Utmost Consideration Should Be Paid to Impact on Employment—Should Minimum Wages Be Raised?

Faculty Fellow, RIETI

At a meeting of the Council on Economic and Fiscal Policy on May 14, Prime Minister SUGA Yoshihide expressed his resolve to raise the national average minimum wage to 1,000 yen per hour at an early time. As the current national average is 902 yen, this represents a significant increase.

As a preliminary step before discussing this matter, let us look at how minimum wages are determined in Japan. As with other labor policy matters, they are determined by a deliberative council comprised of members who represent public interests, workers and employers.

The minimum wage council system is a two-tier structure comprised of the Central Minimum Wage Council and regional minimum wage councils. The Central Minimum Wage Council classifies the 47 prefectures into four classes—Classes A to D—according to their wage level and recommends an appropriate level of increase for each class as a guideline level. Based on the guideline level, the regional minimum wage council in each prefecture determines the actual amount of increase.

The Central Minimum Wage Council's guideline levels are determined based on the actual percentage rates of wage increases identified through the Ministry of Health, Labour and Welfare's annual survey on wage revisions of Fact-finding Survey on Minimum Wages. The survey asks companies with a workforce of less than 30 permanent employees about the wage levels in June of the survey year and in June of the previous year.

The figure below shows the relationship between the rates of wage increases as identified through the survey on wage revisions and the rates of increases recommended as targets for each class of prefecture in 2012 to 2019. It indicates that the target rate has been set higher than the actual rate of wage increase, particularly since 2016. In 2020, it was recommended that minimum wages be kept at the present level in view of the impact of the COVID-19 crisis.

Figure. Relationship between the Rate of Wage Increase and the Rate of Increase in the Minimum Wage Target

The proposal to raise the national average minimum wage to 1,000 yen is probably intended to promote the acceleration of the uptrend in minimum wages. However, Japan has reached a point where it is necessary to consider on what basis minimum wages should be raised. When considering this question, it is useful to look at evidence observed in other developed countries for reference. All the same, what matters is evidence in Japan. Particularly worrisome is a decrease in employment associated with a minimum wage increase.

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Let us look at past studies on the impact of minimum wages on employment in Japan. According to a literature survey of 18 research papers focusing on the impact of a minimum wage increase conducted by Matsuta Shuichi of the Financial Services Agency and published by the Tokyo Foundation for Policy Research in March 2020, of the 11 papers that analyzed the impact on employment, seven reported the finding of negative effects, three reported the absence of any impact and one reported the finding of both positive and negative effects. In other countries, as well as in Japan, different studies reached different conclusions about the impact of a minimum wage increase on employment in other countries.

It is difficult to estimate the impact of a minimum wage increase on employment because minimum wages are determined in accordance with the situation of the labor market. In Japan, the rate of wage increase from the previous year is used as a reference for determining the minimum wage level and therefore, minimum wages tend to be raised when wages are rising. In other countries, too, minimum wages tend to be raised during an economic expansion phase.

Even when a minimum wage increase has a negative impact, it tends to be offset by the effects of economic expansion. There are various methods of estimating the impact of minimum wages on employment while taking this point into consideration, and different methods adopted lead to different findings.

When estimating the impact of minimum wages on employment, Japanese studies use the situation that followed the amendment of the Minimum Wage Act in 2007 as a reference. At that time, controversy was triggered by the fall in monthly income that would be earned by people working under minimum wages if they worked full-time for wages that were lower than the level of benefits they were eligible to receive from public welfare.

This abnormal situation was observed particularly in Tokyo and Kanagawa Prefecture, where housing rents are high, and in Hokkaido and prefectures in the Tohoku region, where wintertime heating costs are high, as welfare benefits are set at a relatively high level, reflecting higher costs of living in those regions. To resolve the abnormal situation, the Minimum Wage Act was amended, and as a result, in Tokyo, Kanagawa and Hokkaido, minimum wages rose regardless of the actual rate of wage increases in small businesses.

My joint study with Associate Professor Yuko MORI of Tsuda University focused attention on this change. Our study found that the minimum wage increase led to a drop in the employment rate among men with junior and senior high school degrees who were aged 19 to 24. The estimated quantitative impact was large enough to be statistically significant. On the other hand, no statistically significant impact was observed with respect to the employment rates among men with junior and senior high school degrees who were in other age groups or among women with junior and senior high school degrees.

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Among other papers that analyzed the impact of minimum wage on employment in relation to the legal amendment in 2007 is one co-written by Associate Professor OKUDAIRA Hiroko of Doshisha University, Professor TAKIZAWA Miho of Gakushuin University, and YAMANOUCHI Kenta, a lecturer at Kagawa University. This paper analyzed the impact in manufacturing industries and showed that the minimum wage increase led to a decrease in employment and that the quantitative impact was large.

What is interesting is that the findings regarding the impact differed on a case-by-case basis. In theory, whether or not a minimum wage increase leads to a decrease in employment should depend on whether or not companies can absorb the impact of the increase by cutting back on their own profits. When workers' productivity is high relative to the cost of wages, a minimum wage increase may lead to lower corporate profits while not necessarily causing companies to reduce employment.

On the other hand, if minimum wages are raised when the productivity level matches the cost of wages, companies reduce employment because there is no room for them to absorb the impact of the wage increase. Roughly speaking, the study by Okudaira et al. estimated the relationship between productivity and wages by comparing the labor productivity calculated from the relationship between the input of labor and the production of added value and the labor share calculated from personnel cost and overall expenditure based on the accounting information. Their study showed that the smaller the disparity between the levels of productivity and wages, the larger the margin of decrease in employment due to a minimum wage increase.

Whether or not a disparity arises between workers' productivity and wages depends on whether companies hold the power to determine wages. Although it may appear to be obvious that companies hold the power to determine wages, they have no option but to accept the wage level determined by the labor market when workers have the freedom to move between companies in pursuit of higher wages. Companies that offer wages that are lower than the market level cannot attract workers, while there is no reason for them to offer wages higher than the market level. That is the situation of a competitive labor market.

If wages are constant, companies can increase profits by employing more workers as long as the productivity level is high relative to the cost of wages. If they continue to increase employment, more and more workers will be assigned to peripheral jobs rather than core jobs, leading to a fall in productivity. As the number of workers continues to increase, the productivity level will ultimately match the cost of wages. In that case, employment will be reduced if minimum wages are raised.

On the other hand, if companies hold the power to determine wages, they feel encouraged to increase profits by reducing wages. The situation of companies holding the power to determine wages is called "monopsony." In that situation, companies pay low wages relative to the productivity level and therefore, a minimum wage increase does not necessarily lead to a fall in employment as the impact of a rise in wages due to the minimum wage increase can be absorbed.

If the government aims to raise the national average minimum wage to 1,000 yen, it faces the decision as to in which prefectures minimum wages should be increased. One option may be to raise wages in prefectures where the labor market is in a monopsony situation and the negative impact on employment is therefore likely to be small.

In countries around the world, including Japan, there are studies ongoing that seek to measure the level of labor market competitiveness on a region-by-region basis with benchmarks that are similar to the one used for the measurement of the level of product market concentration and to identify the heterogeneity of the impact of minimum wages on employment. Over the long term, it is desirable to incorporate the results of those studies into rules on the determination of minimum wages.

>> Original text in Japanese

* Translated by RIETI.

May 24, 2021 Nihon Keizai Shimbun

June 24, 2021