Despite losing much of its competitive edge during the two so-called “lost decades”, a major private-sector initiative to transform Japan’s productivity performance can constitute a “fourth arrow” of economic reform to complement the Abenomics agenda, notes McKinsey.

McKinsey Global Institute’s March 2015 report titled: “The Future Of Japan: Reigniting Productivity And Growth” notes with a twin focus towards enhanced value addition and cost reduction, Japan can boost its annual GDP growth to approximately 3%.

Japan’s demographic headwinds

According to the McKinsey report, after exhibiting promising signs of growth in the first half of 2014, Japan’s economy slid back into recession. The report notes if current trends hold, the GDP per capita would grow by a mere 1.3% annually over the next decade, weakening consumer purchasing power.

The report emphasizes that a demographic challenge of historic proportion has arrived on Japan’s doorstep. It notes Japan’s working-age population will decline from 79 million in 2012 to 71 million in 2025. Consequent to its shrinkage in workforce, Japan has to rely on productivity as its primary catalyst for growth:

Productivity as primary growth Japan

The report argues that by adopting various initiatives such as next generation technologies, Japan can experience a remarkable impact on economic growth and productivity:

Productivity initiatives Japan

There are substantial and widening labor and capital productivity gaps between Japan and other advanced economies today. For instance, the following graph depicts how Japan’s labor productivity gap with the United States has been widening across most industries:

labor productivity gap

Revitalizing Japan’s signature industries

The McKinsey report notes around one-third of the estimated productivity potential in Japan can be captured within the four sectors viz.: advanced manufacturing, retail, financial services, and healthcare. Elaborating advanced manufacturing, the report notes Japan’s productivity gap vs. the United States is not only significant, but it has been widening:

productivity gap

However, Japan has an opportunity to change this path if companies aggressively pursue strategies such as value optimization, targeted globalization, enhanced operational excellence in all corporate functions and deployment of next-generation technologies.

Productivity levers

The report highlights that Japan can reach some 50 to 70% of its productivity goal by applying practices that are already in use elsewhere around the world. However, Japan’s productivity challenge ultimately has to be met by the private sector. That said, there is a great deal that individual companies can do immediately and on their own.

Highlighting the soaring health-care expenditure in Japan, the report notes that expenditures are growing faster than GDP and are on track to swell to 10.7% of GDP by 2025. However, by initiating suitable reforms, Japan can bring the growth rate even below the GDP growth rate:

Reforms can prune health-care expenditure

The McKinsey report concludes that the time is right for Japan to initiate bolder moves, bigger investments, and deeper reforms. If businesses throughout the Japanese economy apply best practices concepts such as “lean” practices to new industries, the country can place itself on a faster track toward economic recovery.