Aim for a 4% Wage Increase at Next Year’s Spring Wage Offensive
Risaburo Nezu
Senior Executive Fellow
December 6, 2010 (Monday)
For some time now, I have asserted that the cause of deflation in Japan is low wages and that to overcome it we must raise wages. I have refrained from such assertions for the past two years because of the recession following the Lehman Shock, but since I was fortunate enough to be given the opportunity to speak at the “2011 Spring Labor Offensive Central Debate Session” hosted by RENGO on this November 1 past, I decided to revisit this problem. Below is an overview of my speech.
Deflation Cannot Be Overcome with Financial Policy Alone
In general, economists think that inflation and deflation arise due to problems with financial policy, in other words, that they are problems of interest rate and total money supply. The Bank of Japan enacted ultralow interest rate policy in the mid 1990s and has promoted quantitative easing intrepidly since 2003. However, deflation remains unresolved, and recently the decline of consumer prices has accelerated. There are still those who strongly believe that this would not be happening if the BOJ were more aggressive in its policy, but I remain unconvinced of this viewpoint.
All the BOJ is able to do is things like lower commercial banks’ tax rates or increase money supply. After that, whether or not money flows out into the real economy depends on whether companies have the motivation to borrow and invest money and whether consumers feel like using their money. For the past ten years, that hasn’t happened. Currently, the same thing is happening in the US as well; in order to prevent deflation like Japan’s, the US’s FRB enacted quantitative easing last year and has recently strengthened it further. As a result, the overflow of funds did not contribute to domestic economic upturn, but rather the majority flowed outwards to foreign countries, especially emerging countries, adding to their bubbles. Currently, the US is taking criticism from the rest of the world and the expected effects of their measures are yet to be seen.
Raising Consumers’ Buying Power is Essential
In order to reduce deflation, lack of demand must also be resolved. In order to achieve such a resolution, at least one of individual consumption, capital spending, public spending, or export must necessarily be increased. Japan would prefer to rely on exports, but, as the debates of the recent G20 clearly showed, countries whose current accounts are in the black are undertaking yen-depreciation maneuvers, and artificial measures for promoting export are difficult to adopt. Under the current conditions, increasing public spending is absolutely impossible. Capital spending may increase if lower corporate tax rates are realized, but with a supply-demand gap equal to 5% of the GDP, this is likely impossible as well.
Based on the current state of Japan’s economy, raising the income of general consumers itself is absolutely vital to correcting deflation. The most direct and effective way of doing this is to raise laborers’ wages. Wages represent both the price of labor as well as laborers’ income. If one considers the former, the argument that raising wages will result in fewer jobs and increased unemployment presents itself. However, if one considers the latter representation of wages, i.e. as laborers’ income, increased wages will result in greater domestic demand, which will raise the price of goods and effectively increase employment.
Japan’s Anomalous Fall of Service Prices
Since the latter half of the 1990s, Japan’s wages have been falling year by year by absolute amounts, and this declining trend continues. Consumer price indices fall in parallel, indicating a prominent deflation trend. In other words, deflation and falling wages are progressing side-by-side. Consumer price indices are calculated based on the composition of consumers’ spending, of which 50% in Japan and 60% in the US is comprised of services. Compared to goods, service prices are strongly determined by the wages of laborers, but, whereas other developed countries have annual increases of 3% in service prices, Japan’s service prices rise hardly at all. Conversely, we observe only marginal changes or drops in global goods prices due to the influx of inexpensive products from China and other emerging countries. If all this is taken into account, the service prices of western developed countries underpin the standard of prices as a whole, and so, while these countries have mild price increases of 1-2% per year, Japan alone continues to suffer from this anomalous falling of prices. This mutual relationship between service prices and wages in the service industry is also quite clear when one looks at the data. Consequently, if wages in the service industry rise then so should service prices, and overall consumer prices should be pushed upward as well.
Remember Wages that Corresponded to Productivity
The problem with wage determination in Japan in recent years is that we have forgotten the principle of “wages corresponding to productivity.” Wages minus labor productivity is called the Unit Labor Cost (ULC), and when this value is low it means that productivity is increasing faster than wages are. A country’s ULC being below zero is an important index by which to judge if it is undergoing deflation. Graph 1 shows a comparison of rates of change of ULC among major powers. It is clear that from the mid 1990s and onward, Japan’s ULC is for the most part negative, which is clearly different from other developed countries. In other words, Japan’s long-held practice of increasing wages together with productivity was broken in the mid 1990s, and since then deflation has continued to advance.
But, why did such a thing happen in the latter half of the 1990s? The cause lay in bad debts after the bubble burst. At that time, not only banks but many Japanese companies as well were affected by the bursting residential and land bubble and were left with sizeable bad debts. In order to deal with these, they had to raise profits and use the money as funding for amortization. Laborers had to prioritize their continued employment, and so were forced to accept pay cuts. However, those bad debts should have been dealt with and done with by 2005. Despite this, why have we been unable to return to the principle of wages corresponding to productivity? One reason is that, at the time, the idea that wages could not be raised because Japan was competing with China was quite prevalent. However, if that were so, then Europe and the US should be no different. Because Japan is not the only country exposed to competition from China and the rest of Asia, this argument is unconvincing.
When one looks at labor productivity over the long term, one sees that it has been increasing quite steadily. Compared to 1998, when the declining trend of wages first began, productivity has in fact risen by about 20%. If wages corresponding to this rise in productivity had been realized, then they too should have risen by the same percentage. The reality, however, is that wages have fallen by approximately 10%. This gap has applied corresponding pressure towards deflation.
If the rates of increase of productivity and wages were the same, then labor shares would not change. The fact is, however, that from the beginning of the new millennium until 2007, Japan’s labor shares have fallen continuously. In 2008, the greatest recession since WWII caused labor productivity to drop precipitously, and, together with substantial decreases in corporate profits, this resulted in a meteoric rise in labor shares. Unfortunately, as the economy rallied, they fell again thereafter to average levels from 2003 to 2007, when the Japanese economy grew without generating any benefit for workers (Graph 2). The financial performance for the fiscal year for 2010 is looking relatively good as of November, so if we are to secure wages corresponding to productivity, a certain amount of wage increase is justified.
A 4% Raise in Wages is Vital for Growth Strategy
Japan’s growth strategy assumes a nominal growth rate of 3%; this is in reality 2%, but based on the expectation of 1% inflation, it seems that the strategy aims at escaping deflation at the same time as encouraging growth. If we are to realize such growth centered on domestic demand, citizens’ buying power must be increased nominally by 3%. If we factor in an annual decrease of 1% in the labor force population, this becomes an annual wage increase of 4%. In terms of money, this comes out to about a \10 trillion burden on companies but, since this will increase buying power, quite a large portion of this will be returned in the form of increased sales. One caveat to this strategy is that a transient wage increase will have the same result as the fixed-sum benefits of 2008, i.e. the majority of those funds was put into savings and had no effect on the economy. Not until a permanent wage increase, such as raising base salaries, is effected will we be able to increase consumer confidence. The burden of increased costs that comes with increased wages should be borne by raising product prices. By doing so, not only will ill effects on corporate profits be avoided, but deflation can be resolved as well. If the promise of inflation can once be offered, consumption will stop being postponed, and we will at last be able to break free of the deflation spiral.
Low Wages Cause Yen Appreciation
There are many factors that contribute to deciding currency exchange rates, such as interest rates and international balance of payments, but Unit Labor Cost (ULC) is an important factor as well. A country with a low ULC has correspondingly high competitive power, and therefore, in order to counterbalance this, that country’s currency becomes more expensive on the exchange market. Japan is a representative example of this, but the currencies of countries with low rates of wage increase, such as Switzerland and Sweden, are generally on the rise. Before Germany was integrated into the Euro, the deutschmark was know as the strongest currency in the world, but the reason it was so strong was that Germany’s rate of wage increase was lower than most other countries in Europe. On average, developed countries have a wage increase rate of 3% per year. Assuming that Japan’s rate of productivity increase is not appreciably different from other countries, if Japan were to maintain a similar level of wage increase, then the yen’s appreciation pressure should be eased. Of course, there are other factors affecting the yen’s appreciation, such as the international interest spread, but the fact is that Japanese corporations effected appreciation of the yen themselves in order to achieve wage cuts. It is therefore not going too far to say that they have hanged themselves with their own rope.
Management and the Labor Force Must Have a Sincere Discussion
Among all developed countries, Japan alone has suffered declining wages for more than 10 years. This has resulted in decreased domestic demand and a decline in workers’ desire to work, which are undesirable effects for management as well. While corporations have stockpiled upwards of \200 trillion in cash, they have completely forgotten about investment in growth and appropriate share-outs to enlarge the domestic market. Heading towards next year’s spring wage offensive, I hope to see meaningful debate on how companies and their employees can break the vicious cycle of deflation and lowering wages and enjoy the fruits of growth together.
