Wages rise where it should: Market mechanism at work

The puzzle of tight labor market with low wage increase

The active job openings-to-applicants ratio is now at its highest for more than 40 years. The ratios for April and May, which recorded a seasonally adjusted 1.48 and 1.49, respectively, exceeded the peak that was recorded in the bubble period (1.46 in July 1990) . It has become next only to the peak that was recorded just before the first oil crisis (1.53 in February 1974). Combined with the fact that the unemployment rate has recorded 2.8 in April and 3.1 in May, the labor market in Japan is now at full employment. We hear a lot about labor shortages in various sectors of the economy.

Nevertheless, wages seem to lack reaction to the situation. As Figure 1 shows, base wage per worker at April has risen by year-on-year rate of 0.4 percent, only marginally higher than the average rate of increase for 2016 of 0.2 percent. It looks as though the market mechanism is not at work in the Japanese labor market. In this month’s column, I intend to offer an explanation to this seemingly a puzzling situation.

Wages are rising for part-time workers where labor demand is high

The active job openings-to-applicants ratio is a weighted average of the ratio for the non-temporary workers (about 90 percent of the total job openings) and temporary workers (about 10 percent). Non-temporary workers consist of full-time workers (about 60 percent of the total job openings for regular workers) and part-time workers (about 40 percent).

The active job opening-to-applicants ratio for part-time workers is actually much higher than the average, as Figure 2 shows. It was a seasonally adjusted 1.77 in May compared to the 1.49 for the total workers. Correspondingly, base wages for the part-time workers have been rising at a relatively high rate; by a year-on-year rate of 1.2 percent in May. If the changes in working hours are taken into account, hourly wage of part-time workers have risen by a year-on-year rate of 2.6 percent.

Wages are stagnant for regular workers where labor demand has been low

The relatively high rate of increase for base wage for part-time workers implies that the rate of increase for full-time workers was low. In fact, the year-on-year rate for full-time workers in May was only 0.3 percent.

An important point to note in this connection is that the low rate of wage increase reflects less tight labor market condition faced by full-time workers, as Figure 3 shows. For instance, the active job-openings-to-applicants ratio for regular workers (those under lifetime employment contracts, and whose share in the total job openings for non-temporary workers is about 80 percent) is still less that one in May, at a seasonally adjusted 0.99.

The above breakdown shows that wages are rising where it should, in part-time workers, and are not where it shouldn’t, in regular workers. This being the case, we can say that the market mechanism has been at work in the Japanese labor market until now.

Higher wage increase expected

If we look into the future, we may see some changes in the wages-front. Since the active job-openings-to-applicants ratio for regular workers is about to exceed one, the base wage for the regular workers may finally start to rise more strongly. Reflecting the changes, total wages may also start to rise at a relatively higher rate.

However, we need to acknowledge, at the same time, that there is a number of factors that may make the upward revision of average base wage for regular workers slow.

But the wage increase may have to wait for the next spring round

First, a major revision of base wages in Japan takes place only once a year, at the spring wage round between the employers and the trade unions. This being the case, the higher wage increase may not become evident until next spring.

According to the final report on the spring wage round published by the JTUC-Rengo in early July shows that, of the total 2.15 percent increase in wages for an average worker, the increase in base wages (the “base-ups”) was still only 0.48 percent (the remainder is due to seniority: an increase in wages as the worker gets a year older). It has stayed roughly the same as the base-ups achieved in the 2016 spring wage round. (Note: 2.15 percent is an average for the outcomes where breakdowns are available: if the outcomes whose breakdowns are not available are also included, the average wage increase will be 1.98 percent).

Wage increase may also be subject to structural downward pressure

Second, wages may rise for the younger workers, but may not for the older workers: in fact, the wages for the older workers may actually fall. As can be seen in Figure 4, the base wages in 2016 for workers younger than 45 had increased, but those for workers aged between 45 and 64 had fallen.

The flattening of the wage profile of this kind has been taking place in Japan for some time. It is a reaction by the firms to the aging of the work force and a more fierce competitive environment. Younger workers have a higher rate of mobility so that, in order to persuade them to join and stay in the firm, companies are offering more attractive wages. In contrast, older workers have low rates of mobility and prefer job-security rather than wage increase so that the wages are adjusted in order to reduce the total payroll.

Optimistic in the short-term but not much so in the medium term

The market mechanism has been working in the labor market in Japan. The low average rate of wage increases for total workers reflected uneven tightness of the labor market: the wages have been increasing for the part-time workers where demand for labor was high, but it was clouded by the low rate of wage increase for regular workers where demand for labor was low.

Since the labor market condition for regular workers seems to be tightening, assuming that economic environment do not deteriorate, wages for this type of workers will start to rise more strongly. It should lead to higher rate of wage increase for total workers as well. In this respect, I am relatively optimistic in the short-term.

However, since structural downward pressure continues to be exerted on wages, especially for the older workers, the rate of wage change will be limited. Taking this into account, I remain relatively cautious in the medium term.