Home .Change and innovation Japan's stunted economy
Japan's stunted economy
Tuesday, 08 November 2011 03:34

How developed really is the Japanese economy?  When you compare its service sector to other developed countries, it just does not make the grade. 

As countries develop, they usually shift from being agriculture-based economies to manufacture-intensive economies, and then to service-oriented economies.  Despite massive protection, Japan's agricultural sector is now minuscule.  In recent decades, Japan has outsourced much of its lower-skill manufacturing to its neighboring Asian countries like China.  And it has also seen its service sector increase in size.

But Japan's service sector remains inefficient, even compared with many of its Asian neighbors.  This is a major reason why Japan's GDP per capita ranks only 16th highest out of the OECD's 34 members, and is about 25% less than that of the US.

For internationally traded services, tourism is one of the leading sectors.  But Japan does not rank among the world's top ten countries for tourist arrivals, a list headed by France, the US and China.  In fact, Japan is only the 8th most popular destination in the Asia, being outclassed by China, Malaysia, Hong Kong, Thailand, Macau, Singapore, and even South Korea.  What's more, Japan's national flag carrier, Japan Airlines, stumbles from one government bail-out to another.

A rapidly growing are of services trade is higher education.  But according to most rankings, like the Times Higher Education Supplement (THES), the world's leading universities are in the US (places like California Institute of Technology, Harvard, Stanford and Princeton), and the UK (Oxford, Cambridge and Imperial College).  Japan's highest ranked university by the THES is Tokyo University at 30th.  Overall, Japan has only two universities in the world's top 100, the same as China or Hong Kong, and even less than Australia, which has three.

Japan has been trying to penetrate the market for international students by offering English language-based courses.  But it has not been able to compete with countries like the US, UK, Australia, Germany, France, and Canada.  Most of the international students that study in Japan benefit from Japanese government scholarships, rather than being fee-paying students.

Financial services are another leading area for international services trade.  But Japanese banks have never recovered their international status since the country's financial crisis two decades ago.  According to the Global Financial Centre's Index, London and New York are the world's leading financial centres, followed by three other Asian cities ahead of Tokyo, namely Hong Kong, Singapore and Shanghai.

Entertainment is another key services industry.  Once upon a time Japan was a leading film-making nation.  That is no longer the case.  In Asia, it is countries like India with Bollywood and also Korea that are leading the pack.  Even in areas where the Japanese should be leaders, like anime and computer games, they are having trouble competing with the US and Europe.

There is much that Japan could do to become more internationally competitive in services trade .  Improving English language skills would help -- Japan currently has the lowest scores on English language tests in Asia, even lower even than North Korea.  Eliminating the labyrinth of regulations would also help.  A more open and innovative culture is also crucial -- this is a real challenge because Japan has been turning inward in response the combination of decades of crisis, and the rise of China.

The OECD recently did some analysis of Japan's domestic services sector.  They see the Japanese economy as being made up of two main sectors.  In the first place, there is the manufacturing sector which is very competitive on world markets.  Its labour productivity has been rising by 4% annually for the last 30 years.  Then there is the service sector which is not exposed to international competition and which has a weak and indeed weakening productivity performance.  From 1999-2004, service productivity growth was less than one-quarter that of the manufacturing sector and mark-ups were three times as high.

There are several big problems with this.  First, the competitiveness of the manufacturing sector increasingly depends on the services sector, as services feed into manufacturing processes.  In this way, the services sector could actually drag down the manufacturing sector.    Second, in most economies, the services sector is becoming more competitive thanks to information and communications technologies, and globalization which is leading to increased trade in services.  Third, the services sector accounts for the lion's share of our economies, some 70% of GDP and rising in Japan.  A weakening services sector could even drag down the economy.

So what, according to the OECD, accounts for the weakness of Japan's service sector?

The service sector has long been sheltered from competition, both international and domestic.  Japan is riddled with regulations which hinder entrepreneurship and new business creation -- as we mentioned above.  They have also hindered investment in ICT-using services.  The government has launched initiatives to boost productivity in the services sector, including through the "New Industry Development Strategy 2005".  But despite some progress made, there is still a long way to go.

Another area for improvement is competition policy.  The Japanese Fair Trade Commission has increased its efforts to combat anti-competitive practices, a legacy of government guidance of investment and industry-wide co-ordination that was permitted by numerous exemptions from the Antimonopoly Act.  And many other measures have been undertaken.  However, there is still a need to strengthen competition policy.  Out of its 34 member countries, the OECD ranks Japan at only 21st in terms of the effectiveness of competition policy.  Mergers and acquisitions are almost never rejected for being a threat to competition.

Lastly, Japan seems to be missing the train for the globalization of services driven by ICT and market opening.  Product market and foreign investment restrictions mean that import penetration of the Japanese services sector is the lowest of all OECD countries, as is also the case for foreign investment in the services sector.  There is enormous scope for globalizing Japan's domestic services sector.

Let's take a look at a few sectors, starting with retail distribution.  Japan's retail sector is characterised by an exceptionally large number of small stores and a corresponding lack of large stores.  Multinational enterprises are virtually totally absent.  Once again, this is due to a lack of competition stemming from regulations, weak application of competition law and the prevalence of unfair trade practices.  The result is one of the lowest productivity growth among the OECD group.

Turning now to electricity, we find predictably that prices are very high compared with other OECD countries.  While this pushed the government into reform action, prices still remain high.  In the transport sector, the same story as harbour and airport charges are high.  Following the bold initiative of former prime minister Koizumi, Japan Post, is being split into four companies and privatised.  There is hope that this will actually happen and generate important benefits.

After listening to this litany of inefficiency, one may well ask "does it matter?...surely this is the Japanese way!".  In reality, it does matter very much.  Japan has an aging and declining population, and improved productivity is necessary to maintain prosperity.

Japan is suffering from a case of stunted development due to its weak services sector.  And lack of services dynamism has also held back its recovery from financial crisis.



"Enhancing the productivity of the service sector in Japan" by Randall S. Jones and Taesik Yoon.  OECD Economics Working Papers No. 651 -- www.oecd.org/eco/working_papers

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