Japan’s economy in transition: Why the old rules no longer apply
For decades, Japan was considered one of the world’s great economic success stories. Its manufacturing strength, technological innovation and export performance drove sustained economic growth, while the Japanese yen steadily appreciated against other major currencies.
However, around the mid-1990s, that trend began to reverse.
This shift prompted an important question: had the economic theories that once explained Japan’s success become outdated, or was something more fundamental happening in the global economy?
Our latest research suggests the answer lies in the way globalisation and technology have transformed what it means for an industry to compete internationally.
Globalisation has changed the rules
Traditional economic theory argues that countries with stronger productivity growth in internationally traded industries tend to experience stronger currencies over time. For much of the post-war period, Japan fitted this pattern remarkably well.
But today’s global economy looks very different from the one these theories were originally developed to explain.
Advances in digital technology, communications and global supply chains have dramatically expanded the range of services that can now be traded across borders. Industries such as information technology, finance, professional services and business support—once considered largely domestic—are now competing internationally alongside manufacturing.
This raised an important question: does the traditional distinction between “tradable” and “non-tradable” industries still reflect the realities of today’s economy?
Services have become globally competitive
To explore this question, we analysed international data on productivity, prices and trade across Japan and the United States between 1996 and 2021.
Our findings show that many knowledge-intensive service industries have become increasingly exposed to international competition. As businesses have embraced digital technologies and global production networks have expanded, these sectors have become far more important drivers of national competitiveness than they were just a few decades ago.
This changing landscape means that understanding today’s economy requires looking well beyond manufacturing.
Understanding Japan’s long-term decline
The research also reveals that Japan has experienced slower productivity growth than the United States across many of these newly tradable industries.
While Japan continues to perform strongly in some sectors, it has fallen behind in areas such as information and communication technologies, as well as in parts of its traditional manufacturing base. These industries have become increasingly important in determining long-term economic competitiveness.
Together, these productivity gaps help explain why Japan’s long-standing currency appreciation stalled in the mid-1990s before gradually reversing.
Updating economic thinking
One of the most encouraging findings from our research is that traditional economic theory still provides valuable insights into long-term exchange rate movements.
Rather than replacing these theories, our findings suggest they need to be applied differently. As industries evolve, our understanding of which sectors compete internationally must evolve with them.
When modern service industries are recognised as tradable, the theory does a much better job of explaining Japan’s experience over the past three decades.
Looking ahead
Although this research focuses on Japan, its implications extend far beyond a single country.
As economies become increasingly digital and knowledge-driven, productivity growth in technology-intensive service industries will play a growing role in shaping international competitiveness. Countries that invest in innovation, digital capability and high-value services will be better positioned to succeed in an increasingly interconnected global economy.
For policymakers, researchers and businesses alike, the message is clear: understanding today’s economy requires recognising that the boundary between manufacturing and services is no longer fixed. In the age of globalisation, competitiveness depends on far more than factories—it increasingly depends on ideas, knowledge and digital innovation.
AUTHOR
Professor Eiji Fujii is a Griffith Business School visiting scholar from the School of Economics, Kwansei Gakuin University, Japan.