Potential for Wage Hikes: A good opportunity for wage system reform

Program Director and Faculty Fellow, RIETI

Expectations for wage hikes this spring are growing. Indeed, according to the Monthly Labour Survey in November 2022, total cash earnings increased 1.9% on a year-on-year basis. However, as the growth rate of the consumer price index (the overall index excluding imputed rents of owner-occupied houses) in the same month was 4.5%, real wages recorded a steep year-on-year decline. Rolling back the steep decline in real wages is the main goal of the springtime wage hike negotiations this year. Major companies have showed readiness to meet the demand for a 5% wage hike from Rengo, the Japanese Trade Union Confederation.

Some people argue that although wage hike demands made during the springtime labor-management negotiations affect major companies’ wages, the effects do not extend to small and medium-size enterprises. What is the relationship between major companies’ wage hikes and the nationwide average rate of wage growth in Japan?

The Japan Institute for Labour Policy and Training has published a Laspeyres wage index table compiled by fixing the labor force structure in terms of gender, academic achievement, age and longevity at the state in the reference year based on the Status of Springtime Wage Hike Demands and Agreed Hikes at Major Private-Sector Companies and the Basic Survey on Wage Structure, both of which were compiled by the Ministry of Health, Labour and Welfare. The Laspeyres wage index is assumed to closely follow the trend in workers’ actual sentiment about wage hikes. The figure below shows the relationship between the rate of wage hikes at major companies and the nationwide average rate of wage growth between 1995 and 2020, the period for which relevant data are available.

Relationship between the Rate of Springtime Wage Hikes at Major Companies and the Nationwide Average Rate of Wage Growth
Relationship between the Rate of Springtime Wage Hikes at Major Companies and the Nationwide Average Rate of Wage Growth
Source: Ministry, of Health, Labour and Welfare, Japan Institute for Labour Policy and Training

In principle, the higher the rate of springtime wage hikes at major companies, the higher the nationwide average rate of wage growth. A hike of one percentage point in wages at major companies corresponds to an increase of 0.93 points in the nationwide average rate of wage growth. However, the nationwide average rate of wage growth is 2.09 points lower than the rate of wage hikes at major companies. In light of this relationship, if Rengo’s demand for a 5% wage hike is met, the nationwide average rate of wage growth in 2023 is expected to come to 2.54%. In other words, if the demands in springtime labor-management negotiations are met, nationwide overall wage hikes can be realized to a certain degree.


Now, let us look at the structural factors that cause wage hikes from another angle. There are two major forces that determine the wage level. One is the competitive pressure in the labor market that encourages workers to move to companies that raise wages from companies that do not. The competitive pressure is liable to work in the case of workers whose job skills are easily transportable across different workplaces, such as restaurant workers and temporary staff workers. The other force is the corporate internal dynamics that work to raise wages in order to motivate workers despite a lack of labor mobility across companies. This applies better to regular workers at major companies.

Looking at the Laspeyres wage index, which was mentioned earlier, we can see that since 1995, nominal wages in Japan have remained almost flat. Let us consider the structural factors that led to the prolonged period of wage stagnation and look at the prospects for wage hikes this spring.

The competitive pressure in the labor market is expected to lead to wage growth, reflecting the current labor shortage. The main factor that has prevented wages from rising over the past two decades is the fact that the labor market has eased because of a significant increase in labor supply due mainly to an increase in women’s labor participation rate.

However, as many economists in the public and private sectors have pointed out, the surplus supply capacity is probably being depleted. For example, according to the Labour Force Survey, the labor participation rate among women aged 35 to 44 rose from 66.7% in 2012 to 78.4% in 2022, and there is apparently little room left for further future growth.

On the other hand, some people are pinning hopes on the surplus supply capacity of foreign labor. As a matter of fact, the number of foreign workers engaging in manual labor under the governmental technical training program increased from around 150,000 in 2012 to around 400,000 in 2020. This program, together with the new training program regarding specified skills launched in April 2019, under which around 110,000 foreign workers were working in Japan as of September 2022, serves as an additional supply of labor. However, relative to the expected annual decrease of around 700,000 people in the Japanese population aged from 15 to 64 in the period through 2040, the additional labor supply is likely to produce only a limited impact in offsetting the decline. As a result, the Japanese labor market is expected to become tight, resulting in wage growth through competitive pressure.

Meanwhile, we cannot ignore the long-term change in pay systems designed by companies. At major Japanese companies, internal promotion and pay rises premised on long duration of service are the main factors behind wage growth. Those companies have maintained freedom in designing internal pay systems by shielding themselves against the competitive pressure of the labor market on the premise of a rigid labor market structure lacking in labor mobility. Many theoretical studies have shown that such pay systems are economically rational because they promote the internal accumulation of skills among employees, leading to productivity growth.

The foundation for the economic rationality of internal accumulation of skills leading to productivity growth was gradually eroded by the end of Japan’s economic growth in the 1980s that was geared toward catching up to other advanced economies and this continued in more recent years of technological innovation. As a matter of fact, many studies have reported the shortening of the duration of service and a decline in the rate of pay raise linked to longevity.

For example, a study by three researchers at the Bank of Japan—Taro Kimura, Yoshiyuki Kurachi, and Tomohiro Sugo—reported that the pay rise for every additional year in the duration of service declined from 2.5% in the 2005-2008 period to 0.0% in the 2013-2017 period, representing the flattening of the wage curve. This trend is expected to continue and to exert downward pressure on wages.


The rate of wage growth this spring will depend on the balance of two forces—the upward wage pressure due to labor shortages and the downward wage pressure associated with the long-term change in pay systems. If we look at the wage situation from this perspective, workers’ wage growth this spring is expected not only to be affected by the average rate of wage growth but also to differ across different categories of workers. While wages are expected to rise for those who work short hours or under a fixed-term contract and for dispatched workers, the rate of wage growth for regular employees at major companies is expected to be limited. Recognizing that wage hikes this spring will bring about change in wage systems as explained above presents us with both business management implications and policy implications.

Regarding business management implications, employers should regard the uptrend in wages as a good opportunity to reform their wage system. When overall wage growth remains stagnant, lowering some employees’ wages is necessary in order to raise the wages of others. However, as lowering wages in nominal terms dampens employee morale, it becomes difficult to reform the wage system. Meanwhile, when wages are on an uptrend, employers can reform the wage system by raising wages for some groups of employees while leaving wages for other groups unchanged. A seniority-based wage system can be modified by raising wages generously for younger employees while leaving wages for middle-aged and older employees unchanged.

The uptrend in wages can also be used to promote the narrowing of the gender wage gap, which is the key to women’s empowerment. Although it is difficult to raise wages for women alone, employers may grant more generous wage hikes for jobs and ranks that are occupied by higher proportions of women. Strategically raising wages—varying the rate of wage hike according to the job type and worker attributes—will lead to wage system reform. Both companies and labor unions should see this good opportunity for reform in a positive light.

As for policy implications, the wage uptrend has implications for the Bank of Japan’s monetary policy. It is said that the Bank of Japan is paying attention to changes in the wage level for clues as to the sustainability of the ongoing inflation, as it explores the timing of an exit from its unconventional monetary easing.

Although monetary policy may affect the wage level through the supply-demand balance in the labor market, its effects are unlikely to extend to wage systems. In the Outlook Report, in which the BOJ focuses attention on wage systems for both regular workers and part-time workers, greater emphasis should be placed on changes in wages for part-time workers, which better reflect the supply-demand balance. The BOJ should also take care to avoid missing the right timing of an exit from monetary easing by allowing itself to be distracted by the slowness of the wage growth for regular workers, which is significantly affected by companies’ wage policies.

When it comes to wage hikes this spring, it is important to pay attention not only to the average trend in overall wages but also to changes in wage systems that may be the result of the general trend in wages.

>> Original text in Japanese

* Translated by RIETI.

February 22, 2023 Nihon Keizai Shimbun

April 27, 2023