Patrizio Sicari
Tetsuya Yoshioka
OECD Economic Surveys: Japan 2026
Abstract
Japan faces the challenge of low labour productivity and sluggish productivity growth. In the context of a shrinking working-age population, stronger productivity gains will be required to sustain living standards. This is complicated by a business environment that discourages firm entry, constrains scale-up, and delays the exit of less productive firms. Cumbersome business regulations and persisting barriers to competition in key service sectors are additional obstacles to stronger growth. Easing these constraints and remaining regulatory and informal barriers to inward foreign direct investment would help attract more innovative foreign businesses and talent, fostering productivity spillovers. SMEs’ access to R&D and research-partnerships with universities is comparatively weak, suggesting the need for more targeted public support to broaden the diffusion of new technologies. Stronger pipelines of tertiary students in research-oriented pathways would underpin a more innovation-driven economy. More flexible insolvency, restructuring and business succession processes should be prioritised to increase the efficiency of resource allocation. Boosting the currently low uptake of advanced digital technologies, including artificial intelligence, will be crucial to realising untapped productivity gains.
The decline in Japan’s working-age population has been the major driver of the gap in Japan’s per capita income to the top half of the OECD (Figure 2.1). Labour productivity, measured as productivity per persons employed, which is well below that of the top half of the OECD countries, also contributed to the gap. On the other hand, the increase in employment worked in the opposite direction. As the working-age population is projected to decline to 49.9% by 2050 under the government’s low birth rate scenario, higher labour supply or productivity is needed to sustain growth. Labour productivity, measured as GDP per hour worked, is also lower than the OECD average (Figure 2.2, Panel A). Annual growth in hourly productivity fell from 1.2% in the 2000-08 period to 0.3% between 2019 and 2024 (Panel B).
Source: OECD, Historical Population data; OECD, National Accounts database and OECD, Productivity database.
Note: OECD and EA (euro area) refer to a weighted average based on hours worked.
Source: OECD, Productivity Statistics database.
The marked slowdown in capital deepening since 2000 has constrained labour productivity growth (Figure 2.3, Panel A). Indeed, the growth of real investment per worker has lagged the rest of the OECD (Panel B). The stagnation of tangible capital assets accumulation reflects demographic and structural factors. Firms’ growth expectations were shaped after the collapse of the bubble economy, reducing incentives to expand domestic production capacity. Coupled with corporate risk aversion, this has led to high cash and deposits in non-financial corporations. At around 60% of GDP, this is high in international perspective. In addition, large firms increased their share of investment in securities, reflecting the shift of production overseas. These trends are reflected in a high share of outward foreign direct investment (FDI) (Figure 2.4, Panel A). On the other hand, inward FDI to Japan is low at 5.1% of GDP.
Note: Panel A: Annual change of potential real GDP per trend person employed split into trend capital per worker and trend multi-factor productivity growth. Panel B: Workers defined as total employment.
Source: OECD, Economic Outlook database.
The contribution of trend multi-factor productivity growth (the efficiency with which labour and capital are utilised) remained broadly stable after 1990s, albeit at a relatively low level (Figure 2.3, Panel A). While rebounding somewhat after the pandemic, trend multi-factor productivity has grown at an average annual rate of only 0.4% between 2000 and 2024. This is below the OECD average of 0.8% and that in the United States and Korea at 1.2% and 1.9%, respectively. Furthermore, while intangible assets continued to accumulate, especially in R&D and software, they did not deliver productivity gains. This has been attributed to a lack of investment in organisation capital and training (Figure 2.4) (Miyagawa and Ishikawa, 2021[1]). Cross-country regressions reveal that the efficiency of investment in intangible assets is lower in Japan than in its peers (Yagi et al., 2022[2]). Hence, complementary investment in ICT, artificial intelligence and human capital (Chapter 1) is essential.
Resource reallocation has also been a drag on productivity growth. The probability of low-productivity firms escaping from low productivity levels, whether through upgrading or exit, is lower in Japan than in the United States (Yagi et al., 2022[2]). Reflecting these patterns, Japan’s aggregate productivity growth has been largely driven by within-sector and within-firm improvements, while the contribution of resource reallocation across sectors and firms has been consistently small (Fukao, Kim and Kwon, 2021[3]). Furthermore, the share of zombie firms increased after the pandemic, from 10.1% in 2019 to 14.3% in 2024 (Teikoku Data Bank, 2026[4]). As resources are stuck in low-productivity sectors and firms, the innovative potential of more productive ones is constrained, preventing them from scaling up and weighing on aggregate productivity growth. Consequently, business dynamism remains low, with firm entry and exit rates at around half of those in the United States (Figure 2.5). Enabling firm entry and subsequent growth and the timely exit of less productive firms are key to addressing Japan’s productivity challenge.
Source: Ministry of Finance; Cabinet Office and Bontadini, F. et al. (2023), EUKLEMS & INTANProd: Industry Productivity Accounts with Intangibles.
Note: The number of firms joining or leaving employment insurance as a ratio of the total number of firms at the end of the previous fiscal year.
Source: Ministry of Economy, Trade and Industry and Ministry of Health, Labour and Welfare; and United States Census Bureau, Business Dynamics Statistics.
Labour productivity in the services sector is lower than in manufacturing. Within services, productivity in professional and technical services is particularly low, possibly reflecting tighter regulatory constraints. Productivity gaps between small and large firms, which are more pronounced in the services sector, also contribute to low aggregate productivity. As in other OECD countries, labour productivity increases with firm size in both manufacturing and services (Figure 2.6). The impact on aggregate productivity is high as SMEs make up 70% and 56% of employment and value-added, respectively. SMEs engaged in global value chains tend to be more productive and have access to more diversified products and services (OECD, 2023[5]). The low productivity of SMEs in Japan reflects the fact that they are concentrated in services (71% of employees in non-agricultural SMEs), lag in innovation and adoption of digital technologies, tend to be old, and participate less in international trade. As such, SMEs tend to be less competitive, which, coupled with weak business dynamism, conspire to keep productivity levels and growth subdued.
Gross value added per worker, JPY million
Source: Ministry of Internal Affairs and Communications/Ministry of Economy, Trade and Industry, 2021 Economic Census for Business Activity.
Ageing may also affect labour productivity through a variety of channels. Workers may become less productive as they age, while innovation and entrepreneurship may weaken if younger people are more likely to innovate. Conversely, as older workers have accumulated experience, companies that combine them effectively with prime-age and younger peers tend to be more productive than others. Mandatory retirement can also lead to a loss of firm-specific knowledge, weakening overall productivity. Shifts in demand towards sectors where productivity gains are more difficult to achieve, such as some labour-intensive personal services, and the crowding-out of productive investments by ageing-related spending, may further weaken productivity (Andre et al., 2025[6]). In this regard, non-market sectors (primarily education, health and social work, and public administration) accounted for 16% of Japan’s gross value added in 2023, up by around four percentage points relative to 1995. The rise mainly reflects the expansion of health and social work, a trend that pre-dated the pandemic shock. However, the relative incidence of non-market sectors remains below those in most EU countries and the United States.
Accompanied by increasing labour shortages, ageing is likely to incentivise productivity-enhancing automation. Enhanced digitalisation, deployment of robots and AI-integrated systems could make manual tasks more efficient, possibly mitigating the Baumol-type pressures associated with ageing (Filippucci et al., 2024[7]). In this context, boosting productivity growth will require policies in a wide range of areas, such as increasing entry and exit, reforming the low productivity SME sector and facilitating the scale-up of successful firms, improving human capital (throughout education and working life), boosting inward foreign direct investment and streamlining regulations. Other policies, such as trade openness, are also important for productivity growth, but are beyond the scope of this chapter.
Vibrant market competition is key to more efficient resource allocation and improved consumer welfare. The 2023 OECD Product Market Regulation (PMR) indicators show that Japan’s overall regulatory framework remains among the least competition-friendly in the OECD, despite some improvements since 2018 (Figure 2.7, Panel A). However, a breakdown by regulatory area reveals a more nuanced picture. Barriers to trade and investment are among the lowest in the OECD, while the administrative and regulatory burden on businesses is the second highest in the OECD (Panels B-C). Distortions to competition arising from public ownership and state involvement in business operations are more severe than in top-performing countries, such as the Netherlands and Norway. Such distortions limit the efficiency of resource allocation. The regulatory environment in services is generally open but further easing some restrictions in a few network sectors and professions could enhance competition and productivity.
2023
Note: The indicator ranges from zero (least stringent) to 6 (most stringent). Panel C: Low-level indicators for the following medium-level ones: regulations impact evaluation, administrative and regulatory burden, and barriers in service and network sectors. LLCs and POEs stand for Limited Liability Companies and Personally-Owned Enterprises, respectively.
Source: OECD, Product Market Regulations database.
2.2.1. Overhauling cumbersome business regulations
Japan’s administrative proceedings for registering and starting a business are complex and involve multiple institutions. Entrepreneurs seeking to establish a Personally-Owned Enterprise (POE, Kojin Jigyo) must first submit a notification form to the tax authorities, while the registration of Joint-Stock Companies (JSCs, Kabushiki Gaisha) and Limited Liability Companies (LLCs, Godo Gaisha) takes place with the Ministry of Justice. In principle, paper-based applications are registered within three days from their filing, but depending on the workload of the registration authorities, that term may often extend to a couple of weeks. Thereafter, the entrepreneur must liaise with the authorities responsible for sector-specific licenses and permits and register in person their employees with labour, pension, and social security institutions. Direct registration with the postal service is also needed to secure the official business mailing address required to open a bank account. Overall, according to OECD PMR indicators, starting a POE or an LLC involves five and nine direct contacts, respectively, which is two to four additional steps than average in the OECD.
Ongoing improvements in digital infrastructure and public services are gradually paving the way for boosting entrepreneurship. Reducing entry-level administrative and regulatory burdens helps create a more business-friendly approach in other downstream areas (Martins and Veiga, 2022[8]). In addition, streamlined entry regulations may ease barriers for incumbent companies undergoing cross-sector business model transformation. The government enabled – albeit under certain conditions – fully online business registration in 2020. In line with paper-based proceedings, POEs are required to register with tax authorities via the e-Tax portal, using the My Number digital card as identifier. As for corporations, applications are filed via the Ministry of Justice’s online registration system, using certificate-based electronic authentication.
Digital access to government services for businesses has been significantly streamlined through the gBizID platform. The latter consists of a common digital authentication system, managed by the Digital Agency, allowing businesses to connect securely with government services based on a unique account and a two-factor authentication. Regardless of their legal form, once registered, businesses can use gBizID to access a broad range of government services, including applications for sector-specific licenses and permits, subsidies, grants, and other support schemes, or for compliance with post-registration regulatory requirements.
The digitalisation of (post-registration) employment-related regulatory compliance is a key step in streamlining entry proceedings. In-person interaction with institutional or third-party counterparts, though, is still required for registering the official mailing address, opening a bank account and depositing the initial capital (for JSCs and LLCs). Electronic licensing applications are not available in all sectors. Moreover, uneven progress across public institutions suggests that the use of traditional physical seals (hanko) persists in some resource-constrained local authorities lacking the capacity to adopt fully digitised systems. Survey evidence suggests that companies’ continued use of physical seals is driven by customers’ preferences and legislation not yet aligned with using new e-authentication systems (Bengo4, 2024[9]).
The government also plans to develop a remote signature method using electronic certificates issued by the Commercial Registration Certification Authority. By creating a tamper-resistant system for storing users’ electronic certificates and integrating it with gBizID, the new service, which is set to enter into force in mid-2026 (Cabinet Office, 2025[10]), will allow electronic signatures across multiple devices and remove the need for users to store certificates locally. While not modifying statutory review requirements, this reform may reduce pre-filing delays. The planned adoption of a new encryption standard by 2030 will further enhance the security of e-certificates.
The availability and uptake of digitised administrative procedures for businesses should be strengthened. About 250 government services from national and local authorities are accessible via the gBizID. Of these, around 68% were local governments. As Japan has 1 788 local governments, this suggests scope for expanding its uptake. GBizID has issued approximately 1.45 million accounts as of March 2026, with only around 33% of Japan’s corporations having registered, well below the 80% target by 2030 (Cabinet Office, 2025[10]). Monthly registrations would need to grow at more than twice the average monthly increase recorded in the year to November 2025 to meet that objective. The trend in gBizID ‘prime’ accounts, the only ones that function as a full authentication credential, also shows scope for improvement. While these accounts grew by 27% since June 2024, about a quarter of existing prime accounts were held by sole proprietorships, which make up around 44% of all enterprises.
The time required to start a business also depends on the firm’s intended activity, especially if it involves complex licenses and permits. Current regulations do not set specific time limits for the relevant public bodies to complete the required procedures. Although the monetary administrative start-up costs are low, lengthy or multi-step regulatory proceedings may involve considerable paperwork requiring additional time and resources, thereby increasing uncertainty and reducing effective planning. The associated higher regulatory costs can have negative or inverted U-shaped effects on entrepreneurship (Audretsch et al., 2024[11]). Moreover, evidence from 17 European countries suggests that reducing the time needed to comply with administrative burdens has a stronger impact on firm entry than lowering the financial costs of existing regulations (Tomasi, Pieri and Cecco, 2023[12]). Hence, adopting a ‘silence is consent’ principle in entry regulations, as in France and the Netherlands, could boost entrepreneurship.
Easing the administrative burden on business formation through greater digitalisation will rest on complementary investments. Seamless digital integration across government services will be essential to enable full implementation of the ‘once-only’ principle, whereby businesses do not have to resubmit information already shared with other public authorities, as in Austria and Norway. In this context, moving towards a single digital gateway for most business-related procedures, as in Denmark and Greece, could further consolidate user access and improve transparency on procedural requirements.
2.2.2. Reducing distortions from state involvement and sectoral regulations
Japan’s comparatively high aggregate PMR index partly reflects distortions arising from public ownership and state involvement in business operations. Following privatisations of key State-Owned Enterprises (SOEs), the share of market capitalisation owned by the state has fallen to around 3% in 2023 (OECD, 2024[13]). Nonetheless, strong SOE governance frameworks are key for private companies and investors in regulated sectors, as they signal the credibility of the government’s commitment to fair competition.
Japanese commercial SOEs, which are largely in the services sector, do not benefit from more favourable tax or regulatory treatment than privately-owned competitors, nor are they subject to specific insolvency rules (Ministry of Finance, 2025[14]). Even so, relatively lenient SOE governance standards reduce transparency and accountability. Unlike in most OECD countries, there is no specific requirement for SOE boards to include independent members nor to subject their financial statements to external audit, as publicly listed and privately-owned firms must do according to standard corporate governance regulations (see below). Centralised disclosure of SOE pay packages for board members and executive managers and a strategic framework outlining the rationale for holding ownership rights in each commercial SOE are also lacking (OECD, 2022[15]). Better aligning national SOE regulations on disclosure and transparency requirements with the OECD Guidelines on SOE corporate governance would improve accountability (OECD, 2020[16]). Such moves would send positive signals to foreign investors (see below).
There is also room to improve Japan’s regulatory stance on digital services (Figure 2.8, Panel A). At present, there is limited contestability and a lack of transparency on rules governing the use and access to data. The authorities’ approach to digital markets is largely based on a ‘monitor and review’ process occurring in a co-regulation framework (METI, 2024[17]). Large service providers voluntarily adjust services and processes in line with government recommendations based on evaluations of their platform. However, these are mainly compliance assessments informed by monitoring experts, feedback from business users of the platform, and a provider-submitted report.
The 2024 Mobile Software Competition Act (MSCA) could help enhance competition in digital markets. The Act imposes ex-ante obligations on companies providing smartphone-related software and services and holding a significant market position. The new rules are backed by substantial fines for non-compliance. The obligations compel companies to enhance interoperability across operating systems and ease customers’ access to alternative application stores or in-app payment systems. Changing default browsers will also be made simpler, while designated companies will be required to publish clearer terms and conditions. This should be accompanied by measures ensuring business users have fair access to their data. Greater data portability will allow users to transfer data to alternative providers. The ultimate impact of the MSCA in lowering entry barriers and stimulating innovation will hinge on more precise compliance requirements and guidelines (ITIF, 2025[18]), regular assessments and robust enforcement. If successful, this approach could be extended to other key digital markets.
Japan would also benefit from further relaxing regulatory obstacles to competition in service sectors, where requirements for accountants, for example, are more stringent than the OECD average (Figure 2.8, Panel B). While only certified public accountants can perform statutory audits, certified public tax accountants hold exclusive rights to represent or assist undertakings before tax authorities. Moreover, firms of tax accountants – the category of licensed accountants used as the reference for Japan in the OECD Product Market Regulation database – must operate under a legal form entailing unlimited personal liability for their members (a feature shared only by Mexico in the OECD), exclude non-licensed accountants from any ownership or voting rights, and are subject to limitations on advertising and marketing. Such requirements stifle competition and reduce incentives to innovate, improve service quality, and ease costs (OECD, 2024[19]). Allowing licensed tax accountants to operate under limited liability structures, while easing restrictions on multi-disciplinary practices, i.e. integrated joint ownerships between professionals providing services in complementary fields (such as accountants, auditors, and lawyers), combined with profit-sharing, would better align Japan’s legal framework with OECD standards.
Note: Based on legislation as of early 2024. The indicator ranges from zero (least stringent) to 6 (most stringent).
Source: OECD, Product Market Regulations database.
2.2.3. Reforming corporate governance further
Low productivity also reflects a lack of corporate dynamism. Weak corporate governance discourages foreign investors and lowers innovation and risk-taking. Better corporate governance has the potential to improve firms’ access to equity, the monitoring of firms’ performance and allocation of capital, leading to more effective use of R&D and human capital (OECD, 2023[20]). This would boost productivity by facilitating the downsizing of low productivity activities and shifting resources to high productivity ones.
Japan enhanced its corporate governance framework with the 2014 Stewardship Code for institutional investors, to promote sustainable growth of companies through responsible investment and dialogue with stakeholders, and the 2015 Corporate Governance Code to boost listed companies’ mid- to long term corporate value, on a comply-or-explain basis. These codes have been revised several times to improve their effectiveness. The government also launched the Asset Owner Principles in August 2024 to encourage asset owners, including pension funds and insurance companies, to fulfil fiduciary duties, such as conducting stewardship activities and signing the (voluntary) international Principles for Responsible Investment (Cabinet Secretariat, 2024[21]). The Japan Stock Exchange (JPX) also improved disclosure and incentivised some firms to enhance corporate value.
The impact of the new framework on firm performance and productivity has not fully materialised. While the average return on equity (ROE) of listed firms has improved, it has plateaued around 9%, barely clearing the 8% minimum benchmark return commonly expected by foreign investors (METI, 2014[22]), and well below that in the United States (around 18%). Around 40% of TOPIX 500 firms reported a ROE below 8% in 2022, implying returns below their estimated cost of equity, and approximately 43% had a price-to-book ratio (PBR) below 1, indicating that shareholders would gain more if the firm were liquidated than by keeping it as a going concern (Figure 2.9, Panel A). Japan’s persistently large corporate saving–investment balance, relative to the United States and the euro area, points to subdued domestic investment by Japanese firms (Panel B). Indeed, firms’ high cash holdings, at 57% of GDP in 2024, are considerably above that in the United States (16.6%) (Cabinet Office, 2025[23]). Rather than investing and taking risks to spur innovation, management in many firms continue to maintain the status quo.
To some extent, the limited impact of the reforms on profitability reflects the fact that high compliance often stems from firms’ formalistic responses (Buchanan and Deakin, 2024[24]), with firms tending to focus on fulfilling minimum recommendations rather than improving resource allocation. Several companies reclassified part of their strategic shareholdings as participations held for ‘pure investment’ purposes – i.e. with the sole intention of enhanced returns, but often without sufficient justification. In some cases, companies had neither agreed a timeline with the issuing company for disposal nor developed concrete sale plans, despite having obtained the issuing company’s agreement, resulting in largely cosmetic changes (FSA, 2024[25]). To enhance transparency in the reclassification process, in 2025, the FSA adopted regulations that require companies to disclose any shares reclassified from “strategic” to “pure investment” within the past five fiscal years, which is welcome. Firms are also required to provide reasons for the change and the subsequent policy on holding or selling those shares (FSA, 2024[26]).
Note: 1. Net lending (+) / net borrowing (-).
Source: Japan Exchange Group; OECD National Accounts Database; Cabinet Office; and OECD calculations.
Broader measures are needed to accelerate the unwinding of strategic crossholdings, which can lower market openness to foreign investors, weaken external managerial discipline and lower profitability (Miyajima and Saito, 2023[27]). One possibility is to encourage companies with exposures exceeding a certain threshold (as a percentage of net assets) to establish internal committees of independent directors and auditors. Such committees could be tasked with reviewing existing holdings and formulating a medium-term divestiture strategy with clear targets, complemented with a plan for the productive use of proceeds extending beyond the review period. More generally, promoting strategic investors’ voluntary alignment with the principles of the Stewardship Code, which seek to shape investor behaviour vis-à-vis listed companies in support of long-term corporate value creation, would advance more responsible asset management. The regular dissemination of good examples of disclosure related to strategic shareholdings, together with the main associated challenges, would further improve the quality of dialogue between investors and listed companies.
Improving the composition and quality of boards of directors is also essential to boost the effectiveness of corporate reforms. Boards in Japan are gradually shifting from a management model to a monitoring board model, with nomination and remuneration committees becoming more common, especially in the Prime Market (Figure 2.10, Panel A). Current policy recommends that at least one third of directors are independent for the firms in the JPX Prime Market. Many OECD countries recommend or require at least 50% independent board members for listed firms (OECD, 2025[28]). The share of firms with such a majority remains at around 26% in the Prime Market and 7% in the Standard Market, although this is increasing. Diversity is also limited among Japanese board members in terms of gender, nationality (Panel B), and age. Despite the scarcity of external director candidates, only 8% and 2% of Prime and Standard Market firms, respectively, have succession plans for their external board members (METI, 2025[29]). These external members largely overlap with independent directors, i.e. directors not linked to the company by significant business relationships or shareholdings, in larger listed companies. Finally, the separation of the roles of CEO and board chair is rare, with only 3% of the firms in the Tokyo Stock Exchange having an external board chair (Tokyo Stock Exchange, 2025[30]). Over three-quarters of OECD countries require or encourage such a separation (OECD, 2025[28]).
Note:1. Committees include voluntary ones. 2. Firms covered are those in Nikkei 225 (Japan), top 100 companies in market capitalisation (Italy), SBF120 (France), FTSE150 (UK), Dax40 (Germany), S&P500 (US) and CSSBI100 (Canada).
Source: Japan Exchange Group and Spencer Stuart.
2.2.4. Effectively leveraging public procurement
Effective procurement processes can stimulate innovation, encourage supplier efficiency by promoting transparency and competition (Bleda and Chicot, 2020[31]) and boost firm and aggregate productivity (Hebous and Zimmermann, 2016[32]; Yuan, Ortega-Argiles and Uyarra, 2025[33]). In addition to ensuring public spending efficiency, procurement systems can help support reform initiatives. This involves improving the professionalisation of government purchasing (by developing flexible structures and processes that ease operational constraints), enhancing competition – including by ensuring SMEs have a fair access to government contracts – while preserving accountability and limiting the scope for mismanagement and fraud.
As a signatory to the 1994 World Trade Organisation’s Government Procurement Agreement (GPA), Japan is committed to fair, non-discriminatory and transparent procurement. The GPA covers central ministries, agencies, designated sub-central authorities and public corporations. It requires annual reporting of contracts above specified thresholds which vary by procurement type and authority level. To encourage foreign participation, the government has voluntarily lowered certain thresholds for public corporations, extended bid deadlines, and expanded English-language notices. At the same time, the authorities improved access to high-technology tenders in fields such as supercomputers, ICT and medical equipment (EU-Japan Centre, 2025[34]). Procurement outside the GPA is governed by domestic legislation.
The market for public procurement is sizeable. According to internationally comparable data, general government spending on procurement (excluding that of public corporations) was 16.8% of GDP in 2024, above the OECD average of 13.1%. This accounted for 44% of total government expenditure (Figure 2.11, Panel A). Public procurement spending is also more concentrated by function, with 56% allocated to health and social protection, which is substantially higher than the OECD average of 40% (Panel B).
Note: 1. Expenditure on environmental protection, housing and community amenities, and recreation, culture and religion.
Source: OECD (2025), Government at a Glance 2025, OECD Publishing, Paris; and OECD, Government Expenditure by Function (COFOG) database.
The Administrative Reform Promotion Council – a body that oversees reforms and makes recommendations – bi-annually disseminates aggregate public procurement data, broken down by level of commissioning entity and type of contractual approach. However, the data only cover national procurement, i.e. contracts by ministries at both central (headquarters) and sub-central (local offices) level and exclude local administrations and public corporations (even if GPA-designated) and smaller voluntary contracts. As a result, the Council quantified the total contract value of national procurement at approximately JPY 15 trillion in FY2023 (ARPC, 2024[35]), around one-third of which reflects an increase in tenders for the Defence Build-up Programme. This is just a fraction of the JPY 102 trillion expenditure estimated based on national accounts data, suggesting room to improve availability and quality of public procurement data.
In FY2023, over 60% of government purchases was completed via competitive tenders, although about one third attracted only a single bidder. In other cases, contracts were directly awarded outside of any competition (17%) or following informal quotation exchanges with a small number of potential contractors (20%) (ARPC, 2024[35]). However, under Japan’s trial ordering scheme, discretionary contracts can also be awarded to SMEs and innovative start-ups with no past procurement history, helping them build the track record needed to compete in future open tenders. Anecdotal evidence points to high reliance on lowest-price bidding across local governments. Price-only awards can constrain innovation, whereas multi-criteria approaches encourage suppliers to improve practices, supporting broader productivity gains. However, this typically comes at the expense of higher fiscal costs (OECD, 2025[36]). Contracting entities should therefore be encouraged to reserve the lowest-price criterion for well-standardised goods and services (OECD, 2025[37]).
In value terms, the share of non-competitive contracts has risen markedly to 62% in FY2023, largely reflecting recent jumps in defence spending (Table 2.1). Excluding such defence-related items brings the share of non-competitive proceedings down to 34%. To some extent, the succession of recent economic shocks complicates the interpretation of these statistics. That said, the declining relevance of contracts awarded in procurements that induced multiple bids, together with single-bidding rates only slightly lower than in FY2019, raises concerns about structural barriers to open competition. These concerns are compounded by recent Cabinet draft legislation aimed at strengthening SME public procurement set-asides. By increasing the likelihood of preferential treatment for domestic firms in local procurement markets, such measures, if not carefully designed, could further restrict competition, particularly for foreign investors. Although formally resulting from competitive procedures, when not related to statutory exceptions (e.g. exclusive patent rights, urgency, or unique technical expertise), recurrent single bids could create distortions in terms of market concentration and higher prices (Titl, 2023[38]). Data for public works tenders in Ehime prefecture from the 2014-22 period suggest that each bidder beyond the mean number of effective participants reduced the contract price ratio by roughly 1% (Nishikawa, 2025[39]).
The development of e-platforms has improved the procurement ecosystem, but some underlying weaknesses persist. Unified digital interfaces and consolidated e-procurement portals (such as Chotatsu Portal and CALS/EC) have streamlined submissions of tender notices and bid documentation. This has gradually resulted in increased suppliers’ participation, thanks to easier access to information, greater procedural clarity, lower administrative burdens, and more effective oversight. However, these efforts are often not coordinated across jurisdictions, resulting in local e-procurement initiatives with distinct approaches to definitions and surveillance frameworks. There is also no common qualification system for firms willing to participate in competitive bidding projects across local authorities and special public corporations, implying burdensome registrations. This can limit competition as potential bidders in one jurisdiction have to invest in understanding a different jurisdiction.
Value of central authorities’ procurement, % of yearly total
Note: Coverage is restricted to procurement by ministries and national agencies at central and sub-central levels, excluding local administrations and public corporations (even if GPA-designated) and smaller voluntary contracts.
Source: Administrative Reform Promotion Council (2024), Inspection Results for FY2023 Procurement Improvement Efforts, Cabinet Office.
The Digital Government Promotion Standard Guidelines recommend that raw procurement operational data be delivered in a machine-readable form that allows cross-analysis (Digital Agency, 2025[40]). However, there is no centralised authority responsible for setting general procurement policies or enforcing harmonised monitoring across ministries. Prefectures, municipalities, and public corporations manage their procurement processes autonomously under different legal procedures, often with their own reporting requirements (WTO, 2023[41]). At decentralised levels, data on the different phases of the procurement cycle are usually scattered across different platforms, which can complicate planning processes (Hirayama and Maeda, 2024[42]).
Such fragmentation reduces overall transparency and hinders the production of reliable aggregate indicators of procurement performance. This weakens the capacity to leverage public procurement for broader strategic objectives or improved public expenditure control and tends to generate higher infrastructure and operational costs. Greater integration and standardisation, for example through shared digital platforms and a common reporting and monitoring framework across all levels of government, are thus needed. To support this process, a core objective should be the creation of a set of key macro-level procurement indicators – for example, the number and value of awarded contracts by expenditure category, type of procuring authority, contract type, number of bidders, and award criteria. The framework could build on the existing Chotatsu Portal and be gradually extended to decentralised authorities on a collaborative basis.
2.2.5. Reinforcing integrity for a level playing field
High levels of integrity in government can boost public sector efficiency and productivity growth. Accountable governance reduces waste and improves policy effectiveness. Greater transparency could play a key role in strengthening trust in public institutions, which remains comparatively low in Japan according to international surveys (Edelman, 2025[43]). However, perceptions of corruption, as well of the authorities’ capacity to control it, are better than the OECD average (Figure 2.12, Panels A-C).
Japan has relatively stringent public-sector rules on conflicts of interest and public service ethics laws are also well established. Transparency of public information is broadly aligned with OECD standards, while the regulatory framework for political finance was tightened in December 2024 (Panel D). Adopting centralised and harmonised internal control and audit standards, rather than devolving responsibilities to individual ministries as in the current system, could strengthen corruption risk management. Legislation covering lobbying activities is also underpowered. Introducing a requirement for public officials to disclose information on their interaction with lobbyists through publicly available registries, as in most OECD countries (OECD, 2021[44]), would boost transparency.
Note: Panel B shows the point estimate and the margin of error.
Source: Panel A: Transparency International; Panels B and C: World Bank, Worldwide Governance Indicators; Panel D: Financial Action Task Force (FATF).
Newly enhanced legal safeguards for whistleblowers may pave the way for more effective anti-corruption enforcement. Revisions to the Whistleblower Protection Act in June 2025 expanded coverage to freelancers, including up to twelve months after the termination of their contracts, introduced provisions allowing on-site inspections, strengthened fines for retaliatory conduct, while shifting the burden of proof onto employers to demonstrate that any dismissal or disciplinary action within one year of reporting is not retaliatory (Baker McKenzie, 2025[45]). The 2025 reform did not alter the company-size threshold for the requirement to establish an internal whistleblowing system, which is triggered at more than 300 employees, but introduced criminal penalties for non-compliance with the obligation to designate personnel to handle whistleblowing.
Japan is largely compliant with OECD best practices on the exchange of information with tax authorities (Figure 2.13, Panel A), and a National Action Plan to counter money laundering, terrorist and proliferation financing was adopted in 2024. The plan improved deterrence through clearer rules and more proportionate penalties, and noted the need for greater coordination and digitalisation to make investigations and prosecutions more effective. (FATF, 2024[46]) noted Japan’s progress in technical compliance in areas, such as targeted financial sanctions (including asset-freezing) and the extension of due diligence obligations to providers of professional services. Even so, challenges remain in anti-money laundering and combating the financing of terrorism (AML/CFT) policy enforcement, particularly on the side of investigation, prosecution, and confiscation (Panel B).
The 2024 revision of the Financial Services Agency’s (FSA) AML/CFT guidelines required financial institutions to strengthen their risk assessment processes, particularly in terms of ongoing customer due diligence. In 2025, AML supervision was strengthened by the issuance of general procedures to assist supervised entities in validating the effectiveness of their AML/CFT framework to appropriately identify, assess, and mitigate evolving risks (FSA, 2025[47]). These welcome reforms could help Japan align more closely with international standards (FATF, 2024[46]), although the ultimate impact will depend upon timely and consistent implementation.
Note: Panel A summarises the overall assessment on the exchange of information in practice from peer reviews by the Global Forum on Transparency and Exchange of Information for Tax Purposes. Peer reviews assess member jurisdictions' ability to ensure the transparency of their legal entities and arrangements and to co-operate with other tax administrations in accordance with the internationally agreed standard. The figure shows results from the ongoing second round when available, otherwise first round results are displayed. Panel B shows ratings from the FATF peer reviews of each member to assess levels of implementation of the FATF Recommendations. The ratings reflect the extent to which a country's measures are effective against 11 immediate outcomes. "Investigation and prosecution¹" refer to money laundering. "Investigation and prosecution²" refer to terrorist financing.
Source: OECD Secretariat’s own calculation based on the materials from the Global Forum on Transparency and Exchange of Information for Tax Purposes; and OECD, Financial Action Task Force (FATF).
Inward foreign investment was around 5.1% of GDP in 2024 (Figure 2.14, Panel A), roughly ten times lower than the OECD average, and below that of other G7 economies. This contrasts with a recent trend of increasingly favourable international perception of the Japanese market’s potential. For example, the 2025 FDI Confidence Index from a survey of global business executives identifies Japan’s investment outlook over the next three years as the fourth most attractive, up from seventh in 2024 (Kearney Foresight, 2025[48]).
The government has stepped up efforts to enhance Japan’s attractiveness to foreign investors with the Programme for Promotion of Foreign Direct Investment in Japan published in June 2025. The Strategy includes measures to streamline regulations and administrative procedures, reform immigration policies to attract and retain foreign talent, provide tax credits and subsidies for innovative and strategic investment and strengthen institutional and financial support for local governments’ FDI initiatives (Cabinet Office, 2025[49]). The government revised its key policy objective of doubling Japan’s inward FDI stock (JPY 53 trillion at end-2024) by raising the 2030 target to JPY 120 trillion and setting a new goal of JPY 150 trillion in the early 2030s. The stock of inward FDI rose to JPY 61 trillion by end-2025, measured on a gross basis.
Investment support will prioritise strategic sectors. The government plans to provide support to innovative foreign firms that establish production capacity in Japan, focusing on sectors critical to the Digital Transformation (DX) and Green Transformation (GX), as well as to life sciences, with an emphasis on semiconductors and AI. The support may take the form of GX Economy Transition Bonds (Chapter 1) or access to long-term subsidy programmes, such as the next-generation semiconductor scheme. While ambitious, the Programme for the promotion of FDI currently lacks detail. Early publication of the envisaged additional funding allocations would increase investment certainty and allow an assessment of the programme’s fiscal sustainability over the medium to long term.
% of GDP, 2024
Note: Data are presented on an immediate counterpart basis and cover all resident units, including Special Purpose Entities (SPEs), whereas the OECD and EU averages refer to resident operating units (non-SPEs).
Source: OECD, Foreign Direct Investment Statistics (database).
2.3.1. Lifting remaining regulatory barriers
Regulations on inward FDI, as measured by the OECD FDI Regulatory Restrictiveness Index, are slightly less stringent than the OECD average, but more binding than in the most open OECD economies, such as the United Kingdom and the Nordic countries (Figure 2.15). This was mostly driven by the comparatively tighter restrictions on the mobility of key foreign personnel and investment screening based on the prior-notification requirement for designated business sectors. More stringent restrictions on the mobility of key foreign personnel are concentrated in a few highly regulated sectors, including broadcasting, air and water transport. In general, nationality is not a determining factor in Japanese business law. Foreign nationals can be appointed as representative directors of Japanese companies and board members. However, due to national security concerns, the appointment of foreign directors is effectively constrained by sector-specific licensing rules that cap foreign ownership.
OECD FDI Regulatory Restrictiveness Index, from 0 (less stringent) to 1 (most restrictive), 2024
Source: OECD, FDI Regulatory Restrictiveness Index (database).
Only FDI initiatives in designated business sectors are subject to prior screening, but the scope of these sectors has been steadily expanded (Box 2.1). Under the 2019 revised Foreign Exchange and Foreign Trade Act, foreign direct investment in such designated sectors must be pre-notified. Violations are subject to criminal penalties. The threshold for prior notification in listed companies was lowered from 10% to 1% of voting rights, which is stringent from an international perspective, although that was accompanied by the introduction of a prior-notifications exemption system.
Even before the effects of reforms started in 2025, administrative proceedings appeared not to be particularly burdensome, with a high clearance rate for planned investments (Box 2.1). The high clearance rate, however, largely reflects the authorities’ practice of engaging proactively with foreign investors at an early stage to mitigate potential risks associated with FDIs and reduce the likelihood of formal objections in later stages. To enhance the screening system’s effectiveness, the government is strengthening the capacity of Local Finance Bureaus – the regional branches of the Ministry of Finance (MOF) – to collect and analyse information to identify non-compliance cases and apply corrective measures more rapidly (MOF, 2025[50]).
Outside designated business sectors, foreign investors are only required to report inward FDI initiatives within 45 days of acquiring at least 10% of the voting rights in a listed company or any ownership stake in an unlisted company. Compliance entails submitting a post-investment report to the Bank of Japan, which generally consists of a standardised form requesting information on the investor, the Japanese counterparty, and the transaction, and can be filed electronically. The post-investment reporting obligation also extends to cases where foreign investors rely on the prior notification exemption scheme. The main function of post-investment reports is to allow the government to monitor foreign investment trends and assess whether follow-up supervision is warranted. Failure to submit such reports is also subject to criminal penalties.
Under the 2019 revised Foreign Exchange and Foreign Trade Act (FEFTA), foreign investors acquiring either at least 1% of voting rights in a listed company or any stake in an unlisted one – a relatively low screening threshold by G7 standards (Table 2.2) – need to file a pre-notification with the Ministry of Finance and relevant line ministries. This only applies to foreign investment in a set of designated business sectors deemed relevant for ensuring national security, maintaining public order and protecting public safety, as well as ensuring the smooth operation of the economy. These include semiconductors, energy and water supply, railway and marine transportation, broadcasting, telecommunications, cybersecurity, vaccines and pharmaceuticals, as well as agriculture and fisheries.
Note: Thresholds and other information in the mandatory pre-screening row are for listed companies. The number of mandatory pre-screenings is based on the most recent published data at the time of writing (Japan, Apr 2024-Mar 2025; United States, France and Italy, Jan-Dec 2023; United Kingdom and Canada, Apr 2023-Mar 2024; Germany, Jan-Dec 2024).
1. There is a prior notification exemption system (blanket exemption for foreign financial institutions, regardless of acquisition ratio; general exemption for general investors (acquisition ratio: 1%-10%) only if investors comply with certain conditions.
2. Prior notification is mandatory for any transaction granting foreign investors access to critical technologies, critical infrastructure, or sensitive personal data on US citizens, by controlling any share of a US business’ capital. Moreover, the mandatory filing requirement applies only when the foreign investors’ acquired rights related to businesses designing, testing, manufacturing, or developing critical technologies subject to US export controls. Only the total number of pre-screenings is displayed (including voluntary ones).
3. The number of applications subject to net benefit review is six. In addition, there are 1 195 notifications which can be provided up to 30 days after the investment has been made.
Source: Ministry of Finance (2025), Foreign Investment Screening System – Annual Report FY2024 and OECD Secretariat.
Upon submission of a prior notification, implementation of the investment is subject to a mandatory standstill period of thirty days, during which the authorities may review the transaction and request additional information. This review period may be extended by up to four months for more in-depth screening in sensitive cases or shortened where the investment is assessed as posing no risk under FEFTA regulations. The statutory standstill period lapses automatically absent any objection by the competent authority. In practice, 79% of the 2 903 prior notifications received (covering stock acquisitions and action-related cases) were screened within 14 days in FY2024. Among the 1 638 notifications for stock acquisitions, 89% concerned unlisted companies. Foreign investors withdrew 363 prior notifications. Overall, the authorities issued only three requests for reporting in FY2024.
The near-universal clearance of prior notifications and their relatively frequent withdrawals can largely be attributed to the authorities’ practice of engaging in informal communications with foreign investors before or after the official filing. Such exchanges allow for the early identification of transactions that may pose risks under FEFTA regulations, prompting investors either to cancel the planned investment or to recalibrate the project’s parameters and resubmit the notification. Failure to submit a prior notification exposes foreign investors to criminal penalties, particularly if the omission is intentional, concealed, reiterated, or not promptly reported once discovered. In FY2024, there were 356 non-notified cases, most of which reflected a lack of awareness of the system, prompting enhanced information initiatives. The authorities have been enhancing cooperation across relevant ministries and agencies, while strengthening monitoring and analytical capacity by increasingly using public announcements and drawing on a wider range of business information.
Source: Ministry of Finance (2025), Foreign Investment Screening System – Annual Report FY2024.
As foreign investment screening systems spread across countries (UNCTAD, 2025[51]), tighter screening conditions may also increase regulatory complexity. The authorities should ensure transparency in the regulatory objectives and practices of the screening regime to enhance the system’s predictability for foreign investors (OECD, 2025[52]). Regularly published guidelines, drawing on lessons and information emerging from early informal exchanges with foreign investors ahead of prior notifications, together with illustrative case studies, could help clarify sector-specific compliance standards for potential investors. Japan’s current rules place a greater emphasis on strict entry regulations than on post-screening requirements, making the regulatory approach less reactive to changes in shareholding structures that may modify the security implications of the initially accepted foreign acquisitions (Hiraki, 2024[53]). Better post-investment monitoring and enforcement could support regulatory transparency and ensure a more balanced approach between safeguarding economic security and maintaining open domestic markets.
2.3.2. Overcoming informal barriers to enhanced foreign investment
While Japan’s formal regulations on inward FDI are not too restrictive, integration into local business ecosystems often proves more challenging. This partly reflects informal barriers, most notably, language constraints and difficulty in navigating the regulatory environment.
Easing the language obstacle
Language barriers could weigh on Japan’s ability to meet the ambitious target of tripling the stock of inward FDI over the next decade. Language differences and geographical distance have been associated with lower bilateral FDI flows, with a strong penalty for non-English languages (Golesorkhi et al., 2024[54]). However, institutional and cultural proximity between host and source countries can mitigate this negative effect (Ly et al., 2018[55]). In this light, improving cross-border information flows is key to attracting more FDI.
Foreign-affiliated companies rank more effective foreign-language communication among the top improvements needed for doing business (JETRO, 2025[56]; JETRO, 2024[57]). Difficulties in the interaction with local partners and the limited availability of English-translated documents and websites emerged as key obstacles. Poor access to information increases costs, influencing investment incentives and entry strategies. Indeed, around 70% of surveyed foreign companies identified collaboration with local partners key for business expansion.
Some progress has been made. For example, Japanese financial authorities accept English-language documentation from foreign investors in targeted business areas. The Financial Services Agency, in cooperation with local branches of Ministry of Finance, established the Financial Market Entry Office (FMEO) in 2021. Acting as a single point of contact for newly or potentially entering foreign asset management firms, and investment advisory and agency businesses, the FMEO handles the full spectrum of related regulatory activity – from pre-consultation up to registration and the ensuing supervision –in English (FSA, 2025[58]).
The FMEO’s remit has broadened over time. Shortly after its launch, FMEO’s role was extended to cover certain Type I and Type II financial instruments. These are activities involving higher-risk securities or derivatives and financial assets defined as non-securities but still requiring regulation, respectively. However, the approach remains fragmented, as full Type I licences for broader securities operations continue to be subject to more onerous procedures outside FMEO’s scope. An evaluation of FMEO, with a view to expanding its scope of permitted business types (for example, to include full Type I financial instruments) and strengthening human resources to accelerate registration processes, could be considered.
In April 2025, the Tokyo Stock Exchange (TSE) made it mandatory for companies listed on its Prime Market (around 1 600) to release their financial results and timely disclosure documents in full in both Japanese and English. Already by 2024, 94% of target companies were disclosing earnings reports in English. Furthermore, 59% of companies were providing timely disclosure documents, although a substantial share consisted of partial translations (Figure 2.16). With respect to other key documents, TSE regards English translations as ‘desirable’ and preferably in full. While this is already common practice for investor-relations presentations, the number of listed companies for which English translations of corporate governance, shareholders’ meeting, and annual securities reports are not available remains considerable. Even as machine translation systems reduce the informational disadvantage faced by foreign investors, mandatory simultaneous translations would give these disclosures an official status. This may boost investor confidence.
Proportion of English disclosure across companies listed in Tokyo Stock Exchange Prime Market, %
Source: JPX (2025), Summary Report of the English Disclosure Implementation Status Survey, Tokyo Stock Exchange.
The government is working to ease language barriers for businesses. Under the 2025 FDI Strategy, the government is required to consider extending the preferential business regime currently applied in Japan’s four special zones for financial and asset management businesses (broadly covering main metropolitan areas and cities) to other local governments, subject to needs assessments (Cabinet Office, 2025[49]). These special zones offer lighter regulatory requirements and tailored support through local authority one-stop centres. The centres assist foreign firms with registration procedures, provide access to interpreters, and offer English-language support. In this context, they complement the FMEO’s role at the national level. The government also pledged to expedite translations of Japanese laws and regulations. This welcome step should be accompanied by enhanced efforts to ensure the timely English translation of key policies and relevant analysis.
Improving business matching
Business matching is a key component of FDI promotion strategies. The Japan External Trade Organisation (JETRO) serves as the primary gateway linking foreign investors with Japanese firms, offering tailored support to identify reliable partners and foster collaboration. It also provides market entry assistance, regulatory facilitation, and aftercare services for foreign-affiliated companies. Acting as a hub within Japan’s multi-layered FDI promotion system, JETRO connects ministries, local governments, domestic support centres and overseas networks with prospective investors through its digital platforms.
A revamped, free-of-charge digital platform promises to facilitate cross-border business matching. In 2022, JETRO replaced its long-running unvetted business-matching service (TTPP) with e-Venue, a more controlled and policy-aligned system augmented with a user-friendly interface. Unlike TTPP’s open-posting approach, e-Venue ensures higher quality by having all proposals checked and translated into Japanese before publication. Although not structurally coordinated with JETRO’s FDI promotion initiatives, the platform now includes around 20 000 users from more than 150 countries (JETRO, 2025[59]) and plays a key role in facilitating the establishment of cross-border investment partnerships, particularly between SMEs. Through E-Venue, users can search for opportunities, post offers and engage directly with prospective partners. The platform also integrates leads from JETRO’s overseas offices and Invest Japan Business Support Centres to support the development of concrete business collaborations.
JETRO also runs Invest Japan Business Support Centres (IBSCs) in six major cities (Tokyo, Yokohama, Nagoya, Osaka, Kobe, and Fukuoka). These are one-stop centres offering foreign investors temporary office space, multi-dimensional expert consulting, support for incorporation and licensing procedures and guidance on available national and regional incentives. They also offer tailored matching services, including curated meetings with potential domestic business partners. The development of digital IBSC services has been stepped up so that foreign investors can remotely access some of the services provided by JETRO’s 128 offices (76 overseas and 52 in Japan), including via online consultations with bilingual experts (JETRO, 2025[59]). Further extending the scope of support offered online, thereby bringing IBSCs closer to a virtual one-stop shop service, could help lower entry costs and strengthen perceptions of Japan as an accessible business location. Regularly evaluating the pipeline of inward FDI projects supported through the IBSC network could help identify best practices and get value for money.
In playing a key facilitating role in the promotion of inward FDI, one-stop IBSCs are complemented by JETRO’s Invest Japan Business Hotline. This offers foreign investors a readily available front-end coordination mechanism, helping to mediate and assist in interactions with relevant ministries and agencies when regulatory bottlenecks arise. The Hotline also helps relay investor concerns and coordinate follow-up with competent authorities. Even so, prospective investors making use of IBSCs’ support must still interact separately with other ministries or public agencies to secure the requisite licenses and approvals. This reinforces the impression of an overly complex institutional framework, while increasing the risk of procedural duplication and higher compliance costs. To address similar challenges, some OECD countries have streamlined their inward FDI institutional frameworks by establishing more centralised investment promotion agencies (Box 2.2). In this context, strengthening the co-ordination mandate of IBSCs can improve their one-stop function. A simplified institutional landscape, combined with the digitalisation of key enabling public services, would also contribute to more effective domestic investment promotion.
Ireland’s Industrial Development Agency (IDA) operates, since 1994, as an increasingly centralised and hands-on inward investment promotion agency, effectively acting as a one-stop shop for foreign investors. As a statutory agency operating under the aegis of the Department of Enterprise, Trade and Development, IDA serves as the main point of contact for investors from initial enquiry through establishment and expansion. While formal approvals remain with the competent authorities, IDA’s project-management role allows regulatory, location, and incentive discussions to proceed in parallel. Combined with its direct administration of a broad range of financial incentives, this model substantially reduces administrative complexity and enhances procedural clarity.
The United Kingdom’s approach to foreign investment promotion pursues similar simplification policies, albeit within a somewhat less centralised institutional framework. The Department for Business and Trade (DBT) serves as the primary entry point for foreign investors, while the Office for Investment (OFI) acts as a dedicated cross-government coordinator for strategically significant projects. Together, they provide project-management support that aligns regulatory processes and helps resolve bottlenecks across authority levels. While regulatory authority and incentive provision remains distributed, this functional specialisation helps streamline investor engagement and reduce administrative frictions.
Source: OECD Secretariat based on OECD Investment Promotion Agency Network and national sources.
Boosting Japan’s productivity performance will depend on broader innovation diffusion and advanced skills development, supported by strong research pathways and international talent. More efficient resource reallocation, including the timely exit of low-productivity firms, is also essential to free resources for more innovative start-ups. At the same time, sizeable productivity gains could be unlocked through greater adoption of digital and AI technologies.
2.4.1. Making the R&D system a catalyst for widespread innovation diffusion
Japan’s appeal to foreign investors is deeply rooted in its technological prowess and long history of industrial excellence. Survey evidence from executives of large global companies suggests that high technological and innovation capacity is perceived among the main drivers of foreign investment in Japan, ahead of economic performance and quality infrastructure (Kearney Foresight, 2025[60]). Indeed, foreign-affiliated companies consider the R&D capabilities of domestic companies and research institutions a key competitive advantage of Japan’s manufacturing sector (JETRO, 2024[61]).
Japan has one of the highest levels of research and development (R&D) spending in the OECD (Figure 2.17, Panel A). However, the average annual real growth rate of around 1% since 2013 is one of the lowest in the OECD. Measured by expenditure, 79% of R&D activity is concentrated in the business sector, of which about 86% is undertaken by manufacturing firms. This composition limits the potential contribution of services to aggregate productivity growth. Only around 4% of business R&D spending is allocated to the ICT sector, compared with 31% in the United States. SMEs undertake around 5% of business R&D, the lowest share among OECD countries (Panel B). This reduces the scope for innovation and diffusion, reducing the likelihood that small firms will develop breakthrough innovations and subsequently scale up.
Limited integration with international innovation networks and linkages across the domestic R&D ecosystem are constraints to greater innovation and diffusion. The share of R&D expenditure funded by foreign sources was 0.6% of the total in 2023, the second lowest in the OECD. However, international interest in innovative Japanese SMEs is growing. Foreign-funded R&D carried out in firms with 10-49 employees has increased by almost fivefold compared with the 2015-19 average, albeit from a low base.
Note: 1. Includes higher education and private non-profit sectors. 2. SMEs refer to firms with up to 249 employees. Data for France, Ireland, Norway, and Sweden exclude R&D projects from firms with less than 10 employees.
Source: OECD, Main Science and Technology Indicators; and OECD, Research and Development Statistics database.
Despite a relatively generous tax credit for joint research projects with universities and certain public research institutions (30% of R&D expenses can be deducted from corporate tax liabilities), business funding for research performed in universities and public research institutions accounted for only 0.9% of business-financed R&D expenditures in 2023. Likewise, government’s direct funding of business R&D remains well below the OECD average (Figure 2.18, Panel A). A relatively siloed approach to innovation constrains total spending on basic research (Panel B), of which 46% is performed by businesses. This could limit the extent to which basic research serves broader, collective objectives, as universities – key actors in more socially-oriented research – account for only 37% of basic research, around twenty percentage points below the average in the OECD countries with available data. Strengthening research partnerships between businesses, public research institutions and universities may help in this regard.
2024 or latest year available
Source: OECD, Research and Development Statistics database.
Public support to business R&D is largely based on tax incentives. The overall public support for business R&D – at 0.2% of GDP in 2023 – lags the OECD average. Around 75% of this support is allocated through R&D tax support (Figure 2.19, Panel A). There are two stand-alone but combinable tax credits with various scheme-specific and aggregate ceilings on allowable tax relief (METI, 2024[62]). These schemes serve different policy goals, are separately administered, and apply distinct eligibility criteria and rate calculations (Table 2.3). A recent tax reform introduced enhanced R&D tax credit rates for business investment in strategic-technology research fields (MOF, 2025[63]), which could increase fragmentation. Conditional on an approved multi-year R&D plan, the scheme would apply a 40% tax credit rate from FY2027, rising to 50% for joint research with universities or certified public research institutes. These changes are accompanied by streamlined documentation and certification requirements for open innovation projects.
2023 or latest year available
Source: OECD, R&D Tax Incentives database.
Note: R&D tax credit rates are subject to both scheme-specific and aggregate ceilings, expressed as the maximum share of corporate income tax liability that can be offset through the credit. In both schemes qualifying research and experimental expenditures cover all R&D costs except for services not directly linked to R&D activities. The open-innovation credit is typically subject to a stand-alone ceiling of around 10%. For qualified R&D venture companies, the combined use of General R&D tax credit and the Open Innovation Activity-Based R&D tax credit may raise the aggregate ceiling to as much as 60%. SMEs are firms with capital below JPY 100 million. The table does not include the enhanced R&D tax credit scheme for investment in strategic technologies, approved in late March 2026. For additional details, see https://stip.oecd.org/innotax/countries/Japan.
Source: OECD, INNOTAX portal; and (METI, 2024[62]).
Stability and predictability are key determinants of effective R&D tax incentives (Appelt et al., 2016[64]). Repeated revisions, many of which have stemmed from temporary provisions, including the temporary introduction of dynamic deduction ceilings (i.e. varying depending on the rate of increase or decrease in experimental research expenditures) in 2023, have lowered the predictability of Japan’s system. The resulting administrative burdens for smaller firms, particularly start-ups (Nagato, 2024[65]), may partly explain SMEs’ significant under-representation in business R&D expenditure, as also reflected in their low share of total public support for R&D, namely through tax incentives (Figure 2.19, Panel B).
A more streamlined and stable system of tax incentives would help enhance their uptake among smaller innovative businesses, which are more likely to be the ones supporting higher productivity growth. Implementation and compliance functions for the R&D tax credits are handled by the National Tax Authority under the Ministry of Finance, whereas METI ensures policy design, sometimes supported by Ministry of Education, Culture, Sports, Science and Technology for issues on collaboration with universities. The Cabinet Office, through the Council for Science, Technology and Innovation, provides strategic oversight and ensures the overall alignment of research promotion policy with national innovation targets. Highly centralised governance structures are ill-suited to delineate responsibilities and evaluate outcomes for increasingly complex and multi-actor innovation systems (Larrue et al., 2024[66]). Strengthening feedback channels between the authorities and actual and potential R&D tax credit users to adapt policy may help the schemes to become more effective in promoting innovative SMEs.
The design of R&D tax incentives should be reformed and where possible, simplified. Firms’ responsiveness to such incentives is markedly higher when these are decoupled from firms’ profitability, for instance when tax relief is refundable or can be redeemed against payroll taxes (Appelt et al., 2023[67]). Some countries have preferential tax relief provisions for SMEs, either through enhanced tax credit rates or SME-specific refundability provisions. Allowing the carry-forward of unused R&D tax credits is equally beneficial. Hence, the design of R&D tax incentives should allow firms to devote a larger share of their resources to R&D, even when they have little or no taxable income, as is typically the case for young and high-growth start-ups.
As highlighted in the 2024 OECD Survey of Japan, the absence of mechanisms, such as carry-forward or refundability for unused tax incentives, has limited access to R&D subsidies among firms with low or no tax liabilities. As a result, support remained largely concentrated on established, profitable firms, weakening investment incentives for new ventures. The government amended the Act on Special Measures Concerning Taxation in March 2026 to allow SMEs to carry forward unused R&D tax credits for up to three years from FY2027, which is welcome. However, under the general R&D tax credit, this was accompanied by a revision to the credit rate curve, making it less favourable to companies not increasing R&D spending over time. The SME carry-forward mechanism could also be complemented by measures making the credit refundable for innovation activities aligned with specific policy objectives (e.g. projects fostering systemic innovation), which would help ensure more equal access and broaden the innovation base. Combining these measures with caps on the overall amount of unused tax incentives that can be carried forward or refunded could help limit their fiscal costs.
Direct R&D support is an important complement to R&D tax incentives and is broadly comparable in effectiveness. The tax incentive effect is more pronounced for liquidity-constrained smaller firms – confirming previous Japan-specific results from firm-level data (Kobayashi, 2014[68]) – and inversely related to the initial level of R&D (OECD, 2024[69]). OECD micro-based cross-country analysis of the impact of innovation support instruments finds that every additional unit of government direct funding or tax support yields, on average, a gross incrementality ratio of around 1.4 units of additional business R&D (Appelt et al., 2023[67]).
A greater use of direct grants would effectively complement R&D tax incentives and help align business investment with specific policy priorities. With few exceptions (OECD, 2024[69]), tax incentives are designed to be technology neutral and are therefore insufficient to direct innovation towards specific priority areas. They also increasingly require frameworks to address potential fraud or misuse (Dai and Zou, 2025[70]). On the other hand, wider deployment of direct support can promote business investments in basic and applied research (Appelt et al., 2023[67]) and target specific objectives, such as reducing the financing gap for intangible investment by high innovation potential start-ups. Competitive grant schemes contribute to more effective transformational innovation, as they tend to encourage early-stage basic and applied research (OECD, 2020[71]). Although associated with higher relative costs, well-designed competitive grants are better suited to supporting high risk, high impact projects while limiting the risk of squandering resources by picking winners.
The government has broadened its approach to R&D support by complementing input-based subsidies with a new output-based incentive. Effective from April 2025 for a period of seven years, a new Innovation Box scheme offers a 30% tax deduction on qualified income derived from patents and AI-related software developed through domestic R&D (METI, 2025[72]). By proportionately linking benefits from the intellectual property (IP) regime to domestic R&D expenditure, the scheme aligns with Action 5 of the OECD/G20 Base Erosion and Profit Shifting (BEPS) minimum standard (OECD, 2015[73]). Access is conditional on certification by METI confirming that the intellectual property falls within the scheme’s scope. In the case of AI-related software, additional approval from an authorised third party (e.g. the Software Association of Japan) is required (Abe et al., 2024[74]).
The objective of the new scheme is to position Japan as an innovation marketplace. However, with corporate tax rates – including local taxes – at around 30%, the Innovation Box regime is expected, at best, to reduce the applicable tax rate to about 21%. The box should be regularly assessed to ensure it is supporting new innovations. This is because tax incentives, especially intellectual property regimes, tend to concentrate monetary benefits among larger incumbents and may be a less cost-effective way to support innovation compared to tax credits and grants (Appelt et al., 2023[75]). The implementation of the OECD Global Minimum Tax, which introduces a 15% effective minimum corporate tax rate for large multinationals, may further limit the attractiveness of income-based tax incentives compared to expenditure-based ones (OECD, 2022[76]), prompting many countries to reconsider their tax incentive frameworks.
2.4.2. Promoting an effective skills pipeline
Japan’s ability to innovate will largely depend on cultivating a workforce equipped with advanced and adaptable skills. Japan’s current innovation capacity, measured by the number of R&D researchers per 1 000 employed persons, was around the OECD average in 2023 (Figure 2.20, Panel A). This masks a trend divergence from Japan’s main competitors, where the number of researchers has risen faster than overall employment since 2015, whereas in Japan both have grown at a similar pace (Panel B). This limited expansion partly reflects the comparatively weak pipeline of new talent emerging from the tertiary education system.
Note: 1. 2024 or latest year available. 2. Unweighted average of Denmark, Finland, Norway, and Sweden.
Source: OECD, Research and Development Statistics database.
Making research-oriented education pathways more attractive
The share of graduates in science, technology, engineering, and mathematics (STEM) fields, at around 20% of the total in 2023, trails the OECD average (Figure 2.21, Panel A). This is particularly the case for women, whose STEM share in total graduations at 3.6% is the lowest in the OECD. Japan’s ranking in the share of PhD graduations in STEM is also low (Panel B), although this partly reflects the overall lower share of PhD holders (35-40% of that in Germany and the United States). The rate of advancement to doctoral programmes peaked in 2000 at 17% before falling back to under 10% more recently. Moreover, around 40% of entrants to doctoral programmes in FY2024 were working adults (NISTEP, 2025[77]). As highlighted in the 2024 OECD Survey of Japan, this relatively weak interest for research-oriented careers partly reflects stagnant wages, slow career progression and limited academic opportunities for younger and female professors (Panels C-D).
With Japanese 15-year-old pupils the highest-scoring in mathematics and science across the OECD, boosting the share of STEM graduates will require building active interest for scientific professions, starting from primary and lower secondary education levels. For this purpose, in FY2024, the Ministry of Education, Culture, Sports, Science and Technology launched a project to review how problem- and enquiry-based teaching approaches could be leveraged in primary and lower secondary schools to stimulate pupils’ concrete interest in these subjects (MEXT, 2024[78]). Results from pilot projects indicate that allowing pupils to identify their own problems helps them perceive the relevance of science and mathematics to everyday life, but adequate teacher training is a key factor to the initiative’s success.
The underrepresentation of women in STEM education and career pathways partly reflects stereotypes that scientific professions are too work-intensive to reconcile with family and maternity responsibilities (Katsumura, 2023[79]). To counter such stereotypes, the Gender Equality Bureau – a central government body tasked with formulating, coordinating and promoting national gender policies – organises workshops to raise awareness and interest in STEM careers among girls of all ages and their parents through the RICO-challenge programme. The STEM Girls Ambassadors and Girls Meet STEM in Tokyo programmes also connect female STEM professionals with lower and upper secondary schools. These welcome initiatives should be supported through effective female mentoring to promote STEM vocations among female students in upper secondary and in early university years (OECD, 2024[80]).
Note: Panels A and B: STEM refers to engineering, manufacturing and construction, information and communication technologies, and natural sciences, mathematics and statistics. The OECD refers to the unweighted average of OECD countries with available data.
Source: OECD, Education at a Glance (database).
Recent policies to lift the number of doctoral students receiving annual living expense support of around JPY 1.8 million – potentially rising to about JPY 2.9 million when combined with research-expense components under specific schemes – are expected to increase interest in research careers. These could be complemented by making university employment and salary systems more flexible, based on effective performance evaluation frameworks. Universities are allowed to use external funds from donations, competitive or joint research projects for personnel expense funding, supporting research posts and structures. In addition, external funds attracted by universities are not offset against the amount of government subsidies for national university corporations provided by the Ministry of Education, Culture, Sports, Science and Technology, when calculating future allocations (MEXT, 2025[81]). This could significantly strengthen universities’ willingness to engage in research with broad potential applications across science and industry. The implementation of these measures should be regularly evaluated to ensure they support high-quality research and effective use of resources.
Greater financial autonomy could also enable universities to better insulate research staff from excessive involvement in administrative and managerial tasks (OECD, 2024[80]). Progressively setting lower caps on the share of time that different academic positions may allocate to non-research activities could lead to a more innovation-friendly work environment. Likewise, easing seniority norms in project management and delinking young researchers’ funding from mandatory affiliation with associate or full professors could encourage more innovative projects. Making cross-organisational experience, staff-development capacity, and advances in gender and age diversity key promotion criteria for senior university managers could foster stronger innovation in university management.
The gradual operationalisation of the University Endowment Fund could have a significant impact on Japan’s innovation ecosystem. Established in 2022, the Fund aims to use the investment returns from its JPY 10 trillion initial capital to provide selected universities long-term funding to transform their innovation systems. The resources are intended to strengthen research infrastructure, improve researchers’ wage and working conditions to attract top talent. This can be promoted through a new tenure-track system providing early- and mid-career researchers greater autonomy and supervision roles, and foster university start-ups. While selected universities will enjoy full discretion in the use of these funds, support is conditional on their commitment to institutional reform, the existence of credible business and financial strategies and the implementation of autonomous and accountable governance structures. The fund awarded JPY 15.4 billion to Tohoku University in March 2025, while Institute of Science Tokyo has been selected following the second round of applications and started to receive funding in April 2026. Continued monitoring should ensure that funded research does not become locked into preferred technologies or purely commercial pathways.
Creating suitable conditions for international talent
Given shrinking cohorts and the reduced propensity to enter STEM careers, attracting international students is essential to securing the skills base for innovation-driven productivity growth. International student mobility was the eighth highest in the OECD in 2022, with international students accounting for 4.2% of total tertiary enrolments (OECD, 2025[82]). After declining during the pandemic, the number of foreign students enrolled in Japanese higher education institutions rebounded in 2024, with around 25% pursuing studies in science and engineering. Asian nationalities account for more than 92% of the total, with students from China, Nepal, and Viet Nam as the largest communities (JASSO, 2025[83]).
Japan has a well-developed framework and various policies to attract and retain international students and researchers, such as post-secondary scholarships and highly competitive postdoctoral research fellowships and programmes. Some recent reforms could have unintended adverse signalling effects to international students, and communication of their rationale is crucial. For example, the 2024 reform allows national universities to set tuition fees for international students at a level above the government-defined benchmark, as is the case in several other OECD countries. The reform aims to strengthen national universities’ autonomy and financial sustainability and enable them to provide more internationally attractive educational and research programmes. Similarly, international doctoral students’ access to the living-expense component of subsidies paid under the Support for Pioneering Research Initiated by the Next Generation (SPRING) programme will be discontinued from FY2027, while preserving support for research expenses. The aim is to bring the scheme in line with its original purpose of broadening access to doctoral careers for excellent Japanese students in strategic research areas. The potential impact of such policies on international enrolments should be monitored.
Japan has had moderate success in attracting foreign academics, who accounted for around 5% of full-time academic staff in 2024 (MEXT, 2025[84]). However, survey evidence points to many international academics experiencing limited access to responsibilities, professional development and career advancement (Chen and Chen, 2023[85]). This partly stems from cautious recruitment practices, where universities often prioritise candidates perceived as more likely to remain in Japan (Chen, 2024[86]). Such a conservative stance risks constraining knowledge spillovers, while selected ‘pragmatist’ candidates may eschew more ambitious career trajectories within Japan’s relatively secure academic job market. This reinforces the need for strengthened retention policies, starting from transparent career progression pathways based on effective performance management assessment frameworks.
Japan’s immigration pathway for highly-skilled professionals is well-developed. Under the Highly Skilled Professionals visa, researchers, business managers and highly-specialised workers are granted a five-year stay and benefit from preferential treatment for permanent residency, the ability to engage in multiple professional activities, and facilitated entry and employment conditions for family members (ISA, 2025[87]). The government is also strengthening efforts to support the school enrolment of foreign children, aiming for a nationwide model to be rolled-out by the end of FY2026, expanding multilingual support in key medical institutions and developing a new website providing multilingual information and practical guidebooks on housing (Cabinet Office, 2025[49]). Such policies to integrate migrants should be continued (Chapter 1).
2.4.3. Increasing the efficiency of resource allocation
Making public support to SMEs more effective
Public financial support for SMEs has receded from its pandemic peak but remains well above pre-COVID levels, potentially weighing on the efficient allocation of resources. By March 2025, public-guaranteed loans, still offering a generous 80% coverage, were held by 44% of all SMEs. This amounted to 5.3% of 2024 GDP and 9.6% of all outstanding SME loans, which is substantially above FY2019’s 3.6% of GDP (Figure 2.22, Panel A). SMEs also received direct loans from public financial institutions worth an additional 4.2% of GDP. Broad-based guarantees and subsidised loans help non-viable firms remain afloat, delaying restructuring and hindering the reallocation of resources toward more dynamic businesses. Likewise, generous guarantees by Credit Guarantee Corporations, which cover the credit risk of private banks and are re-insured by the publicly-owned Japan Finance Corporation, lowers banks’ risk exposure and may weaken credit screening. Lowering guarantee coverage rates, as recommended in the 2024 OECD Survey of Japan, would help strengthen banks’ risk assessment. Improving systematic data collection on recipient firms’ characteristics (e.g. size, sector, profitability, repeat-borrowing status) would also enable regular evaluations of the scheme’s impact across different firm categories, allowing support to be more effectively targeted across SME segments.
Japan’s public credit guarantee scheme channels most SME support through bank lending, reinforcing reliance on traditional credit relationships and limiting the development of alternative financing options. This has also encouraged a conservative lending culture, with banks historically favouring real-estate collateral and personal guarantees, which constrains innovative, asset-light firms. Even so, recent data shows that over 52% of SME loans are now issued without manager personal guarantees, up from 12% in FY2015 (Figure 2.22, Panel B). More flexible financing practices that are gradually taking hold should be reinforced by ongoing progress in reforms aimed at boosting the financing of innovation.
In May 2025, the government enacted legislation clarifying the legal framework for collateralising movable property and receivables. Previously, such practices – often involving temporary transfers of ownership of assets like machinery, inventories, or the pledging of receivables – relied largely on court precedents (MoJ, 2025[88]). The new rules, set to take effect in late 2027, should support broader use of existing receivables-based financing instruments, including the “Liquid Asset Secured Loan Guarantee System” operated by regional Credit Guarantee Corporations. By improving legal certainty, the reform is expected to ease short-term cash-flow volatility for SMEs and strengthen their ability to invest and scale up, although the impact will depend on robust valuation methods and lender uptake.
Note: The axis refers to fiscal years. Direct loans in Panel A refer to loans granted by government-affiliated financial institutions.
Source: Japan Finance Corporation, Guide to the Operations of the SME Unit – 2025; METI; OECD, Economic Outlook (database); and Financial Service Agency.
Reforms that will allow incorporated firms to use intangible assets as collateral by end-2026 are progressing. The Enterprise Value Charge (EVC), created under the 2024 Act on the Promotion of Cash Flow-Based Lending, introduces a security interest over a firm’s enterprise value, enabling the use of intangibles, goodwill, and future receivables as collateral (JBA, 2025[89]). The authorities plan to restrict EVC to corporations, require a security-trust agreement with a licensed non-possessory EVC-holder and make the charge effective only upon registration (FSA, 2025[90]; FSA, 2025[91]; Baker McKenzie, 2024[92]). While the scheme may expand financing options for innovation-oriented firms, its complexity and trustee-related costs could initially limit usability for smaller companies until valuation and operational practices mature.
Implementing the EVC poses several challenges. Financial authorities are preparing supervisory guidance, coordination arrangements, and templates to help banks build the necessary operational infrastructure (FSA, 2025[90]), while commercial registries require major upgrades and staff training to support enterprise-level security filings. Banks, which are expected to serve as primary advisers to debtor firms on strategies to enhance enterprise value, will need to adapt processes and capabilities significantly. Regulation must also ensure a level playing field, as trustee companies may simultaneously act as a debtor’s main bank. Although expected to reduce trust-related costs, such an overlap could have implications for competition. If EVC-related transactions concentrate among a small number of financial institutions, banks could use the new system to lock in borrowers and refrain from offering value-enhancing support (JBA, 2025[89]). While regulations allow debtors to request principal fixation at any time, preserving formal refinancing optionality, the effectiveness of this mechanism in limiting main banks’ bargaining power should be regularly monitored. The EVC’s ability to strengthen innovation financing will depend on a flexible regulatory framework that allows market dynamics to guide its evolution. At the same time, meaningful protection in insolvency proceedings, where the charge – which is secured only upon registration – remains subject to enforcement stays and potential subordination to pre-existing security interests, should be ensured (Sakai and Yoshizawa, 2025[93]).
Boosting the efficiency of firm exit and restructuring
Rising uncertainties and the exit from pandemic-related financial support measures have led to an increase in the number of corporate bankruptcies involving debts of at least JPY 10 million (EUR 61 600) in 2023-25 (Figure 2.23, Panel A). This number is around the long-term average. Deteriorating business conditions among firms with fewer than 10 employees accounted for 89% of all bankruptcies. This largely reflects the phasing out of COVID-19 special tax deferrals, persistent labour shortages and rising price pressures. These factors have weighed on the profitability of less-structured businesses, especially in services and construction (Tokyo Shoko Research, 2025[94]). Monthly bankruptcy data point to a further year-on-year increase in bankruptcies during the first quarter of 2026.
Note: Panel A: Bankruptcies with total debt of JPY 10 million or more. Bankruptcy is defined as the company's inability to repay its debts or continue economic activity and includes private bankruptcies, i.e. suspension of bank transactions and internal reorganisation. Panel B: Voluntary exits refer to company's suspension, closure, and dissolution. Profitable and loss-making firms are based on net income for the period immediately prior to the suspension, closure, or dissolution.
Source: Tokyo Shoko Research, National Corporate Bankruptcy Situation and Teikoku Databank, Nationwide Corporate Suspension, Dissolution, and Dissolution Trends Survey.
Weaker profitability in low margin sectors, driven by rising input costs and wages, also led to an increase in voluntary exits. Around 68 000 firms (around 2% of total firms), completed non-judiciary business exits through suspension, closure, or dissolution procedures in 2025 (Teikoku Databank, 2026[95]). However, only about 51% of these voluntary exits involved loss-making firms (Panel B). Almost two thirds (63%) of exiting companies had positive asset-liability gaps – a record high – and roughly one-quarter of these also reported net profits. Although the share of viable companies in total voluntary exits has steadily declined since 2020, their absolute number remains higher than pre-pandemic levels. The rapid ageing of business owners, together with policy efforts to promote orderly business cessations, appears to underpin the rise in voluntary exits. In 2025, the average age of managers, who suspended, closed, or dissolved their businesses, reached a record-high of 71.5, while nearly one-quarter of all voluntary exits involved owners aged 80 or above (Teikoku Databank, 2026[95]), reflecting weak business succession transitions.
The share of zombie firms remains high despite the phasing-out of pandemic support
Extensive public SME support contributed to a rise in the share of zombie firms, i.e., businesses that remain active despite persistent losses and earnings insufficient to cover interest payments. While the zombie share fell from 18% in FY2022 to 14.3% in FY2024 (to about 210 000 businesses), as pandemic-era support was scaled back and repayments on “zero-zero” loans began, they remain high compared to pre-pandemic levels (Figure 2.24, Panel A). Zombies are especially concentrated among smaller firms, at 21% of those with fewer than six employees (Panel B). Economic non-viability, however, is not limited to SMEs. OECD Secretariat estimates show that zombie rates among listed companies follow the same trend, albeit at lower levels, with the pandemic shock hitting listed companies more severely than the 2008 financial crisis, partly due to the concentration of public support on SMEs (Panel A).
Note: 1. Zombie firms are firms that have been established for at least 10 years and report an interest coverage ratio below one for three consecutive fiscal years and. 2. Firms listed in the Premium and Standard Markets of Tokyo's Stock Exchange.
Source: Teikoku Data Bank and OECD calculations based on Worldscope data.
Public loan guarantees, subsidised lending, and creditor forbearance may distort competition and weaken effective resource allocation, by enabling non-viable firms to withstand substantial shocks. Large concentrations of zombie firms tie up resources in low-productivity incumbents, crowding out more efficient businesses (Adalet McGowan et al., 2017[96]). Empirical evidence for Japan shows that rigid exit processes in the 1990s have imposed significant costs on potential output (Caballero et al., 2008[97]). The relatively high share of non-viable SMEs may help explain Japan’s low exit rates and delayed restructuring, lowering productivity growth. Strengthening resource reallocation mechanisms is thus paramount.
Making the insolvency regime more flexible
Greater business dynamism depends on insolvency rules that enable the timely exit of non-viable firms at minimal cost, while providing flexibility to restructure viable ones, supporting resource reallocation, risk-taking, and productivity growth, especially in intangible-intensive sectors (Demmou and Franco, 2021[98]). Post-pandemic reforms in many OECD countries have increasingly embedded pre-insolvency and simplified resolution tools into statutory frameworks, while Japan has focused on improving the conditions of existing out-of-court mechanisms (Ueno et al., 2025[99]). Japan’s court-led insolvency framework performs relatively well internationally and prioritises business continuation (André and Demmou, 2022[100]), complemented by size-dependent out-of-court workout schemes. Despite efficient case handling and predictable timelines, high procedural costs and the stigma of bankruptcy deter debtors’ use of formal procedures (Ueno et al., 2023[101]). As of 2024, 89% of court cases were ordinary bankruptcies, with only a small share involving corporate reorganisation and civil rehabilitation, the two restructuring procedures (Box 2.3).
Rigid eligibility and operating criteria have limited the uptake of Japan’s out-of-court restructuring schemes. As a rule, the SME Turnaround and Turnaround Alternative Dispute Resolution frameworks – introduced in the 2000s as rules-based, privately administered procedures – exclude non-financial creditors and lack cram-down mechanisms, requiring unanimous creditor consent to approve restructuring plans (Box 2.3). This constrains their speed, predictability, and scope in cases where creditors’ interests are not perfectly aligned. The 2025 Early Business Recovery (EBR) Act established a hybrid out-of-court scheme for all firms, allowing those at risk of financial distress to recover their business before formal insolvency. Expected to become operational by end-2026, the scheme tasks independent entities designated by METI with verifying a debtor’s pre-insolvency status and reviewing its recovery plan. Under the Act, a resolution to modify the unsecured portion of the relevant claims becomes binding if approved by creditors representing 75% of the voting rights. Where a single creditor holds 75% or more of those rights, an additional majority vote is required. Courts also ensure the scheme’s fairness and procedural integrity. Proceedings are confidential and apply only to financial liabilities, with adjustments limited to unsecured portions of secured claims. Temporary stays on enforcement can be granted to preserve assets throughout the procedure (METI, 2025[102]).
In addition to ordinary bankruptcies, Japan’s in-court procedures include one special liquidation procedure and two restructuring schemes serving different firm sizes. The special liquidation is a simplified, court-supervised winding-up under the Companies Act, mainly for solvent or near-solvent firms that have resolved to dissolve. It offers a lighter, lower-cost alternative to bankruptcy, often used for voluntary or group restructurings. Corporate reorganisations provide creditors with stronger protection by excluding debtors from business operations, which are taken over by a court-appointed trustee. Procedural complexity and higher costs make them suitable mostly to large-scale insolvencies (13 cases in 2024). The civil rehabilitation procedure enables debtors to continue business operations while restructuring their liabilities, based on a court-approved and supervised business revitalisation plan. This must be backed by the majority of creditors, both in number and representative value (at least half of total claims). A simpler civil rehabilitation procedure for individuals with small-scale debts is available to sole proprietors whose debt levels fall below given thresholds, lowering court fees and administrative costs. The take-up of civil rehabilitations decreased by approximately 20% in 2024, leaving them at a historical low of 91.
Japan also operates two main out-of-court restructuring frameworks, with judicial involvement only if enforcement is later sought. Both apply solely to financial creditors and require unanimous consent for approving a business revitalisation plan. The SME Turnaround scheme supports SMEs through a coordinated process led by appointed turnaround experts who help prepare the revitalisation plan and mediating negotiations. For medium-to-large firms, the Turnaround Alternative Dispute Resolution (ADR) offers a formally administered workout conducted by a certified ADR organisation.
Source: Ueno, H. et al. (2024), Chambers Global Practice Guide: Japan Insolvency 2024, Nishimura & Asahi.
The use of the EBR by SMEs could be restricted by its procedural costs, as the EBR does not explicitly subsidise experts’ involvement in the formulation of the recovery plan, in contrast to the SME Turnaround scheme. To strengthen SME incentives to use the EBR, the authorities could subsidise EBR costs for SMEs. In addition, there is a risk that financial creditors have a preference to use the other options, where their bargaining power is stronger.
Improving business successions
Growing numbers of voluntary exits by companies owned by managers older than 69, who accounted for around 63% of closures in 2023, partly reflect the rising share of SME managers in this age group (Figure 2.25, Panel A). Lack of adequate succession planning is also a key driver, with around 50% of all SMEs lacking or not yet having identified a successor in 2025, an improvement from the 67% peak in 2017, but still high. The absence of a successor affects about 22% of firms with managers older than 80. Limited availability of suitable younger candidates is an additional constraint, particularly in rural areas with a high prevalence of family-run businesses, reflecting population ageing and generational divides in career preferences (Teikoku Databank, 2025[103]). Although still at an earlier stage of the demographic transition, several Central European OECD countries – where SMEs are predominantly family-owned – are already facing similar issues (Schiefer et al., 2019[104]). In this context, policy measures implemented in Japan may offer valuable lessons.
Note: Panel B: M&A refers to the total of acquisitions, secondments, and spin-offs, while Entrepreneur refers to cases in which the founder remains or resumes the role of representative because no successor has been appointed.
Source: Teikoku Data Bank and Small and Medium Enterprise Agency, 2025 Small and Medium Enterprise White Paper.
While some liquidation is inevitable given the changing demographic conditions and could create economies of scale for remaining firms, the liquidation of a large share of viable businesses due to a lack of successors should be monitored. The likelihood of a smooth succession increases with firm size (Xu, 2023[105]), while smaller and low-growth firms are less likely to have identified a successor and, when they have none, tend to hold more cash (Tsuruta, 2021[106]). Older managers without a successor are more likely to close their business or experience bankruptcy, suggesting that voluntary exit at retirement is often the preferred path for smaller owners. At the same time, firm- and industry-specific experience has become an increasingly important criterion in succession decisions, outweighing family ties, with the share of family-based successions at 32% falling below internal non-family promotions at 36% (Panel B), and with 84% of successors having at least ten years of industry-specific experience (Teikoku Databank, 2025[103]).
Under the Business Succession Tax System, transfers of non-listed company shares – or business assets for sole proprietors – to a successor, even one with no prior connection to the firm, can benefit from substantial tax deferrals and, for SMEs, potentially full exemptions (for example when the successor becomes a director, employment levels are maintained or a Special Succession Plan is submitted). This generous treatment, however, discourages alternative succession routes taxed under standard income-tax rules, including outright third-party sales or M&As, which SMEs already perceive as complex and procedurally costly. To mitigate this bias, the authorities have expanded support through the national network of Business Succession and Transition Support Centres (BSTSCs). These bodies offer subsidies, targeted M&A advisory services, an online succession and M&A matching platform operated by the Japan Finance Corporation and a public registry of certified M&A advisors. As a result, BSTSCs facilitated 2 132 M&A-based succession transactions in FY2024, up from 923 in FY2018, out of more than 16 000 firms that sought consultation (OSMER, 2025[107]). The efforts to scale up M&A succession and matching support should be further strengthened, while gradually realigning the tax treatment of different succession modalities to reduce distortions between special-regime transfers and other commercially viable succession options.
2.4.4. Boosting the adoption of advanced digital technologies
Japan ranks 30th out of 69 countries according to the IMD’s World Digital Competitiveness Index (IMD, 2025[108]). While the digital infrastructure is well-developed, uneven take-up of digital innovation, particularly by SMEs and the public sector, has weighed on productivity growth, as discussed in depth in the 2021 OECD Survey of Japan. Hence, it is welcome that the government is prioritising digital transformation (DX), with the establishment of the Digital Agency in 2021 and the adoption of the Priority Plan for the Advancement of a Digital Society in 2025 (Digital Agency, 2025[109]).
Digital transformation by the public sector can streamline processes and create transparent and effective government functions. Japan’s digitalisation of the public sector is lagging according to the 2022 OECD digital government policy index based on six dimensions, from digital by design to user-driven and proactiveness (OECD, 2025[110]), but gradual improvements are ongoing. The Digital Agency is coordinating digital adoption across public bodies and the standardisation of government systems, especially at the local level. The coverage of the My Number (national personal ID) card, which aims to facilitate the linking of data to the provision of public services, reached 81% in December 2025. The authorities have also promoted a government cloud platform to modernise infrastructure across ministries.
The take-up of new digital technologies by different users (households, firms and local authorities) will be crucial to deliver productivity gains. However, survey data suggests that the recurrent use of e-government services for both daily life and work-related purposes remain low (Figure 2.26, Panel A). While increasing gradually, the use of the online services for administrative procedures and issuance of certificates, e.g. of residence, remains low at 16% and 26%, respectively. Narrowing the digital divide, by ensuring older people and rural areas are not left behind, ensuring data privacy and building public trust in digital services would boost take-up. Legacy IT systems and lack of capacity have led to weak adoption of digital services by some local authorities, which need to be supported to make a smooth transition. Digitalisation in the public sector can increase the efficiency of public procurement and regulations to raise start-up rates (above), help overcome labour shortages in education and care services and boost health spending efficiency (Chapter 1).
Note: Panel B: Stage 1 refers to no implementation of digitalisation. Stages 2-4 refer to using digital tools to replace analogue solutions, improve business efficiency and transform business models and strengthen competitiveness, respectively.
Source: Ministry of Internal Affairs and Communications, Information and Communications in Japan White Paper 2025 and the Small and Medium Enterprise Agency, White Paper on Small and Medium Enterprises in Japan.
Digitalisation creates challenges and opportunities for Japanese SMEs, with demographic shifts, changing consumer expectations and increasing global competition intensifying the need to adopt new technologies. Adoption of digital technologies varies by firm size, ranging from 90% in large firms (over 1 000 employees) to 30% in firms with less than 100 employees (IPA, 2025[111]). Furthermore, digitalisation by SMEs mainly occurs through substitution of analogue functions, while reliance on digital transformation to improve business efficiency and competitiveness remains low (Figure 2.26, Panel B), as they are often constrained in terms of time, skills and capital to invest in complementary organisational capital. Hence, boosting digital skills (Chapter 1) and creating an environment to support digital adoption of SMEs are key.
Japan has several policies to help SMEs, including subsidies, training programmes, tax incentives and advisory services. These services include step-by-step guides to implementing basic digital tools, from e-invoicing platforms to customer relationship management systems. However, according to a recent OECD survey, only 14% of Japanese SMEs are aware of government support programmes, higher than that in the United States, but lower than that in Korea and large European countries (OECD, 2024[112]). Of those who are aware, only 25% benefited from them.
Existing financial tools should be complemented with measures boosting awareness and technical assistance to exploit digital technologies. For example, Germany has 26 Mittelstand Digital Innovation Hubs that offer a wide range of services focused on digital take-up by SMEs, which include demonstration factories that reproduce corporate operations to provide managers with real-life examples of how digital technologies could transform their operations and opportunities to try out their own technical solutions. The Latvian Investment and Development Agency operates a one-stop shop that dispatches groups of university researchers to firms to help them deal with technological issues.
Personal and business use of generative AI is rising but remains subdued compared with major competitors. Survey data from 2024 indicate that only 27% of individuals reported using or having used generative AI services. This is around three times that in 2023, but well below levels in Germany and the United States (Figure 2.27, Panel A). On the business side, only 55% of Japanese companies use generative AI, compared with more than 90% in Germany and the United States (MIC, 2025[113]), and uptake of AI is especially low among SMEs (Panel B). The limited uptake of AI may partly reflect low technology-specific private investment, as cumulative business investment in AI in Japan amounted to USD 5.9 billion over 2013-24, the ninth highest in the OECD. However, this is below Sweden’s USD 7.3 billion and representing just 1.3% of that in the United States. Consequently, over the same period, Japan registered only 0.3 newly-funded AI companies per 100 000 population, compared with 0.5 in Korea, 1.3 in the United Kingdom and 2.0 in the United States (Maslej et al., 2025[114]). At the same time, Japanese companies are around three times more likely than US companies to cite shortages of AI-related talent as a barrier to AI adoption (OECD, 2025[115]).
Note: Panel B: Replies to the question: “Does anyone in your company, and please include yourself, ever use generative AI for work?”.
Source: Ministry of Internal Affairs and Communication, 2025 Information and Communications White Paper and OECD, 2024 Survey on How SMEs Use Generative AI to Address Skill and Labour Needs.
Japan’s AI governance operates via coordinated multi-ministerial systems led by the Cabinet Office, with coordination support provided by the Council for Science, Technology and Innovation. Traditionally based on a multi-stakeholder soft-law approach, it is now shifting toward a hybrid model combining flexibility with principles-based legislation (Ichikawa, 2025[116]). Central to this transition is the 2025 AI Act, which does not regulate AI prescriptively but promotes research, development and innovative deployment through stronger cross-government coordination and proportionate responses to emerging risks.
Achieving broader AI development and diffusion will require sustained progress in digital infrastructure. Despite extensive fibre-optic deployment, which provides the high-bandwidth connectivity needed for AI workloads, Japan hosts only two data centres per million population (for a total of 250), below the OECD average of ten (Data Centre Map, 2025[117]). METI launched the Generative AI Accelerator Challenge in 2024 to support companies’ access to the computing resources necessary to develop generative AI foundation models – including by subsidising usage fees for cloud and supercomputing services to train and test such models – and to promote community-building (METI, 2024[118]). The government is also supporting the development of large-scale data centres outside Tokyo and Osaka, for example in the Hokkaido and Kyushu regions, with programmes aimed to offset developers’ infrastructure and facility construction costs by up to JPY 30 billion. These decentralisation programmes should be adequately reviewed before being rolled out, including the complementary investments required to ensure resilient electricity-grid infrastructure in the regions concerned.
The small size of the venture capital market, at 0.05% of GDP in 2023 (OECD average: 0.11% of GDP) could weigh on domestic AI development. AI-related venture capital (VC) investment, at USD 1.7 billion in 2024, was equivalent to USD 14 per inhabitant, compared with an OECD average of USD 87 (USD 26 when excluding the United States). VC investment expanded at an average annual rate of only 5% since 2017, well below the OECD average of 21%. The amounts invested per firm also remain modest, with a median of about USD 2 million, compared with USD 4.5 million for the OECD average and USD 6 million in the United States (OECD, 2025[119]). Low valuations remain common among innovative start-ups, as limited domestic late-stage VC often pushes them to go public before achieving sufficient scale (micro-IPOs), constraining their ability to raise follow-on funding (Palmer, 2025[120]). For AI and deep-tech start-ups, greater reliance on public VC, e.g. through Japan Investment Corporation’s Venture Growth Investment subsidiary, could provide time to scale before entering public markets. To limit direct public exposure, this support could be complemented by wider use of mezzanine financing instruments, which offer flexible growth capital and help bridge the gap between venture equity and traditional debt.
Although the number of new industrial robots fell by 9% in 2023, Japan remains a leading adopter of robotics, with more than 46 000 units installed (Maslej et al., 2025[114]). While the AI Act does not explicitly identify robotics as a strategic policy area, the 2025 Integrated Innovation Strategy designates AI-robotics and physical AI as priority fields for strengthening Japan’s innovation capacity. The Strategy focuses on developing foundational AI-robotics models and virtual training environments, strengthening AI-robotics R&D, and integrating advanced AI into next-generation robots, while promoting faster AI uptake in robotics-intensive sectors. Against this backdrop, in March 2026, the government formulated an AI Robotics Strategy that is underpinned by enhanced institutional coordination, which is welcome (Cabinet Secretariat, 2026[121]). In line with the AI strategy, greater policy emphasis should be placed on scaling the social implementation of AI-enabled robotics, notably by strengthening demand-side measures and operational robotics know-how.
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