.54%

f-1.32%
0.30%
0.24%
0.95%
0.27%
1.50%
1.56%
0.04%
-0.13%
1.13%
0.11%
1.70%
2.17%
1.22%
1.74%
0.45%
-3.52%
2.28%
1.89%

Another important factor which may be having a negative effect on TFP growth inJapan’s service sector is the rapid increase in part-time workers in the 1990s. As Figure
11 shows, the share of part-time workers in total workers increased sharply in some14

service sectors, such as retail, finance, telecommunication, and information services.
Moreover, the increases in these service sectors are larger than those in manufacturingsectors, such as computers and related devices, communication equipment, andautomobiles. Although the share of part-time workers declined in many sectors during
the economic expansion of the 2000s, it still remains at a high level.
This increase in part-time workers will slow down human-capital accumulation, as
firms invest little in on-the-job and off-the-job training for part-time workers (Fukao,
Miyagawa, Mukai, Shinoda and Tonogi, 2009; Ikenaga and Kawaguchi, 2010).
According to Kim, Fukao and Makino (2010), the increase of part-time workers from1990 to 2000 reduced Japan’s human capital by 2.0 percent.10
As shown in Fukao et al. (2006), the productivity gap between part-time workers
and regular workers is larger than the wage gap between them, suggesting that firms pay
a premium to part-time workers in order to obtain flexibility of employment. Thus, theincrease in part-time workers poses a problem not only in term of equity but also interms of productivity.

10

During this period, many elder employees, who were less educated on average than younger
employees, have retired. Moreover, the share of the self-employed, whose average labor income issmaller than that of other workers, has declined. These factors contributed to the growth of humancapital in Japan. In total, the growth rate of human capital in Japan was not lower than that in the
United States.
15

Figure 11. Share of part-time workers in total workers by sector: 1970-2005 (in %)
35.0

30.0

25.0
Computers and related devices
20.0

Communication equipment
Automobiles
Retail15.0

Finance
Telecommunication
10.0

Information services

5.0

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

1978

1976

1974

1972

1970

0.0

Source: JIP Database 2009.

A final issue to be pointed out here that may contribute to Japan’s disappointing
productivity performance is that Japanese firms in service sectors tend to be smallerthan, for example, their US counterparts in the same sector. Table 3 compares thenumber of listed firms and their average size measured in terms of the number ofworkers in the United States and Japan. The data are on a consolidated basis for all
stock market-listed firms. In the manufacturing sector, the gap between Japan and theUnited States in terms of average firm size is not very large. However, in the case ofwholesale and retail as well as other services, US firms are much larger than Japanesefirms on a consolidated basis. This difference in average firm size implies thatJapanese firms in these sectors are much less likely to be internationalized and enjoy
economies of scale than their US counterparts.

16

Table 3. Number of listed firms and their average size measured by consolidated workers: US-Japan comparison (based on
consolidated financial data of all listed firms)
Manufacturing
Wholesale and retail
Other services
Number Average
Average
Numberofnumbernumberof US
Japanese of
of
firms
firms
workers
workers
2000
2001
2002
2003
2004
2005

909
774
1,079
1,291
1,567
1,622

7,306
1,451
6,611
1,466
4,799
1,490
4,546
1,558
4,702
1,575
4,960
1,606
Communication
2000
17
16,42296
2001
13
19,438102
2002
23
11,193
108
2003
32
8,046
121
2004
44
6,440
122
2005
50
5,881
123
Source: Kwon (2010).

Number Average
Average
Numberofnumbernumberof US
Japanese of
of
firms
firms
workers
workers

7,145
6,729
6,501
6,314
6,560
6,376

262
243
418
540
630
668

11,576
10,938
10,664
9,453
9,204
9,281

234
214
307
367
466
493

2,554
363
1,626
361
1,093
368
1,207
375
1,506
390
1,597
389
Other industries
5,970
763
4,343
827
2,944
848
2,858
894
3,191
963
3,052
967

19,62020,302
19,857
21,841
21,404
23,175

Number Average
Average
Numberofnumbernumberof US
Japanese of
of
firms
firms
workers
workers
148
157
315
398
496
564

1,866
1,462
906
855
999
981

655
655
691
690
717
715

7,183
7,096
7,745
7,418
7,658
7,736

5,302
4,981
5,111
4,822
5,120
5,195

4. Conclusion
This paper aimed to examine three issues: the productivity performance in Japan’s
service sector; why it is important to accelerate TFP growth in the service sector; andwhy TFP has stagnated in Japan’s service sector. The main findings of the paper are as
follows.
(1) TFP growth in the manufacturing sector is much higher than that in the othersectors. However, the share of the manufacturing sector is declining rapidly. For
Japan, which is now experiencing population decline, productivity growth in theservice sector is key for economic growth.
(2) TFP growth in ICT-using sectors declined substantially after 1995.
(3) Accumulation of ICT assets in Japan was very slow in comparison with otherdeveloped countries.
(4) The low level of intangible investment is probably one important cause of thestagnation of TFP; another is that Japan’s service sector has fallen behind withregard to investment in ICT.
(5) It seems that Japan’s low metabolism also impedes productivity growth.
(6) Firms invest little in on-the-job training and off-the-job training for part-timeworkers. The increase in part-time workers may have slowed down human-capital
accumulation.
(7) It appears that Japanese firms have fallen behind in terms of internationalizationand enjoying economies of scale.
17

Unfortunately, these are deep-seated structural issues that cannot be resolved
overnight. Moreover, they tend to be closely intertwined and overcoming them will
require both changes in economic policies and corporate practices. For example, if
Japan’s comparatively low investment in ICT indeed is the result of a reluctance toreorganize business structures and retrain workers, this may in turn be linked to theincrease in part-time workers, which at least in part is a consequence of Japan’s labormarket structures. Possible government policies to address these issues would include
the provision of structures and incentives that facilitate and reward investment in ICT(and intangible assets) and in the training of part-time workers and mitigate thepolarization in the labor market between regular workers and part-time workers while atthe same time providing for greater labor market flexibility.
Similarly, slow growth, the low metabolism of the economy, and the fact thatJapan’s service sector has fallen behind in terms of internationalization and exploiting
economies of scale are all interrelated. Many areas of the service sector remain heavily
regulated, thus preventing competition and greater dynamism through the entry, growth,and exit of firms. Obvious policy measures would be to continue with deregulation and,for instance, facilitating inward foreign direct investment to encourage the entry offirms that already operate internationally and enjoy economies of scale.
To end on a brighter note, although the challenges for Japan’s economy are
considerable, they are not insurmountable. Moreover, the fact that Japan’s productivity
in many service sectors lags behind that of, say, the United States also carries thepromise of catch-up growth in these areas. If Japan’s firms were to invest in ICT andintangible assets to a similar extent as their US counterparts and invested in the trainingof those now working part-time, this could provide Japan with productivity growth inthese sectors for years to come.

18

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