Two lost decades have taken a toll on Japan’s competitiveness, but the nation has a window of opportunity to shift its trajectory. A new McKinsey Global Institute report, The future of Japan: Reigniting productivity and growth, highlights potential avenues for growth and renewal, emphasizing areas where the private sector can take the lead. With its working-age population shrinking, Japan will have to rely on productivity as the main catalyst for economic momentum. While continued policy reform is necessary, the private sector is critical to capturing new growth opportunities. If individual companies take action to improve their performance, they could add trillions of dollars of value annually to the world’s third-largest economy.
Overall productivity growth in Japan has stalled below 2 percent for much of the past 20 years. Even Japan’s advanced manufacturing industries, which once introduced the world to the concept of “lean,” lag behind the comparable US and German sectors in labor productivity by almost one-third. A continuation of current trends would lead to annual GDP growth of only 1.3 percent through 2025. This sluggish pace will do little to boost household purchasing power and will only intensify the fiscal pressures of providing social-security and healthcare benefits to an aging population.
Yet if Japan can successfully double its rate of productivity increase by sharply focusing on raising value added and reducing costs, it could boost annual GDP growth to approximately 3 percent. By 2025, Japan’s GDP would increase by up to 30 percent over its current trajectory. The size of the prize would be growth of $1.4 trillion in that year alone (Exhibit 1).
Continuously capturing new productivity improvements becomes more difficult over time, but it is achievable, particularly if policy makers take steps to unleash competitive dynamics across entire industries. This would spur individual companies to become more efficient and to seize new opportunities to increase value added by launching business lines, pushing the boundaries of innovation, and entering new markets (Exhibit 2).
A major private-sector initiative to transform Japan’s productivity performance can launch a “fourth arrow” of economic reform, complementing measures to boost growth through monetary policy, fiscal stimulus, and structural reform. Many of the barriers and bottlenecks that have constrained growth stem from traditional ways of doing business. Japan can reach some 50 to 70 percent of its productivity goal simply by adopting practices that are already in use around the world. Much of the remaining improvement can be captured by deploying new technologies and business models.
Japan will also need to ensure that the enablers of growth are in place, including education and the development of skills, labor-market frameworks, innovation, and entrepreneurship. One crucial element will be increasing labor-force participation by engaging millions of women in the workforce. Changes in policy, business practices, and cultural attitudes will be needed to launch a new wave of female leaders into the ranks of Japan’s corporations and government institutions.
Japan has at hand many of the building blocks of future growth: a highly educated labor force, technological prowess, abundant capital, extensive modern infrastructure, and a legacy of industrial innovation. But the country’s foundations need to be shored up and reconfigured to withstand demographic headwinds and the demands of a fast-paced, hypercompetitive global economy.