A Point in Question on the Wage Hike Policy: The government should focus on the creation of a facilitating environment

Faculty Fellow, RIETI

One year has passed since Abenomics, a set of economic policies under the second government of Prime Minister Shinzo Abe, went into full swing. Particularly conspicuous among the various policies that have been put in place so far are the government's repeated calls on private-sector companies to increase wages for employees. Since employees' wages are, by right, determined through negotiations between the management and labor unions of individual companies, it is necessary to examine whether such aggressive interference by the government is justifiable and consistent with other policies.

The simplest reasoning for justifying the government's request for wage increases is University of Tokyo Professor Hiroshi Yoshikawa's argument pointing to lower wages in recent years as a cause of deflation. Even if we accept this logic, there still remains the question of how this particular policy relates to the ongoing monetary policy, which is the centerpiece of Prime Minister Abe's fight against deflation, in terms of the division of roles.

Ignoring the question of consistency between policies and looking over a short-term horizon, we could say that the environment is ready to accommodate wage increases in the next fiscal year that typically starts from April 2014. Under the current Abe government, Japan's gross domestic product (GDP) has been showing solid growth, and, owing partly to a sharp depreciation of the yen in the first half of 2013, corporate earnings performance has improved remarkably. As the job-offers-to-seekers ratio now has risen above 1 and the jobless rate has fallen below 4%, it is unlikely that wage increases will have a negative impact on employment. Rather, with the consumption tax rate set to rise in April, it makes sense for the government to find it necessary to raise wages as a way to secure certain levels of real income for households.

However, will such an upward trend of wages continue on a sustainable basis? Should wages be increased on a one-time basis by boosting bonuses or on a permanent basis by raising monthly basic pay rates? In order to find answers to these questions, we cannot afford to avoid examining not only the expected earnings performance of individual companies but also the relationship between this particular policy of urging for wage hikes and other economic policies.

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If the recovery trend is to continue for the entire economy, it would be possible to increase wages across a broad range of industries on a sustained basis, transcending the differences in earnings performance among individual companies. However, the decomposition of the GDP growth over the past year reveals an increasing tendency to depend on public-sector investments as a contributing factor for growth while private-sector investments, which has been much-touted under the government's growth strategy, has contributed barely to the recovery. Market participants are beginning to suspect that Abenomics might end up just being fiscal expansion and the financing of it. The seesawing of the stock market is a reflection of such concerns.

The government seems to be pinning its hopes on wage increases to stimulate consumption and thereby break the ongoing sense of hitting a ceiling in the economic cycle. However, is this realizable? This process might have stood a reasonable chance in the Japanese economy of the latter half of the 1980s. Back then, people's real income was on the rise helped by the appreciation of the yen, which in turn led to an increase in consumption and growth in domestic production. Not subject to minimum capital requirements, banks lent aggressively to support corporate investments in the expansion of production capacity.

However, the structure of the Japanese economy has changed drastically since then. The continuing trade deficits amid the weakening yen are a stark evidence of this. An increase in energy imports following the suspension of nuclear power plants is a contributing factor to the deficits. But Japanese exports have not recovered as much as expected in spite of the yen's depreciation while a recovery in consumption has led to an increase in imports, all of which are contributing to the trade deficits. The mass exodus of manufacturing over the years has changed Japan's domestic production structure completely. Today, an increase in consumption does not necessarily lead to a recovery in domestic production and rather tends to be accompanied by an increase in imports.

The government also seems to believe that companies can tap their retained earnings to pay higher wages. However, having gone through the financial crisis of the latter half of the 1990s, Japanese companies shifted their strategy to reduce dependence on banks and instead retain cash flows to secure their sustainability. As such, not only Japan's trade structure but also customary employment practices and the relationship between banks and companies are quite different in nature from how they used to be in the latter half of the 1980s. Given those structural changes, expectations on a virtuous economic cycle starting from an increase in wages could turn into disappointment.

This leads to the all-too-natural conclusion that whether to increase wages on a one-time basis, for instance, through bonuses or on a permanent basis by raising the monthly basic pay rates, should be determined by individual companies based on their prospects for productivity improvement and earnings performance in the future.

Figure: Deviations of wages in the manufacturing and non-manufacturing sectors from the average for the entire private sectorFigure: Deviations of wages in the manufacturing and non-manufacturing sectors from the average for the entire private sector
Source: Japan Industrial Productivity (JIP) Database 2013 developed by the Institute of Economic Research, Hitotsubashi University and the Research Institute of Economy, Trade and Industry (RIETI)

However, what needs to be kept in mind here is the widening productivity and wage gaps between companies as well as between industries, a tendency that has been observable since the burst of the Japanese bubble economy. Plotted in the figure below are the deviations of wages in the manufacturing and non-manufacturing sectors from the average for the entire private sector. We can see that the wage gap between the manufacturing and non-manufacturing sectors has been widening consistently over the past 20 years. What lies behind this is the productivity gap between the manufacturing and non-manufacturing sectors.

The similar trends are observed at subdivision levels, and it is inferred that productivity gaps are emerging between companies within the same industry or between operational units within the same company. Up until now, companies have prevented intra-company productivity gaps across operational units from translating into wage gaps by means of cross-subsidization from high productivity units to low productivity units. However, as seen in the select-and-focus pursued by many electric appliance manufacturers, such cross-subsidization cannot be continued forever, and it is quite likely that productivity gaps will surface in the form of wage gaps in due time.

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How can we enable a broad spectrum of people to receive the benefit of higher wages amid widening productivity gaps across the country? There are two ways to achieve that end. One way is to increase the progressivity of the individual income tax and thereby redistribute more income from high earners to low earners. However, this method may end up putting constraints on productivity growth, a source of wage increases, by undermining the motivation of high earning workers.

This leaves the second method as a favored choice, namely, creating a more facilitating environment for workers to shift to more productive and higher-paying jobs and sectors by promoting the fluidity of the labor market while maintaining a degree of progressivity in taxation. If the government wishes the forthcoming wage increases to be sustainable, it must recognize that labor market reform is inevitable and act quickly toward its realization.

What is certain in any event is that the process toward securing higher wages for workers is extraordinary in that it has been promoted under the initiative of the government. Instead of inducing companies to raise wages voluntarily by creating a facilitating environment through corporate tax cuts and deregulation, the government opted to make a direct request for corporate employers to raise wages.

The distribution of income to labor is an important matter for management to decide based on their consultation labor unions. Japanese companies are paying corporate taxes that are relatively high by international standards, and their management strategies are subject to significant constraints imposed by government regulations. The government's demand for wage hikes came on top of all these, and companies are complying obediently with the request. Such development seems to be pointing to the need to reexamine the role of corporate managers. Should this approach result in more companies falling into the habit of waiting for government instructions before taking any action, it would be contradictory to what is intended by the government's growth strategy.

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Instead of trying to yield its influence on the private sector where indirect intervention in wage decisions is the most that can be done, the government should find ways to induce wage hikes in the non-profit sector--including medical services, long-term care services, and nursery services--where it can exert greater influence by regulations and other means. According to the Japan Industrial Productivity Database (JIP Database), the not-for-profit sector as a whole accounts for 4% (20% including the public sector) of Japan's total value added, which is comparable to the share of the financial sector.

Medical and other non-profit services are perceived to be a growth area with labor input increasing at the pace of 6% per annum. Nevertheless, wages for those engaged in such services are falling at 1.5% per year. This is caused by a distortion in the functioning of the market mechanism. More specifically, an increased supply of labor has been working to decrease wages because value added fails to increase proportionately with additional labor input with the freedom of corporate management constrained by government regulations. If the government seriously intends to raise overall wage levels in Japan, it should aim to increase wages in the non-profit sector through regulatory reforms as its policy focus.

In order to increase people's income sustainably, urging private-sector companies to cooperate for short term effects is not enough. An environment where companies find it easier to raise wages must be created by helping them to improve productivity through such means as reducing corporate taxes and pushing forward regulatory and labor market reforms. That is exactly the role the government should be playing.

>> Original text in Japanese

* Translated by RIETI.

February 18, 2014 Nihon Keizai Shimbun

March 14, 2014

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