Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
ViewpointOctober 1 2014

The job of reforming Japan's labour market

Japan's unemployment rate may be shrinking but behind this headline figure lurks problems such as low labour mobility and excessive reliance on part-time employment. These are deep-rooted issues that new government initiatives are trying to flush out.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
The job of reforming Japan's labour market

The unemployment rate in Japan is now 3.7%, which is close to the recent structural unemployment rate, estimated in June to be about 3.5%. Hidden unemployment has also been decreasing. According to a business survey conducted by the Bank of Japan, the number of firms suffering from a shortage of workers has been exceeding the number of those suffering from an excess of workers.

In fact, in some industries, a shortage of workers is now acting as a constraint on firms seeking to expand their business. This situation is quite different from the one in the US and Europe, where unemployment is a major problem.

Vicious cycle

This does not mean, however, that all is well and that there are no concerns regarding Japan's labour market. There still are important challenges to be addressed. To fully understand the problems in Japan's labour market, we have to go back to the problems the country suffered as a result of the bursting of the asset bubble in the early 1990s.

In the 2000s, Japanese firms were faced with sluggish sales, as a result of increasing deflationary pressure from inside and outside the economy. To maintain their profitability, firms cut their expenses, including labour costs.

Labour cost restraint was originally achieved by replacing regular employees with non-regular employees. As a consequence, the share of part-time workers among total employees steadily increased in the 1990s. The increase continued unabated throughout the 2000s.

Labour cost restraint was also achieved by cutting wages. Wages for non-regular employees declined, reflecting slack demand. Wages for regular employees, which are largely determined by long-term implicit contracts, also declined. In the face of protracted deflation and severe labour market conditions, employees had no choice but to accept employers' demands to reduce wages, for fear of losing their jobs. Consequently, unemployment did not increase as much. Wages, however, declined at a considerable pace. This is in stark contrast to labour markets in the US and Europe, where unemployment tends to increase substantially during a recession.

Deflation had a significant impact on firms' investment behaviour. After the asset bubble burst in the early 1990s, Japanese firms were forced to save in order to reduce excess debt. However, they continued to save based on the prospect of deflation even after the excess debt problem had been resolved in the 2000s. Deflation expectations not only reduced the discounted present value of investment returns and lowered firms' investment appetite, but they also led firms to hoard cash in preparation for potential future losses. As a result, firms, once net investors, turned into and continue to be net savers. Particularly in recent years, net saving in the corporate sector has become far larger than that in the household sector.

The transformation of many firms into net savers has driven the economy into a contractionary equilibrium through the paradox of thrift. If firms use profits obtained through wage cuts to build up internal funds rather than to invest, aggregate demand in the economy will shrink. Moreover, since a decline in aggregate demand lowers corporate profits, firms will face the need to cut wages further. This is a typical example of the fallacy of composition. The vicious cycle of declining wages and aggregate demand was initially set in motion by the balance sheet adjustments following the burst of the asset bubble, but it became entrenched due to the spread of deflationary sentiment.

The role of QQE

How is Japan escaping this contractionary equilibrium? If the decline in wages was due to uncertainty and concern over the future, it is crucial that both employers and employees feel more optimistic about the days to come. This will lead Japan's economy away from stagnation under deflation towards sustainable growth under moderate inflation. The Bank of Japan's quantitative and qualitative easing has been effective in this regard.

The country's labour market situation has already improved, as mentioned earlier. However, the Japanese labour market still suffers from some of the problems that arose during the period of deflation.

One is the growing reliance on part-time workers. In fact, the recent increase in the number of workers is mainly due to an increase in the number of part-time workers. However, recently there have also been some welcome signs of change, such as an acceleration in the increase in the number of full-time workers. This shift in demand for permanent workers suggests that firms have become more confident about their growth prospects. If economic growth is sustained, which will underpin firms' growth prospects, Japan is likely to experience a fully fledged increase in the number of full-time workers.

Another more troublesome problem is that wage-setting practices have been altered as a result of prolonged deflation. At least in the short term, wages for regular employees in Japan reflect labour market conditions only partially. This is because of low labour mobility caused by lifetime employment practices. Therefore, a 'visible hand' is necessary for wages to rise.

Prior to the period of deflation, the 'spring offensive' – wage negotiations between management and labour at major firms in Japan starting at the beginning of March – served as such a mechanism. However, this mechanism ceased to work effectively as deflation persisted. Firms needed to cut wages in order to reduce costs in the face of falling prices, while it was rational for workers to accept a decline in wages in exchange for job guarantees. As a result, the practice of raising base wages through the spring offensive has almost disappeared in the past decade or so.

There have, however, been increases in base wages and bonuses this year, partly reflecting calls by the government. For wages to increase at an appropriate pace in the future, it is necessary to develop a coordination mechanism that facilitates wage increases. In such a mechanism, the Bank of Japan's price stability target can serve as a benchmark for firms in their wage setting.

Wage negotiations between management and labour will be conducted once the bank succeeds in anchoring inflation expectations at 2%. Firms and households will then base their economic decisions on the expectation that prices will rise at a rate of about 2%. This will create an appropriate wage-setting mechanism, which will play a significant role in anchoring inflation expectations at 2%.

Demographic shifts

I would like to conclude by touching briefly on the supply side of the labour market in Japan and the demographic changes. Until recently, the problem of labour supply has not been addressed significantly, since a wide output gap made labour demand sluggish. However, the labour force participation rate has been on a downwards trend, reflecting the rapid ageing of Japan's population. Serious labour shortages are thus likely to emerge in the future.

Fortunately, labour force participation rates, in particular those of women and the elderly, have been rising during the current economic recovery. We have to make this phenomenon a permanent one by creating a work environment that is favourable to both women and the elderly, and ultimately alleviate labour force shortages over time.

Utilising foreign workers is also an option worth considering. Investment in labour-saving technology and research and development are further ways to mitigate future labour shortages. All of these issues have already been incorporated into the government's growth strategy. If the strategy is implemented in a steady fashion, Japan's economy will regain its vitality and achieve sustained growth.

Haruhiko Kuroda is the governor of Bank of Japan.

Was this article helpful?

Thank you for your feedback!

Read more about:  Analysis & opinion , Asia-Pacific , Japan , Viewpoint