Is The Japanese Dynamo Losing Juice?

For almost two decades, Japanese companies relentlessly grabbed market after market away from their U.S. rivals. A few years ago, the Japanese economic juggernaut seemed ready to wrest global economic leadership away from the U.S., much as world hegemony once passed from Britain to America.

No longer. The U.S. is regaining market share in industry after industry, from microprocessors to automobiles. America's global rebound is partly an exchange rate advantage from the dramatic rise in the yen. And Japan's economy has been mired in its worst slump in the post-World War II era, while the U.S. is well into its economic recovery.

Yet Japan's economic woes could persist long after its business cycle improves. The reason: The highly touted Japanese economic machine is not all that productive compared with the U.S., the world's productivity leader. True, gross national product per worker in Japan rose strongly in the 1970s and the early 1980s, but by the late 1980s it had slowed down considerably (chart). And since 1990, Japanese productivity growth has actually declined. By contrast, U.S. productivity growth has surged ahead in recent years

as American companies reaped the

rewards of investing in information technologies and overhauling the


SURPLUS LABOR. Even in 1989, before recession set in, the level of productivity in Japan was only 65% of America's, according to calculations by Angus Maddison, an economist at the University of Groningen in the Netherlands. Despite its vaunted economic successes, a number of Japanese industries are not globally competitive, a situation that may only worsen as its economy becomes more service-oriented and information-intensive.

Indeed, Japan's service industries are quite unproductive. Says William P. Sterling, economist at Merrill Lynch & Co.: "When you do international comparisons, Japan really falls down in service-sector productivity." Adds David D. Hale, chief economist at Kemper Securities Inc.: "The nonmanufacturing sector is where they dump all their surplus labor."

Japan's service industries are inefficient because they have long been protected from foreign competition or shielded from domestic competition by government regulations. In the U.S., deregulation and foreign competition has helped raise service-sector productivity to a 1.6% annual rate in the 1990s, double its 0.8% pace of the 1980s, says Stephen S. Roach, an economist at Morgan Stanley & Co.

What's surprising is that Japan even has some productivity problems in its famed manufacturing sector. Of course, Japan's prowess is unmistakable in such industries as steel, automobiles, and electronics--the very industries that sent U.S. companies reeling in the 1970s and 1980s. And these industries are still the principal cause of Japan's $50 billion trade surplus with America.

But Japan's lead over U.S. rivals in these manufacturing industries is narrowing considerably. For instance, in autos, productivity in Japan was roughly 16% higher than in the U.S. in 1990, according to a recent analysis by McKinsey & Co. Today, U.S. auto makers are about as productive as most of their Japanese rivals. And in some manufacturing industries, Japan lags well behind. Processed food is one of the largest manufacturing industries in both Japan and the U.S., yet Japanese productivity is only 33% of America's. Overall, U.S. manufacturers lead Japan in productivity by about 17% in nine key industries, according to McKinsey.

SAPPED VITALITY. In a comparison of manufacturing productivity among the major industrial nations, William J. Baumol, director of the C.V. Starr Center for Applied Economics at New York University, notes that "other countries are no longer significantly ahead of us in terms of growth rate, while they remain behind us in productivity level."

Why is Japan no longer gaining on America? One answer may be that, over the long haul, Adam Smith was right--competition boosts productivity and protection hinders it. Eventually, a protected economy loses its economic vitality.

For decades, Japan achieved stunning export success while at the same time shielding many of its industries from foreign competitors. But now Japan finds too many of its industries insulated from foreign and domestic competition. They lack the innovative spur needed to prosper in a world economy where new information technologies are transforming both the service and manufacturing industries.

There are signs of change. Japanese managements are trying to restructure their companies, and a growing number of service companies are embracing price competition. The world's second-largest economy also has enormous reserves of strength, including a well-educated workforce. Still, Japan is moving too slowly. By not opening up its markets faster to competition, Japan is not only aggravating trade tensions with the U.S. but, more important, eroding its own productivity.

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