The services economy: Policy challenges and the Japanese experience
Phuah Eng Chye (9 September 2017)
The significance of the transition from manufacturing to services has never been fully grasped in economic policies. The decline of the manufacturing sector share of GDP marks the passing of the economic leadership baton to the services sector. The services sector thus leads the economy. When the service sector grows, it generates demand for manufactured goods (rather than the reverse) but if it implodes, demand for manufactured goods will contract. Hence, the status of production should be demoted from a primary objective to being a secondary outcome.
Another implication is that the services sector need to pick up the slump in manufacturing employment and wages; otherwise economic growth will falter. Addressing this challenge probably requires envisaging new uses or new ways of using labour that may not contribute to higher production.
In this regard, the industrial-capitalism paradigm was underpinned by the circular logic of perpetual expansion. Hence, youthful demographics are a positive development portending an expansion in demand (more consumers) and supply (more workers). The onset of secular stagnation is associated with aging demographics as it portends shrinking demand and labour supply. I suggest it may be possible to discard the logic of perpetual expansion in the services economy; providing there is a viable non-output paradigm as an alternative.
As I had argued in my earlier articles, the central challenge in the service economy is not output but service costs and income distribution. In a service economy, income growth can only be generated by raising service costs but the outcome is a high-cost and unequal environment with adverse social and macroeconomic effects.
These themes can help shed some light on the long-standing macroeconomic puzzle of Japan’s deflationary decades. Following advice based on traditional paradigms, Japan experimented with massive fiscal and monetary stimuluses but Japan remains trapped in economic and wage stagnation. In fact, the outcomes are close to those predicted by the anorexic economy which is that stimulus triggers stock market rallies while wages and aggregate demand remains subdued.
A service economy paradigm provides an alternative perspective on the possible causes of Japan’s prolonged stagnation. First, Japanese prices had probably run up substantially during its asset bubble phase. The massive collapse of asset prices in 1990 was naturally followed by price deflation. The absence of service cost increases could have been a factor inhibiting the growth of the services sector. Combined with hollowing out of the manufacturing sector, the Japanese economy lacked sector growth drivers to take it out from an economic depression.
Second, weak domestic demand certainly contributed to wage stagnation. But the fact that many countries experienced wage stagnation implies that there were other forces at work such as global competition and technology. Hence, it is likely that domestic policies are unlikely to be able to trigger a wage recovery on their own. One possibility is to explore policies that can rebalance wage and profit shares of GDP but we currently lack sufficient understanding of how rebalancing works.
Third, Japan did not make a fully committed transition to a service economy. There was resistance to the hollowing-out of the manufacturing sector and insufficient investment in services to offset the manufacturing slack. In this context, Japan is famed for its industrial keiretsu or networks comprising suppliers, manufacturers and distributors. The reliance on a relationship-based network becomes a weakness when the environment moves against legacy production relationships. The relationships delay the necessary adjustments and exposes the entire supply chain to pressures from uncompetitive costs and aging demographics.
As manufacturing growth stalls, the burden for generating growth shifts to the service sector. This is also consistent with advice that successful exporting countries need to boost domestic consumption (relative to export production). But Japan’s traditional ethos of manufacturing supremacy and its unique but insular culture may have become obstacles blocking a fully committed push into services. As a major global economy, Japan does not compete aggressively to recruit non-Japanese talent nor develop the global platforms necessary to scale production and distribution.
The problem can also be diagnosed by analysing corporate balance sheet trends which link private sector behaviour and macroeconomic policies. The collapse in asset prices (properties and stockmarket) took its toll on overleveraged corporations. The monetary stimulus assisted Japanese firms to repair their damaged balance sheets. But even after several decades, Japanese firms remain net savers.
The corporate balance sheet retrenchment had a deflationary impact on the economy which needed to be offset by massive fiscal expenditures. While there were other contributory factors, the corporate balance sheet retrenchment is evidence that the Japanese private sector wasn’t undertaking sufficient market-based adjustment to improve balance sheet liquidity (e.g. disposing plant assets quickly enough) and that it wasn’t investing enough to position services as the new engine of growth.
Analysis of corporate balance sheet retrenchment within the traditional fiscal-monetary policy paradigm will miss the point. It will result in policy advice to sustain fiscal stimulus (presumably until private sector investments in manufacturing recover which seems not to be the case). This presents an incomplete picture that does not co-relate corporate and macroeconomic behaviours in the context of a transition to the services economy. In my next article, I will explore service growth policy issues in the context of an information society.
Phuah Eng Chye (2015) Policy paradigms for the anorexic and financialised economy: Managing the transition to an information society. http://www.amazon.com/dp/B01AWRAKJG
Phuah Eng Chye (29 July 2017) “Macroeconomic frameworks for the information society”. Economicsofinformationsociety.com. http://economicsofinformationsociety.com/macroeconomic-frameworks-for-the-information-society/
Phuah Eng Chye (12 August 2017) “The services economy: Macroeconomic overview.” Economicsofinformationsociety.com. http://economicsofinformationsociety.com/the-services-economy-macroeconomic-overview/
Phuah Eng Chye (19 August 2017) “The services economy: deindustrialisation and global unbundling”. Economicsofinformationsociety.com. http://economicsofinformationsociety.com/the-services-economy-deindustrialisation-global-unbundling/
Phuah Eng Chye (26 August 2017) “The services economy: Revisiting Baumol’s cost disease.” Economicsofinformationsociety.com. http://economicsofinformationsociety.com/the-services-economy-revisiting-baumols-cost-disease/
Phuah Eng Chye (2 September 2017) “The services economy: Comparing the manufacturing and service paradigms”. Economicsofinformationsociety.com. http://economicsofinformationsociety.com/the-services-economy-comparing-the-manufacturing-and-service-paradigms/
Richard Koo (2015) The escape from balance sheet recession and the QE trap. Wiley
 Phuah Eng Chye (29 July 2017) “Macroeconomic frameworks for the information society”
 Described extensively by Richard Koo