The purpose of this paper is to investigate empirically the relationship between demand fluctuations and productivity of service industries. Specifically, by using unique establishment-level data on service industries in Japan, this paper estimates production functions for six narrowly defined personal-service industries. In almost all the examined service industries, statistically and economically significant negative effects of demand variation on establishment-level productivity are found. This result suggests dispersing holidays may have positive effects on the productivity of service industries.

MORIKAWA Masayuki

English

Research Papers in Economics

%1
RIETI Discussion Paper Series 08-E-030
Demand Fluctuations and Productivity of Service Industries
MORIKAWA Masayuki
RIETI
The Research Institute of Economy, Trade and Industry
http://www.rieti.go.jp/en/ -1   -
RIETI Discussion Paper Series 08-E -030 
 
 
Demand Fluctuations and Productivity of Service Industries 
 
Masayuki Morikawa
∗ 
Research Institute of Economy, Trade and Industry (RIETI) 
August 2008 
 
 
 
Abstract 
 
The purpose of this paper is to investigate empirically the relationship between 
demand fluctuations and productivity of service industries. Specifically, by using 
unique establishment-level data on service industries in Japan, this paper estimates 
production functions for six narrowly defined personal-service industries. In almost all 
the examined service industries, statistically and economically significant negative 
effects of demand variation on establishment-level productivity are found. This result 
suggests dispersing holidays may have positive effects on the productivity of service 
industries. 
 
Keywords: Service Industry, Productivity, Demand Fluctuation, Paid Leave 
JEL Classification: D24; L83; L84 
 
                                                  
∗ I would like to thank Jiro Ushio and Akira Chouno for their helpful suggestions in drafting this paper. I 
also wish to thank Masahisa Fujita, Kiichiro Sato, Sadao Nagaoka, Kyoji Fukao, Toshiyuki Matsuura, and 
Daiji Kawaguchi for their valuable comments.  -2   -
Demand Fluctuations and Productivity of Service Industries 
 
 
1.  Introduction 
 
Recent studies stress the importance of service industries on a country’s economic growth 
performance. Amid a decreasing labor force due to population aging, productivity growth of 
industries, especially service industries, is a focus of economic policy in Japan. Recently, the 
Service Productivity and Innovation for Growth (SPRING) ― a business-government-academia 
forum ― and the Service Engineering Research Center were established to enhance service 
sector innovation and productivity. However, analysis of productivity in service industries using 
microdata lags far behind that of the manufacturing industry, for which solid and reliable data 
are available. 
The purpose of this paper is to document evidence on the relationship between short-term 
demand fluctuations and the total factor productivity (TFP) of service industries. Specifically, 
by using unique establishment-level data on six personal-service industries, in which the 
simultaneity of production and consumption is especially prominent, this paper estimates 
production functions for narrowly defined service industries in Japan.
1  
  In many personal-service industries including restaurants, hotels, passenger transportation, 
and amusement services, demand fluctuates daily, weekly, and seasonally. On the other hand, 
capital and labor inputs cannot be adjusted immediately. As a result, service industries’ 
productivity is heavily affected by short-term fluctuations in demand because the output cannot 
be stored. This is different from the manufacturing industry, where inventory can be used as a 
buffer to smooth production. 
    Several time-series analyses have shown that the relationship between measured TFP and the 
business cycle is stronger for service industries (Basu et al., 2006; Inklaar, 2007; Kawamoto, 
2005; Miyagawa et al., 2006). This issue is closely related to the adjustment costs of labor and 
capital, as many studies have indicated significant factor adjustment costs and their negative 
                                                  
1 Morikawa (2008) uses the same data to analyze the effects of spatial demand density on the 
productivity of service industries. The result indicates significant economy of demand density.  -3   -
effects on productivity (see, for example, Hamermesh and Pfann, 1996; Groth, 2008). Although 
it is somewhat related to these studies, the focus of this paper is the effects of very short-term 
variability of demand on the establishment-level TFP.
2 
  According to my analyses, significant negative effects of demand fluctuations on the 
establishment-level productivity are found in almost all the examined service industries. This 
result holds even if we use physical output measures that are not affected by price. The effects 
are quantitatively large: if demand varies by one standard deviation, the productivity of the 
establishment is on average 10% - 20% lower. 
  The rest of the paper proceeds as follows. In section 2, I describe the data and methods of 
analyses. Section 3 presents estimation results. Section 4 contains a brief conclusion. 
 
 
2.  Data and Method 
 
    This paper uses data on personal-service industries covered by the Survey of Selected Service 
Industries conducted by the Ministry of Economy, Trade and Industry (METI). This Survey, 
started in 1973, now covers more than twenty service industries. The sample covers all 
establishments operating in Japan. In this paper, I use recent (2001 or 2002) establishment-level 
data on six personal-service industries: movie theaters, golf courses, tennis courts, bowling 
alleys, fitness clubs, and golf driving ranges. The Survey asks establishments of these six 
industries about their ratio of users between weekdays, Saturdays, and Sundays. In addition, the 
number of users per month is also surveyed. This provides a good opportunity to assess the 
effects of short-term demand fluctuations on establishment-level productivity.   
  This paper estimates simple Cobb-Douglas production functions, augmented to account for 
measures of establishment-level demand fluctuations, as indicated below. The dependent 
variables are (i) value added and (ii) measures of physical output. Independent variables include 
labor, a proxy for tangible capital, degree of diversification, a dummy for multiple 
establishments, and a measure of demand fluctuations. 
                                                  
2  Among the service industries, the effect of variability in demand for hospital services on costs has been 
studied (for example, Baker et al., 2004).  -4   -
 
lnY = ß0 + ß1 lnL + ß2 lnK + ß3 Diversification + ß4 Dummy for Multiple Establishment 
+ ß5 Measures of Demand Fluctuation 
 
  Value  added  (va) is calculated as sales minus costs plus wages and rents. As for the physical 
measures of output, the total number of yearly users (users) is available. 
  L a b o r   ( L) is the number of employees (emp) which includes part-time workers and temporary 
workers.
3 Unfortunately, the Survey  does not collect information on capital stock, but the 
Survey does contain data on good proxies for fixed capital (K) in the personal-service industries. 
Specifically, floor area for movie theaters (floor), number of holes for golf courses (holes), 
number of courts for tennis courts (courts), number of lanes for bowling alleys (lanes), floor 
area for fitness clubs (floor), and number of boxes for golf driving ranges (boxes) were used. 
These proxies for capital stock capture the most important aspects of each service. 
The share of the main business sales (mshare) is calculated as the sales of main services 
divided by the establishments' total sales. The coefficient measures the degree of the economies 
of scope. If there is an economy of scope, the coefficient of this variable will be negative. At the 
same time, this variable (mshare) may absorb a possible bias because the capital stock measures 
used here do not cover all of the fixed capital stocks. In this sense, this variable can be 
interpreted as a control variable. The dummy for multiple establishments (multidum) equals one 
if the establishment is part of a firm that has more than two establishments in the same industry, 
and the dummy equals zero otherwise. The coefficient of this variable indicates the existence of 
firm-level economies of scale.   
    Measures of demand fluctuations are (i) the share of users on weekends (weekend) and (ii) 
the coefficient of variation of the number of users per month (month). The sign of the 
coefficients of these variables is expected to be negative because demand fluctuation is 
detrimental to productivity. Table 1 shows the mean and standard deviation of these variables 
for each one of the six industries analyzed. With the exception of fitness clubs, the demand on 
weekends exceeds 50% of the total. As the standard deviations of demand fluctuations are not 
                                                  
3  The number of hours is unavailable.  -5   -
small, there is a considerable difference in demand variation among establishments. 
 
 
3.  Results 
 
  Estimation results using value-added as the dependent variable are presented in Table 2. As 
mentioned above, the coefficients of the measures of demand fluctuations are what is of interest 
here. The coefficients of weekend are negative and significant for movie theaters, golf courses, 
tennis courts, and golf driving ranges. The coefficients of month are negative and significant for 
five industries with the exception of movie theaters.   
    Table 3 contains the regression results using physical output (users) as the dependent variable. 
The coefficients of weekend are significantly negative for five industries with the exception of 
fitness clubs. The coefficients of month are negative and significant for five industries except 
movie theaters.
4 Almost all of the results obtained by using physical output measures confirm 
the results using value-added measures. 
  In order to understand the magnitude of the coefficients, Table 4 shows the effects of a one 
-standard-deviation demand fluctuation on productivity. Generally, when demand varied one 
standard deviation, the productivity of the establishment was 10% - 20% lower. These results 
indicated that smoothing demand had considerable effect on the productivity of service 
establishments. For example, the full utilization of paid leave may enhance the productivity of 
several service industries by dispersing the demand of weekends or certain months.
5 For this 
purpose, good labor management practices that achieve flexible timing of work without 
affecting production are essential.
6 
 
                                                  
4 In addition to the abovementioned results, economies of scale in terms of establishment size and firm 
size, and economies of scope are found in almost all the examined service industries. These results are the 
same with Morikawa (2008). 
5 According to the General Survey on Working Conditions 2007 (Ministry of Health, Labour and 
Welfare), the average use of paid leave is 8.3 days in Japan. The utilization rate is 46.6%, which has been 
declining over the last fifteen years. 
6   Hamermesh et al. (2008) argue that synchronous behavior will be productive because of 
complementarities in generating output and consuming goods and services.  -6   -
 
4.  Conclusion 
 
  This paper, by using a unique data set, empirically investigates the relationship between 
demand fluctuation and the TFP of personal-service industries. Statistically and quantitatively 
significant negative effects of short-term demand variations on the establishment-level 
productivity are found in almost all service industries. 
This result suggests dispersing holidays may have positive effects on the productivity of 
personal-service industries by smoothing demand. Although this paper analyzes only six 
industries, the result may be generalized to other service industries such as hotels and 
restaurants. 
  -7   -
References 
 
Baker, Laurence C., Ciaran S. Phibbs, Cassandra Guarino, Dylan Supina, and James L. 
Reynolds (2004), “Within-Year Variation in Hospital Utilization and its Implications for 
Hospital Costs, ” Journal of Health Economics, vol. 23, no. 1, pp. 191-211. 
Basu, Susanto, John G. Fernald, and Miles S. Kimball (2006), “Are Technology 
Improvements Contractionary?” American Economic Review, vol. 96, no. 5, pp. 
1418-1448. 
Groth, Charlotta (2008), “Quantifying UK Capital Adjustment Costs,” Economica, vol. 75, 
May, pp. 310-325. 
Hamermesh, Daniel S. and Gerard A. Pfann (1996), “Adjustment Costs in Factor Demand,” 
Journal of Economic Literature, vol. 34, no. 3, pp. 1264-1292. 
Hamermesh, Daniel S., Caitlin Knowles Myers, and Mark L. Pocock (2008) “Cues for 
Timing and Coordination: Latitude, Letterman, and Longitude,” Journal of Labor 
Economics, vol. 26, no. 2, pp. 223-246. 
Inklaar, Robert (2007), “Cyclical Productivity in Europe and the United States: Evaluating the 
Evidence on Returns to Scale and Input Utilization,” Economica, vol. 74, November, pp. 
822-841. 
Kawamoto, Takuji (2005), “What Do the Purified Solow Residuals Tell Us about Japan’s 
Lost Decade?” Monetary and Economic Studies, vol. 23, no. 1, pp. 113-148. 
Morikawa, Masayuki (2008), “Economies of Density and Productivity in Service Industries: 
An Analysis of Personal-Service Industries Based on Establishment-Level Data,” RIETI 
Discussion Paper, 08-E-023. 
Miyagawa, Tsutomu, Yukie Sakuragawa, and Miho Takizawa (2006), “Productivity and 
Business Cycles in Japan: Evidence from Japanese Industry Data,” Japanese Economic 
Review, vol. 57, no. 2, pp. 161-186. 
  -8   -
 
Mean S.D. Mean S.D.
Movie Theater (2001) 57.53 15.49 0.501 0.266
Golf Courses (2001) 50.72 10.48 0.367 0.270
Tennis Courts (2001) 55.91 21.81 0.250 0.269
Bowling Alleys (2001) 50.72 10.99 0.212 0.114
Fitness Clubs (2002) 27.70 12.52 0.131 0.243
Golf Driving Ranges (2001) 51.92 15.43 0.220 0.233
Source: the Survey of Selected Service Industries (METI).
Coefficient of Variation
per Months
Ratio of Weekends
Table 1
Mean and standard deviation
 
 
 
 
ln L 0.8368 *** 0.7393 *** 0.9526 *** 0.6916 *** 0.7373 *** 0.6046 ***
(20.20) (30.30) (31.63) (23.39) (29.60) (28.56)
ln K 0.2491 *** 0.5554 *** 0.4151 *** 0.4891 *** 0.4377 *** 0.8529 ***
(7.08) (10.05) (9.77) (9.94) (16.94) (30.57)
msale -0.9227 *** -0.4137 *** -1.0745 *** -0.7149 *** -1.0830 *** -1.2869 ***
(-3.36) (-3.15) (-6.30) (-6.56) (-10.25) (-14.05)
multidum 0.4224 *** 0.0897 *** 0.1765 *** 0.0760 ** 0.4071 *** 0.0269  
(6.37) (3.37) (2.67) (1.98) (9.23) (0.83)
weekend -0.0082 *** -0.0094 *** -0.0095 *** -0.0030 * 0.0019   -0.0033 ***
(-4.00) (-7.16) (-6.50) (-1.70) (1.22) (-3.69)
month -0.0376   -0.9333 *** -0.5588 *** -1.3499 *** -0.7832 *** -0.8505 ***
(-0.32) (-18.39) (-4.97) (-7.40) (-9.75) (-14.24)
cons. 5.6094 *** 6.4566 *** 6.4013 *** 6.3283 *** 4.1333 *** 4.9410 ***
(16.58) (34.63) (28.71) (30.73) (25.30) (39.24)
Number of obs
Adj R-squared
(5) (6)
Movie Theater
Table 2
Regression results using value added as dependent variable
(1) (2) (3) (4)
Fitness Clubs
0.7697 0.6918
Notes: OLS Estimates with t-values in parentheses. *significant at 10%; ** significant at 5%; *** significant at 1%.
Golf Driving Ranges
859 1,987 1,062 979 1,676 2,812
Golf Courses Tennis Courts Bowling Alleys
0.6515 0.6213 0.6874 0.6646
 
 
  -9   -
 
ln L 0.8131 *** 0.2120 *** 0.4925 *** 0.4483 *** 0.4981 *** 0.3817 ***
(25.74) (16.38) (15.75) (17.43) (18.38) (22.43)
ln K 0.3094 *** 0.7659 *** 0.4408 *** 0.7784 *** 0.6652 *** 1.0317 ***
(11.50) (27.70) (9.88) (18.19) (23.60) (46.05)
msale 0.8815 *** -0.0116   0.7956 *** 0.5690 *** 1.2000 *** 0.4655 ***
(4.21) (-0.18) (3.55) (6.06) (10.38) (6.34)
multidum 0.5236 *** 0.0178   0.3805 *** 0.1407 *** 0.4136 *** 0.0755 ***
(10.42) (1.40) (5.98) (4.22) (8.58) (2.89)
weekend -0.0079 *** -0.0089 *** -0.0100 *** -0.0051 *** 0.0006   -0.0073 ***
(-5.17) (-13.71) (-6.03) (-3.37) (0.36) (-10.14)
month 0.3731 *** -0.8366 *** -0.8793 *** -1.0001 *** -0.8694 *** -0.8842 ***
(4.23) (-33.58) (-6.03) (-6.43) (-10.11) (-18.37)
cons. 6.3437 *** 8.0166 *** 7.3725 *** 7.2134 *** 3.1840 *** 5.5413 ***
(24.56) (84.29) (27.09) (40.37) (17.88) (54.80)
Number of obs
Adj R-squared
Table 3
Regression results using physical output as dependent variable
0.7437
(1) (2) (3) (4) (5) (6)
Movie Theater
Notes: OLS Estimates with t-values in parentheses. *significant at 10%; ** significant at 5%; *** significant at 1%.
894 1,798 702 993 1,708 2,868
0.7179 0.7770 0.7185 0.5093 0.6413
Golf Driving Ranges Golf Courses Tennis Courts Bowling Alleys Fitness Clubs
 
 
 
 
value added physical value added physical
Movie Theater (2001) -0.126 -0.123 - 0.099
Golf Courses (2001) -0.098 -0.093 -0.252 -0.226
Tennis Courts (2001) -0.206 -0.219 -0.150 -0.237
Bowling Alleys (2001) -0.032 -0.100 -0.168 -0.205
Fitness Clubs (2002) - - -0.190 -0.211
Golf Driving Ranges (2001) -0.051 -0.113 -0.198 -0.206
Notes: Effects of 1 standard deviation. "-" means insignificant at 10% significance level.
Weekly fluctuations Yearly fluctuations
Table 4
Effects of demand fluctuation on productivity
 
 
 

Adjustment Costs in Factor Demand,”

Cues for Timing and Coordination: Latitude,

Economies of Density and Productivity in Service Industries: An Analysis of Personal-Service Industries Based on Establishment-Level Data,” RIETI Discussion Paper,

Productivity and Business Cycles in Japan: Evidence from Japanese Industry Data,” Japanese Economic Review,

What Do the Purified Solow Residuals Tell Us about

Within-Year Variation in Hospital Utilization and its Implications for Hospital Costs,

Demand Fluctuations and Productivity of Service Industries

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Demand Fluctuations and Productivity of Service Industries

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