Why Are Wages Not Rising Despite the Labor Shortage?

Japan’s Persistent Shortage of Labor

Statistics from the government’s “Hello Work” employment offices show that the ratio of job offers to job seekers has been rising steadily since 2010, following the end of the global economic downturn. The latest figure, for May 2017, is 1.49 job offers per job seeker. In other words, there is a shortage of labor, with only about two people available to fill every three openings. And the unemployment rate has fallen below 3% for the first time in 23 years. The labor surplus of 1993 to 2005, when the talk was of “restructuring” (companies’ pruning of their workforces) and of the “employment ice age” (referring to the severe scarcity of jobs for new graduates) seems almost like ancient history.

According to textbook economics, a shortage of labor leads to higher wages. And so in Japan the hope has been that the tightness of the labor market will cause wages to rise, thereby pushing prices up and ending the economy’s long bout of deflation. But there is no sign of this actually happening despite the ongoing labor shortage. Real wages have remained basically unchanged since the collapse of Japan’s economic bubble in the early 1990s. And these days, though the labor shortage has become more acute, real wages are actually on a downward trend.

Why, one wonders, are wages failing to go up? Many economists have sought to explain this phenomenon by citing the shift toward nonregular employment. Workers other than regular employees now account for about 40% of the total, and they form an indispensable part of the staff in many workplaces. Since their pay is lower than that of regular employees, the increase in their numbers has caused average wages to fall. So these economists explain.

But if the rise in job openings has caused the ranks of nonregular workers to swell, one would expect that these workers’ pay would have risen. This, however, has not happened to any great degree. The same goes for regular employees: Despite the steady rise in the percentage of graduating students securing firm offers of postgraduate jobs, the salaries for these jobs are failing to rise significantly. So it seems that the increase in nonregular employment alone cannot account for the stagnation in wage levels.

Is Insufficient Investment the Problem?

In the 2017 Annual Report on the Japanese Economy and Public Finance released on July 21 (in Japanese), the government identified insufficient capital investment by enterprises as the reason for the failure of wages to rise.

On the macroeconomic level, real wages—meaning the effective purchasing power of nominal (cash) wages—are analyzed as having three determinants: (1) labor’s share of total income, (2) labor productivity, meaning the added value produced by labor, and (3) the ratio of producer prices to consumer prices. Of these three, labor productivity is the one that has fallen sharply since the years of the bubble economy. And so, the government concludes, companies must invest more to raise this productivity level.

Based on this thinking, the government can be expected to implement measures like subsidies and tax breaks for capital investment, though these produced little notable effect during the economic slump, and in addition it may step up pressure on the Bank of Japan to continue its low-interest-rate policy. But even if such moves result in more investment, will this lead to higher wages as the government intends?

The Key Role of Labor Supply and Demand

In April this year a book that I planned and edited was published by Keiō University Press. Titled Hitode-busoku na no ni naze chingin ga agaranai no ka (Why Are Wages Not Rising Despite the Shortage of Labor?), it includes contributions from a total of 22 people, including respected scholars of labor economics and people involved in work relating to labor policy. They offer their individual explanations of the reasons for the stagnation of wage levels based on their various individual perspectives. The book has drawn an unexpectedly great number of responses. Here I would like to draw on its contents to consider the question of whether greater capital investment will indeed lead to pay hikes.

New investments in plant and equipment improve the environment for achieving higher added value from each worker, thereby offering the prospect of increased labor productivity. This creates additional demand for labor, because enterprises seek to hire more workers in the expectation of increased profits. In other words, more capital investment leads companies to step up their efforts to recruit new workers, and in the face of a pronounced labor shortage, they will be forced to offer higher wages. This is the government’s scenario.

According to economic theory, though, no matter how much the demand for labor may increase, the extent to which this will cause wages to rise depends on the nature of the labor supply. If modest wage hikes are not enough to produce a significant increase in the labor supply, enterprises will have to offer big increases to get the workers they want, and wage levels will head up. Contrariwise, if even a small rise in wage levels brings forth a surge in the supply of labor, enterprises will find plenty of workers without having to offer substantially higher pay, and overall wage levels will not rise that much.

Seniors Swell the Nonregular Employment Rolls

In practice, seniors and women are more responsive to changes in wage levels than younger people and men, respectively. To use economics terminology, their wage elasticity is higher. The government, under its slogan of “dynamic engagement of all citizens,” has been striving to increase employment among seniors and women, and their employment rates have in fact risen. As a result, the overall wage elasticity of the Japanese economy is higher than it used to be. That being the case, it is likely that any increase in employment produced by an increase in capital investment will consist primarily of more jobs for seniors and women, and that the failure of wages to rise significantly will continue.

Another factor that has kept wage levels from going up is the entry into the labor market of large numbers of aging baby boomers who have retired from their previous jobs as regular employees. Under Japan’s traditional system of seniority-based pay, these employees had been earning large salaries, and their retirement has therefore been working to lower the overall average level of wages. Many of them seek post-retirement jobs as nonregular employees, and their presence in the labor market has put dampers on the wages of young people in nonregular employment, who otherwise could have expected to enjoy higher pay due to tightness in the supply of workers.

As long as the supply of seniors seeking nonregular employment continues to rise, increased capital investment is unlikely to lead to significant wage increases anytime soon.

The Sorry State of Workplace Training

There is another crucial requirement in order for capital investment to bring about a rise in labor productivity, namely, the development of workers’ abilities.

During Japan’s period of high growth rates in the 1950s and 1960s, strong investment in new equipment on factory floors and elsewhere powered the rapid spread of technological innovations. At the time, relatively few people received higher education, and workers without specialized knowledge coped with new technology through trial and error. This process was supported by the enhancement of their abilities with on-the-job training. The practice of lifetime employment took hold as a way of promoting this training on a long-term basis, and the payment of seniority-based wages took hold as a way of recognizing the advanced abilities achieved through this sustained process. Capital investment did not lead directly to higher labor productivity; the advances were made possible by diligent efforts to train workers on the job.

Now, however, on-the-job training has fallen by the wayside. The sorry state of this workplace training is the most serious labor problem that Japan faces. When companies speak of labor shortages, they are not talking of hiring simply anyone; what most of them want are employees capable of coping appropriately with the changing times. Even if they are able to hire such people, they need to provide a certain amount of training in workplaces to enable them to deal with future changes and uncertainty. Companies say that they lack the time to provide this training, and they hope to hire workers who have already acquired the necessary abilities elsewhere. But because proper training is not being provided anywhere, there is a chronic shortage of such experienced, skilled human resources.

As long as the lack of proper in-house training continues to prevail, so will the failure of wages to rise despite the overall shortage of labor.

The Lingering Effects of the Employment Ice Age

The decline in the development of workers’ abilities is especially pronounced among those in their late thirties to early forties, who graduated during the so-called employment ice age. The salaries of university graduates in their early forties are substantially lower (on average, ¥23,000 less) than those of their seniors hired during the go-go years of the bubble economy. Job hopping became a common practice among the graduates hired during the employment ice age, meaning that their years of service with their current employers tend to be lower than those of their stay-put seniors. Also, the numbers of graduates taking jobs with small or medium-sized enterprises increased during the ice age. Both of these changes have tended to hold down their wage levels. On top of that, many say that they did not have sufficient opportunity to develop their abilities when they were in their twenties. In other words, the decline of on-the-job training dating back to the employment ice age is continuing to put dampers on the wages of those in the prime of their working lives.

Another point we must consider in relation to the impact of capital investment on wages is the content of the investment. The government has noted that labor productivity is lower than it was in the 1990s, but that was a decade when computers and information technology were coming into wide use in workplaces. In the case of the United States, the introduction of new technology led to a sharp widening of the income gap between “winners”—highly skilled people able to deal with this new technology, whose wages rose substantially—and “losers”—people short of skills and ill equipped to adjust to the technological advances, whose wages went down.

The technological innovations introduced through capital investment now and in the years to come are liable to produce only a tiny minority of winners and turn the large majority of employees into losers. Investments will be directed toward full-scale introduction of artificial intelligence and robots into workplaces. The minority of employees whose abilities have been developed sufficiently for them to make full use of AI and robots will earn high salaries, but the remaining majority will have to seek employment opportunities in other fields or take lower-paying jobs. So capital investment, rather than raising wage levels, may well actually push them down further.

The Downward Rigidity of Wages

As set forth above, I am doubtful about the scenario of increased capital investment leading to higher wages. It seems to me that we are more likely to find the clue to raising wages by looking at the structure of the labor market.

The book I mentioned above consists of 16 chapters, four of which deal with the close connection between downward wage rigidity and upward wage rigidity. It is known both in Japan and elsewhere that workers resent wage cuts and that such cuts have a negative impact on their motivation. Conversely, as long as their wages hold steady, they tend not to be that insistent on pay raises.

Suppose an enterprise considers raising wages in response to the current labor shortage. Given the high level of uncertainty about the future, the enterprise cannot exclude the possibility that deterioration of its business performance at some point will put pressure on it to cut back on personnel expenses. But once wages have been hiked, it will be hard to reduce them. The enterprise may as a result find its very survival in jeopardy. This is why employers hesitate to raise wages even when labor is in short supply. The book also refers to data indicating that enterprises that have never cut wages over the past 10 years have not raised them either, while those that have repeatedly cut wages have also been positive about raising them.

If workers’ psychology limits the scope for changes in wage levels, it becomes all the more difficult to envisage wage hikes being achieved through fiscal and monetary policy measures.

Aiming for Higher Bonuses

So is there no way of getting wages to rise? If companies want to respond to the labor shortage and to increase the motivation levels of their employees, their first step should be to increase bonuses, even if only temporarily, while holding monthly pay steady. Though workers resist cuts in their monthly pay, this attitude does not apply to bonuses. So companies should use bonuses as a tool for adjusting their personnel expenses, cutting them when necessary to cope with a downturn in business results.

The process of negotiating bonus levels will give the labor market a mechanism for adjusting annual pay levels in response to shifts in labor market supply and demand. Back when labor unions were powerful, bonus levels used to be set more flexibly from year to year on the basis of labor-management agreements. This has been cited as the reason for Japan’s success in keeping its unemployment rate low.

According to a survey by the daily Nikkei, this year’s summer bonuses in the nonmanufacturing sector, where the labor shortage is severe, are 5.5% higher than last year. It is the first time in 27 years that this figure has risen by more than 5%. Workers should push for even bigger hikes in this winter’s bonuses.

Japanese workers are altogether too complacent regarding their own compensation. Pay hikes do not emerge naturally through the operation of an invisible hand. The question is whether workers will be able to act with solidarity to make their voices heard.