Policy Update 079

Make the Consumption Tax Hike an Opportunity to Steadily Raise the Wage Level

NAKAJIMA Atsushi
Chairman, RIETI

Weak Last-minute Demand

Less than two months are left before the consumption tax hike. But unlike the previous cases, the so-called last-minute demand surge has not been seen clearly to date. The current consumption trend of durable goods is unexpectedly flat (Figure 1).

Figure 1: Change in Retail Sales Value in Japan
Figure 1: Change in Retail Sales Value in Japan
Note: Percentage change from the same month of the previous year, after seasonal adjustment.
Source: Current Survey of Commerce by METI.

This is partly due to sluggish consumption, which is caused by an uncertain economic outlook in response to the U.S.-China trade conflict. But in addition to that, we have to admit that the government's countermeasures against the consumption tax hike seem to be helping a lot. These countermeasures include the introduction of reduced tax rates, the free-of-charge preschool education program, reward points, premium vouchers, car tax cuts, and the expansion of mortgage tax breaks.

The most noticeable of the items above are the introduction of reduced tax rates, reward points, and other similar measures because they help curb the growth of last-minute demand. The introduction of reduced tax rates makes it unnecessary to stock up on food and drinks. Measures such as reward points, the expansion of mortgage tax breaks, and car tax cuts will at least partially offset consumption tax hikes for the time being or permanently.

In the previous consumption tax hikes, the large last-minute demand and the subsequent demand reduction had a significant influence on the economy. If they are both minimized this time, hopefully it will help maintain stable economic growth.

There is more good news. The next consumption tax hike is expected to cause price increases in a more limited manner. In addition to the introduction of reduced tax rates, the free-of-charge preschool education program, which will be financed partly by the consumption tax hike, may render the additional payment, or even the payment itself, of the relevant consumption tax unnecessary. Furthermore, if the large price reduction of mobile phone services asked by the administration occurs at around the same time, consumer price increases caused by the consumption tax hike may mostly be offset.

Insufficient Wage Increase

Nevertheless, even if economic fluctuations and price increases around the time of the next consumption tax hike are minimized, we still cannot feel safe. That is because the prices of goods and services subject to consumption taxes will increase accordingly even though the overall increase in consumer goods prices will not be so intense. In the first place, many countermeasures against consumption tax hikes are temporary and do not supplement the reduced real purchasing power forever. Therefore, to ultimately supplement the real purchasing power reduction that the consumption tax hike represents, it is indispensable to increase wages so that real incomes do not decrease.

Of course, companies are not obliged to increase wages in response to the consumption tax hike. Raising wages is even more difficult when the consumption tax hike worsens the economy and moves corporate revenues downward.

Indeed, past wage increases have not necessarily covered consumer price increases caused by consumption tax hikes (Figure 2). Moreover, the gap between consumer price increases and wage increases, or the extent to which price increases exceed wage increases, has widened and continued for a longer period each time the consumption tax rate was raised (from 0% to 3%; from 3% to 5%; and from 5% to 8%).

Figure 2: Increase/Decrease in Nominal Wages and Consumer Prices in Japan
Figure 2: Increase/Decrease in Nominal Wages and Consumer Prices in Japan
Note: Percentage change from the same month of the previous year. Nominal wage = Monthly cash salary – Special pay. Price means consumer price (general index). Gap (real wage) = Nominal wage – Consumer price.
Source: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications.

Wage increases were weak after 1997, when the consumption tax rate was raised from 3% to 5%, partly due to the financial crisis in the 1990s. Traditional labor negotiations were based on the idea that wage increases should reflect price increases. After the financial crisis of the late 1990s, however, emphasis was placed on maintaining employment rather than raising wages, resulting in wage increase rates that were lower than price increase rates. This trend is actually observed in spring labor negotiations. As shown in Figure 3, price increases have not been reflected in wage increases for the last two decades.

Figure 3: Spring Wage Increase Rates and Consumer Price Increase Rates in Japan
Figure 3: Spring Wage Increase Rates and Consumer Price Increase Rates in Japan
Note: Spring wage increase rates of key private companies. Consumer price increase rates: General index.
Source: Ministry of Health, Labour and Welfare; Ministry of Internal Affairs and Communications.

Consumption Tax Hike: An Opportunity to Raise Wages

Let's compare the situation in Japan with that in the US. In both countries, there is a strong correlation between wage increase/decrease rates and consumer price trends. Especially in the US, many companies raise prices every year to partly finance wage increases. While this surely leads to price hikes, such hikes are likely to be offset by corresponding wage increases, which drive consumer spending—a virtuous economic cycle.

In Japan, wage increases/decreases are also correlated with price trends. But the correlation is weaker than in the US, and the amount of increased corporate revenues allocated for wage increases is larger in the US than in Japan. In addition, Japanese consumers are more resistant to price increases. That is another reason why it is difficult for Japanese companies to use price increases to raise wages while maintaining profits.

Given the current situation of Japan in which wage increases are not keeping up with consumer price growth rates, in contrast to the situation in the US, Japanese labor and management need to take consumer prices into account when raising wages. Furthermore, Japanese companies now have record-high internal reserves of 466.8 trillion yen, a large savings surplus. But compared with 1990, nominal wages per capita remain flat, despite the fact that corporate current profits have increased by 140% and serious labor shortages have occurred (Figure 4).

Figure 4: Corporate Current Profits and Nominal Wages in Japan
Figure 4: Corporate Current Profits and Nominal Wages in Japan
Note: 1990 Q1 = 100; seasonally adjusted value.
Source: Ministry of Finance; Ministry of Health, Labour and Welfare.

At the dawn of the fourth industrial revolution, corporate competitiveness will depend on how well companies can tap the benefits of artificial intelligence. To that end, companies have to urgently enhance related investments, including investments in human resources. Given the current serious labor shortage, it is even more important that companies institute wage raises that are consistent with price increases to restore the steady wage-hike level that prevailed in the first half of the 1990s and before.

The consumption tax hike in October 2019 may be a disrupting factor for the Japanese economy. But, in addition to addressing the financial needs of social security, it may also provide a springboard for wage increases that will cover price increases. After a storm comes a calm. No matter how paradoxical it may seem, I think the consumption tax hike retains the potential to give birth to a virtuous economic cycle: wage increase → consumption increase → corporate revenue increase → wage increase. I strongly hope to see steady wage increases after the coming tax hike.

The original text in Japanese was posted on July 26, 2019.

August 28, 2019