On Digitization, Think Bigger, Mr. Prime Minister

By Richard Katz : Senior Fellow, Carnegie Council For Ethics in International Affairs
January 20,2021
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(Photo by kokouu/iStock)

It’s a great first step. The digitization campaign announced by Prime Minister Yoshihide Suga will both save money and improve performance. Now, as the details of the plan are being worked out, PM Suga needs to think much bigger. His plan should be expanded in three ways.

Firstly, it should not just apply to intra-government communications and citizens’ contacts with the government for taxes, health care, etc., but to the business world as well. That’s because greater, more effective use of ICT is one of the most powerful things a country can do to boost economic growth.

However, among 34 rich countries, Japan ranked a dismal 25th in overall digital competitiveness in 2020, according to the IMD World Competitiveness Center.

In the era of COVID where telework is becoming a necessity, 74% of SMEs in Tokyo had no plans for remote work. Of these, a third said that they lacked the proper equipment. Only one in four SMEs said they had invested in new ICT equipment or software during 2017.

Secondly, when Suga talks about using digitization to get rid of the hanko and FAX machine, he is talking about automating tasks that people are already doing.

While this cuts costs, what makes ICT revolutionary is that it enables entities to do things that they could not do before at any cost. This includes not just e commerce, but also using enormous amounts of data—so-called “big data”—to develop new products, improve old products, and increase sales of existing products.

At present, unfortunately, Japanese companies focus mainly on cutting costs of already-existing tasks, like inventory control. In the IMD ratings on ICT use, Japan ranked 56th among all countries in “business agility,” which measures not how much companies invest in ICT, but how well they use it.

As a result, reports the OECD, Japan came in last among rich countries in how much growth it gets for every dollar invested in what is called Knowledge-Based Capital, major portions of which are ICT and R&D.

If used well, ICT should enable the ICT-using sectors of the economy—distribution, services, non-ICT manufacturing, etc.— to raise their productivity, i.e., how much additional output they get for every 1% additional input of capital and labor.

Unfortunately, research by Professor Kyoji Fukao has found that, unlike in the US, only Japan’s ICT-producing sectors enjoyed the anticipated productivity boost, not the much bigger ICT using sectors.

Finally, the government needs to make sure that its efforts are especially directed toward small and medium enterprises (SMEs), i.e., firms with fewer than 300 employees, which employ the majority of Japan’s workforce. Japan suffers a much bigger gap than other countries in labor productivity between SMEs and big companies.

One reason is the poor use of ICT. Japan’s living standards cannot improve unless SME productivity is improved. Unfortunately, when the government tries to boost Japan’s technological prowess, it typically focuses most of its effort on big companies.

For example, 90% of the aid that the government gives to increase business spending on R&D is directed toward the big cash-rich companies. Japan’s digitization campaign must address both problems faced by SMEs: not enough ICT investment and lack of knowledge in how to use it.

What Makes Digitization Revolutionary

ICT has the capacity to revolutionize goods and services in all sorts of industries, and not just among large companies. When a grocery store in Finland used ICT to analyze customer purchases, they found to their surprise that, on weekends, the same buyers hiked their purchases of both diapers and beer.

That helped them realize that young couples compelled to stay home wanted to enjoy a beer while watching a movie on TV. The store improved sales just by putting beer next to the diapers on the shelves. Without “big data,” they never would have discovered this pattern.

Furniture retailer Nitori expanded its e-commerce business by using software called “augmented reality.” Via a smartphone app or laptop, customers can experiment with different types of furniture for size and fit, and looks. In the spring of 2020, when sales at other Japanese retailers were crashing due to COVID, Nitori’s online revenues increased 40% from 2019.

ICT can improve existing products. UPS in the USA has sensors built into every parcel delivery truck that use “big data” to monitor conditions that typically precede a part breaking down, like temperature or stress. This avoids the expensive breakdowns of a truck filled with parcels. Nissan has put similar sensors into its Leaf cars.

Eventually, such monitoring systems will go into all vehicles. Already, 10% of a car’s cost involves software, an amount heading toward 30% in the coming years. That means auto mechanics need new skills.

ICT can also help create new products. Using “big data,” Procter and Gamble discovered that householders’ biggest problem with laundry detergent was measuring the right amount, something that conventional market research had not picked up. So, in 2012, they invented laundry detergent pods. This innovation was copied by others and these pods are now the fastest-growing segment of laundry products.

Digital Divide

The “digital divide” between big and small companies is putting fetters on Japan’s growth potential. When METI asked SMEs why they had not invested in ICT, 43% of respondents said the answer was “lack of personnel who can introduce ICT,” followed closely at 40% by “the effects of introducing ICT are unclear or are not sufficient.”

These days, neither the equipment nor the software is that expensive. What is costly is hiring a technical expert, or even a private consulting firm, that can select the best software for an SME and teach it how to build its business using it.

The fact is that even many of the large companies fail to use to ICT to its full potential, because of a rigid mindset too focused on cost-cutting. Cost-cutting can improve the bottom line, i.e., profits, but it does not improve the top line, i.e., sales.

A surprisingly high 40% of large enterprises need to use external consulting companies to help them utilize sales enhancing and product development ICT (Information and Communication Technology).

That’s because of insufficient ICT skills and the absence of a genuine “digital mindset” among too many of their own employees. Only 23% of SMEs use ICT for these purposes, partly because of cost and partly because they don’t realize what benefits they are missing.

How The Government Can Help

To help with the costs, the government could expand tax credits on investment in ICT equipment, software, consulting services, and R&D. A tax credit of 10% would mean that, if an SME invested $20,000 in ICT equipment, software, and consulting, its tax bill would be reduced by $2,000.

Of course, tax credits only help companies already earning profits. So, to help out much-needed startups, Japan should do what many other countries do: institute a 10-to-20 year “carry forward” so that the company gains the benefit when it finally does produce profits. Japan used to have a measly one-year carry forward for R&D, but that was eliminated during the Abe administration. That’s one of the factors in Japan’s shortage of innovative startups.

The EU also has lots of SMEs who don’t know how to use ICT, so, in 2016, it began a pilot program to train them via “Digital Innovation Hubs.” These hubs sent digitalization experts to visit SMEs. There was such a high level of satisfaction among SMEs that the EU has expanded the program, setting a 2021-27 budget of ¥165 billion ($1.6 billion) per year.

METI runs its own low-cost consulting program for SMEs called the “CIO development support program.” The program dispatches ICT specialists for six months to a year to help SMEs at the very low cost (in 2016) of just ¥17,600 ($169) per day.

Unfortunately, its size pales in comparison to the EU effort, just ¥20 billion ($192 million) per year for everything METI does to aid businesses digitization, not just training SMEs. During 2019, the CIO aided only 192 SMEs. This is dwarfed by the 2,000 SMEs trained in the EU during the testing phase.

Now, the EU is creating 211 hubs that can help many thousands of companies every year. When Suga announced his digitization campaign, METI requested a doubling of its total budget for aiding business digitization, not just for a consultation. Even if this request is approved, it’s not enough even to make a dent in the problem.

One of the biggest obstacles to digitization is Japan’s huge shortage of ICT professionals. In 2020, the shortfall was estimated at 300,000 people. By 2030, Japan will need 1.44 million ICT pros, but will have only 856,000, a shortfall of 41%. Efforts should be stepped up to attract more professionals from other countries to work in Japan.

If that is not successful, the large companies will have the option of sending more of their research and production facilities to countries that have these professionals. The SMEs, however, have no such option. Japan’s growth would continue to be anemic and real personal income would continue its slow decline.

The MOF will undoubtedly contend that Japan cannot afford such programs. But that is “penny-wise/pound-foolish” thinking. Without good growth, Japan’s tax base will continue to fall. The fact is that Japan cannot afford not to do this.