Reallocation and Productivity Growth in Japan: Revisiting the Lost Decade of the 1990s: Working Paper 2006-02

Naomi N. Griffin and Kazuhiko Odaki

Hayashi and Prescott (2002) argue that the so-called lost decade of the 1990s in Japan is explained by the slowdown in exogenous total factor productivity (TFP) growth rates. At the same time, some have suggested that Japanese banks’ support for inefficient firms prolonged recession, by reducing productivity through misallocation of resources and interference with entry and exit mechanisms. Using firm-level data between 1969 and 1996, this paper investigates the micro-reallocation mechanisms to disentangle the factors behind the slowdown in productivity growth during the 1990s. The main results show that the lack of exits by the least productive firms and lack of entries by small productive firms reduced TFP growth during the 1990s. However, the paper does not find strong evidence of misallocation of resources across incumbent firms; hence, misallocation seems mostly to have taken place at the entry and exit margin. Most important, during the 1990s there was a large drop in productivity growth within firms, the component not affected by reallocation of input and output shares across firms over time. These findings suggest that, as the Japanese economy matured, a policy that fosters technological innovations via creative destruction process may have become increasingly important in promoting economic growth.