Abstract
Japan has a universal public pension system. Social security spending is a key fiscal policy challenge in Japan. The 2004 pension reforms have increased the ratio of the government subsidy to the basic pension benefit. Three reform measures are necessary to improve pension finances: an increase in pension eligibility age, a reduction in the pension benefit, and an increase in contributions. Eliminating the preferential tax treatments of pension income and collecting pension contributions from dependent spouses could contribute to fiscal savings.
II. Japan’s Growth Challenge: What Needs to be Done and What can be Achieved?1
1. During the last decade, Japan’s growth rate has been one of the lowest among advanced economies. At an average rate of 0.8 percent in the 2000s, growth was below that of France, Germany, the U.S., and many other developed economies. Deflation, lingering effects of the asset bubble burst in the late 1980s, and structural constraints on domestic markets have commonly been thought of as the main culprits for this outcome. Yet, economic fundamentals have also been less favorable than in other countries. In particular faster and earlier population aging weighed on growth.
2. Given the need for robust growth to support fiscal consolidation and reduce the very high public debt-to-GDP ratio, this note poses three questions:
(1) Does Japan have a growth problem?
(2) How can growth be raised? And,
(3) How much faster can Japan grow?
3. The paper finds that productivity growth has been comparable to that in other countries, but the decline in the labor force has weighed on overall GDP growth. There is considerable scope for raising trend growth, although macroeconomic policies can only play a limited role: necessary fiscal consolidation will likely depress growth for some time and conventional monetary policy is constrained by the zero interest bound. The most promising avenue for increasing potential growth is to pursue mutually reinforcing structural reforms aimed at raising labor supply, deregulating protected domestic sectors, creating new growth sectors (e.g., energy, environment, health care services), establishing a more growth-supporting financial sector, and integrating further with Asia.
4. Growth gains could be sizeable. Based on evidence from country case studies and model simulations we assess that real GDP growth could increase by up to 1 percentage point to 2 percent over the course of a decade including though increased immigration, greater labor force participation of women and the aged, higher productivity, especially in protected sectors.
5. The remainder of the note is structured as follows. The next section assesses Japan’s past growth performance. It is followed by a discussion of policy options to raise growth. The final section assesses the potential economic impact of various reforms.
A. Does Japan Have a Growth Problem?
6. Japan’s large growth deceleration stands out compared to other advanced economies (Figure II.1). Potential growth fell precipitously from an average of 4 percent in the 1980s to less than 1 percent in the 2000s. Other large advanced economies also experienced growth declines, but decreases were more modest in comparison.
Japan’s Growth Challenge
Citation: IMF Staff Country Reports 2012, 209; 10.5089/9781475506341.002.A002
7. A long-term growth decomposition by the Bank of Japan shows that the slowdown came in two waves (Figure II.1 bottom chart). In the early 1990s—the first decade after the asset bubble burst—growth fell by over 2 percentage points, primarily as a result of a rapid deceleration in capital formation and a reduction in total factor productivity (TFP) growth. In the second phase, beginning in the late 1990s, TFP growth began to recover, but was held down by declining labor input and weak investment growth. More recently, the effects of the global recession in 2008-09 have depressed investment as in many other countries.
The main reasons for the decline in trend growth during the last two decades were:
➢ A drawn-out resolution of Japan’s banking crisis and balance sheet repair. Following the collapse of asset prices in the late 1980s, banks and non-financial corporations were slow in addressing balance sheet problems (including sizable bad debt and high leverage). Low nominal interest rates allowed banks to roll over credit to nonviable “zombie” firms, and a muted policy response facilitated the accumulation of bad debt on banks’ balance sheets (Hoshi and Kashyap 2010). With lending constrained, as banks needed to rebuild capital buffers, private investment declined and growth fell, requiring repeated fiscal stimulus to keep the economy going. Only after decisive financial sector reforms in the early 2000s under Prime Minister Koizumi did credit conditions ease again.
Japanese Banks Cumulative Loan Losses since 1992
(In Trillion Yen)
Citation: IMF Staff Country Reports 2012, 209; 10.5089/9781475506341.002.A002
Source: Hoshi and Kashyap (2008).➢ Population aging accelerated in the mid 1990s and with a shrinking labor force reduced potential growth (Figure II.1). The growth penalty from aging has been larger than in other advanced economies (OECD 2010) and will continue to weigh on growth during this decade. Aging effects are projected to level off in the 2020s as the old-age dependency ratio approaches 50 percent in 2030 compared to 35 percent now.
➢ Mild deflation for over a decade has lowered growth expectations and slowed private investment by raising real levels of debt, sustaining high real interest rates, and aggravating fiscal problems by lowering tax revenue and raising real social spending as many benefits are not adjusted for deflation.
8. On the upside, government spending and labor market reforms supported growth. Large public infrastructure spending after 1995 boosted the public capital stock, although the impact on trend growth has likely been small due to declining marginal productivity gains (Doi and Ihori 2006). Amendments to the dispatched labor law in 1999 and 2003—which eased employment conditions for temporary and part-time workers first in non-manufacturing and then in manufacturing sectors—created new employment opportunities and may have raised contribution from labor to growth, especially in manufacturing (Hoshi and Kashyap 2010).
9. Stripping out the effects of aging, Japan had a solid growth record until the global crisis (text figure). During the 2000s, growth in per capita terms was at par with the U.S., and TFP growth was comparatively high and at similar levels as in Germany. This overall positive development was, however, interrupted by the global recession, which hit Japan particularly hard—given its specialization in high-end consumer durables and capital goods—and lowered its potential growth rate to an estimated ½ percent in 2012, mainly on account of a sharp decline in investment and discouraged labor supply.
In per capita terms, growth has increased last decade…
Real GDP per Capita Growth
(In percent, y/y)
Citation: IMF Staff Country Reports 2012, 209; 10.5089/9781475506341.002.A002
Source: IMF WEO.…reflecting primarily strong productivity growth.
Total Factor Productivty Growth
(In percent; period average)
Citation: IMF Staff Country Reports 2012, 209; 10.5089/9781475506341.002.A002
Source: OECD, and IMF staff estimates.10. Regaining a potential growth rate of 1 percent over the medium-term would be consistent with a continuation of demographic and economic conditions that have shaped trend growth. While the negative effects of the global crisis on employment and capital formation will gradually wane, long-term brakes on growth will continue to weigh on potential growth. Aging will slow growth further as the labor force shrinks, and an exit from deflation will take time and depress business profitability and capital formation. Despite a temporary boost from reconstruction spending, uncertainty about the global outlook and, more recently, electricity supply is weakening growth prospects.
Potential Growth in Japan
Current policies
Total factor productivity, which captures technology growth.
11. Although productivity growth is already high, Japan could grow faster given several favorable factors. Japan has close ties to the fastest growing economic region, strong balance sheets among large corporations, and a steady current account surplus. About 50 percent of Japan’s exports go to Asia, and businesses are well placed to meet the needs of a growing middle class in the region. Innovation has remained an important driver of growth as a result of comparatively high spending on research and development (text figure).
Research and Development Spending
(In percent of GDP)
Citation: IMF Staff Country Reports 2012, 209; 10.5089/9781475506341.002.A002
Source: OECD.12. Raising potential growth significantly above 1 percent would be essential to:
➢ Offset some of the short-term growth costs of fiscal consolidation and provide long-term support for a decade of fiscal withdrawal that is necessary to put the very high public debt-to-GDP ratio on a downward path;
➢ Provide steady job and income growth to avoid reform fatigue; and
➢ Generate sufficient momentum to facilitate a return to positive inflation. A rise in potential growth can help raise inflation, if new activity meets pent-up demand and growth is supported by accommodative monetary policy and rising private sector activity.
A one-percent higher real growth rate, for instance, would reduce the debt-to-GDP ratio by 10-15 percentage points over a decade by increasing the denominator and boosting tax revenue. This improvement would also help generate a policy buffer given that a cyclical downturn would likely occur sometime during the 10-year long fiscal adjustment period.
B. How Can Growth be Raised?
13. The government’s updated growth strategy prepared in 2011 lays out a broad action plan. The goal of the policy efforts is an achieve an average nominal GDP growth rate of about 3 percent and an average real GDP growth rate of about 2 percent between 2011 and 2020. Its key elements are reconstruction after the earthquake, the development of tourism, energy, environment, and health care as new growth sectors, and structural reforms to raise labor supply and domestic demand. Although a detailed assessment of the growth effects is beyond the scope of this paper, a potential drawback of the strategy is that it may rely too much on picking winners through targeted sectoral incentives—a strategy, which is not very effective in advanced economies (Aghion 2009). The strategy also sidesteps difficult labor markets reforms (e.g., accelerated immigration), an opening up of domestic sectors (e.g., services and agriculture), and reforms of the financial system to raise the availability of risk capital to encourage investment.
14. To raise potential growth significantly, Japan’s growth reforms will likely need to proceed simultaneously on multiple fronts. There appears no single measure that could raise growth substantially and quickly. Moreover, lack of fiscal space and the zero interest rate bound limits the scope for jump-starting growth through supportive macroeconomic policies. A depreciation of the yen—which is assessed to be moderately overvalued in the 2012 IMF Staff Report for Japan—would help and could be the result of a decade long fiscal consolidation effort as suggested by IMF staff.
To create growth synergies, the strategy should be centered on achieving three goals:
➢ Sustainable public finances by adopting a credible fiscal consolidation strategy while minimizing growth costs.
➢ Steady positive inflation by achieving a robust recovery and powerful monetary easing.
➢ Structural reforms to spur private activity through greater labor supply, an opening of domestic sectors, a growth-supporting financial system, and closer links with overseas economies.
15. The immediate priority is a firm commitment to fiscal consolidation to limit fiscal vulnerabilities and continue powerful monetary easing. Due to the high level of public debt and large holdings of JGBs by banks a rise in interest rates poses a risk to the stability of public finances and the financial sector. The adoption of a credible adjustment strategy would limit these concerns. Given continued deflationary pressures further powerful monetary easing is needed including through an expansion of the BoJ’s asset purchase program This would accelerate an exit from deflation and help raise growth, but to be more effective such efforts would need to be also supported by ambitious structural reforms to boost confidence and raise domestic demand (discussed below).
16. The remainder of this section focuses on a set of structural reform measures that in combination could create important growth synergies.
Raising Labor Participation Rates
17. Given the decline in the labor force, increasing participation needs to be an integral part of any growth strategy for Japan. Luckily, there is much Japan can still do to help mitigate the decline in the size of its workforce relative to other OECD countries as both female labor force participation and immigration are low (see text chart). Old-age participation rates are high in comparison to other countries, but low when adjusted for Japan’s higher life expectancy and better physical health and functionality of the aged (Sanderson and Scherbov 2010).
Immigration and female Labor Participation
(In percent)
Citation: IMF Staff Country Reports 2012, 209; 10.5089/9781475506341.002.A002
Source: OECD.18. This section will discuss policies to raise labor participation of women and the old-aged, policies to encourage a better allocation of labor, and finally the possibility of immigration.
Female Labor Participation
19. Japan has a very low female labor participation (FLP) rate when compared to other advanced economies, with the difference between male and female participation rates nearly 25 percentage points. At the same time, young women in Japan are more educated than both their OECD peers and their male counterparts, with women in their 20s having on average 14.3 years of schooling. Thus, getting more women into the workforce would not only increase the size of the labor force but also possibly increase its skill intensity. We estimate that if Japan was to raise its FLP ratio to the level of the G-7 average, per capita GDP would be approximately 5 percent higher, raising potential GDP growth by as much as a quarter of a percentage point during the twenty year transition period.
Difference by Gender in Prime-age Labor Participation Rate
(In percent, 2009)
Citation: IMF Staff Country Reports 2012, 209; 10.5089/9781475506341.002.A002
Source: OECD, and IMF staff estimates.20. One obstacle to higher FLP rates is the high drop-out rate of women from the labor force following child birth. FLP rates for women in their early twenties are similar to comparator countries, but then fall off sharply. This reflects both weak support systems for working mothers and the reluctance of firms to hire career female employees at the start of their careers. When women re-enter the labor market, they often choose lower-paying non-regular positions, and as a result, Japan stands out in cross-country comparisons with a low share of female managers (text chart).
Female Managers (2009)
(As percent of total)
Citation: IMF Staff Country Reports 2012, 209; 10.5089/9781475506341.002.A002
Source: UNDP.21. While societal preferences need to be respected, providing support for working mothers and making the workplace more flexible may help reduce this disparity in female labor participation. Recent work by Steinberg and Nakane (2012) shows that demographic shifts within countries—for example, the number of marriages, higher levels of female education, and fewer children—are highly associated with changes in FLP rates over time. But they also find that policies matter. Sweden has a high level of female labor participation because it provides significant support for working mothers. Denmark too, has been very successful by making part-time work equal in pay and benefits to full-time work; thus, making it possible for more women to participate in a meaningful way that at the same time allows them to balance work-life demands.
22. According to OECD statistics, Japan provides much fewer of these benefits. Public expenditure on childcare and early educational services is in the bottom one-quarter of the distribution, and informal reports within Japan also show that demand largely outstrips supply, with potential unmet demand as high as one-third of current childcare capacity. Making the workplace more flexible in terms of hours worked, would also go a long way in encouraging more women to enter the workforce.
23. Women also often provide home-based care for the old-aged, which also prevents them from seeking employment. New designs of long-term care services in other countries have allowed women to remain in the labor force, while at the same time creating a new service market (Box II.1).
24. Another disincentive for women to work full-time may arise from Japan’s tax system. Japan’s tax system, like that of many other advanced economies, has implicitly compensated women for not fully participating in the workforce, as tax systems were originally designed to treat families rather than individuals equally. In Japan the threshold for tax and private companies’ benefits on pensions and spouse allowances is ¥1.03 million. This level is commonly referred to as the “barrier to full-time female employment,” with many female spouses often preferring part-time to full-time work. A histogram of annual wages of female workers indeed indicates that just under one-third of workers (first two bars on the right hand side chart) earn less than the ¥1.03 million threshold.
Tax System and Wages
Citation: IMF Staff Country Reports 2012, 209; 10.5089/9781475506341.002.A002
25. Reducing tax distortions could encourage more married women to seek full-time employment. In 2004, one of the special dependent exemptions was eliminated as part of a package of reforms to promote gender equality following the passage of the Basic Law for a Gender-Equal Society, which provides general guidelines for the promotion of gender equality in society but does not stipulate penalties. Elimination of two other exemptions, one on pension contributions and one on dependent income, would raise employment incentives and is currently under review. Their elimination would have the additional benefit of reducing tax expenditures.
26. The short-term impact of removing tax disincentives on female labor supply may not be large if implemented as a standalone measure. Analyses of micro datasets to date largely find a minimal impact from these distortions. Ishizuka (2003) finds that eliminating the distortions would lead to a small increase in regular full-time employment, but at the same time lead to a decrease in overall participation. Murakami (2008), meanwhile, found that the 2004 reforms had no discernible impact on participation choices in the short-run. Given other constraints to female labor force participation, this outcome does not seem surprising.
Old-Aged Labor Participation
27. Across the OECD, life expectancy has risen faster than the average retirement age. In Japan, the OECD country with the highest life expectancy at 82.6 years, a mandatory retirement age of 60—relative to the OECD average of 64.4 years—is incongruous with the rising longevity. A recent law that encourages firms to rehire productive workers on non-regular contracts between the ages of 60 and 64 has helped lift employment rates for workers in this age group from 53 percent in 2006 to 57 percent in 2010. Despite this rise employment rates still fall significantly with age, from 75 percent of the 55-to-59 group in 2010 to 57 percent of the 60-to-64 group and 36 percent of the 65-to-69 group (OECD 2011).
28. Increasing the average retirement age would help increase labor participation and help reduce pressure on pension systems. The current standard retirement age is 65 years with early retirement possible at age 60. Raising the average retirement age under the current lifetime employment system may create inequities for the younger generations, with many firms currently using the early retirement age as a means to reduce the number of workers. Thus, to achieve greater labor participation of the old aged by raising the retirement age requires also a change to the current lifetime employment system to one that places greater weight on performance and flexibility.
A more flexible labor market to help increase participation and facilitate job mobility.
29. Achieving greater labor participation will also require changes to the functioning of Japan’s overall labor market. The current market’s continued reliance on implicit lifetime contracts (Ono 2010)—albeit much less pronounced than in the past—has discouraged firms from hiring in several ways: it creates disincentives to hire career women employees—because they may quit after childbirth; discouraged the hiring of young employees—because they may not be able to afford them over the long-term; and discouraged firms from raising the retirement age—because they need this rule to shed the firm of unproductive and expensive employees. And in recent decades, as the number of available lifetime employment contracts has declined, an increasing number of youth, women, and old-aged have found themselves in non-regular positions with fewer benefits.
Share of Male Non-regular Workers by Age Group, 2010
(In percent)
Citation: IMF Staff Country Reports 2012, 209; 10.5089/9781475506341.002.A002
Source: MIC.30. Reforms of labor contracts are key to creating a more flexible and equal labor market overall. Introducing a new, uniform, and more flexible labor contract could increase incentives for hiring nontraditional workers and allow a greater number of young and female workers to enter mainstream career paths with established firms. One possible option is to modify regular work contracts to include phased-in employment protection. Such a new regular work contract would gradually increase the dismissal costs to employers over the course of a worker’s tenure. This would help reduce hiring risks given unknown skills of new workers (or more importantly, the length of their tenure), while maintaining employment protection for tenured employees. Such a new uniform regular employment contract would help facilitate greater labor market flexibility, more efficient hiring practices, and fairness (Steinberg and Nakane 2011).
31. Greater labor market flexibility would also contribute to growth synergies. Removing rigidities in product markets in combination with more flexible employment arrangements has been shown to lead to a rise in employment and growth in a number of EU countries (Berger and Danninger 2007, Bouis and Douval 2010). A possible channel is the removal of market entry barriers which can lead to an erosion of existing rents accruing to incumbents through the entry of new firms and a restructuring of existing ones. Japan’s has made much progress in this area (text chart) although there is room to lower the comparatively high administrative burden on corporations and barriers to entry in network industries, especially electricity.
Product Market Regulation in Advanced Economies
(Restrictiveness indicator)
Citation: IMF Staff Country Reports 2012, 209; 10.5089/9781475506341.002.A002
Source: OECD.Immigration—An Extraordinary Measure?
32. A complementary reform option would be to raise the level of immigration.2 Recently, the government introduced a “points-based” preferential immigration treatment system to attract highly skilled foreign professionals. This measure could be broadened to include lower-skilled immigrants who could fill potential employment bottlenecks in non-tradable sectors, such as childcare and long-term care for the old-aged (Box II.1). With the percentage of foreign-born workers around 1.7 percent3, there is substantial scope to increase the supply of foreign-born workers. Public opinion polls too show a surprisingly neutral stance in Japan towards immigration relative to other OECD countries (OECD 2011).4
33. High-skilled immigrants could also be an important source for innovation in traditional sectors. Kerr and Kerr (2010) report that in the U.S. immigrants represented almost one half of the engineering workforce based on the 2000 census and several studies connect high-skill immigration to growth in innovation by city or states. Immigration is also essential in providing long-term care for aging populations The vast majority of studies suggest that immigration does not exert significant effects on native labor market outcomes either on employment and earnings (Kerr and Kerr 2010). In Japan a more ambitious targeted immigration policy for high-skilled could be considered.
Growth Nexus: Long-term Care, Female Labor Force Participation, and Immigration
A growth area in health and social services is long-term care for the old aged.1 Long-term care (LTC) is a small but growing sector globally. The OECD (2010) estimates that average LTC expenditure accounted in 2008 for 1.5 percent of GDP across the OECD. Spending will likely more than double over the coming decades and could exceed 4 percent of GDP in Japan by 2050. Since LTC is a labor-intensive sector, labor demand will likely grow rapidly in line with rising demand for these services (text chart)
Projected demand of long-term care workers 1/
Percent of labor force
Citation: IMF Staff Country Reports 2012, 209; 10.5089/9781475506341.002.A002
1/ Percentage of FTE nurses and personal carers to total projected working population Source: OECD calculations based on OECD Health Data 2010, European Commission(2009), Ageing Report and OECD Labour Force and Demographic database, 2010 and de la Maisonneuve (2009)Long-term care programs across the world have steadily evolved and are increasingly shifting to cash benefits with more user choice. There are many different arrangements, but trends have been to move away from fully-covered institutional care-which is costly- to more flexible at-home care arrangements. New cash-for-care programs provide consumers with more choice and control over services (OECD 2010). Recent reforms in Austria, Finland, and Germany, for instance, provide cash benefits for targeted groups, such disabled elderly, which they then can use to hire home-care help from private providers. Services vary and usually imply some private cost- sharing.
Because of domestic shortages many countries rely on immigration to supply long-term care services. In Europe labor mobility within the EU and simplified licensing requirements provided a boost for such activities.
From a growth perspective a flexible LTC program can raise growth by:
➢ Freeing up captured labor or preventing dropouts of family care-givers, while providing employment for the underemployed. Availability of qualified in-home care for the old-aged reduces demands on family members, mostly women, to provide care. A study on Australia estimates the opportunity cost of forgone earnings as a result of unpaid family caring as equivalent to nearly 10 percent of the total expenditure on formal health care in Australia (Manaaki, 2009). In several countries the growing service need is met by trained foreign workers, but could also be a source of employment for underemployed domestic labor.
➢ Creating a new private service market. Country experiences, such as in Austria, show that LTC programs with cash-benefits, adequate choice, and quality control address a rising unmet demand (Riedel and Kraus 2010). While the funding for these services currently still comes primarily from the public sector, private contributions are rising. A well-functioning market could draw in private households savings and generate a new services market that could generate substantial employment and income.
34. With the aging of the population and associated fiscal costs, a theme of much immigration in other economies is the positive impact this will have on public finances. In Japan this is particularly relevant. New immigrants improve public finances by raising output and paying taxes, but at the same time they consume social services. The balance between these revenues and costs are difficult to quantify, however, with most recent studies having mixed results (Kerr and Kerr, 2011).
35. There are also potential labor market displacement effects that may emerge due to an increase in the labor supply. In general, this should put downward pressure on wages overall, with the impact largest on relative wages or employment of natives for whom immigrants are close substitutes. In the health and old-aged care industry where wages are already 25 percent lower than other industries, there is a strong concern that immigration would put downward pressure on wages or at least keep wages from rising. International evidence of these effects, however, is mixed but with the majority of studies unable to substantiate a significantly large impact (Kerr and Kerr, 2011).
36. Beyond increasing the size of the labor force, immigration can also have non-traditional positive impacts on the economy. Saiz (2003, 2007) has shown that immigration has a positive impact on housing prices in the U.S., and an emerging literature is linking immigration to increased entrepreneurship (OECD 2011). And although recent immigrants tend to have lower earnings than natives, the increasing use of point systems—in, for example, Australia, Canada, and the U.K.—can have a compositional effect on the skill-intensity of new immigrants. Finally, immigration can also have positive effects on entrepreneurship through self-employment and job creation.
Opening Up Protected Sectors and Easing Regulations
37. Japan’s domestic oriented sectors accounts for more than 80 percent of activity. Comparisons of productivity levels across countries, especially of services, are unreliable and differences in preferences (e.g., for more labor-intensive services) may play a role. But time-series data show that productivity growth in Japan’s tradable sector has been much higher than in the services sector (Ogawa, Saito, and Tokutsu 2012). One reason for the much slower services sector productivity growth could be the lingering effects of past public support policies—generous exemptions and weak penalties in the Anti Monopoly Act—which have limited competition. Reforming the agricultural sector, although affecting only an small share of the economy, could have an important symbolic effect and lead to land consolidation, a rise in land prices, and positive wealth implications.
Labor Productivity Index
(2000=100)
Citation: IMF Staff Country Reports 2012, 209; 10.5089/9781475506341.002.A002
Source: OECD.38. Growth benefits of deregulation could also be seen in downstream industries. Reforms would not only generate efficiency gains in the directly affected sectors, but also create positive spillover to sectors which use services as inputs. A recent cross-country study finds that greater service sector competition is associated with greater output growth, productivity gains, and exports in downstream sectors (Barone and Cingano, 2011). Across industries the effect is more pronounced in energy provision and through regulation of professional services.
39. An effective means to open domestic sectors could be the participation in international economic and trade agreements. The most promising decision in this regard, has been Japan’s application in late 2011 to join membership negotiations of the Trans Pacific Partnership (TPP) free trade agreement. TPP requires unfettered market access by foreign companies to domestic markets, including agriculture and services, potentially triggering domestic reform and efficiency gains. However, given the early stages of the negotiations, improvements are unlikely to materialize before the end of this decade. More recently Japan has also expressed its intention to pursue trade agreements with China and Korea.
A More Growth Supportive Financial Sector
40. More effective financial intermediation and a greater willingness to allow SME restructuring could foster innovation, raise investment, and help generate new markets. Availability of credit appears ample, but pervasive risk aversion of financial institutions and underdeveloped risk management tools have constrained financing for more risky investments in new growth areas. At the same time, reluctance to let non-viable zombie firms fail and government involvement in credit intermediation (e.g. through direct credit support) have weakened credit assessment, limited SME turnover, and kept corporate debt-levels among SMEs high. Chapter III in this volume discusses how financial sector policies can help promote growth.
International Integration
41. At the international stage, Japan has not taken full advantage of its growth potential in a number of areas. During the last decade, export market shares have declined faster than in Germany, a country with similar characteristics. Both inward and outward foreign direct investment is low, reducing gains from technology spillovers and limiting competition in domestic sectors. According to the OECD Japan had the lowest import penetration rate for services in 2003 and the lowest growth rate of service imports between labor market reforms that raised labor force participation (Brooks, 1990). In the Netherlands and Sweden, where reforms stand out as having been particularly durable, the improvements 1997 and 2005. Financial and non-financial firms have been cautious in investing overseas with banks often following their clients who have established themselves overseas. At the same time private capital inflows to Asia have recovered remarkably rapidly from the impact of the global financial crisis to reach around 4 percent of GDP (IMF, 2011).
42. Measures to better tap into Asia’s growth momentum include:
Encouraging overseas investment to help strengthen competitiveness of the export sector and reap benefits from long-term complementarities between foreign investment and domestic activity.
Promoting inward FDI by reducing legal and non-legal impediments, especially in services, and strengthening the business environment. Trade agreements could help with the harmonization or mutual recognition of licenses. Agreeing on common standards and qualification requirements would also substantially enhance market integration and reduce setup costs of foreign firms.
Pursuing FTAs with regional trading partners, especially China and Korea.
C. How Much Faster can Japan Grow?
43. Sustained increases of potential growth over a decade are rare among advanced economies, but not unheard of. Using the IMF’s World Economic Outlook database we find 8 country cases since the 1980s in which real trend GDP growth increased by more than 1 percent over a decade and this increase was sustained over at least 5 years. Several of these growth improvements came after a deep economic crisis (e.g., Finland, New Zealand, and Sweden) and as a result public debt ratios were higher at the end of the 10 year span for the majority of countries.
Durable Potential Growth Rate Increases 1/
advanced economies only and defined as a growth rate increase by 1 percentage point over one decade sustained for 5 years.
Durable Potential Growth Rate Increases 1/
| Decade | Potential growth | ||||
|---|---|---|---|---|---|
| Initially | End of decad | ||||
| Canada | 1988-98 | 2.9 | 3.9 | ||
| Finland | 1987-97 | 2.1 | 3.2 | ||
| Greece | 1985-95 | 0.7 | 2.5 | ||
| Iceland | 1987-97 | 2.3 | 3.3 | ||
| Ireland | 1983-93 | 1.7 | 4.1 | ||
| Netherlands | 1982-92 | 1.2 | 2.9 | ||
| New Zealand | 1985-95 | 1.9 | 3.4 | ||
| Sweden | 1989-99 | 1.7 | 3.5 | ||
advanced economies only and defined as a growth rate increase by 1 percentage point over one decade sustained for 5 years.
Durable Potential Growth Rate Increases 1/
| Decade | Potential growth | ||||
|---|---|---|---|---|---|
| Initially | End of decad | ||||
| Canada | 1988-98 | 2.9 | 3.9 | ||
| Finland | 1987-97 | 2.1 | 3.2 | ||
| Greece | 1985-95 | 0.7 | 2.5 | ||
| Iceland | 1987-97 | 2.3 | 3.3 | ||
| Ireland | 1983-93 | 1.7 | 4.1 | ||
| Netherlands | 1982-92 | 1.2 | 2.9 | ||
| New Zealand | 1985-95 | 1.9 | 3.4 | ||
| Sweden | 1989-99 | 1.7 | 3.5 | ||
advanced economies only and defined as a growth rate increase by 1 percentage point over one decade sustained for 5 years.
44. The factors behind the growth gains differ substantially across the identified cases. A decomposition of the growth accelerations by contributing factors shows that the main sources of growth were productivity gains (TFP) and increases in the growth contributions from labor (text chart). But the winning formula was quite different across countries. Much of the improvements in New Zealand, for instance, was a result of labor market reforms that raised labor force participation (Brooks, 1990). In the Netherlands and Sweden, where reforms stand out as having been particularly durable, the improvements came from productivity growth in Sweden and greater labor contributions in the Netherlands. A deep recession (Netherlands, 1980–82) and banking crisis (Sweden, 1990–92) triggered a change in macro-economic policies and supply side reforms. The public expenditure to GDP ratio was reduced significantly, allowing a reduction of both the large fiscal deficit and high tax levels; labor markets were made more flexible with increased incentives to work; and product markets were reformed to boost competition. Sweden as a result experienced two decades of rapid growth; and the Netherlands, which previously was associated with the “Dutch disease”, became known for its employment miracle.
Growth Accelerations and Sources of Increase
(Difference in potential growth rates over decade)
Citation: IMF Staff Country Reports 2012, 209; 10.5089/9781475506341.002.A002
Source: OECD, IMF staff calculations.45. In Japan, a tailored package of reforms could raise potential growth from 1 to up to 2 percent over a decade. This assessment is based on an aggregation of different estimates derived from simulations with the IMF’s GIMF model. The key elements of the growth estimate include:
➢ An increase in female labor force participation rates to the G-7 average and a rise in old age labor force participation, which could increase the growth contribution from labor by 0.3 percent in the transition period to higher labor force participation.
➢ Immigration equivalent to 1 percent of Japan’s labor force distributed over a decade could yield another 0.1-0.2 percent higher growth per year. For immigration to be successful, restrictions on foreign employment in labor intensive domestic sectors, such as child, health or old-aged care, would have to be eased simultaneously.
Potential Growth in Japan
Total factor productivity, which captures technology growth.
Potential Growth in Japan
| Medium-term with current policies |
Upside scenario with strong structural reforms |
|||
|---|---|---|---|---|
| Potential GDP growth | 1.0 | 2.0 | ||
| Contributions from: | ||||
| Labor | −0.2 | 0.2 | ||
| Capital | 0.4 | 0.8 | ||
| TFP 1/ | 0.8 | 1.0 | ||
Total factor productivity, which captures technology growth.
Potential Growth in Japan
| Medium-term with current policies |
Upside scenario with strong structural reforms |
|||
|---|---|---|---|---|
| Potential GDP growth | 1.0 | 2.0 | ||
| Contributions from: | ||||
| Labor | −0.2 | 0.2 | ||
| Capital | 0.4 | 0.8 | ||
| TFP 1/ | 0.8 | 1.0 | ||
Total factor productivity, which captures technology growth.
➢ Financial sector reforms that raise risk capital and induce a restructuring of the SME sectors could lift long-term growth by about 0.2 percentage points. This estimate is derived from simulations with the IMF’s GIMF model, which postulates that productivity increase among smaller firms would reach about 80 percent of that among large firms. This in result would boost productivity by about ¼ percentage points.
➢ The remaining growth increase of 0.3-0.4 percent could come from confidence effects from fiscal consolidation and improved growth prospects as a result of far-reaching structural reforms, which would raise investment and consumption (Berkmen 2011).
46. Japan’s growth challenge is significant, but its growth goal of 2 percent is attainable. A broad based structural reform package could aid job and income growth, support the necessary fiscal consolidation to bring down public debt, and facilitate a return to steady positive inflation rates.
References
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Prepared by Stephan Danninger and Chad Steinberg.
Raising potential growth by ½ a percent would require additional employment of ½-1 million (out of an 80 million labor force) per year.
The actual share is likely much lower with second generation Japanese, and long-term Korean residents accounting for a significant share of this number.
This may reflect the low level of immigration, with anti-immigration sentiment generally rising in countries with larger stocks of immigrants.
