Journal of Applied Input-Output Analysis, Vol. 10, 2004

Detailed Discussion on the Multiplier Effect of Public Investment in Japan:

Policy Simulations Using the Short-Term Multi-Sector Econometric Model1

By
Takayuki Takeshita*

ABSTRACT
Using the short-term multi-sector econometric model, this paper discusses in detail the multipliereffect of public investment in Japan. After examining its fundamental characteristics, the differ
ence in government investment multiplier by the pattern of investment distribution among indus
tries and the factors causing such a difference are analyzed. According to the simulation results,

the multiplier becomes large when public investment is allocated more to the agriculture, construction, and tertiary industries. The causal factors identified are the sectoral differences in: (1)marginal and average propensity to import; (2) column sum of Leontief inverse matrix coeffi
cients; (3) net indirect tax rate; and (4) marginal propensities to employ and invest.

1. Introduction
The Japanese economy has been in a severe, prolonged recession since the burst of the
bubble economy in the early 1990s. As a result, the unemployment rate reaches thehighest level of the past. Thus, the large-scale expansive fiscal policy measures haveoften been implemented during the same period, but it does not lead to the autonomous
recovery supported by private demand whereas a fiscal deficit is growing up to be ahuge amount because of such a fiscal policy management. Under these circumstances,
there is a growing interest in the effect of fiscal policy on the Japanese economy, espe

cially in the government investment multiplier as its short-term effect. At the sametime, there is a growing necessity of thoroughly examining how the Japanese govern
ment should distribute its expenditure to stimulate the economy effectively and effi
ciently. However, there are very few previous empirical studies focusing on these controversial issues. In particular, the question of how the multiplier would be affected byReceived October 2002, final version received November 2003.

* Takayuki Takeshita was Econometric Model Team Leader in National Institute of Science and Technol
ogy Policy, Japan, when this paper was written. He is currently in Department of Advanced Energy,

School of Frontier Sciences, The University of Tokyo, Japan. E-mail: taka@yamaji.t.u-tokyo.ac.jp

1 The author expresses his deep gratitude to Prof. K. Ban (University of Osaka), Prof. N. Yoshino and
J. Suzuki (University of Keio), Prof. J. Kikuchi (Aoyama Gakuin Women's Junior College), Prof. H.
Odagiri (University of Hitotsubashi), N. Sakurai (Central Research Institute of Electric Power Industry), and two anonymous referees for their valuable advice and suggestions. Responsibility for thecontents of the article, of course, remains with the author.

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Journal of Applied Input-Output Analysis, Vol. 10, 2004

the change in the pattern of distributing final demand among industries has received far
less (or even no) analysis in the case of the Japanese economy, although a few empiri

cal studies have presented a brief analysis to this question in the case of the foreign
economy, e.g. Cloutier and Thomassin (1994) for the Canadian economy, West (1995)

for the economy of Queensland state in Australia, and Schindler et al. (1997) for the
Chicago economy. Moreover, the factors causing a difference in the multiplier by thepattern of final demand distribution have not yet been analyzed in detail even in thecase of the foreign economy.

In order to appropriately make an empirical analysis of the government investment

multiplier, it is necessary to use the policy simulation model that considers not only thereal side but also the price and monetary side of the economy because it is determinedthrough the complicated interactions among these factors. Furthermore, in order to ap

propriately make an empirical analysis of the difference in the economic impact ofgovernment expenditure by its pattern of distribution, it is necessary to use the policy
simulation model that is disaggregated into sectors. A multi-sector econometric (MSE)model is the model type that satisfies these conditions. However, there are only a few
previous empirical studies using the MSE model because the cost and labor necessary
for developing the MSE model, which requires a large number of time series data andforces its scale to be extremely large, are much larger compared with developing othermodel types.

In such a context, using the short-term multi-sector econometric model of theJapanese macroeconomy (MS-JMACRO) explicitly considering almost all the short-term impact paths of fiscal policy on the economy, this paper provides a detailed dis
cussion on the multiplier effect of public investment in Japan in the following manner.

First, its fundamental characteristics are examined in a detailed and quantitative way byfocusing on the change in the economic variables due to the additional public invest
ment. Secondly, the difference in the government investment multiplier by the patternof investment distribution among industries is quantitatively analyzed, and then the fac
tors causing such a difference are identified on the basis of the characteristics of eachindustry. In both analyses, the results are compared with those of the previous related
studies to discuss these issues in more detail.

This paper is organized as follows. The next section presents an overview of the
MS-JMACRO model. Section 3 shows the results of policy simulations and factor
analyses, and makes policy discussion. Finally, Section 4 provides concluding remarks.

2. Overview of the MS-JMACRO Model
This section provides an overview of the MS-JMACRO model. For more detailed ex

planations on this model (such as the description of formulations, estimation results,

structural change test results, final test results, and source of each data), see Takeshita(2002)2.

This literature is available on request to the author (E-mail: taka@yamaji.t.u-tokyo.ac.jp).

Detailed Discussion on the Multiplier Effect of Public Investment in Japan

41

2.1. Basic Structure and Characteristics of the MS-JMACRO Model
The MS-JMACRO model is a short-term multi-sector econometric model of nonequilibrium dynamic type developed for the Japanese economy. It is a large-scalemodel consisting of approximately 1200 time series data and 530 equations. The basic
structure of the model is shown in Figure 1. The model describes commodity market,
labor market, money market, and foreign bond market and is comprised of 8 blocks:(1) the final demand block; (2) the output block; (3) the labor block; (4) the supply
block; (5) the price block; (6) the value added block; (7) the monetary block; and (8)the income and assets block. All the blocks are interdependent, and are solved simulta
neously and iteratively by the Gauss-Seidel method until the model converges on a solution. This model is a macroeconomic model at the same time being disaggregatedinto 17 sectors as shown in Table 1, considering the availability of a consistent set oftime series data, and describes the interindustry linkages and the decision rules for eco

nomic variables by each sector. In addition, the institutional sectors are classified into
households, incorporated enterprises, foreign countries, and general government in themodel. The model appropriately describes three aspects of the economy: production,
distribution, and expenditure, and explicitly considers almost all the short-term eco
nomic impact paths of fiscal policy (i.e. the factors causing the difference in the gov
ernment investment multiplier), including those through the price and monetary side as

well as those through the real side of the economy.

The MS-JMACRO model is developed using open and available annual data3 on
the basis of the System of National Accounts 1968 (SNA68)4 by 1990 price. The inputoutput (10) submodel is a commodity-by-commodity format and is based on the SNA
Input-Output Table. The sample period of the behavioral equations is, in principle,

Figure 1: Basic structure of the MS-JMACRO model
Impact paths of fiscal policy on the economy(D(D

Direct effectIndirect effectPrice adjustment effect(3)

Induced effect (through C)

Crowding-out effect(D(D

Induced effect (through I)
Leakage-to-import effectMundell-Fleming effect

Leakage-to-tax effectOperating ratio

GDP « C-HH+I+S+G+E-M

Production
capacity(Production)(Expenditure)

OutputFinal demand
C (Private final consumption expenditure)

Output = Intermediate demand + Final demand-Imports

H (Residential investment)
I (Private capital investment)
S (Inventory changes)

G (Government expendirure)=Policy variable (T)E (Exports)
M (Imports)(Distribution)]-H Wages [^Employment] | Value added]*

Households'
financial assetst<». .

Households'
disposable income■j Wage income-H TaxGovernment's
net lending*

Exchange42

Journal of Applied Input-Output Analysis, Vol. 10, 2004

Table 1: Sectoral disaggregation in the MS-JMACRO model
Sector no.

Sector name(1)

Agriculture, forestry & fishery(2)

Mining(3)

Food & beverages(4)

Textiles(5)

Pulp, paper & paper products(6)

Chemicals(7)

Petroleum & coal products(8)

Non-metallic mineral products(9)

Basic metal(10)Fabricated metal products & machinery(11)

Other manufacturing industry(12)

Construction(13)

Electricity, gas & water supply(14)

Transportation & communication(15)

Services & other tertiary industry(16)

General government(17)

Private non-profit institutions serving households

from 1981 to 1998 because of the data limitations. The commodities and industries areclassified separately in the model; for example, outputs and prices are determined foreach commodity and for each industry. Because of the data limitations on the use matrix, this classification is made not by adopting make-use 10 tables but by translating
commodity/industry variables into the others statistically, assuming that the row andcolumn sectors are in a one to one correspondence. In addition to the suitable statisti
cal properties of each behavioral equation, the final test results prove that the precisionand dynamic stability of the MS-JMACRO model are fairly reasonable (see Takeshita,2002). It can be argued that this model is a full-scale MSE model competitive with thenotable MSE models developed so far5.
The main data sources are as follows: Annual Report on National Accounts (Economic Planning
Agency); Gross Capital Stock of Private Enterprises (Economic Planning Agency); SNA Input-

Output Table (Economic Planning Agency); Economic Statistics Annual (Bank of Japan); Economic
and Financial Data (Bank of Japan); Macro Data File (Toyo Keizai Shinpo-sha); Financial Statements Statistics of Corporations by Industry (Ministry of Finance); Annual Report on Indices of In
dustrial Production (Ministry of International Trade and Industry); Survey of Overseas Business Ac

tivities of Japanese Companies (Ministry of International Trade and Industry); Annual Report on the
Labor Force Survey (Management and Coordination Agency); and Annual Report on the Monthly
Labor Survey (Ministry of Labor).

Although the SNA93 has been adopted since the national accounts for fiscal year 1999, the model isbased on the SNA68, because, at this stage, the SNA93 has not been retroacted enough to estimate
behavioral equations with sufficient degrees of freedom and is not consistent with the SNA68.
Notable examples of the MSE models of the Japanese economy are the KEO model (Ozaki, 1984),

the FORECAST model (Uchida, 1990), the Medium-Term Multi-Sector Econometric Model (Economic Council, 1996), and the COMPASS model (Uno and Meyer, 1999). Those of the foreignDetailed Discussion on the Multiplier Effect of Public Investment in Japan

43

Besides having the general characteristics of the MSE model, the MS-JMACRO
model has new notable features summarized as follows. First, in the process of estimat

ing behavioral equations, the CUSUM test results are added to the evaluation criteria todevelop the model that is robust against the change in external environment such aspolicy changes (for details, see Ban (1991)), and the Ramsey's RESET test results arealso taken into consideration to avoid the problem of specification error (for details, seeHall and Cummins (1999)). Secondly, structural changes are analyzed in detail in developing the MS-JMACRO model: the time points of structural changes in behavioral
equations and their patterns are identified on the basis of the results of the repetitive

Chow test6 and the CUSUM test (while at the same time taking into consideration theanalytical reports on the structural changes that have occurred in the Japanese economy

such as white papers on the economy (EPA, 1998, 1999, 2000)), and the identified
structural changes are reflected in behavioral equations using dummy variables. This

process is systematically applied to all the behavioral equations representing consum
ers' and private firms' behaviors, i.e. households' consumption function, investment

functions, labor demand functions, and import functions. Thirdly, the MS-JMACRO

model has the advantage of very short computational time on a personal computer
without simplifying the characteristics of the MSE model due to the adoption of theblock decomposition technique. Such an easy operation feature facilitates carrying out

policy simulations repeatedly to make a detailed empirical analysis. The MS-JMACRO
model with these characteristics can be the analytical framework suitable for the purpose of this study7.

2.2. Formulation of the MS-JMACRO Model
The final demand block determines the real final demand components. The households'
consumption function at the macro level is derived from the life cycle/permanent income hypothesis (based on microeconomic theory) and the adaptive expectations formation hypothesis of Friedman regarding how consumers expect their permanent income. The consumption function adopted in this model is characterized by its ability toconsider the effect of the monetary side factors on households' consumption expendi
ture due to the introduction of monetary side variables (e.g. interest rates) as explana

tory variables. Private residential investment is estimated as a function of real households' net financial assets, lagged private housing stock, and real lending rate. The
weighted average of price deflator for private residential investment and land price is
economy include the MSM model (Meyer et al., 1990), the INFORUM model (Almon, 1991), the
LIFT model (McCarthy, 1991), the REMI model (Shao and Treyz, 1993), the QUIP model (West,1994), the E3ME model (Barker et al., 1996), and the CREIM model (Israilevich et al., 1997).

6 The repetitive Chow test means performing Chow tests repetitively, in which each year within thesample period is assumed to be the time point of structural changes. The second Chow test is appli
cable when analyzing the structural changes near the endpoint of the sample period (for details, see
Wago and Ban (1995)).

7 Even in a general context, the recent empirical studies have shown that the use of a MSE model improves the precision of the forecast (Rey and Dev, 1997) and the reliability of the economic impact
analysis (West, 1994), compared with the use of other model types. Advantages of a MSE model inshort-term economic impact analysis over the other model types are summarized in Takeshita (2002).

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Journal of Applied Input-Output Analysis, Vol. 10, 2004

used to deflate explanatory variables for the residential investment function to consider

the effect of land price on private residential investment. Capital investment by industry

is determined by the investment function based on the acceleration principle, into
which the user cost of capital (based on the neoclassical investment theory) and thetime lag of capital investment are incorporated. Exports are estimated for each com
modity as a logarithmic linear function of its relative prices and a given foreign demand. Imports are estimated for each commodity as a logarithmic linear function of its

domestic demand, its relative prices, and its given foreign production ratio. The formu
lation of relative prices in the export and import functions makes it possible to explic

itly consider the effect of import duties and exchange rate on exports and imports. The
real gross domestic product (GDP) is determined by identity as the sum of real final

demand components less real imports. Government expenditures such as public invest
ment are given exogenously as policy variables.

The output block determines sectoral output: the final demand components are fed

into the commodity-by-commodity IO submodel and the output is determined for eachcommodity. The input coefficients and the bridge matrix coefficients allocating eachdomestic final demand component to each commodity are treated as exogenous basedon the assumption of their short-term stability.
The labor block determines the employment and wages by industry, and the un
employment rate. Employment by industry is determined by the labor demand function

based on the first postulate in the classical school (using a Cobb-Douglas production
function) and the partial adjustment mechanism concerning how employment is adjusted to the optimal employment level. Average wages are determined on the basis of
the expectations-augmented Phillips curve. Taking into consideration the stability of theunemployment rate in Japan due to its peculiar employment practice, an average oper

ating ratio rather than the unemployment rate is used as the explanatory variable foraverage wages. On the basis of the labor productivity principle, wages by industry arethen determined as a function of the average wages, its labor productivity, and its oper
ating ratio. The unemployment rate is a function of the average operating ratio.
The supply block determines production capacity and operating ratio for each industry. Capital stock by industry is first determined by an accumulative approach.
Then, the linear homogeneous Cobb-Douglas production function is estimated for eachindustry. The primary factors are assumed to be capital by industry (defined as the
product of its lagged capital stock and its capital operating ratio) and labor by industry(defined as the product of its employment and its working hours). Time trend is also
used as an explanatory variable for production functions based on the assumption of aneutral technical progress. Production capacity by industry is determined by assuming

full operation of capital and labor inputs in its estimated production function, and oper
ating ratio by industry is then defined as the ratio of its actual production determinedthrough the demand side of the economy to its production capacity. The operating ratio

plays a role in the dynamic adjustment path to the equilibrium over time by affecting
prices and wages.

The price block determines the price variables and the nominal final demand com
ponents. Price of product by industry is estimated as a function of its operating ratio

and its cost price (defined as its total cost per unit of output) on the basis of the markup pricing principle. The import price in dollars before including tax by commodity isDetailed Discussion on the Multiplier Effect of Public Investment in Japan45

given exogenously, and is translated into the import price in yen before/after including

tax by commodity by taking into consideration the exchange rate and a given importduties rate by commodity. The export price by commodity is determined by its costprice, its import price, and the exchange rate. These price variables are used to deter
mine other sectoral and macro price variables (such as domestic demand price by com
modity, price deflators for final demand components, and consumer/wholesale price index) based on a weighted average or econometric estimation method. Then, nominal fi
nal demand components, nominal GDP, and GDP deflator are determined by identity.
The value added block determines value added and its components for each indus
try. Value added by industry is defined by subtracting its nominal intermediate inputs

from its nominal output. Operating surplus by industry is defined as the residual obtained by subtracting its consumption of fixed capital, its wage income (defined as the
product of its wages and its employment), and its net indirect tax (defined as the prod
uct of its given net indirect tax rate and its nominal output) from its value added. The
wage income and operating surplus are used to determine income distribution in the income and assets block.
The monetary block determines the money supply, interest rates, and the exchange
rate. The short-term interest rate is given exogenously as a policy variable in the lightof the Japanese monetary policy management, and the real money supply is determinedby the money demand function. The long-term interest rate is determined by the increase rate of the GDP deflator (expected inflation rate factor), the ratio of general
government's net lending to the nominal GDP (fiscal deficit factor), and the term structure of interest rates. The lending and deposit rates are determined by assuming thatthe trend of the short- and long-term interest rates is reflected in them. The exchange
rate is determined on the basis of the assets preference approach and is estimated as afunction of the ratio of the wholesale price index in Japan to that in the U.S. (equilib

rium exchange rate derived from the theory of purchasing power parity), the difference

between the real long-term interest rate in Japan and that in the U.S., and the ratio of
the cumulative current account surplus to the nominal GDP (risk premium). Interest
rates have an effect on the real side of the economy by affecting households' consump

tion expenditure through the assets effect, private investment through capital cost, andexports and imports through the exchange rate.

The income and assets block determines income (components), saving-investment
balance, and financial assets/debts (components) for each institutional sector. The income components (such as compensation of employees, property income, social secu
rity, and taxes) and the saving-investment balance are first determined for each institu

tional sector on the basis of the income and outlay accounts and the capital finance ac
counts in the SNA, respectively. Then, the financial assets/debts are determined foreach institutional sector by using its saving-investment balance, and their components

are determined based on the theory of portfolio selection. Real households' disposable
income and real households' net financial assets are fed back into the households' ex
penditures. Net tax revenue is defined as the sum of the direct tax (whose components

are determined as a function of income by the corresponding institutional sector) andthe net indirect tax, which affects general government's net lending. Direct tax onhouseholds affects households' disposable income, direct tax on incorporated enter

prises affects capital investment through the user cost of capital, and net indirect tax af-

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Journal of Applied Input-Output Analysis, Vol. 10, 2004

fects prices through cost price by industry.

The short-term economic impact of the increase in public investment is replicatedby the MS-JMACRO model in the following way. An additional public investment

raises GDP directly through the GDP identity (Direct effect). It also creates intermedi
ate demands for the relevant industries through the process of intermediate inputs andinduces outputs throughout the economy (Indirect effect). The increase in income andoutput due to the direct and indirect effects induces final demand such as consumption
expenditure and private investment, which in turn raises GDP further (Induced effect).
The induced effect creates another induced effect in the same manner and this ripple

effect continues until the succeeding effect becomes negligible. On the other hand, partof the generated demand leaks to import (Leakage-to-import effect), and part of thegenerated income leaks to tax (Leakage-to-tax effect). The increase in prices due to thehigh economic performance caused by the additional public investment also reduces
the generated demand (Price adjustment effect). In addition, the tight money balance
and increase in the fiscal deficit caused by the additional public investment raise interest rates, and this crowds out private investment (Crowding-out effect). There are two
possible effects of the additional public investment on the exchange rate. One is thatthe exchange rate appreciates because of the capital inflow due to the increase in do
mestic interest rates, and the current account becomes worse (Mundell-Fleming effect).

The other is that the exchange rate depreciates because of the increase in domestic
prices. The relationship between the increase in domestic interest rates and domestic
prices due to the additional public investment determines the direction in which the exchange rate moves.

3. Results and Discussion
3.1. Flow of the Analysis
Using the MS-JMACRO model, policy simulations are carried out for the following

purposes: (1) the short-term economic impact of the increase in public investment inJapan is examined in a detailed and quantitative way to analyze the fundamental characteristics of the multiplier effect of public investment in Japan; and (2) the differencein the government investment multiplier in Japan by the pattern of investment distribu

tion among industries is quantitatively analyzed, and then the factors causing such a
difference are identified on the basis of the characteristics of each industry. For these
purposes, four cases are set up for policy simulations as shown in Table 2.

In the 3-year sustained change case and the 3-year sustained change case in nomi
nal terms, the public investment is increased by 1 trillion yen at constant and current

prices, respectively, continuously for three years from 1996 to 1998. In the 1-year impact change case, the public investment is increased by 1 trillion yen at constant prices
temporarily in one of the years from 1996 to 1998. In these three cases, the additional
public investment is allocated to each industry similarly to the actual share in the pub

lic investment in Japan in the corresponding year. On the other hand, the assumption of
the modified distribution pattern case is as follows: it is first assumed that the publicDetailed Discussion on the Multiplier Effect of Public Investment in Japan

47

investment actually implemented in Japan in 1998 (approximately 38 trillion yen atconstant prices) were distributed widely among industries in the same way as in 1998;

and then the public investment is assumed to be increased from this level by 1 trillion
yen at constant prices temporarily in 1998 and this additional public investment is as

sumed to be allocated to one of the industries (i.e. this additional public investment isassumed to lead to an increase in the final demand for one industry). It should be

noted that this assumption does not mean that all the public investment created the demand only for one industry in 1998. Rather, the modified distribution pattern case as

sumes that the pattern of distributing public investment were modified so that it was allocated more to one industry in 1998 and attempts to examine its short-term economic
impact. This case is used for analytical purposes to highlight the difference arisingfrom the change in the pattern of public investment distribution and does not attempt
to compare the alternative policy options available, because its change is actually accompanied by multiple changes across a range of sectors.

Based on the above four cases, the analyses are made in the following way. First,
a comprehensive analysis of the government investment multiplier is made by compar

ing the results of the 3-year sustained change case, the 3-year sustained change case in
Table 2: Case definitions for the policy simulations
Case

Time

name

period3-year1996-98

Increasing pattern

Allocating patternof the publicof the additional

investment

public investment

Continuous increase Similar to the share of

Matter of discussion- Change in major economic

sustainedof ¥1 trillion

each industry in thechange caseat constant 1990

public investment in the - Contribution of each final

prices for 3 years

corresponding year

variables
demand component to thechange in GDP- Cumulative effect3-year1996-98

Continuous increase Similar to the share of- Price adjustment effecteach industry in thesustainedof ¥1 trillion

change caseat current prices

public investment in thein nominalfor 3 years

corresponding year

terms

- Change in major economic

Temporary increase

Similar to the share of

impactof ¥1 trillion

each industry in thechange caseat constant 1990

public investment in the - Contribution of each final

prices for 1 year

corresponding year

1-year1996-98

variables

demand component to thechange in GDP- Rebound effect- Difference in the

Temporary increase

Allocation to

distributionof ¥1 trillion

1 industry3

pattern caseat constant 1990

multiplier by the pattern ofprices for 1 year

investment distribution

Modified1998

government investment

Notes:a

It is assumed that the public investment actually implemented in Japan in 1998 (approximately¥38 trillion) was allocated to each industry in the same way as in 1998, and that an additional
public investment of ¥1 trillion was allocated to one industry.

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Journal of Applied Input-Output Analysis, Vol. 10, 2004

nominal terms, and the 1-year impact change case. Here, the changes in major eco

nomic variables due to the additional public investment are analyzed by examining theresults of the 3-year sustained change case and the 1-year impact change case simu
lated for 1996. The contribution of each final demand component to the change inGDP, the cumulative effect due to the continuous increase in the public investment, andthe price adjustment effect are then analyzed by examining the results of the 3-yearsustained change case, the 3-year sustained change case in nominal terms, and the 1year impact change case simulated for the period 1996-98. The rebound effect due tothe temporary increase in the public investment is finally analyzed by examining theresult of the 1-year impact change case simulated for 1996. Secondly, the modified dis
tribution pattern case is simulated for every industry. By examining and comparing theresults, the difference in the government investment multiplier by the pattern of invest
ment distribution among industries is quantitatively analyzed. Then, the factors causing
such a difference are identified by focusing on several sectoral indices reflecting thecharacteristics of each industry. In all cases, the changes in the economic variablesfrom the observed values, referred to as the base case, are analyzed. In this study, thegovernment investment multiplier is defined asGovernment investment multiplier =

. ,^

(1)

where AIG is the increase in the public investment (i.e. 1 trillion yen at constant orcurrent prices in these policy simulations), and AGDP is the increase in the real GDP.

Major assumptions for policy simulations are as follows. First, policy simulations

are carried out within the sample period throughout this study. This is because it is dif

ficult to appropriately forecast exogenous variables for the out-of-sample period andbecause these forecasts may have a significant effect on the results of the policy simu
lations. Secondly, the time span of the policy simulations is restricted to the short-term,
3 years at the longest, in this study. This is because behavioral equations in the MSJMACRO model are estimated using relatively small samples and because the model
does not fully consider the medium- and long-term economic impact paths of fiscal

policy through the supply side of the economy (e.g. the productivity effect of social
capital) or the theoretical constraints to ensure the equilibrium condition (e.g. thebudget constraint of the general government) at this stage of the model. Thirdly, taking

into account the Japanese fiscal and monetary policy management, it is assumed thatthe additional public investment is financed with the issue of public bonds and a shortterm interest rate is fixed in the model as a policy variable in carrying out fiscal policy

simulations. The assumption of a fixed short-term interest rate implicitly assumes thatmonetary policy is managed in cooperation with fiscal policy and that it is eased simul
taneously in implementing the expansive fiscal policy. It should be noted that the gov

ernment investment multiplier is largely affected by the assumptions about the financeof public investment and the monetary policy management.

3.2. Comprehensive Analysis of the Government Investment Multiplier
Table 3 shows the deviation rate from the base case for the major macro variables ofDetailed Discussion on the Multiplier Effect of Public Investment in Japan49

the Japanese economy in the 3-year sustained change case and the 1-year impact
change case simulated for 1996. Note that the exchange rate is based on the Japanese
yen per U.S. dollar exchange rate.

As shown in this table, the major macro variables can be classified into twogroups in terms of how they are affected by the additional public investment. The firstgroup consists of GDP, private residential investment, private capital investment, ex
ports, imports, private output, and average operating ratio. The second group consistsof private final consumption expenditure, employees, average wages, GDP deflator, interest rates, and exchange rate. The macro variables of the first group increase almost

simultaneously with the additional public investment. In the 3-year sustained change
case, their deviation rates from the second year of the simulation do not rise so muchbeyond their levels in the first year. In the 1-year impact change case, they converge on
the level in the base case almost simultaneously after the end of the additional public
investment. These results mean that these macro variables tend to be affected almost si
multaneously by the change in the public investment and that the direct effect, the indi
rect effect, the induced effect through capital investment, and the leakage-to-import ef
fect have the characteristics of affecting the government investment multiplier almost
simultaneously in implementing the additional public investment. On the other hand,
the macro variables of the second group increase gradually over time in the 3-year sus
tained change case. In the 1-year impact change case, they continue to be affected evenafter the end of the additional public investment: the converging movements of thesevariables toward their base case levels are slow. These results mean that these macro

variables tend to be affected gradually and continuously by the change in the public investment and that the induced effect through consumption expenditure, the price adjust
ment effect, the crowding-out effect, and the Mundell-Fleming effect have the characteristics of affecting the government investment multiplier gradually and continuously.
It should be noted that the exchange rate depreciates due to the additional public
investment. This result is in line with the results derived from the previous studies thathave analyzed the economic impact of the additional public investment with a fixedshort-term interest rate (e.g. Hori et al., 1998)8. This is because when the public invest
ment is increased, the increase in domestic interest rates is moderate because of the as

sumption of the fixed short-term interest rate whereas the increase in domestic prices isobserved. The relationship between the increase in domestic prices and the depreciationof exchange rate determines how exports are affected by the additional public invest

ment. Here, exports increase due to the additional public investment. These results indicate that if monetary policy is eased so that the short-term interest rate is kept constantin implementing the expansive fiscal policy, it is possible that the Mundell-Fleming ef
fect does not appear. Although the short-term interest rate is kept constant, lending rateand long-term interest rate increase because of the increase in domestic prices and fis

cal deficit. According to the result of the 3-year sustained change case, private capital
investment is continuously induced because of the continuous increase in private out

put. In contrast, private residential investment is crowded out by the increase in real
lending rate, and it becomes smaller than the level in the base case after 1997 because
8

Hori et al. (1998) pointed out that this is one of the most important results derived from the theoreti
cal analysis where the public investment is increased with a short-term interest rate kept constant.

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Journal of Applied Input-Output Analysis, Vol. 10, 2004

Table 3: Deviation rate from the base case for the major macro variables of
the Japanese economy in the 3-year sustained change case andthe 1-year impact change case for 1996 (%)
3-year sustained change

1-year impact changecase for 1996

case

1996

1997

1998

1996

1997

1998

Private final consumption expenditure

0.07

0.14

0.23

0.07

0.08

0.08

Private residential investment

0.14

-0.03

-0.10

0.14

-0.26

-0.06

Private capital investment

0.66

0.55

0.51

0.66

-0.05

-0.08

Exports

0.19

0.14

0.02

0.19

-0.06

-0.14

Imports

0.43

0.45

0.49

0.43

0.01

0.04

GDP

0.34

0.36

0.37

0.34

0.02

0.00

Private output

0.40

0.41

0.41

0.40

0.01

-0.01

Employees

0.05

0.07

0.09

0.05

0.03

0.03

Average wages

0.17

0.27

0.32

0.17

0.09

0.05

Average operating ratio

0.37

0.34

0.32

0.37

-0.03

-0.03

GDP deflator

0.02

0.09

0.13

0.02

0.07

0.03

Long-term interest rate

0.71

3.20

3.15

0.71

1.88

-0.95

Lending rate

0.17

0.55

0.58

0.17

0.35

-0.01

Exchange rate

0.18

0.26

0.20

0.18

0.07

-0.08

the increase in real households' net financial assets, i.e. the explanatory variable forprivate residential investment, is moderate. These results imply that it is real lending
rate that affects private investment, and that even if the short-term interest rate is fixed,

it is possible that the crowding-out effect would appear.

Figure 2 and Table 4 show the government investment multiplier in Japan derived
from the 3-year sustained change case, the 3-year sustained change case in nominal
terms, and the 1-year impact change case simulated for the period 1996-98. Table 4shows the contribution of each final demand component to the change in GDP in Japanderived from these three cases, and Figure 3 also shows the results of the 3-year sus

tained change case and the 1-year impact change case simulated for the period 1996-98
excluding public investment whose contribution is constant over the simulation period,
i.e. 1 trillion yen at constant prices.

As shown in these figures and tables, when the public investment is increased, private capital investment, private residential investment (except for the period 1997-98 in

the 3-year sustained change cases), private final consumption expenditure, and exports
increase and contribute to the increase in GDP. However, the increase in GDP induces

imports and the increase in imports contributes to the decrease in GDP. Among the fi
nal demand components, the increase in private capital investment is the most important factor for the government investment multiplier in the first year when the public

investment is increased. On the other hand, the government investment multiplier in the
3-year sustained change case becomes larger and larger over time than that in the 1year impact change case due to the continuous increase in the public investment. Thisis because the induced private final consumption expenditure increases over time due tothe continuous increase in the public investment. It is this phenomenon that is calledDetailed Discussion on the Multiplier Effect of Public Investment in Japan51

the cumulative effect (West, 1994, 1995). In other words, the contribution of the induced private final consumption expenditure to the government investment multiplierbecomes larger and larger over time as the public investment is increased continuously.
The reason for the gradual increase in private final consumption expenditure is that
employees and wages increase gradually with the additional public investment. The
empirical analysis using the Medium-Term Multi-Sector Econometric Model of theJapanese economy (Economic Council, 1996) reaches the same conclusion, describingthat private capital investment increases immediately and private final consumption expenditure increases gradually when the public investment is increased.

As for the magnitude of the government investment multiplier, the government investment multiplier in Japan derived from this study is relatively larger than that de

rived from other empirical studies, as shown in Table 5. The main reason is the differ
ence in the assumption about the monetary policy management. In this study, it is as
sumed that monetary easing measures are adopted to enhance the economic impact of

the additional public investment and the short-term interest rate is fixed in implement
ing the expansive fiscal policy, as described in the previous subsection. On the other
hand, in other empirical studies, a policy reaction function of the short-term interest
rate is usually adopted concerning how monetary policy is managed in implementing
the expansive fiscal policy.

The government investment multiplier derived from the 3-year sustained changecase in nominal terms is smaller than that derived from the 3-year sustained changecase or the 1-year impact change case. Moreover, the difference in the government investment multiplier between the 3-year sustained change case and the 3-year sustainedchange case in nominal terms becomes larger and larger over time. This is because anadditional public investment of 1 trillion yen at current prices becomes smaller andsmaller in real terms over time than an additional public investment of 1 trillion yen atconstant prices because of the continuous increase in prices due to the additional public

investment (i.e. the price adjustment effect). In the 3-year sustained change case innominal terms, the cumulative effect is significantly offset by such a price adjustment
effect.

In the case of introducing the impulse-type external shock, e.g. the temporary increase in the public investment, to a macroeconomic model, the rebound effect is often
reported by several previous empirical studies (e.g. Hori et al., 1998). The rebound ef
fect means the phenomenon that GDP becomes smaller than the level in the base casefor a few years after the end of the additional public investment. The reason for thisphenomenon is that the upward trend of the price and monetary side variables (e.g.

prices and interest rates) continues even after the end of the additional public invest
ment whereas most of the real side variables (e.g. final demand components) converge
on the level in the base case immediately after its end. In this study, the rebound effectis observed in the 1-year impact change case simulated for the period before 1992.
However, in the 1-year impact change case simulated for the period thereafter, GDPdoes not become smaller than the level in the base case, although such variables as pri
vate capital investment and private output become smaller than their levels in the basecase after the end of the additional public investment. This is because the extent of theincrease in prices due to the additional public investment becomes smaller over time.

This implies that the rebound effect is not so important in the current economic situ-

52

Journal of Applied Input-Output Analysis, Vol. 10, 2004

Figure 2: Government investment multiplier in Japan derived fromthe 3-year sustained change case, the 3-year sustained changecase in nominal terms, and the 1-year impact change case
1.8
1.7

1.6

i

-1 -year impact change case1.5

- 3-year sustained change case

1.4

- 3-year sustained change casein nominal terms

1.3
1.2
o

O

i

i

1996

1997

1998

Figure 3: Contribution of each final demand component to the change in GDP
in Japan derived from the 3-year sustained change and 1-year
impact change cases (excluding public investment)□Private final consumption expenditure{^Private capital investment■Private residential investment
DExports[H Imports

f 1200
ON

c
to

1000

800

'k 600

% 400
E 200
c

0

I-200

| -400(3-year sustained change case)

1200
1000
800

600
400

200
0

■200
CO"'400(1 -year impact change case)Detailed Discussion on the Multiplier Effect of Public Investment in Japan

53

Table 4: Government investment multiplier and contribution of final demand com
ponents in Japan derived from the 3-year sustained change case, the 3-year sus
tained change case in nominal terms, and the 1-year impact change case(3-year sustained change case)
1996

1997

1998

Change in final demand components(billion yen at market prices in 1990)
Private final consumption expenditure

196.406

Private residential investment

401.719624.219-18.824

34.379-6.742

Private capital investment

502.438487.313438.875

Public investment

1000.000

1000.000

1000.000

Exports

105.71989.855

16.578

Imports

227.988

243.023267.738

1.611

1.729

1.793

Government investment multiplier(3-year sustained change case in nominal terms)

1

1996

1997

1998

Change in final demand components(billion yen at market prices in 1990)
Private final consumption expenditure184.656

Private residential investment

373.156575.500-18.424

32.459-7.143

Private capital investment

472.125447.523391.305

Public investment

939.822916.611901.535

Exports

99.04782.914

8.867

Imports214.270

222.902242.223

1.514

1.590

1.617

Government investment multiplier(1-year impact change case)

J|

1996

1997

1998

Change in final demand components(billion yen at market prices in 1990)
Private final consumption expenditure

196.406

191.313187.656

34.37945.17446.391

Private capital investment

502.438529.516546.844

Public investment

1000.000

1000.000

1000.000

Exports

105.719127.594155.516

Imports

227.988

238.375

242.164

1.611

1.655

1.694

Private residential investment

Government investment multiplier

54

Journal of Applied Input-Output Analysis, Vol. 10, 2004

Table 5: Comparison of the government expenditure multiplier in Japan derived
from the related studies based on sustained change simulations3
Government expenditure
Model nameAuthor/Institution

Year ofpublication

Sampleperiodmultiplier derived fromsustained change
simulations
1st year

1985-1997

Short-run macro

econometric model ofHori et al.

1998

the Japanese economy

Medium-term multisector econometric model Economic council

1996

Nikkei Quick
NEEDS model for the

Information

Japanese economy

Technology Co.,

1.31

1.24

model)

1.22b

1.43b

1.50b

1975-1990

1.30

1.45

1.24

1.40b

2.01b

2.08b

1.07c

1.65C

1.80c

1.38

1.89

1.90

1.61b

1.73b

1.79b

(half-yearly

1986-1996
1997

Ltd.

Institute ofElectric Power(quarterly
model)

Central Research

DENKEN macro model

1.21(quarterly

model)of the Japanese economy

2nd year 3rd year

1980-1994
1996(annualmodel)

Industry

1981-1998
MS-JMACRO modelTakeshita

2002(annualmodel)

Notes:aPart of this table is based on the information by Hori et al. (1998).

b The multiplier derived from the case with a fixed short-term interest rate.
c The multiplier derived from the case assuming an increase in public investment in nominal terms.

ation in Japan which is characterized by a widening deflationary gap and a slow priceadjustment speed.

3.3. Quantitative Analysis of the Difference in the Government Investment
Multiplier by the Pattern of Investment Distribution
Figure 4 and Table 6 show the comparison of the government investment multiplier inJapan derived from the modified distribution pattern case. As shown in this figure, even
if the same amount of the additional public investment is implemented, there is a great

difference in the government investment multiplier by the pattern of investment distri

bution among industries. The government investment multiplier is largest in the case of
allocating the additional public investment to the services & other tertiary industry, fol
lowed by the cases of allocating it to the agriculture, forestry & fishery industry, theconstruction industry, and the other manufacturing industry. On the contrary, the gov

ernment investment multiplier is small in the case of allocating it to the mining indus
try, the petroleum & coal products industry, the basic metal industry, and the textiles

industry. It can be seen that the government investment multiplier is generally larger inthe case of allocating the additional public investment to the agriculture, construction,and tertiary industries than in the case of its allocation to the manufacturing industries.

Detailed Discussion on the Multiplier Effect of Public Investment in Japan

55

Figure 4: Government investment multiplier in Japan derived fromthe modified distribution pattern case

1.5
•a

*

0.5
>

o

O

I

c

is

.1

J

3

J3

-0.5

■*!

-69-

II §2

32
1° SI

Industry to which an additional public investment of ¥1 trillion is allocated

Table 6: Government investment multiplier in Japan derived from the modified
distribution pattern case, and five important sectoral indices
Government
investment

Product of self-sufficiency ratio
and column sum ofmultiplier

inverse matrix coefficients

Marginal propensity
to employ

(13)

NA

-0.060 (15)0.274 (15)1.699 (14)(3) Food & beverages

1.500 ( 8)1.892 ( 5)5.196 ( 8)(4) Textiles

1.073 (12)1.531

66.055 ( 1)(5) Pulp, paper & paper products

1.592 ( 6)

1.999 ( 2)3.260 (12)(6) Chemicals

1.482

(10)

1.813 ( 7)4.026 ( 9)(7) Petroleum & coal products

0.801

(14)

1.229 (14)2.128 (13)(8) Non-metallic mineral products

1.385

(11)

1.729

( 8)

14.288(9) Basic metal

1.070 (13)

2.123

( 1)

3.272 (11)(10) Fabricated metal products & machinery

1.547 ( 7)1.918 ( 4)9.617 ( 7)(11) Other manufacturing industry

1.626 ( 4)1.820 ( 6)

13.114 ( 6)(12) Construction

1.718 ( 3)1.971

14.294 ( 4)(13) Electricity, gas & water supply

1.499 ( 9)1.580 (11)3.839 (10)(14) Transportation & communication

1.607 ( 5)

1.615

(10)

21.036 ( 3)(15) Services & other tertiary industry

1.813

1.623 ( 9)23.230 ( 2)(1) Agriculture, forestry & fishery(2) Mining

1.746 (2)

( 1)

1.495

(12)

( 3)

( 5)

Notes: Numbers in parentheses denote the rank. The marginal propensity to employ represents the marginal change in

employment per billion-yen increase in industrial output.

56

Journal of Applied Input-Output Analysis, Vol. 10, 2004

Table 6: Continued
Marginal propensity

Marginal propensity

to invest

to import

Net indirect tax rate(1) Agriculture, forestry & fishery

0.008 (15)0.052 (10)0.035 (10)(2) Mining

0.019 (13)

1.051

( 1)

0.048 ( 6)(3) Food & beverages

0.038 (12)0.084 ( 9)0.114 ( 2)(4) Textiles

0.010 (14)0.466 ( 2)0.054 ( 5)(5) Pulp, paper & paper products

0.100 ( 8)0.105 ( 8)0.038 ( 9)(6) Chemicals

0.148 ( 5)0.147 ( 5)0.035 (11)(7) Petroleum & coal products

0.043 (11)0.048 (11)0.260 ( 1)(8) Non-metallic mineral products

0.178 ( 3)0.117 ( 7)0.048 ( 7)(9) Basic metal

0.072 ( 9)

0.171

( 4)

0.034 (12)(10) Fabricated metal products & machinery

0.127 ( 7)0.124 ( 6)0.029 (15)(11) Other manufacturing industry

0.217

( 2)

0.185 ( 3)0.033 (13)(12) Construction

0.053 (10)0.000 (14)0.030 (14)(13) Electricity, gas & water supply

0.166 ( 4)0.000 (14)0.072 ( 3)(14) Transportation & communication

0.132 ( 6)0.043 (12)0.058 ( 4)(15) Services & other tertiary industry

0.251

0.021

0.046 ( 8)

( 1)

(13)

Notes: Numbers in parentheses denote the rank.

Of the manufacturing industries, it can also be seen that the government investment
multiplier is larger in the case of allocating the additional public investment to theprocessing and assembly industries (numbered (10)-(ll)) than in the case of its allocation to the material industries (numbered (4)-(9)).

Next, the following discussion attempts to identify the factors causing such a differ
ence in the government investment multiplier on the basis of the characteristics of eachindustry. In other words, the focus is placed on identifying what characteristics of eachindustry cause the difference in the government investment multiplier by the pattern ofinvestment distribution among industries. For this purpose, taking into consideration
the short-term economic impact paths of fiscal policy summarized in Section 2, thecorrelation between the difference in the government investment multiplier by the pattern of investment distribution among industries and the sectoral difference in the fol

lowing indices9 is examined: (1) the product of the self-sufficiency ratio and the column sum of the Leontief inverse matrix coefficients of competitive imports type by in9 The self-sufficiency ratio and the Leontief inverse matrix are derived from the SNA Input-Output Ta
ble for calendar year 1998. The net indirect tax rate is defined for each industry as the ratio of net

indirect tax to nominal output in 1998. The marginal propensity to invest is defined for each industry
as the derivative of its capital investment with respect to its output, and is derived from the estimation results of the investment function by industry. The marginal propensity to employ is defined foreach industry as the product of output elasticity of labor demand by industry (derived from the esti
mation results of the labor demand functions) and the ratio of employed persons to output in 1998
by industry (i.e. average propensity to employ). Similarly, the marginal propensity to import is defined for each industry as the product of domestic demand elasticity of import by industry (derived
from the estimation results of the import functions) and import ratio in 1998 by industry (i.e. average
propensity to import).

Detailed Discussion on the Multiplier Effect of Public Investment in Japan

57

dustry (the factor reflecting the sectoral difference in the direct and indirect effects); (2)the marginal propensity to employ by industry (the factor reflecting the sectoral differ
ence in the induced effect through consumption expenditure); (3) the marginal propensity to invest by industry (the factor reflecting the sectoral difference in the induced ef
fect through capital investment); (4) the marginal propensity to import by industry (thefactor reflecting the sectoral difference in the leakage-to-import effect); and (5) the net
indirect tax rate by industry (the factor reflecting the sectoral difference in the leakageto-tax effect). In Figure 5, the government investment multiplier in Japan derived fromthe modified distribution pattern case is plotted against the product of each industry's
self-sufficiency ratio and its column sum of the Leontief inverse matrix coefficients, its
marginal propensities to employ, invest, and import, and its net indirect tax rate. Table
Figure 5: Plot of the government investment multiplier in Japan derived fromthe modified distribution pattern case, versus five important sectoral indices(15) Services & other tertiary industry

.1

.2

2

(12) Construction(12) Construction(15) Services & other tertiary industry

♦

1.5

♦

(14) Transportation & communication
♦

♦

♦

g

(4) Textiles♦ (7) Petroleum & coal products(7) Petroleum & coal products
0.5

E

I °

(2) Mining(2) Mining

♦

I

0.5

1

1.5

2

2
40

R2= 0.783

60

70

R:= 0.571 (excluding "Textiles")Product of self-sufficiency ratio and column sumof the Leontief inverse matrix coefficients

Marginal propensity to employ(15) Services & other tertiary industry^(12) Construction(15) Services & other tertiary industry-(1) Agriculture, forestry & fishery

% 1.5

2 ' 5
3

E

(11) Other manufacturingindustry(4) Textiles(7) Petroleum & coal products(2) Mining
0.05(2) Mining
0.1

0.15

0.2

0.25

0 3

0.2

0.4

0.6

0.8

R2= -0.847

R2= 0.478
Marginal propensity to import

Marginal propensity to invest(1) Agriculture, forestry & fishery1^^ (15) Services & other tertiary industry(7) Petroleum & coal products
g

E

E

0.5

(2) Mining
0.05

0.1

0.15

0.2

0.25

R:= -0.639 (excluding "Mining")
Net indirect tax rate

0 3

58

Journal of Applied Input-Output Analysis, Vol. 10,2004

6 shows the numerical values for all these indices. In the plot of the government investment multiplier derived from the modified distribution pattern case versus each industry's marginal propensity to employ, the agriculture, forestry & fishery industry is
excluded because the labor demand function is formulated by the decreasing trend forthis industry.

As shown in these figures, there is a high positive correlation between the govern

ment investment multiplier in the case of allocating the additional public investment to

one industry and the product of its self-sufficiency ratio and its column sum of the Le
ontief inverse matrix coefficients. In addition, there is a high negative correlation be
tween the government investment multiplier in the case of allocating the additional
public investment to one industry and two indices relating to leakage factors: its mar
ginal propensity to import and its net indirect tax rate. It can also be seen that there isa moderate positive correlation between the government investment multiplier in thecase of allocating the additional public investment to one industry and its marginal pro
pensities to employ and invest. These results imply that the government investment

multiplier tends to become large if the public investment is allocated more to the in
dustry with the following characteristics: (1) the product of self-sufficiency ratio andcolumn sum of the Leontief inverse matrix coefficients (the direct and indirect effects)
is large; (2) the marginal propensity to import (the leakage-to-import effect) and/or the
net indirect tax rate (the leakage-to-tax effect) are small; and/or (3) the marginal pro

pensity to employ (the induced effect through consumption expenditure) and/or themarginal propensity to invest (the induced effect through capital investment) are large.
This finding can, for the most part, explain the rank of industries with respect to thegovernment investment multiplier arising from allocating the additional public invest

ment to one industry. The high rank of the agriculture, construction, and tertiary indus
tries is mainly due to their low average and marginal propensity to import, and themining industry is ranked last mainly because it depends heavily on imports. Anotherreason for the high rank of the construction and tertiary industries compared with the

manufacturing industries is the labor-intensive feature of the construction and tertiaryindustries. The lower rank of the material industries compared with the processing andassembly industries is considered to be caused mainly by the two factors: the stronger

backward linkage effects of the processing and assembly industries; and the material
industries' large energy consumption in the process of intermediate inputs which results
in a leakage to import. Indeed, such features are partly reflected in the rank of each industry with respect to the product of its self-sufficiency ratio and its column sum of the
Leontief inverse matrix coefficients, but not exclusively. Although not shown here, it isproved that the import inducement coefficient by industry Am} defined as equation (2)can appropriately explain the lower rank of the basic metal industry.
0

...

Mi

0

0

0
0

...

#*

(2)

Detailed Discussion on the Multiplier Effect of Public Investment in Japan59

where IM denotes imports by commodity, Q denotes output by commodity, A denotes
the input coefficients matrix, and Id denotes the diagonal matrix of import ratios. The
basic metal industry is ranked 5th with respect to the import inducement coefficient, reflecting the large share of coal products in overall intermediate inputs by this industry.
It is likely that this factor contributes to the lower rank of the basic metal industry withrespect to the government investment multiplier. The textiles industry can be regarded
as an outlier in the plot of the government investment multiplier derived from themodified distribution pattern case versus each industry's marginal propensity to employ.
This is because employed persons per unit of output, i.e. the average propensity to em
ploy, are much larger for the agriculture, forestry & fishery industry (not shown in thisTable 7: Comparison of the GDP multiplier arising from the same amountincrease in the final demand for one industry in question among
the related studies3
Closed IO

Short-term MSE

Short-term MSE

multiplier

multiplier

multiplierin Canadab

in Queensland0

in Japand

1.347 ( 1)0.809 ( 3)1.746 ( 2)NA

0.857 ( 1)-0.060(15)1.500 ( 8)Primary industry
Agriculture, forestry & fishery
Secondary industry
MiningFood & beverages

1.094 ( 2)0.756 ( 6)

TextilesNA

Part of 0.670(11)1.073(12)Pulp, paper & paper products

NA

0.588 (12)1.592 ( 6)

Chemicals

0.859 ( 3)Part of 0.670(11)1.482(10)Petroleum & coal products

NAPart of 0.670(11)0.801 (14)Non-metallic mineral products

NA

0.699 ( 9)1.385(11)Basic metal

NA0.744 ( 7)1.070(13)Fabricated metal products & machinery

NA

0.551 (13)1.547 ( 7)Other manufacturing industry

NA

Part of 0.670(11)1.626 ( 4)Construction

NA

0.711 ( 8)1.718 ( 3)1.499 ( 9)Tertiary industry
Electricity, gas & water supply

NA0.766 ( 5)Transportation & communication

NA

0.801 ( 4)1.607 ( 5)Wholesale and retail trade

NA

0.855 ( 2)Part of 1.813 ( 1)

Finance and business services

NA

0.434(14)Part of 1.813 ( 1)Recreation, personal & other services

NA

0.672(10)Part of 1.813 ( 1)Notes:a

It should be noted that the classification of industries is not always the same across these studies.
Numbers in parentheses denote the rank in each study.

b This denotes the closed IO multiplier in Canada arising from 1 million Canadian dollar increasein the final demand for the industry in question (Cloutier and Thomassin, 1994).
cThis denotes the short-term MSE (QUIP) multiplier in Queensland state in Australia arising from
1 Australian dollar increase in the final demand for the industry in question (West, 1995).

d This denotes the short-term MSE (MS-JMACRO) multiplier in Japan arising from ¥1 trillion increase in the final demand for the industry in question.

60

Journal of Applied Input-Output Analysis, Vol. 10, 2004

plot for the above reason) and the textiles industry than other industries; in otherwords, labor productivity is much lower in these industries.

Table 7 compares the GDP multiplier arising from the same amount increase in
the final demand for one industry in question (as shown in Table 6) with that derived
from previous related studies: Cloutier and Thomassin (1994) and West (1995). Cloutier and Thomassin (1994) estimated and compared the multiplier in Canada arisingfrom a 1 million Canadian dollar increase in the final demand for one industry, using
the closed 10 model that is extended to consider the difference in the average propensity to consume and consumption pattern by income group, the difference in the income coefficients and revenue source by industry, and the income of the unemployed
and their consumption expenditure. West (1995) estimated and compared the multiplierin Queensland state in Australia arising from a 1 Australian dollar increase in the final
demand for one industry using the short-term MSE model, QUIP. Note that there is agreat structural difference among the three models compared, and that the classificationof industries is not always the same across these three models. Nevertheless, this com
parison provides some insights into the general characteristics of each industry and thedifference between the economies.

Although these three studies focus on different regions, the rank of industries
shows a similar tendency among the three model applications. It is similarly estimatedthat the multiplier is generally larger in the case of an increase in the final demand forthe agriculture and tertiary industries than for the manufacturing industries. This might
be because the general characteristics of each industry, more specifically the rank of in
dustries with respect to the factors causing a difference in the multiplier (as identified

in Figure 5) are similar among the economies compared here. Data limitations make adetailed discussion difficult, but the examples of such a similarity among the econo

mies might include the relative importance of industries in the magnitude of theleakage-to-import and employment inducement effects: the leakage to import might beless and the employment inducement effect might be larger in the case of an increasein the final demand for the agriculture and tertiary industries than for the manufactur
ing industries. Another important factor for the high rank of the agriculture industry inthree studies might be the relatively lower indirect tax and higher subsidies for this in

dustry. On the contrary, the rank of the mining industry is completely different between
these studies. It is ranked first in West's study and is ranked last in this study. This isdue to the great difference in the domestic mining resource production between Austra

lia and Japan. Australia has a plentiful mining resource, especially coal, and hencemuch of the demand for the mining resource can be met domestically. In contrast, Ja

pan satisfies almost all the demand for the mining resource by import, which signifi
cantly decreases the rank of the mining industry in Japan. This can also explain the

difference in the rank of the basic metal industry between West's study and this study,
because the production of basic metal (especially steel) requires a large amount of coalproducts as intermediate inputs as described above.
Table 8 compares the government investment multiplier in Japan derived from themodified distribution pattern case with the actual allocation of public investment in Ja
pan in 1998. It is interesting to note that the rank of industries with respect to the actual share in public investment allocation in 1998 is well in line with the rank with respect to the government investment multiplier derived from the modified distribution

Detailed Discussion on the Multiplier Effect of Public Investment in Japan61

pattern case. This implies that the current distribution pattern of public investment inJapan is appropriate at least in terms of enhancing the short-term economic impact, al
though the policy discussion on this issue should not be made only from this view
point.

Table 8: Comparison of the government investment multiplier in Japanderived from the modified distribution pattern case with the actual
allocation of public investment in Japan in 1998
Government
investment
multiplier(1) Agriculture, forestry & fishery(2) Mining

1.746 ( 2)Actual share of eachindustry in public
investment allocationin 1998

0 ( 7)-0.060 (15)0( 7)(3) Food & beverages

1.500 ( 8)0(7)(4) Textiles

1.073 (12)0.0001 ( 6)(5) Pulp, paper & paper products

1.592 ( 6)0( 7)(6) Chemicals

1.482 (10)0(7)(7) Petroleum & coal products

0.801 (14)0(7)(8) Non-metallic mineral products

1.385 (11)0( 7)(9) Basic metal

1.070 (13)-0.0012 (15)(10) Fabricated metal products & machinery

1.547 ( 7)0.1698 ( 2)(11) Other manufacturing industry

1.626 ( 4)0.0095 ( 4)(12) Construction

1.718 ( 3)0.7820 ( 1)(13) Electricity, gas & water supply

1.499 ( 9)0(7)(14) Transportation & communication

1.607 ( 5)0.0028 ( 5)(15) Services & other tertiary industry

1.813 ( 1)

0.0369 ( 3)Notes: Numbers in parentheses denote the rank. The minus share of the basic metal industry is dueto the adoption of the Stone method, implying the scrap of iron arising from public institutions.

4. Concluding Remarks
This paper has discussed in detail the multiplier effect of public investment in Japan

using the short-term multi-sector econometric model of non-equilibrium dynamic typedeveloped for the Japanese economy (MS-JMACRO), which is characterized by its ex

plicit consideration of almost all the short-term economic impact paths of fiscal policy(i.e. the factors causing the difference in the government investment multiplier). First,
the fundamental characteristics of the multiplier effect of public investment have been
examined in a detailed and quantitative way by focusing on the change in the eco
nomic variables due to the additional public investment. Secondly, the difference in thegovernment investment multiplier by the pattern of investment distribution among in
dustries has been quantitatively analyzed, and then the factors causing such a difference

have been identified on the basis of the characteristics of each industry. The major

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Journal of Applied Input-Output Analysis, Vol. 10, 2004

findings derived from these analyses can be summarized as follows.
1. The direct effect, the indirect effect, the induced effect through capital investment,
and the leakage-to-import effect have the characteristics of affecting the government
investment multiplier immediately. The increase in private capital investment due tothe additional public investment is the major factor for the government investment
multiplier in the first year when the public investment is increased. On the other
hand, the induced effect through consumption expenditure, the price adjustment ef
fect, the crowding-out effect, and the Mundell-Fleming effect have the characteristics of affecting the government investment multiplier gradually and continuously.
In the case of increasing the public investment with the short-term interest rate kept
constant, the crowding-out effect appears, but the Mundell-Fleming effect does notappear and the exchange rate depreciates.

2. There is a great difference in the government investment multiplier in Japan by thepattern of investment distribution among industries. The government investment

multiplier tends to become large if the public investment is allocated more to theindustry with the following characteristics: (1) the marginal and/or average propensity to import are small; (2) the column sum of the Leontief inverse matrix coeffi
cients is large; (3) the net indirect tax rate is low; and/or (4) the marginal propensi
ties to employ and/or invest are large. In concrete terms, the government investment

multiplier is generally large in Japan in the case of allocating the additional public
investment to the agriculture, construction, and tertiary industries.
It can be argued that this study could provide a more detailed empirical analysisof the economic impact of the increase in public investment in Japan compared withthe previous related studies. Furthermore, to the author's knowledge, the quantitative
analysis of the difference in the government investment multiplier in Japan by the pattern of investment distribution among industries and the detailed analysis of the factors
causing such a difference on the basis of the characteristics of each industry are newcontributions. The finding that the induced private investment is the major factor forthe government investment multiplier suggests the danger associated with the economic

impact analysis using the conventional 10 model that does not consider the induced ef
fect through capital investment. The findings derived from this study may be useful forthe discussion of fiscal policy, and provide important policy implications. However, it
should be kept in mind that we need to discuss how fiscal policy should be managed

from the viewpoints of creating productive capacity, providing public goods, redistrib
uting income, and the soundness of public finance as well as the viewpoint of creating
demand to enhance the short-term economic impact. For example, given the lower pro
ductivity of the agriculture, construction, and tertiary industries in Japan, the finding
suggests the possibility that the policy for enhancing the short-term economic impact(such as allocating the additional public investment to these industries) might prevent
its long-term economic growth through preserving the lower productivity of these in
dustries.

It should be noted that the results and conclusions drawn here are subject to somereservations and limitations, which are going to be addressed in future analyses. First,
some of the economic variables showing the trend of sharp and irregular fluctuations,such as private inventory change and asset prices, are treated as exogenous in the current policy simulations to avoid the spread of errors in the model. However, in order toDetailed Discussion on the Multiplier Effect of Public Investment in Japan63

carry out more rigorous policy simulations, it is necessary to endogenize these variables. Furthermore, taking into consideration the increasing importance of the monetary
and assets sectors in the Japanese economy, it is necessary to specify these sectors inmore detail in the model. Secondly, because of the large-scale and complicated featureof the Japanese economy, a more detailed sectoral disaggregation than the current con
figuration of the MS-JMACRO model is, strictly speaking, desirable to more accuratelyreflect the sectoral differences. Thirdly, in order to more accurately discuss the differ
ence in the government investment multiplier by the pattern of investment distribution
among industries, it is desirable to adopt the households' consumption function disag
gregated into each income class or each industry in which households are engaged10 because this is regarded as another important factor reflecting the sectoral difference in

the induced effect through consumption expenditure. Fourthly, labor market is sepa
rated by each occupation or by each industry in the actual economy, and thus not only
the unemployment caused by the lack of demand but also the structural unemployment,
which is usually not resolved by the increase in labor demand, occurs. Taking into con
sideration the increasing importance of the structural unemployment in the Japanese
economy, it is desirable to incorporate such an imperfect mobility of labor into themodel, which may lead to the decline in the government investment multiplier derived
from the model.

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