Considering the Potential Side Effects of Employment System Reform

Visiting Fellow, RIETI

The growth strategy adopted by the government of Prime Minister Shinzo Abe includes a call for reform of Japan's employment system, especially by the promotion of policies that are aimed towards enabling women to play a more central role in society.

A set of legal measures and ideas have been implemented in Japan with the aim of making women's family lives more compatible with their careers and providing equal social opportunities to both men and women. Such measures include the Basic Law for a Gender-Equal Society, enacted in 1999, and the Work-Life Balance Charter, adopted in 2007. Japan, however, has lagged far behind other countries in the representation of women in society. In fact, Japan's ranking is falling in the annual Gender Gap Index, a global index indicating the extent of gender inequality based on economic, political, and education- and health-based criteria compiled by the World Economic Forum. Of the 135 countries indexed in 2012, Japan ranked very low (102nd) in the category of "economic participation and opportunity." The Abe government has placed priority on promoting women's social participation in its policy agenda, a stance that should be highly commended.

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However, even well-intended policies could have unintended consequences. Such unintended consequences often take place when those who believe new policies or institutions will bring about additional burdens and costs and choose to avoid such costs. In the case of labor policies, attention must be paid to the fact that institutions that are intended to promote better use of human resources could lead to an increase in inequality in social opportunities, if a certain principle of fairness—restricting the potential unintended effects of cost aversion measures taken by employers—is not promoted simultaneously.

The revision of the Labor Contract Law in April 2013 under the recent government of the Democratic Party of Japan is an example in which a policy measure is highly likely to produce unintended consequences. Companies are now obligated to offer indefinite duration employment contracts (which would provide higher employment security) to any worker whose length of employment at the company exceeds five years. The revision was intended to stabilize the employment of fixed-term contract workers, but the measure is likely to bring about unintended consequences by motivating companies to terminate employment contracts with such fixed-term contract workers within five years.

In general, there are two major motivations for companies to employ fixed-term contract workers in addition to the aim of maintaining flexibility in employment adjustments. The first motivation is to reduce personnel costs. The second is to identify candidates for indefinite duration employment by using fixed-term contracts as an extended trial employment period. The latter motivation, but not the former, may open the way for fixed-term contract workers to obtain indefinite duration contracts. However, empirical studies conducted in Japan so far have shown that fixed-term employment contracts have not been the gateway to indefinite duration contracts, therefore they have been used by employers primarily for the purpose of reducing labor costs. Changing labor contracts from fixed-term employment to indefinite duration employment is costly for Japanese companies because of various institutionalized fixed costs associated with each indefinite duration employee. The latest revision to the labor contract law is therefore likely to spur corporate moves to end labor contracts with fixed-term contract workers within five years.

European Union (EU) countries also have similar measures mandating indefinite duration employment for certain workers. Under the 1997 EU Part Time Directive and the 2008 EU Temporary Agency Work Directive, all types of workers—full-time employees, regular workers, temporary workers, and agency workers—must be treated equally by employers. This would render it ineffective for employers to resort to fixed-term contracts for the purpose of reducing personnel costs. Unintended consequences are less likely to occur under such a system. Hence, in order for the revision in the Labor Contract Law in Japan to stabilize non-regular workers by giving them indefinite-duration employment, the 2008 revision to Japan's Part Time Labor Law, which introduced the concept of "balanced treatment" between regular and non-regular workers, is not sufficient. Instead, a further step by which regular and non-regular workers should be treated equally is indispensable. Implementing such a step would be instrumental in discouraging companies from using fixed-term employment contract workers for the purpose of reducing labor costs.

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It is highly likely that several other policy measures envisaged under the Abe government's proposed employment reform will also lead to unintended consequences. The first such is a planned policy shift from "excessive employment protection" to one that facilitates labor mobility. Many Japanese companies have the policy of paying to their fixed-term contract workers or mid-career hires the starting salary of regular workers with similar job positions, regardless of their previous employment experience and the raises that would have accompanied such work experience. The salary of workers is based solely on the length of their service and achievement at the company at which they are currently employed, and does not take into account workers' experience and achievements at other companies, nor is there any attempt to measure the workers' "job capability (shokuno)" so that the starting salary could be adjusted accordingly. As Japanese companies have significantly reduced their investments in the human capital of workers with company-specific knowledge, a compensation system based only on the length of service and achievements at the current employer is extremely irrational.

It is necessary for the government to encourage and support companies' efforts to shift to a merit-based pay system in which workers' achievement is evaluated adequately—taking into account not only their achievements at their current companies but also that at their previous places of employment, thereby reducing the difficulty of workers in establishing their careers that span employment across different companies. Otherwise, the government's policy to promote labor mobility will not result in achieving its intended goal of better matching supply and demand in the labor market. Instead, career development for workers moving between companies will be hampered, eventually leading to a less efficient use of human resources in society—an unintended consequence. If the intended policy goals are to be realized, a compensation principle that is equitable for mobile workers should be promoted.

The second policy to be addressed is a government proposal to improve the work environment by granting childcare leave and shorter work hours to parents until their children turn three years old. The purpose of this proposal—providing more options for workers to engage in both paid work and child rearing—is good, but unintended consequences are also likely. In Japan, women have been traditionally excluded from companies' investment in human capital by many employers due to higher rates of job quits among women, and many companies have introduced gender-segregated tracking systems consisting of career-track positions reserved mainly for male workers and routine-work job positions for the majority of female workers. Labor practices curbing female workers' pay raises through those tracking system have also been prevalent in Japan. Such practices have been significantly hampering the active use of female workers in the workplace. According to my econometric analysis, the biggest cause of the gender wage gap has been a system of such indirect discrimination.

The Supreme Court of the United States ruled in 1971 (Greggs vs. Duke Power Company) that labor practices that generate disparate impacts on outcomes, such as wages and proportion rates between men and women of the same qualification should be deemed discriminatory regardless of whether there was any intention to discriminate against women. Under Japan's equal employment opportunity law, revised in 2006, however, any disadvantageous treatment toward a female worker that applies a criterion other than the person's gender "except in a case where there is a legitimate reason" is deemed indirect discrimination. However, as this definition does not indicate any clear-cut criterion for these "legitimate reasons," practices with no clear intention of discrimination have not been regarded as indirect discrimination. In fact, the two-tiered career track system, which is highly gender-segregated and generates unequal outcomes between men and women, has not yet been considered as an example of indirect discrimination.

Under such circumstances, the government's expansion of childcare leave and shorter work hours during child-rearing may make employers consider women, on average, as a more costly workforce. Thus, even if women's attrition rate in the workforce declines as a consequence, the traditional Japanese labor practices such as refraining from hiring women as regular employees and not investing in women as human capital may become even more prevalent. In order to prevent such an unintended consequence, indirect discrimination should be defined more comprehensively by the law, as in the case of the United States. It is also necessary that employers review the conventional labor practices of valuing only such workers who work long hours with inflexible work conditions as the key elements of the workforce. Instead, it is necessary to promote switching to a system and a practice that treats all types of workers fairly as valuable human resources regardless of their work style preferences.

In this regard, the proposed employment reform to include providing support to those returning to work after taking childcare leave and promoting telecommuting as an alternative work style should be highly evaluated. The latter is important from the viewpoint of making childcare and work life more compatible, and producing a workforce that retains high productivity regardless of the absence of constraints in the time and place of work. However, unless extra pay for late-night work is waived under the labor standard law for telecommuting workers, this work style might not be promoted because employers will try to avoid the additional labor costs of late-night work of such workers. This is also an issue of establishing a new fair compensation standard.

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All of these examples have shown that measures to reform the employment system and encourage women's participation in the workforce may lead to unintended consequences unless new institutions based on the principle of fairness—compensation principle and social opportunitie—which are highly consistent with the intended policies and economic rationality are promoted simultaneously.

In order to prevent unintended consequences, it is therefore necessary to restrict companies from choosing to take actions contrary to the intention of the policies for the purpose of avoiding costs under these new conditions. This does not imply an imposition of unreasonable burden on companies. The policy is intended to encourage companies themselves to generate more rational employment policies and practices by switching to a system that is more inclusive and fair and brings better opportunities to their employees, instead of resorting to some means to avoid costs on the premise of preserving their existing systems.

Many important policy measures were not included in the proposed employment system reform such as the aforementioned equal treatment for non-regular and regular employees, more comprehensive policy to prohibit indirect discrimination against women, and "visualizing" basic corporate personnel statistics by gender. By increasing the transparency of companies' use of human resources, workers, consumers, and investors can choose the desirable companies for an open civil society. This visualization of such personnel statistics is important from the viewpoint of building a social system in which such companies supported by a civil society can prosper.

>> Original text in Japanese

* Translated by RIETI.

July 24, 2013 Nihon Keizai Shimbun

November 7, 2013