Despite Some Positives, Japan's Labor Market Challenges Persist

February 2, 2016Japanby East Asia Forum

Japan's labor market situation is improving though serious issues persist.

Japan’s labour market situation is improving. The unemployment rate of 3.1 percent in October 2015 was the lowest for 20 years. In addition, although improvement has been slow, wage growth has been accelerating. However, Japan’s labour market still faces several serious issues.

Japan is suffering from labour shortages. Japan’s working-age population peaked in the mid-1990s and has been declining since then. According to government projections the labour force is expected to shrink to 44 million by 2060, which is about half of its highest level. This will obviously have a negative impact on potential growth in the long term. In addition, in the short term, mismatches across occupation and employment-type (that is, full-time versus part-time positions) will cause labour shortages.

The labour market duality between regular and non-regular workers has also deepened. In the past 30 years the number of so-called ‘non-regular workers’ — that is, temporary, part-time and contract workers — has increased from 15 percent of the labour force in 1984 to 37 percent in 2015. These workers are usually paid less, have a much lower level of job security and receive significantly less social insurance than regular workers.

Non-regular employment does provide flexibility and cost reductions for firms. However, an excessive imbalance in the labour market reduces productivity incentives and training opportunities. Japan’s economic slowdown, demographic changes, the strict employment protection of regular workers and the low labour costs of non-regular workers have all contributed to this imbalance.

Wages are also trending down. Although wages recently experienced some growth, average nominal wages have dropped nearly 15 percent since 1997. Japan is the only advanced country where wages are downward flexible, meaning that wages can drop in response to falling demand for labour.

Structural factors are responsible for this decline in wages. The rising share of lower-waged non-regular workers has reduced average wages. Japan’s wage system, in which base wages are rigid but firms are able to reduce bonus and overtime payments based on employees’ short-term performance, is another factor. So is the decline in workers’ bargaining power. Population ageing further reduces average wages because retirees are often re-hired as part-time workers at a lower wage rate.

These labour market problems are not cyclical but a result of Japan’s notoriously dysfunctional employment system. Life-long employment, seniority-based wages, internal training and promotion, and enterprise unionism — in which trade unions exist within firms rather than across industries — lies behind these structural problems.

When Japan’s economy was growing rapidly in the 1960s and 1970s, and had a large youth population, this system worked well and helped lower unemployment. However, in the face of Japan’s prolonged economic stagnation and ageing population this structure has become part of the problem.

So how can Japan solve its labour market problems?

To increase employment Japan must enhance economic growth. Companies are still not confident about the future and are reluctant to hire regular workers or to expand employment. For business confidence to improve, it is necessary to lift Japan’s economy out of stagnation and put it on a path towards sustainable economic growth.

At the same time, Japan must enhance flexibility in the labour market to accommodate different working styles. Currently youth, female, elderly and non-regular workers have fewer employment opportunities than regular male workers. Japan needs to better utilise female and elderly workers by abolishing tax and social security disincentives that currently discourage their labour force participation.

Currently, the head of a household (usually the husband) can obtain a spousal income tax deduction if their spouse earns less than 1.41 million yen a year (about US$12,000). In addition, if the spouse earns less than 1.3 million yen (about US$11,000), they are eligible for the national pension and are not required to pay premiums. These benefits discourage many women from working outside their homes. Similarly, the current pension system discourages the elderly from working since its payouts decline as wage earnings increase.

To encourage greater labour force participation among Japan’s elderly, it is also important to reform the seniority-based wage system, under which employees’ wages increase per year until they reach the mandatory retirement age. Limiting the seniority-based wage system would allow companies to raise the mandatory retirement age and flatten the wage curve.

Relaxing the high levels of employment protection for regular workers, and expanding social insurance coverage to non-regular workers, is necessary to reduce the labour market duality and boost youth employment. Japan further needs to attract more skilled foreign workers to boost productivity and solve the labour shortage. One key way to do this would be to provide better working conditions for foreigners. The current policies allowing for foreign workers are restrictive and minimal.

Japan’s labour market faces several serious issues, stemming from its outdated employment system. The Japanese government must push ahead with labour market reforms if it is to revitalise Japan’s stagnant economy.

Reforming Japan’s labour market is republished with permission from East Asia Forum

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