Kiyohiko G Nishimura: Funding for financing economic growth - a
Schumpeterian perspective
Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the GIC
(Global Interdependence Center) Conference on "The Global Financial Crisis - lessons from
Japan", Tokyo, 3 December 2012.
* * *
I. Introduction: beyond standard macroeconomics
Having experienced prolonged stagnation after the global financial crisis of 2008,
economists, market participants, and policymakers alike have arrived at the painful
recognition that per capita real output has a long path toward recovering its pre-crisis level.
To tackle this stagnation, the standard macroeconomic prescription is simple and
straightforward: the policymaker should conduct an expansionary policy to fill the gap
between actual and potential GDP, treating potential GDP as exogenously given. Although it
is difficult to tell in real time whether the observed weakness in economic recovery is cyclical
or structural, it seems obvious that the current GDP gap is large no matter how one
measures the potential. Under this prescription, and facing the zero bound on nominal
interest rates, central banks in advanced countries are currently employing unconventional
measures, such as large-scale asset purchase programs.
However, I believe we need to go beyond such a standard way of policy thinking in order to
bring about effective policy in this slow growth environment. We should consider policies that
influence the growth potential itself. In particular, I suggest that central banks should find
tools to support the efforts to strengthen the foundation for economic growth. This may look
even more unconventional than already unconventional asset purchase programs. But it
should be noted that price stability, the goal of central banking, becomes difficult to achieve
once growth expectations diminish and the economy becomes prone to hit the zero bound.1
Thus, it is absolutely necessary to raise growth expectations in order to alleviate the difficulty
in maintaining price stability. And I presume that monetary policy can influence the growth
potential over a long term, although such effects are uncertain and indirect.
Indeed, there have been several signs of these diminished growth expectations in many
countries. The aftereffect of a financial crisis has been discussed extensively.2 Population
ageing is another factor that is already impacting advanced economies and coming soon to
several emerging economies.3 A not-so-growth-friendly change in the current technological
1
Persistent deflation found in Japan in the past decade was at least partly caused by recurrent negative shocks
that caused continuously diminishing growth expectations. When a negative shock happens to diminish
growth prospects, management refrains from engaging in capital investment and giving pay raises, and
households cut consumption expenditures to increase savings for the future. If a fall in growth expectations
were a one-off event, price levels would stabilize soon after necessary adjustments were made. However,
when such a decline happens several times, a chronic demand shortfall would keep placing downward
pressure on price levels and deflation would persist.
Persistent deflation may also have been caused by the following mechanism that operates through the
price-and wage-setting behavior of firms. Japanese export firms dealt with the severe competition coming from
low-cost emerging countries by cutting costs - that is, cutting wages and delivery prices. This had a spillover
effect on the non-manufacturing and public sectors in Japan, resulting in a fall in the general price level. This
led to an appreciation of the Japanese yen through the purchasing power parity (PPP) mechanism. As this
currency appreciation partly offsets the effects of initial cost cuts by export firms, the whole cycle starts once
again, beginning with cost cuts by firms. Deflation persists in that process.
2
See Reinhart and Rogoff (2012) and IMF (2009).
3
The impact of population ageing is multifaceted. Obviously, it creates the financial burden of supporting a
larger older population with a smaller younger generation, leading to fiscal problems. The dominance of
elderly consumers changes the demand structure and thus necessitates structural changes in corporate
advancements is another element that deserves more extensive discussion, especially in
terms of its impact on employment.4
In my remarks today, I explain my own view about the role of the central bank in a slow
growth environment, which is distinctively Schumpeterian, and describe the policies adopted
by the Bank of Japan from this viewpoint. But first, let me briefly review the development of
the real growth rate in Japan and other advanced countries.
II. Evolution of post-crisis economic growth: Japan as a spearhead of change
Japan has an extraordinary history of real GDP growth over the past six decades, from the
annual average of a roaring 9.7% in the 1960s to a meager 0.6% in the 2000s, as depicted in
Chart 1. Chart 2 decomposes real GDP growth into the growth in labor productivity and that
of labor inputs. Note that the peak of the Japanese property bubble is around 1990.
Comparing pre-bubble growth (1980s) and post-bubble growth (1990s), we find that most of
the change in growth is from the substantial slowdown in labor productivity growth.
There are several factors explaining this slowdown in labor productivity growth, which can
further be decomposed into the growth of total factor productivity (TFP) and the contribution
of the change in capital-labor ratio. Firstly, TFP growth slowed because technological
catch-up opportunities were exhausted, the illusory TFP growth of the bubble period
evaporated,5 and information and communication technology failed to improve the
productivity of Japanese firms, unlike the case for firms in the United States.6 Secondly, and
more importantly, the increase of the capital-to-labor ratio was reduced sharply because
firms hesitated to invest in new projects or even to replace old equipment: the firms' top
priority then was to "deleverage" - namely, to reduce the excessive stock of capital and debt
that had been built up during the bubble period.
Japan has faced a consecutive set of difficult problems during the last quarter century,
starting with a property bubble of an unprecedented magnitude and its bursting, followed by
financial crises in Asia and at home in the situation of a fast-paced population ageing and
now declining population. However, the development of the global economy since the
mid-2000s suggests that other advanced countries also face similar problems, making Japan
look like a spearhead of change. Indeed, Chart 3 depicts the rolling ten-year average of per
capita real GDP growth rate among advanced economies between 1971 and 2010, which in
theory is closely related to the natural rate of interest. Since the financial crisis, this has fallen
in the United States and Europe to a level similar to that in Japan. Thus, the issue of raising
growth potential is likely to become a common policy challenge for advanced countries.
strategies. Moreover, coupled with the progress of information and communication technology (ICT), an
ageing workforce may result in lower productivity. In Japan, the ageing workforce during the 1990s contributed
to the deceleration in labor productivity growth, since ICT made obsolete the existing firm-specific know-how
and human capital. See Minetaki and Nishimura (2010).
4
Gordon (2012) lucidly explains a changing, non-linear nature of technological progress and suggests that
improvement may be reduced substantially in the near future. This is especially relevant with respect to profit
prospects and employment generation. First, ICT widely reduces profits because more and more products are
becoming digitized and these digitized products' prices are subject to constant downward pressure due to the
fact that their reproduction costs are almost zero. Second, ICT replaces middle management both at the
workshop and in the office, and thus reduces the number of relatively well-paid and career-oriented
medium-skill jobs (Nishimura 2012).
5
The best example may be the construction industry, where huge TFP gains are found in the bubble period,
although construction is an industry of low TFP growth in many countries and many periods. In the bubble
period, irrational exuberance or conspicuous purchasing behavior was often observed, in which the higher the
price of the building, the quicker it was sold. See Minetaki and Nishimura (2010).
6
See footnote 4.
III. A Schumpeterian perspective: banks' role in innovation dynamics
What should be done to lift the growth potential and thus growth expectations, especially in a
time of population ageing? The key is to raise labor productivity - that is, to increase the
value-added generated by labor inputs. There are two ways to do this: cutting costs and
creating new demand. Cost cuts are best fit to a growing population that is demanding more
high-quality products at lower prices.7 However, when demand does not grow as the
population matures, creating demand is much more important than cutting costs. It is all the
more important to figure out the potential needs of the society and to provide those goods
and services for which people are willing to pay.
When firms attempt to engage in demand-creating innovation, financial intermediaries should
play the crucial role of supporting them financially. In the absence of active financial
intermediations, high-risk but high-return projects may end up not being undertaken, the
technology spillover may be severely limited, and the economy may fall into stagnation.
Indeed, it is Schumpeter who emphasizes the role of the "banker," in addition to the role of
the "entrepreneur" that carries out demand-creating innovation.8
Crucial role of the banker in the Schumpeterian creative destruction
Creative destruction, as Schumpeter defines it, starts from a phase of shaking up the existing
market structure. At this phase, the "entrepreneur" brings in a new combination of technology
and knowledge while the "banker" provides to the entrepreneur investment funds, which are
raised through the process of credit creation. Of course, the "banker" here is not limited to
the bank as it literally means, and it also includes venture capitalists.
The banker plays two roles in this process. First, the banker screens prospective
entrepreneurs and selects the most promising ones. This is often called the "expert eye"
function of bankers. Second, and more important in practice, the banker often provides firms
with information related to business matching and new markets, which helps to improve the
recipient firms' performance even after the initiation of funding.9 A banker who selects
successful entrepreneurs and provides appropriate advice to them at a lower cost than other
bankers can earn steady profits from an ongoing relationship with them.10 Such long-term
profit-maximizing behavior of the banker improves the efficiency of risk allocation evaluated
7
The main strength of Japanese companies until the 1980s was their ability to manufacture and sell a large
volume of high-quality products. That was made possible by product quality improvement as well as
cost-cutting efforts that enhanced the operational quality and efficiency. A famous example is the "just-in-time"
system for production and inventory management. There was a limit to maintaining this kind of "cost-cutting
innovation," however: the room for further improvement gradually diminished. Furthermore, the rapid catch-up
by emerging countries in Asia made it difficult for Japanese manufacturers to continue increasing profits
through cost-cutting efforts since the 1990s: standardization based on information technology as well as
globalization have enabled Asian emerging countries to combine technology and capital in advanced countries
with the abundant labor available in their own countries to pursue international specialization that helps them
to achieve an optimal production structure. To put it differently, the old business model that had supported the
high growth of Japanese firms gradually became out of touch with the renewed economic environment
characterized by advances in information technology and globalization. See Nishimura (2012).
8
See Schumpeter (1926).
9
Although the second role is not explicitly examined by Schumpeter in his treatise, it becomes increasingly
important in innovation as the economy enters the age of ICT. In the United States, for example, venture
capital firms contributed to the product development of biotech firms, through both fund provision and other
kinds of assistance (Michalopoulos et al. 2009). The latter includes the provision of information related to
management and help in business contracts.
10
In fact, small and medium-sized enterprises often complain that, although this information-providing function is
most demanded, Japanese banks unfortunately have failed to provide it adequately in post-crisis Japan.
at the macro level and leads to an endogenous increase in the economic growth rate through
an expansion in the production possibility frontier.11
Necessity of Schumpeterian banks, particularly in a recession
Innovation entails long-term investment in research and development (R&D), teaching
workers new technologies, and the search for new markets. In what phase of the business
cycle is such long-term investment stimulated? In theory, long-term investment such as R&D
should gain momentum in a recession, when short-term investment to meet current demand
decreases.12 In reality, however, the opposite is true: innovation drops sharply in a
recession.13 The reason the theory fails provides an important clue for policy.
The opportunity cost of long-term investment, which is the foregone profits of not undertaking
a short-term investment that meets the current demand, decreases in a recession when the
current demand is weak. Consequently, the theory predicts that the entrepreneur will find
innovation to be more profitable in a recession.14 On the contrary, many empirical studies
point out that long-term investment such as R&D may in fact be pro-cyclical, and drop in a
recession. The most plausible explanation is that the theory implicitly assumes that firms are
not subject to credit constraints, but this is not the case in practice. To use Schumpeter's
terminology, the theory assumes that the "banker" is always willing to provide financial
support to the innovative "entrepreneur." In reality, however, the "banker" is not willing to do
so in a recession because credit constraints usually tighten due to firms' worsening balance
sheet conditions and renewed concern about an uncertain return on R&D. The consequence
is that the tone of firms' innovation activity as a whole becomes low, and the risk of impeding
long-term growth potential becomes elevated.
Thus, from the Schumpeterian perspective, the monetary authority should make every effort
to maintain stability in the financial environment, particularly in a recession, so that firms'
innovative activity is not held back. Admittedly, this is a very subtle balancing act, since we
should avoid bank loans from going bad and at the same time preserve efficiency in the
allocation of funds.
Necessity to consider externality in innovation
Lastly, from the Schumpeterian perspective, the policymaker or the monetary authority
should properly take into account "externality" in innovation when it seeks to support the
innovative activity of entrepreneurs. To take as an example, R&D investment leading to the
development of frontier technology has a clear positive externality: such investment has a
social benefit, in that it encourages competition toward technology revolution, which
eventually gives rise to a knowledge spillover. For each individual firm, however, the private
return on such investment is not sufficiently high unless the society-wide spillover benefits
are internalized.15 In fact, we often hear that firms actually give up many projects with high
11
Michalopoulos et al. (2009) present an endogenous growth model that features the entrepreneur and the
banker, and provide a theoretical perspective to Schumpeter's idea. However, the model focuses only on the
"expert eye" function of the banker.
12
See Aghion et al. (2005, 2010).
13
See, for example, Aghion et al. (2008) and Mannasoo and Merikull (2011).
14
This is the heart of the so-called "cleansing effect" of a recession: a recession stimulates innovation activity
and rectifies inefficiencies in the economy. The word "cleansing effect" sometimes refers exclusively to
efficiency gains from the exit of inefficient firms, but the innovation-induced mechanism should properly be
taken into account.
15
Social return has the elements of both dynamic scale effect and learning effect. Specifically, although the
initial investment is costly, the cost decreases as the scale of production increases: even if the private return is
low initially, the social return that takes into account the subsequent benefits may be high.
social return because of their low private return.16 To summarize, in the presence of
externalities, long-term investment such as R&D is not carried out sufficiently from a social
point of view, since each individual firm may not have enough incentive to do so.
Here, a Schumpeterian perspective of innovation becomes important. A standard policy tool
to rectify this problem is the government subsidy or so-called Pigovian tax. However, such a
direct intervention of public authority may severely undermine market efficiency because the
authority does not have sufficient information and the monitoring ability to implement it. Then,
it may be desirable to move indirectly toward using financial institutions' Schumpeterian role,
stimulating firms' incentive for innovation while preserving efficiency at the same time. The
policymaker provides funding for the bankers' support to promising innovations, counting on
the bankers' ability to produce information; namely, the "expert eye" function and "opportunity
provision" function. In other words, we need a social system to promote innovation, providing
backing to private returns and shifting allocation of funds and resources toward investment
projects with high social return. Having this kind of social system is particularly important
when low private return prohibits firms from making an effort toward innovation that
generates social benefits in terms of growth expectations and employment opportunities.
IV. Central banking in the post-crisis world: funding for financing economic growth
Let me now explain the policy initiatives of the Bank of Japan, which specifically aim at
raising the growth potential and thus growth expectations of firms and households. In June
2010, the Bank introduced the "fund provisioning measure to support strengthening the
foundations for economic growth," which I call the GFSF (Growth Foundation Strengthening
Facility).17 In October 2012, the Bank announced the introduction of the "fund provisioning
measure to stimulate bank lending," which at this moment is being carefully prepared. In a
nutshell, we can combine both measures into "funding for financing economic growth."
These measures aim to contribute to lift the potential growth rate through financial
intermediation. Specifically, they supply long-term funds at a very low interest rate against
eligible collateral to financial institutions in order to encourage their lending and investment to
businesses.
Chart 4 depicts steadily increasing GFSF loans provided to financial institutions by the Bank
of Japan, which consist of the main-rule loans starting in September 2010 as well as three
special-rule ones introduced afterward. Chart 5 shows the amount of financial institutions'
loans to firms that the GFSF generated, categorized by growth-related business lines. Here,
the "environment and energy business" accounts for the largest share, followed by the
"medical, nursing cares, and other health-related business" and the "development and
upgrading of social infrastructure." Indeed, the GFSF has induced sizable efforts by financial
institutions to support strengthening the foundations for economic growth.
Let me point out three theoretical rationales of these fund-provisioning measures or facilities
from the Schumpeterian perspective that I have explained. First, they make the most of the
Schumpeterian bankers' informational capacity in screening innovative entrepreneurs and
providing information valuable that will allow them to grow. The "expert eye" of the bankers
plays a vital role in screening projects, and their good-advisor function substantially
increases the value of innovation.18 Second, the policy measures try to counter the negative
effect of a recession by providing financial support to the "banker" at a time of many
headwinds to the economy. Third, the policy measures aim to act as a catalyst for financial
institutions' lending and investment to businesses with high social return. By offering
long-term funds at a very low interest rate, they supplement the low private return that
mirrors the presence of externality in innovation.
The policy philosophy here is different from that of the Keynesian approach. These measures
aim to improve financial intermediation's long-term efficiency in resource allocations, while
the Keynesian approach endorses public spending to fill the short-run shortage in aggregate
demand. It also differs from neoliberalism, which rests on the superiority of free and
competitive markets and thus makes every effort to avoid public interventions.19 It is
distinctively Schumpeterian, in that it has the aim of raising the growth potential or liveliness
of the economy. For this very reason, one could say that it is unconventional in the domain of
monetary policy design. I certainly do not dispute such claim. However, we should recognize
that a secular decline in the real growth rate and sluggish growth expectations have plagued
Japan in past decades. Thus, the Bank's indirect intervention through the financial system -
that is, the Bank of Japan's fund-provisioning measures - is perfectly consistent with the
principle of monetary policy stipulated by the Bank of Japan Act; namely, "currency and
monetary control by the Bank of Japan shall be aimed at achieving price stability, thereby
contributing to the sound development of the national economy."
V. Concluding remarks: a way forward
Let me now conclude. Sluggish productivity growth reduces potential growth. It not only
scales down the supply side but also places a negative impact on the demand side. This is
because household consumption and corporate investment are held back once the
households' income prospects and the firms' earnings forecasts are weakened. Both the
supply and demand sides lose momentum due to productivity declines, resulting in a
persistent fall in the natural rate of interest.
Deleveraging in the aftermath of the bubble bursting and the financial crisis reinforces the fall
of the natural rate of interest, since the private sector reduces expenditures rapidly and by a
large amount.20 As the policy rate reaches the zero lower bound and room for further
unconventional - as well as conventional - monetary easing diminishes, it becomes even
more difficult for central banks to stabilize the economy and price levels. In such a situation,
the central bank needs to shape policy frameworks so as to contribute to growth potential
and thus growth expectations, and hence raise the natural rate of interest.
The situation I have described is no longer unique to Japan and rather common in other
advanced economies, and even for some emerging economies facing population ageing in
the near future. I believe that the seemingly unconventional activist policy of the Bank of
Japan in funding for financing economic growth may be relevant for these economies as well
in the coming years. My interpretation of the Funding for Lending Scheme in the United
Kingdom is that it has similar Schumpeterian effects, although this scheme's origin may be
different from those of the fund provisioning measures of the Bank of Japan.
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