1. Intangible Investment and Economic Growth in Japan Kyoji FUKAO (Hitotsubashi University, RIETI, NISTEP) Tsutomu MIYAGAWA (Gakushuin University, RIETI) Prepared for a teleconference with members of the OECD “New Sources of Growth Project” June 14, 2011 1

2. Background RIETI Program “Raising Industrial and Firm Productivity (FY 2011-2015)” (Program Leader: Fukao; Leader of the Intangible Investment Project: Miyagawa) Grant-in-Aid for Scientific Research (S) “Empirical Research on Intangible Investment in Japan ( ERII, FY 2010-2014)” (Project Leader: Miyagawa) Research for Japan’s SciSIP Program (FY 2011-2013) and Implementation of Japan’s Third Innovation Survey at the 1st Theory-Oriented Research Group, National Institute of Science and Technology Policy (NISTEP) (Group Leader: Fukao; Research Fellow: Miyagawa) 2

3. Agenda 1.Motivation and Research Agenda of the RIETI Program “Raising Industrial and Firm Productivity” 2.Empirical Research on Intangible Investment in Japan 3.Research Agenda for Japan’s SciSIP Program and Implementation of Japan’s Third Innovation Survey at NISTEP 3

4. 1. Motivation of the RIETI Program “Raising Industrial and Firm Productivity” 4 TFP growth in the manufacturing sector has declined sharply. TFP growth in the non-manufacturing sector has been very low for a long time. What Is Needed to Accelerate TFP Growth?

5. Large Manufacturers Still Achieve Rapid TFP Growth 5 In the manufacturing sector, TFP growth of large firms has actually accelerated. Small and medium-sized firms (SMEs) have been left behind.  Possible reasons: (a) SMEs left behind in R&D and internationalization (b) decrease in technology spillovers from large firms.

6. The Market Selection Process Is Not Working 6 The “exit effect” is negative and is a drag on TFP growth. Japan's economy has a low “metabolism.”  It is the productive factories that are being shut down. Less productive factories remain.

7. Why Has TFP Growth in the Non-manufacturing Sector Been So Low for Such a Long Time? Slow selection mechanism (entry and exit rates are low) Stagnation of ICT investment Stagnation of investment in intangibles These factors are closely related with labor market issues. – Example: in order to avoid changes in corporate structure, employment adjustment, and training of workers, firms choose to purchase custom software rather than packaged software. – Expected high closure cost of firms decreases incentives for starting-up of new businesses by all parties. – Firms usually do not train their part-time workers. – Because they avoid employment adjustment (e.g., termination), firms do not or cannot expand their outsourcing. 7

8. Japan’s ICT Investment-GDP Ratio is Very Low in Comparison with Other Major Developed Economies 8

9. 9 Japan Has Been Left Behind in “Intangible” Investment in Economic Competencies (Corporate Organization, Off-JT, Advertising, etc.)

10. Research Agenda The aim of the program is to measure industry- and firm-level productivity and its determinants for Japan and various East Asian countries and to conduct research on policies to raise productivity. The Program will update and expand the Japan Industrial Productivity (JIP) and China Industrial Productivity (CIP) databases in collaboration the WIOD Project and World KLEMS Project. The Program will construct an industrial productivity database by prefecture for Japan and examine the impact of the recent earthquake on regional economies and policies for reconstruction. Using micro data from Japan, China, Korea and Taiwan, the Program will conduct research on productivity differentials between firms, and policies for raising productivity in the service sector. The Program will measure, at the industry and firm level, intangible investment. 10

11. Agenda 1.Motivation and Research Agenda of the RIETI Program “Raising Industrial and Firm Productivity” 2.Empirical Research on Intangible Investment in Japan 3.Research Agenda for Japan’s SciSIP Program and Implementation of Japan’s Third Innovation Survey at NISTEP 11

12. 2. Empirical Research on Intangible Investment in Japan Fukao et, al. (2009) estimated the aggregate intangible investment in Japan, following Corrado, Hulten and Sichel (2005, 2009). (1) Annual intangible investment in Japan was on average 53 trillion yen (450 billion Euro) from 2000 to 2005. (2) The ratio of intangible investment to GDP in Japan was 11.1%, which is similar to the estimates for the US by CHS (2009) and for the UK by Marrano, Haskel and Wallis (2009). (3) However, investment in economic competencies is relatively small among advanced countries. 12

15. 2. Empirical Research on Intangible Investment in Japan Using intangible investment data, we examine the contribution of intangible assets to economic growth in Japan by following CHS (2009). The growth accounting results are as follows: 1. The contribution of intangible capital accumulation to labor productivity has declined since 1990. 2. When we compare the results in growth accounting between Japan and the US, we find that the gap in labor productivity growth between two countries can be explained by the difference in intangible capital deepening. 3. If intangible capital deepening in Japan was as large as in the US, Japanese productivity growth would catch up with the US. 15

17. 2. Empirical Research on Intangible Investment in Japan Two approaches to estimate intangibles at the firm level: Miyagawa and Kim (2008) showed the existence of intangible assets which are complementary to R&D and advertising expenditures. They estimated that measured intangible assets increased MFP growth rate at 0.1% at the firm level. 17

18. 2. Empirical Research on Intangible Investment in Japan Following Bloom and Van Reenen (2007), Professor Lee of Seoul National University and I conducted interview surveys with respect to organizational management and human resource management in Japanese and Korean firms. Based on the results of our interview surveys, we constructed a measure evaluating the management practices of the firm and examined the effects of management practices on firm performance. 18

21. Distribution of Management Scores (All firms)

22. 2. Empirical Research on Intangible Investment in Japan A summary of the production function estimations including management scores. (1) Better management practices with respect to human resource management are related to good firm performance. This relations are significant in Korean firms in particular. (2) In Japanese firms, organizational reform improves firm performance in the service sector. 22

23. 2. Empirical Research on Intangible Investment in Japan ・ In ERII project, we extend the previous studies on intangible investment at the aggregate, industry, and firm levels. Research project at the aggregate level: we extend the estimation by Fukao et, al. (2009) to 2008 or 2009. Using the extended estimation, we can examine the effects of Leaman Shock to the accumulation in intangible assets. 23

24. 2. Empirical Research on Intangible Investment in Japan Research project at the industry level: we will estimate intangible investment by industry. We will classify the market economy into 25- 30 industries, harmonizing with EU and Korean industry classifications. Using our estimates, we will examine the complementary role of intangible assets on ICT assets. 24

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26. 2. Empirical Research on Intangible Investment in Japan Research project at the firm level (1)Management practices and firm performance: ・ We will conduct interview surveys on management practices again. ・ As Samsung Economic Research Institute collaborates with our project, we will get the data of about 1000 firms in Japan and Korea. ・ Using these data, we will conduct a similar work to Miyagawa et, al. (2010). 26

27. 2. Empirical Research on Intangible Investment in Japan (2) Comprehensive estimates of intangible assets. ・ Using the data of listed firms, we will estimate intangible assets at the firm level following Hulten (2010) and Piekkola (2011). ・ In this project, We will examine the effects of intangible assets on firm values. ・ ERII project collaborates with RIETI research project on intangible investment. ・ Our research activities in ERII project are published at the website http://www.erii.jp/english/index.html. 27

28. Agenda 1.Motivation and Research Agenda of the RIETI Program “Raising Industrial and Firm Productivity” 2.Empirical Research on Intangible Investment in Japan 3.Research Agenda for Japan’s SciSIP Program and Implementation of Japan’s Third Innovation Survey at NISTEP 28

29. 3. Research Agenda for Japan’s SciSIP Program and Implementation of Japan’s Third Innovation Survey at NISTEP The aim of this project is to create the data infrastructure to develop the “Science of STI Policy” and analyze the economic impact of innovations and STI policies. Our group will construct a database of input for innovation (intangible investment), innovation itself, and outcomes of innovation (TFP and economic growth) at the industry and the regional level. We will also focus on knowledge spillover effects among firms and from government activities, such as basic science research and university education, to firms. For this analysis, we will use micro data of supplier relationships, location of factories, patents, etc. 29