Silviase/jgov_v1.4_full_ann huggingface dataset:
# Sectoral Productivity and Economic Growth in Japan, 1970-98: An Empirical Analysis Based on the JIP Database $ ^{*} $

Kyoji Fukao**

Hitotsubashi University and RIETI

Tomohiko Inui

Nihon University

Hiroki Kawai

Keio University and RIETI

Tsutomu Miyagawa

Gakushuin University

October 2003
### 1. Introduction

Following the collapse of the so-called “bubble economy,” Japan’s economy has entered a phase of unprecedentedly low growth. Looking for the causes of this stagnation, economists have mainly focused on demand-side factors, such as the deficiency of effective demand, damaged balance sheets of Japanese firms, and the bad loan problems. Although the necessity of structural reforms and deregulation has also been stressed, rigorous empirical analyses of the supply-side were scarce.

From the viewpoint of growth accounting, Japan’s low economic growth in the 1990s can be explained by the following three factors. The first factor is a slowdown of the labor supply caused by structural changes, such as population aging and a reduction of the work-week. The second factor is a slowdown of total factor productivity (TFP) growth. The third factor is a lack of effective demand and deflation. Many economists agree on the importance of the first factor. But they are not unanimous in their view on the significance of the other two factors, which are the subject of continuing controversy. Based on a growth accounting of the Japanese economy, Hayashi and Prescott (2002) argue that the economic stagnation in Japan in recent years can be explained by the first and the second factor, while the demand factor, in their view, does not play an important role. In contrast, M. Fukao (2003) and Yoshikawa (2003) hold that the scarcity of demand is the most important cause of the present stagnation. They also point out the possibility that the recent slowdown of Japan’s TFP growth is caused by the decline of capacity utilization and labor hoarding as a result of the recession.

In spite of the importance of the issue, Japan’s TFP growth has not been well studied in recent years. For example, the growth accounting by Hayashi and Prescott (2002) is not very sophisticated in the sense that they did not take account of the quality of labor and capacity utilization. They treated the slowdown of TFP growth as exogenous and did not try to address important questions,
such as why the TFP growth rate has declined and in what sector in particular TFP growth slowed down.

In this paper we conduct a detailed analysis of Japan’s TFP growth by making use of the Japan Industrial Productivity Database (the JIP Database) which we have recently completed. $ ^{1} $ We try to answer the following questions:

(1) After the quality of labor and the capacity utilization have been taken account of, how much of the slowdown of Japan’s economic growth in the 1990s can be attributed to the decline in TFP growth?

(2) In what sectors is TFP growth particularly low?

(3) What structural factors seem to have contributed to recent changes in sectoral TFP growth?

The paper is organized as follows: in the succeeding section, we conduct growth accounting at macro level. In the analysis we will take account of the quality of labor and capacity utilization. We also compare our results with preceding studies on this issue, such as Hayashi and Prescott (2002) and Jorgenson and Motohashi (2003). In section 3, we analyze sectoral TFP growth. We show that in
the 1990s, TFP growth slowed down in the manufacturing sectors but accelerated in several service sectors. In section 4 we examine possible structural factors that have contributed to recent changes in sectoral TFP growth by reviewing recent researches on sectoral productivity. In section 5, we will summarize our main results.

### 2. Supply-Side Causes of Japan’s Stagnation: An Analysis at the Macro Level

In the succeeding section, we conduct growth accounting at the macro level using the JIP Database. We also compare our results with preceding studies on this issue.

#### 2.1. Growth Accounting at the Macro Level

We begin by explaining our methodology of macro growth accounting. Let us assume that a macro production function at time t can be expressed as the following function of capital input $ K_{t} $ , labor input $ L_{t} $ , and an index of the technology level $ T_{jt} $ .

$$ Y_{j t}=F(K_{t},L_{t},T_{t}) $$

where $ Y_{jt} $ denotes real GDP at time t. We assume constant returns to scale. The capital input $ K_{t} $ is derived by an aggregation of several types of assets, structures and equipment. The labor input $ L_{t} $ is an aggregate of the number of workers cross-classified by sex, age, and educational attainment. The construction of these input aggregates is described in Appendix A.

Additionally we assume that the macro production function has a trans-log functional form. We also assume that because of the cost minimizing behavior of firms, the marginal product of each production factor is equal to its cost share.

$$ \frac{\partial\ln F}{\partial\ln K}=\frac{\partial F}{\partial K}\frac{K}{Y}=\frac{w_{K}}{p}\frac{K}{Y}=s_{K}, $$

$$ \frac{\partial\ln F}{\partial\ln L}=\frac{\partial F}{\partial L}\frac{L}{Y}=\frac{w_{L}}{p}\frac{L}{Y}=s_{L} $$

where
$$ \overline{s}_{Kt}=(s_{Kt}+s_{Kt-1})/2 $$

denotes the average of cost share of capital at time t-1 and time t. $ w_{K}/p $ and $ w_{L}/p $ denote real service price of capital and real wage rate. Similarly,

$$ \overline{s}_{L j t}=(s_{L t}+s_{L t-1})/2 $$

denotes the average of the cost share of labor at time t-1 and time t.

By differentiating the production function (1) over time, we get

$$ d\ln Y_{t}=\ \overline{s}_{Kt}d\ln K_{t}+\overline{s}_{Lt}d\ln L_{t}+d\ln A_{t} $$

where $ d\ln Y_{t} $ , $ d\ln K_{t} $ , and $ d\ln L_{t} $ denote $ \ln Y_{t}-\ln Y_{t-1} $ , $ \ln K_{t}-\ln K_{t-1} $ , and $ \ln L_{t}-\ln L_{t-1} $ respectively. The last term on the right-hand side of equation (2), $ d\ln A_{t} $ denotes the contribution of technology improvement $ \ln T_{t}-\ln T_{t-1} $ to the increase in production at the macro-level.

$$ d l n A_{t}{=}\frac{\partial\ln F}{\partial\ln T}d\ln T $$

$ d\ln A_{t} $ is usually called TFP growth. It is difficult to measure and observe the states of technology T, but we can derive the contribution of technological change to production in the following way.

$$ d\ln A_{t}=d\ln Y_{t}-(\overline{s}_{Kt}d\ln K_{t}+\overline{s}_{Lt}d\ln L_{t}) $$

Subtracting the growth rate of the working age population $ d\ln N_{t} $ from both sides of equation (2), we obtain our basic equation for growth accounting. $ ^{2} $

$$ \begin{aligned}&d\ln Y_{t}-d\ln N_{t}=\ \overline{s}_{Kt}\left(d\ln K_{t}-d\ln N_{t}\right)+\overline{s}_{Lt}\left(d\ln MH_{t}-d\ln N_{t}\right)\\ &\\&\quad+\ \overline{s}_{Lt}\left(d\ln L_{t}-d\ln MH_{t}\right)+d\ln A_{t}\\ \end{aligned} $$

where $ d\ln MH_{t} $ denotes the growth rate of man-hours worked. The left-hand side of equation (4) denotes real GDP growth per working-age population. The four terms on the right-hand side denote
the contribution of capital deepening, the contribution of the increase of man-hour input per working-age population, the contribution of the improvement of labor quality, $ ^{3} $ and the contribution of TFP growth respectively.

Panel A of Table 21 summarizes the result of our growth accounting. Following Hayashi and Prescott (2002), we divided our data into three sub-periods, 1973-1983, 1983-1991, and 1991-1998. 1973 is the year of the first oil shock, and 1983 when recovery from the second oil shock began. This period was followed by the boom of the “bubble economy”, which lasted until 1991. Finally, the years from 1991-1998 represent the period of economic stagnation. Panel B of Table 21 shows the growth rate of each production factor in each of the three periods. By comparing Panel A and Panel B we can derive the cost share of each factor. For example the average cost share of capital in 1991-98 was 0.33 (=0.96/2.88).

According to the JIP Database, real GDP growth declined from 3.94% of 1983-91 to 1.25% of 1991-98. This decline of 2.69 percentage-points can be decomposed into the following factors:

slowdown of the growth of the working age population: 0.79 percentage-points;

slowdown of TFP growth: 0.43 percentage-points;

slowdown of the growth of capital stock per working-age person: 0.51 percentage-points;

slowdown of the growth of man-hour per working age person: 0.72 percentage-points;

slowdown of the improvement of labor quality: 0.25 percentage-points.

All the above changes contributed to the decline in Japan’s economic growth in the period from 1991-98. From a theoretical viewpoint, the above changes can be grouped – as argued in Section 1 - into the following three major factors.

First, structural changes - such as the aging of the population and the reduction of the
work-week - have slowed down the labor input growth. The growth rate of labor quality also declined. According to the Solow-type neoclassical growth model (Solow, 1956), the decline in the working-age population growth rate by 0.79 percentage-points and the 0.25 percentage-point slowdown in labor quality have reduced Japan's balanced growth rate by 1.04 percentage-points.

Secondly, the TFP growth rate declined by 0.43 percentage-points. According to the neoclassical growth model, the decline in TFP growth will also reduce the equilibrium growth rate of the real capital stock in balanced growth. If we assume a Cobb-Douglas production function with a capital share of one third, a 0.43 percentage-point decline in TFP growth will cause a 0.65 percentage-point $ (=0.43+0.43/3) $ decline in the balanced growth rate.

Thirdly, Japan was trapped in deflation in the 1990s. Probably, demand factors, such as the increasing unemployment and the stagnation of private investment, have contributed to the decline in economic growth. It seems that a substantial part of the 0.72 percentage-point decline in the contribution of the growth of man-hour per working-age person and the 0.51 percentage-point decline in the contribution of capital deepening were caused by demand-side factors.

Table 2.2 compares the result of the growth accounting of the US economy by Jorgenson, Ho, and Stitoh (2002) with our result on Japan. $ ^{4} $ Following Jorgenson et al., we have treated IT capital and non-IT capital as different factor inputs. $ ^{5} $ Compared with the US, Japan’s TFP growth and labor input growth were significantly lower in the 1990s. On the other hand, there was no large gap in the contribution of labor quality growth and capital deepening. Like the US, Japan has experienced a
rapid increase in the contribution of IT capital deepening in the latter half of the 1990s.

To sum up our Japan-US comparison, it is confirmed that the three factors, i.e. the structural decline in labor input growth, the slowdown in TFP growth, and the scarcity of demand caused Japan’s ‘lost decade’.

#### 2.2. Growth Accounting with Adjustment of Capacity Utilization

As Burnside, Eichenbaum and Rebelo (1995) and Basu (1996) have shown, there is a risk to underestimate (overestimate) TFP growth, if we do not take account of a decline (an increase) in the capacity utilization rate. Since the capacity utilization rate in Japan seems to have declined under the continuous stagnation of the 1990s, we may have overestimated the decline of the TFP growth in the previous section. In this section we examine this issue. We also compare our results with those of Hayashi and Prescott (2002).

The JIP Database contains sectoral capacity utilization rates, which are based on METI's Index of Operating Ratio in the case of the manufacturing and mining sectors and on the intermediate input-capital ratio and the BOJ's Excess Capacity D.I. in the case of the other sectors. $ ^{6} $ We used this data for the adjustment of TFP growth. Figure 2.1 shows the average capacity utilization rate of the manufacturing and primary sectors and that of other sectors. The average capacity utilization rate of the manufacturing and primary sectors has declined by 9.5 percentage-points from 1991 to 1998. In the case of the other sectors, the decline was negligible (0.5 percentage-points). The decline of the average capacity utilization rate of the macro-economy was relatively small (2.4 percentage-points).

In order to adjust for this change of the capacity utilization rate, we estimated Japan’s TFP growth using the following growth accounting equation. $ ^{7} $
$$ d\ln A_{t}=d\ln Y_{t}-(\overline{s}_{K t}d\ln(\sum_{j}Z_{j,t}K_{j,t})+\overline{s}_{L t}d\ln L_{t}) $$

where $ Z_{j,t} $ and $ K_{j,t} $ denote the capacity utilization rate and real capital input in sector j.

Table 2.3 shows the result of this growth accounting. According to the new growth accounting with adjustment of capacity utilization, the decline in TFP growth for the period 1983-91 to the 1991-98 period is 0.20 percentage-points, which is 0.23 percentage-points smaller than the corresponding result without the adjustment (Table 21). This difference derives from the fact that the capacity utilization rate was at its peak in 1991. Without the adjustment of capacity utilization, the TFP growth before (after) 1991 is overestimated (underestimated).

### 2.3 Comparison between Preceding Researches and Our Results

Let us compare our result with preceding growth accounting studies of the Japanese economy. Table 2.4 shows the result of Hayashi and Prescott (2002). Similar to ours, their result shows that the decline in Japan’s economic growth is jointly caused by a slowdown of TFP growth, a slowdown of capital accumulation, and a decline in labor input. But compared with our result, their estimated decline in capital and labor inputs is much more moderate and, as a result, their estimated decline in TFP growth (2.2 percentage-point decline) is much larger.

Probably we can explain this difference by the following factors.

First, Hayashi and Prescott do not take account of changes of in the quality of labor. As Panel B of Table 21 shows, the improvement of labor quality has slowed down in the recent years. They overestimate the decline in TFP growth by neglecting changes in labor quality.

from the cost of capital. In the following growth accounting we did not take account of this possibility. As Morison (1993) has shown, we can tackle this issue more rigorously by estimating the variable cost function. Using micro data of Japanese manufacturing firms, Fukao and Kwon (2003) estimated variable cost functions and made adjustments of capacity utilization and scale economies. They found that the rate of technological progress, which is defined as a downward shift of the variable cost function, declined from 1994 to 1998 in many manufacturing sectors.
Secondly, they do not take account of changes in capacity utilization. This factor also contributed their overestimation of the decline in TFP growth.

Thirdly, in their growth accounting they use real GNP, not GDP as an output measure. And they include Japan's net external assets in the capital stock. In GNP statistics, the rate of return to domestic capital is in gross term and includes capital depreciation. On the other hand, the rate of return to Japan's external assets is recorded in net term. Therefore, the appropriate capital cost of net external assets for growth accounting is usually smaller than the cost of capital located in Japan.

Hayashi and Prescott (2002) did not take account of this difference and assumed that the cost share of capital was constant over time. Since Japan has accumulated a huge amount of net external assets in the 1990s, $ ^{8} $ Hayashi and Prescott seems to have overestimated the cost share of capital in the 1990s, the contribution of capital deepening in the 1990s, and, as a result, the decline in Japan's TFP growth from the 1980s to the 1990s.

Another important study is that by Jorgenson and Motohashi (2003). They found that Japan’s TFP growth rate declined from 096% of 1975-90 to 061% of 1990-95 but accelerated to 1.04% during 1995-2000. This optimistic result is mainly based on their assumption on the deflator of information technology (IT) products. $ ^{9} $ They assumed that the relative price of IT products compared with non-IT products in Japan has declined in a similar way as in the US. They used their own IT product deflator, which is calculated as $ ((US\ IT\ product\ price)/(US\ non-IT\ product\ price)) $ .
price) $ ^{*} $ (Japan’s non-IT product price) instead of Japan’s official statistics. Since the relative price of IT products declined more drastically in the US than in Japan, this procedure raises their estimation of the GDP growth rate and the TFP growth rate. $ ^{10} $

Jorgenson and Motohashi adopt this procedure because they believe that quality improvements of IT products are not sufficiently taken into account in the case of Japan’s price statistics. $ ^{11} $ Although they raised an important question, it seems to be brave to directly apply US relative prices to Japan. We need a more rigorous analysis of the international price gap and the size of a hypothetical price decline, which is equivalent to the actual quality improvement of IT products.

### 3. Sectoral Productivity Growth in Japan

In the previous section we saw that the decline of Japan’s TFP growth in the 1990s was not large when we make adjustments of the capacity utilization. In this section, we analyze Japan’s TFP growth over the last three decades at a detailed sectoral level, which was almost impossible before the compilation of the JIP Database. $ ^{12} $

#### 3.1. TFP Growth at the 3-Digit Industry Level

First, let us explain our methodology. For the growth accounting of 84 sectors we use the following equation.
$$ d\ln A_{j,t}=d\ln Q_{j,t}-(\overline{s}_{K,j,t}d\ln Z_{j,t}K_{j,t}+\overline{s}_{L,j,t}d\ln L_{j,t}+\overline{s}_{M,j,t}d\ln M_{j,t}) $$

Where $ d\ln A_{j,t} $ denotes the TFP growth rate from time t-1 to t in sector j, while $ d\ln Q_{j,t} $ denotes the growth rate of real gross output. $ K_{j,t} $ , $ L_{jt} $ , and $ M_{j,t} $ denote the capital, labor, and real intermediate input in sector j at time t. $ M_{j,t} $ is a composite index of 84 commodities and services, which is based on the annual real IO tables of the JIP Database. $ Z_{j,t} $ denotes the capacity utilization rate. $ s_{Kt} $ , $ s_{Lt} $ , and $ s_{Mt} $ with upper bars denote the average of cost share of the capital, labor, and intermediate input in sector j at time t-1 and time t. In a similar way as in Table 23, we made adjustments of changes in capacity utilization here.

As Domar (1961) has shown, the contribution of TFP growth in each sector to macro TFP growth is given by that sector's TFP growth rate multiplied by the Domar weight. $ ^{13} $ Table 3.1 shows each industry's TFP growth and its contribution to the macro TFP growth rate for the three sub-periods. $ ^{14} $ This result is summarized in Figure 3.1 and 3.2 at the two-digit industry level. The

$$ \sum_{t=T+1}^{T}\frac{DW_{j,t}+DW_{j,t-1}}{2}\{d\ln Q_{j,t}-(\overline{s}_{K,j,t}d\ln Z_{j,t}K_{j,t}+\overline{s}_{L,j,t}d\ln L_{j,t}+\overline{s}_{M,j,t}d\ln M_{j,t})\} $$

$$ \{(\ln Q_{_{j,T^{\prime}}}-\ln Q_{_{j,T}})-\{\frac{s_{_{K,j,T^{\prime}}}+s_{_{K,j,T}}}{2}(\ln Z_{_{j,T^{\prime}}}K_{_{j,T^{\prime}}}-\ln Z_{_{j,T}}K_{_{j,T}}) $$
correspondence between the 3-digit JIP classification and our 2-digit classification is reported in Table 3.1.

According to our result, the slowdown of TFP growth mainly occurred in the manufacturing sector. The manufacturing sector’s contribution to macro TFP growth declined from 0.74 percentage-points in 1983-91 to -0.03 percentage-points in 1991-98. $ ^{15} $ On the other hand, TFP growth in the non-manufacturing sectors has accelerated in the 1990s. The non-manufacturing sectors’ contribution to macro TFP growth has increased from -0.34 percentage-points in 1983-91 to 0.22 percentage-points in 1991-98. $ ^{16} $

### 4. Possible Structural Factors behind the Recent Change in Sectoral TFP Growth

What structural factors contributed to the recent change in the sectoral TFP growth pattern? In
this subsection, we examine this issue by reviewing our recent researches on sectoral productivity.

#### 4.1. Deregulation and the Acceleration of TFP Growth in the Non-manufacturing Sector

First, let us consider about the acceleration of TFP growth in the non-manufacturing sector. Probably the most important source of this change is deregulation. The following is a list of major deregulation policies implemented in the 1990s. $ ^{17} $

Commerce: Revision of the Large Scale Retail Store Law (1992)

Telecommunication: Privatization of NTT (1985), introduction of the competition principles in all market areas (1985), liberalization of public-leased-public interconnections (1996), abolition of foreign capital regulations (excluding NTT and KDD), complete privatization of KDD (1998).

Finance and insurance: Approval of mail-order sales business of insurance products (1996), partial liberalization of brokerage commission in security trade (1998), initiation of over-the-counter sales of investment trust funds by banks (1998).

Transportation: Change from the license system to the permission system and abolishment of requirement for fare revision permission in truck industry (1990), approval for individual assessment on fares cheaper than the average cost price in the taxi industry (1993), introduction of a flexible airline fare system (1996) and abolishment of double and triple tracking standards (1997) in domestic aviation.

Electric Utility: Relaxation of restrictions on electric power wholesaling (1995).

Employment placement: Expansion of occupations (mainly non-manufacturing occupations) to be covered by fee-charging employment placement agencies (1990, 1997).
These deregulations increased new entries, including M&A of Japanese firms by foreign firms, and more price competition in the non-manufacturing sector, where market competition was relatively limited compared with the manufacturing sector. $ ^{18} $

Using the JIP Database, Nakanishi and Inui (2003) have tested whether Japan’s deregulations have contributed to TFP growth. For this study they prepared a panel data set of a sectoral deregulation index for 68 industries and for every five-year period from 1970 onwards. This index is a frequency measure. A value of industry i and year t denotes the percentage of regulations abolished by year t in relation to the total number of regulations that existed in the starting year 1970. $ ^{19} $ The chronology of Japan’s deregulation is taken from Sumitomo-Life Research Institute (1999) and Ministry of Public Management, Home Affairs, Posts and Telecommunications (2000). Table 41 shows their deregulation index at a relatively aggregated level. We can see that the manufacturing sector was not regulated even in 1970, whereas deregulation in non-manufacturing sector accelerated in 1990s. The increase in the deregulation index was particularly large - more than 20 percentage-points - in communication, wholesale and retail trade, and finance, insurance and retail from 1980 to 1998. This finding is consistent with our result of rapid TFP growth in these industries.

The main results of Nakanishi and Inui's regression analysis are reported in Table 42. The dependent variable is each industry's TFP growth. As explanatory variables they used the deregulation index, the growth rate of R&D stock, the growth rate of IT stock, the spill-over effect of IT capital growth in other industries, the subsidiaries-production ratio, and a time trend. They pooled