Corporate Institutional Reform for a Stronger Japan: The case for incentive-based reform

Visiting Fellow, RIETI

I would like to consider the promotion of gender equality and diversity in Japan from the perspective of consistency between social justice and economic rationality. Liberal principles under social justice bear numerous commonalities with economic rationality. However, current systems in Japan create contradictions in the realization of equity and rationality, causing both the economy and society to lose vitality.

Liberal principles of social justice include equality in social opportunity, in which it is critical to eliminate barriers caused by certain individual situations. Let us consider the situations involving poverty, child rearing, and physical disability.

Through experimental education intervention and follow-up research conducted with children under six years old, Professor James J. Heckman of the University of Chicago showed that a reduction in inequality among children's home environments reduces disadvantages in cognitive development and status attainment under poverty. Regarding Japan, Professor Takehiko Kariya of Oxford University has pointed out the presence of significant class disparities in academic achievement and motivation for learning among elementary school students. Education intervention for preschool-aged poverty-stricken children reduces inequality in social opportunity caused by family environments, representing an efficient investment for generating productive citizens.

For child rearing, realizing workplace environments that enable flexible work arrangements, enhancing the quality and quantity of childcare facilities, and providing government assistance for their use will lower the rate of job separations for women due to marriage or child rearing and enable them to attain a work-life balance. This will promote both gender equality in employment and opportunity to utilize fully one's capabilities.

For physical disability, the employment rate of mildly disabled persons is much higher in the United States compared to Japan. Furthermore, their average income ratio relative to non-disabled persons is 89%, demonstrating that physically handicapped Americans are well utilized. Realizing a barrier-free society brings about equality of opportunity in employment and better utilization of individual capabilities regardless of physical disability. This leads to economic independence and improved productivity of physically handicapped individuals. Generally speaking, realizing a social system to reduce inequalities in social opportunity generated by initial conditions (poverty), life cycle conditions (child rearing), or accidental conditions (physical disability) is important.

In Japan, poverty, child rearing, and physical disability are regarded as welfare issues. However, these are in fact issues of equality in social opportunity, and considering them to be purely welfare issues lacks the perspective that removing these impediments resulting from individual circumstances and realizing a society in which diverse individuals can fully utilize their capabilities is consistent with economic rationality. Although such social and institutional reforms would be accompanied by temporary outlays, such costs are necessary investments for the future.

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Another important principle is that of distributive justice. What constitutes distributive justice differs depending on the societal value system, and may also change according to the needs of the times. At present, the desirable principle of distributive justice is one that can produce a diverse variety of individuals adding value to society. In his 1961 book Social Behavior: Its Elementary Forms, George C. Homans, then a professor of sociology at Harvard University, defined distributive justice as the principle of reward allocation commensurate with individual contribution based on the assumption of freedom of exchange. While this principle is similar to "wages commensurate with marginal labor productivity" which is considered rational by economists, his conception of reward is broader in not being limited to monetary compensation. Through reward, this principle of distributive justice promotes individual incentives to improve productivity and contribute to society.

Current standards of reward in Japan do not make the best use of diverse individual talents, and contradict the aforementioned principle of distributive justice in a number of ways. As an example, even if employees have the same job and demonstrate comparable performance, their wages and opportunities differ greatly depending on whether they are non-termed regular employees ("permanent employees") or termed employees ("non-permanent employees"). Such standards are unfair to women and youth who constitute a large percentage of non-permanent employment and discourage motivation for improving their labor productivity.

In Japan, permanent employees who satisfy certain standards reflecting loyalty and subordination to the firm (seniority wage, long work hours, unspecified work, etc.) are remunerated well. Additionally, job performance is considered only for accomplishments within the company, thereby causing evaluation standards to become firm-specific and uniform. Even while this system incentivizes long-term commitment to the employer, it also discourages utilizing diverse talents in the labor market. This also makes it difficult for employees to engage in child rearing, reinvestment in education, NPO activities, and other productive activities outside of their work life.

What then is the case in Europe and the United States? As an example, let me describe the faculty evaluation system of American universities. Faculty performance is measured based on a variety of factors including the number of research articles and the quality of academic journals in which they were published, the number of academic citations of research articles and other publications, awards given to publications, the amount of external research funds obtained, the average number of students taught per class, the number of graduate students supervised, and the extent of contributions made for various professional committees both inside and outside the university. Whether they receive awards for publications, publish research articles constantly in prestigious journals, obtain large external research funding, or foster a number of outstanding graduate students, each of these elements is considered important. Diverse talents in education and research are thus recognized and individual performance that excels those of peers is highly valued. Such evaluations are also reflected in the allocation of "merit-based" salary raises. For promotion to tenured appointment or full professorship, external reviews are incorporated to assure a universalistic standard for evaluating achievements. In Japanese universities, on the other hand, performance evaluations are a matter of formality, with no clear system linking them to raises or promotions.

Employees can possess talent in a variety of areas. Similarly, methods of productivity improvement and technical innovation are also diverse. I do not specialize in human resource management, but my understanding is that employee evaluation standards within American corporations take into account a variety of factors. In Japan, fair evaluations are believed to be based on monolithic standards, as exemplified by the entrance examination system for school admissions. However, it is desirable for human resource evaluation to be reinforced with an incentive system that encourages a variety of people to bring their capabilities into full play.

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There is also a distinct, economically irrational problem that hinders human resource utilization of diverse talents. The company welfare system for permanent employees that was developed during a period of high economic growth in Japan provides heads of households, typically male, with "family wages" and family allowances. This system presupposes the traditional division of labor in which husbands are mainly responsible for family finance and wives are mainly responsible for housework and child rearing. From the outset, such a system was unfair to women, single individuals, and employees without company welfare. The degree of unfairness has been augmented further with the recent growth in the number of non-permanent employees and single individuals.

Moreover, since corporate welfare systems increase the amount of fixed expenses for each permanent employee, it also gives companies an incentive to keep fewer permanent employees than needed and instead lengthen working hours. As a result, permanent employment with short working hours has failed to become widely adopted due to high personnel cost, thereby leaving child-rearing women with limited options for working style. The desire of companies to reduce cost has also been a major factor in their decision to increase the ratio of non-permanent employees with low overhead.

Japanese firms can adopt a benefit system like those found in Europe or the United States where only a portion of social security benefits such as pension and health insurance are covered. Furthermore, if the amount covered by these benefits is set proportionate to employee wage, then the company's expense for employee benefits would not become a fixed cost per employee, thereby enabling employees to choose diverse work styles.

Regarding more comprehensive welfare benefits, it is desirable to establish a public welfare system that is fair, in the sense that its availability neither depends on the specific employer nor on the type of employment, and is neutral to employee marital status.

Similar problems of irrationality and unfairness also exist in Japan for income redistribution via the tax and social insurance systems. These systems qualify individuals for spousal dependence benefits based on certain thresholds of married women's annual income, known as the "1.03 million yen barrier" and "1.3 million yen barrier." This issue has long been a topic of political debate, with promoters of female employment on one side calling for elimination of spousal dependence benefits, and advocates of fulltime housewives on the other arguing for their retention. However, from the point of view of economic rationality, whether we should eliminate or retain the spousal dependence benefits is not the key issue. The issue is the irrationality of the current system in which a married couple's total income may actually drop as the wife's income rises, due to the qualification thresholds for dependence benefits. To eliminate this problem, spousal dependence benefits should be stepwise reduced such that the combined income of married couples should always increase as the wife's income increases.

Regarding income tax, this issue has been partially addressed with the implementation of special spousal dependence deductions. However, given that spousal dependence criterion also affects residency tax and spousal allowances handed out by private employers, it is necessary to enact comprehensive reforms that include those elements as well. A similar reform is necessary for the "1.3 million yen barrier" problem for social insurance.

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The following chart illustrates a comparison of existing principles in Japan with proposed replacements. Under the new principles, society broadens social opportunities for diverse individuals to utilize fully their capabilities, and firms provide diverse individuals with incentives for self-utilization and self-investment. As individual capabilities become greater, society and firms will also be made stronger. In my opinion, this will be the key to revitalizing the currently stagnating Japanese economy and society.

Chart: Existing Principles in Japan Versus New Principles of Social JusticeChart: Existing Principles in Japan Versus New Principles of Social Justice

>> Original text in Japanese

* Translated by RIETI.

November 30, 2011 Nihon Keizai Shimbun

January 16, 2012