Why Are Wages Not Rising Despite the Labor Shortage?

Genda Yūji [Profile]

[2017.08.14] Read in: 日本語 |

According to standard economic theory, a shortage of workers will cause wages to rise. Why is this not happening in Japan? Is it because of insufficient capital investment, as the government suggests? Other factors may be more important, notably the weakness of companies’ on-the-job training. And given the rigidity of regular wages, greater flexibility in bonus payments seems like a better route to higher pay.

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.

  • [2017.08.14]

Professor at the University of Tokyo Institute of Social Science. Specializes in labor economics. Received his doctorate in economics from Osaka University. Has been a visiting researcher at Harvard University and the University of Oxford and a professor at Gakushūin University. Publications include Kiki to koyō (Crisis and Employment); Koritsu mugyō (SNEP) (Solitary Non-Employed Persons); Shigoto no naka no aimai na fuan (trans. A Nagging Sense of Job Insecurity), awarded the Suntory Prize for Social Sciences and Humanities; and Jobu kurieishon (Job Creation). Member of the Nippon.com editorial committee.

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