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Japanese Economy Update

Ways to Overcome the Limited Growth of Wages

  Senior Research Fellow


The start of the New Year means the launch of the 2016 spring wage round. And the expectation for the outcome of the spring wage round for 2016 is another, and possibly higher, “base-up”, or the upward revision of the wage schedule of the employees. Achieving it is considered to be essential in breaking out from the upward rigid wage regime and promote private consumption.

Limited response of the wages

Indeed, wages in Japan have shown only a limited response to the tightening of the labor market.

Effective job offers to applicants ratio has reached 1.25 in November 2015, the highest ratio since January 1992. Unemployment rate has also reached 3.1 percent in October 2015, which is the lowest since July 1995. The unemployment rate is regarded as a sign that the economy has reached full-employment except for the structural component of the unemployment.

However, the total wages per employee has increased only by a nominal amount. It has increased by only 0.4 percent in 2014, and even fell by 0.8 percent during the first ten months of 2015. The low rate of increase could be argued as being a result of the change in the sample from which the wage data is taken (it led to a downward revision of the historical data). But even the result of the spring wage round shows that the base-up has only taken place in 2014 and 2015 and the rate was also as low as 0.5 percent in 2014, and 0.8 percent in 2015.

Reasons for the limited response suggested by the US experience

Why has the response of wages to the labor market condition been so weak? There are a number of candidates for the answers to this question. First of all, let us discuss the explanations that are often suggested in explaining the similar phenomenon in the United States.

First is the composition effect.

When a recession takes place in the United States, firms layoff those who are the least senior. It usually means a worker with the lowest wage so that after the layoff, average wage will increase. In the following recovery, firms will call-back the laid off workers who are paid relatively low wage. It means that, even though the economy is in a recovery phase, the average wage will fall. The impact of changes in composition of the workers is factor that could, at least partly, explains the limited response of the average wage to a labor market tightening.

Similar effect may also be at work in Japan albeit in a different context. Layoff does not take place in Japan as much as in the United States. However, fluctuation of non-regular workers who are paid lower wages would have a similar implication. Termination of employment in this category of workers would raise the average wages of the workers as a whole, while hiring them would lower the wage. It may partly explain the apparently limited response of wages in the recovery phase.

Second is the pent-up wage decline hypothesis.

It is well know that wages in the United States show a downward rigidity at times of recession because the employers tend to avoid wage cuts during the phase. However, it implies that the employers have to bear the extra labor cost that result from keeping the wage constant. In order to make up for the cost, they choose to keep the wages constant even though the labor market tightens and wages should have increased otherwise.

While it is considered to be a reasonable hypothesis to explain the situation in the United States, it does not seem to be consistent with the Japanese experience. Compared to the United States, Japanese wages seem to have been more flexible during recessions so that the fluctuation in the unemployment rate in Japan has been kept relatively limited: Quantity adjustment in the United States versus Price adjustment in Japan. Since the wages fell during the recessionary phase, there is no reason for the wages to remain flat in the expansionary phase.

In passing, it might be worth noting that, even though the wages seem flexible in recessions, it is the overtime and bonus components of the wages that are flexible: base wages of regular workers are stable even during recessions.

Reasons for the limited response specific to the Japanese experience

In addition to those factors that are discussed as the candidates for explaining the similar phenomenon witnessed in the United States, there are also specific factors that should be considered to explain the Japanese case.

First is the pressure on the firms to review the seniority-based wage structure.

Because of the aging of the work force, the present wage structure would lead to higher labor cost if left unattended. In an effort to remedy the situation, firms have been moving away from the traditional wage structure. As a result of these efforts, wage profile (a curve showing wages for each of the wage group) has been flattening since 1980s. It should exert a downward pressure om average wages.

Moreover, this kind of a review of the wage structure would be easier for the firms to undertake when the economy is expanding compared to when it is in a recession. Consequently, limited wage growth may be more apparent when the labor market is tightening.

Second is the coordination failure that may have been enhanced under a deflationary environment.

We know that if the wages started to increase in a concerted manner it would create a basis for a stronger consumption and further expansion of sales and production, which would raises profits and lead to further wage increases. This kind of a virtuous cycle would be beneficial from a macro-point of view. However, individual firms would find themselves difficult to make the first move because of the possibility that their competitors would benefit by postponing their wage increase.

It may be easier for the firms to raise wages when inflation is taking place. That is because prices and wages are continuously rising, making changes in the ‘relative wage’ hard to identify. In contrast, raising wages would be all the more difficult in a deflationary environment because almost all of the prices and wages are falling and it is easy to identify any increase in them. The market mechanism, therefore, fails to coordinate the wage increase even when the labor market is tightening.

Need for some unconventional tools

If the limited response to the labor market tightening is a result of the reviewing of the wage structure resulting from aging, it may be difficult to stop it from taking place. However, it could be moderated if the competitiveness and productivity is enhanced. That is where government’s growth strategy could make a significant contribution.

However, if the limited response to the labor market tightening is due to coordination failure, the government may be able to promote coordination by providing information about the benefit of wage increase from a macro-point of view, and to provide a platform where the government, the business, and the labor to coordinate. Such an action would, during ordinary times, be seen as an unjustifiable intervention to the industrial relation. But at a time like this, it could be seen as an effort to circumvent the coordination failure.

Spring wage round provides another devise to overcome the coordination failure because it forces the firms to raise their wages in a concerted manner: it reduces the possibility of a competitor benefitting from others’ wage increase.

In addition, if the spring wage round extends its scope to cover, not only regular workers who are the original members of the trade unions, but also non-regular workers, raising the wages of these category of workers could lift the average wage and weaken the composition effect.

At this juncture, it seems that unconventional tools may be needed to provide a final push toward exiting from deflation.