How Productive is the Japanese Manufacturing Sector?

Important task of enhancing productivity

A revised version of the Japan Revitalization Strategy, the policy package compiling the substance of the Third Arrow of the Abenomics, has been published in June 30. The main objective of the Strategy is to increase the productivity of the Japanese industries.

Even though it is the only way Japan can sustain economic growth under aging and shrinking population, productivity in Japan has lagged behind those of the other advanced countries. Japan’s labor productivity in 2013, for instance, ranks as low as 22nd among the 34 member countries of the Organization of Economic Co-operation and Development (OECD), according to the international comparison of labor productivity published by the Japan Productivity Center (JPC).

Main focus has been on the non-manufacturing sector

In the policy front, main focus has been on the non-manufacturing sector; a sector which is sheltered from competition, and subject to weaker pressure towards enhancing productivity. For example, OECD’s Non-Manufacturing Regulation (NMR) indicators of sector regulation calculated for 2013 shows that product market regulations in the non-manufacturing sector is modestly restrictive in Japan (placed about the middle of the member countries) Japan compared to other OECD countries.

In contrast, the Japanese manufacturing sector has proudly been seen as being productive and being at, or at least near, the best practice of the industry.

But manufacturing sector seems to have problems as well

However, there are evidences that the productivity in the Japanese manufacturing sector is also lagging behind those in other economies.

For instance, comparing labor productivity of the manufacturing sector in Japan with those of other economies, also provided by the JPC, shows that Japan ranks 7th within OECD countries in 2012. It is up from 10th in 2005, but down considerably from the top places (1st or 2nd) enjoyed in 1990, 1995, and 2000. Undoubtedly, deflation is a contributing factor (depressing nominal GDP) but the exchange rate should be working otherwise (JPC used a moving average of 88.4 yen for 2012). It seems reasonable to assume that the modest improvement in productivity during the period was the main cause of the relatively low labor productivity in the Japanese manufacturing sector.

Indices of competitiveness compiled by various institutions support this view. Global Competitiveness Report 2014-2015 published by the World Economic Forum reports that Japan is placed 5th among the OECD countries (6th among the 144 economies covered). Much worse, World Competitiveness Ranking 2015 published by the International Institute for Management Development (IMD) shows that Japan ranks 20th in the OECD countries (27th among the 61 economies covered).

In an analytical sense, an interesting report was published by the economists at the International Monetary Fund (Dabla-Norris et al. 2015). They applied stochastic frontier analysis to estimate a total factor productivity (TFP) frontier across all advanced countries (a subset of OECD countries consisting of 16 countries) as well as a distance from the frontier for each country. In particular, they estimated the TFP frontiers and the distances not only at the aggregate level but also at the sectoral level, including the manufacturing sector. According to their estimate, the frontier of the manufacturing sector is set by Germany, and Japan places at the very last but one in terms of the distance to the frontier.

Why is the productivity of the Japanese manufacturing sector low?

Closer look at these reports and surveys are needed in order to have a better idea of where Japan exactly places in the global spectrum of manufacturing sector-productivity. However, it seems almost certain that Japan is not at the frontier of the manufacturing sector, a sector which has been considered as being productive, and probably not even close to where the Japanese feel comfortable.

If that is the truth, why could it be so?

The reason may lie in the way the manufacturing sector has responded to the pressure to be more productive; expanding FDIs and shifting production sites abroad. What remains within the border, as a result, may be the head office or the R&D offices which makes less contribution to directly producing value added. In other cases, less efficient part of the industry may have been left to secure employment which the firms feel obligatory to maintain.

However, there are other reasons which are suggested by analyses and surveys.

First, the high cost structure of low productivity non-manufacturing sector may be hampering the competitiveness of the manufacturing sector. The latest Input-Output Table for 2011 shows that the inputs from the non-manufacturing sector commands about 27 percent of the total outputs, and about 38 percent of total inputs (i.e. total output minus gross value added) of the manufacturing sector. It cannot be denied that the relatively high cost in the non-manufacturing sector is adversely affecting the competitiveness of the manufacturing sector.

Second, the low utilization of ICT capital may be limiting the productivity increase in the manufacturing, as well as non-manufacturing, industries. The paper by the IMF economists cited above reports that the share of ICT capital is low compared to other advanced countries in almost all of the main industries including the manufacturing sector (the only exception is found to be the finance and business services sector). It indicates that there will be a considerable positive impact to the TFP growth in both the manufacturing and services sectors if ICT capital in these industries is increased.

Third, it may reflect the weak turnovers of firms that help in unproductive firms to exit from their businesses while allowing startups of new productive businesses. In fact, there are signs that doing business, including starting new ones, is not so easy in Japan. World Bank’s Doing Business 2015 shows that Japan ranks 19th among the 31 OECD high-income countries (29th among the 189 economies covered).

Need a broader perspective to deal with the problem

The three factors mentioned above can be addressed by structural policies. However, the policies required do not necessarily deal with the manufacturing sector directly: They include policies to reform regulations in the non-manufacturing sector, encourage investment in ICT, and improving environment for doing business in general.

Dealing with the problem in the manufacturing sector requires a broader perspective than focusing on the specific sector of interest.