Japan's cheap-labour folly
Japan has been the pioneer of secular stagnation ever since its stock and property markets crashed 30 years ago. A big reason the condition has persisted has been the country's cheap-labour strategy
A famous story from American industrial history claims that in 1914 the carmaker Henry Ford raised his factory workers’ wages to double the then average wage so that they could afford to buy his cars. It is apparently not really accurate: he actually raised wages in order to reduce staff turnover. But it gets to a truthful point: if employers throughout a country pay low wages, then it will hurt overall demand for their products and services, domestically.
That aptly summarises the state of the modern Japanese economy. This is not an observation about the Covid-19 recession. It is an observation about the past three decades since the bubble economy burst. Japan was once thought of internationally as a high wage, high labour cost country, which prospered by growing productivity fast enough to outpace wages. Now it is a cheap labour country.
When we look at trends over time in each country, the pattern of labour costs is quite clear and can be separated from the effects of exchange rates. The data shows that the movement of unit labour costs in Japan since 2000 is highly unusual compared with other advanced countries.
According to the Ministry of Health, Labour and Welfare, unit labour costs in Japan at the end of 2019 were 3% lower than when the 21st century began. And in fact they had also been declining for much of the 1990s. In Germany at the end of 2019 unit labour costs were 40% higher than in 2000, according to Eurostat; in the United Kingdom they had doubled in those 20 years; in the United States labour costs had also almost doubled, according to the US Bureau of Labor Statistics.
As far as the competitiveness of domestic Japanese business is concerned, this looks like good news. There was unfortunately no productivity boom during those 20 years, except in some exceptional sectors of manufacturing, but this record shows how profitability and price competitiveness were successfully maintained by tight control of labour costs, even as rivals in China, South Korea and other Asian countries were getting stronger, and even as domestic demand was slow-growing or stagnant.
The problem is that this recipe for maintaining profitability comes at a heavy macro-economic price. To restrain unit labour costs so successfully without economy-wide productivity growth requires employees’ earnings to be kept also under tight restraint. For one company or sector, this makes perfect sense. But if it is generalised to the whole economy, this guarantees slow economic growth, in the long term.
Domestic demand can only grow if one or more of its three components can also grow: household incomes and consumption; business investment; and government net spending. None of these have been growing substantially in Japan except for short and unsustainable periods. Without demand growth, there is little incentive for extra business investment; without growing household incomes and consumption, government tax receipts cannot grow substantially; with government debt at more than 200% of GDP, there is no room for fiscal stimulus over a sustained period.
The Bank of Japan’s governor, Haruhiko Kuroda, has dedicated himself since entering office in 2013 to defeating deflation by means of powerful monetary expansion. But although the central bank has made some progress in this quest, it has not succeeded for one simple, big reason: wage rates have not been increasing on a broad, sustained basis. This is true despite the labour scarcity that had emerged before the covid-19 economic setback.
The background to this failure is well known. With nearly 40% of employees working on non-regular, short-term or part-time contracts, there has been plenty of flexibility for companies to avoid raising wages by altering the balance of their workforces between regular and non-regular workers. Moreover the spring wage round, in which traditionally big-company negotiations over regular workers’ wages set a pattern for smaller firms, has repeatedly been settled at very moderate levels, probably in part because of the potential for employers to substitute precarious, non-regular workers for regular ones, over time. Meanwhile, Japan’s national and prefectural minimum wage rates are among the world’s lowest.
This national cheap-labour strategy can be maintained, if that is really what the public, corporate managements and government want. But the result will be constant disappointment. Successive governments will continue to come up with new plans to modernise and revive economic activity, and may even achieve some small signs of progress, but there will always be a limit to how much progress can be made. That limit is set by the permanently depressed state of domestic demand, as a falling and ageing population combines with the cheap labour strategy to guarantee stagnant household consumption.
The right solution is the one associated with Henry Ford: to raise wage rates, right across the economy, starting with much faster rises in minimum wage levels but being extended all the way through the labour market. Only once a consensus is reached to embrace a high-wage strategy will Japan’s prosperity really approach its true potential.
English original of article published in Japanese in Nikkei Business, December 2020