Inflation in Japan has been consistently close to zero over the past 20 years. Given the extreme tightness in the labour market, many argue that wages are due to rise and that inflation will subsequently take off. Our Chief Investment Officer Tim Tacchi does not share this belief and argues in the following paper that labour market tightness in Japan does not necessarily mean rising wages or higher inflation. This is perhaps unsurprising. After all, it is difficult to achieve both reflation and reform at the same time. Reform measures are by their very nature disinflationary as they are intended to improve the productivity of labour and capital. Thankfully, limited wage gains in Japan should mean a benign environment for corporate profitability. Tim’s research was aided by Professor Naohiro Yashiro, Dean of the Global Business Department and Director of the Business Research Institute at Showa Women’s University, Tokyo.
Despite Japan’s very low level of unemployment and a multi-decade high in the vacancy rate, wage growth is muted. This can be seen in the following charts.
Job openings to applicants ratio and unemployment rate
Source: JP Morgan
Employment to population ratio
Source: JP Morgan
Unemployment rate and wage increases (%)
Source: Statistics Bureau and MHLW
This is due to a number of factors, which we discuss below. Firstly, the composition of Japan’s labour market is changing, with part timers and women becoming an increasingly large proportion of the workforce.
Number of regular workers
Labour force participation ratios
Source: MIC, Goldman Sachs Global Investment Research
Secondly, expectations of future inflation are formed with reference to past experience, meaning long periods of low inflation can have a profound influence. Indeed, despite a massive increase in the monetary base since the start of Abenomics, core inflation is hardly changed in Japan, suggesting that a deflationary mindset has become firmly entrenched. The BoJ now faces the prospect of either losing credibility, or of continuing balance sheet expansion, which many also regard as stretching credibility to breaking point.
Inflation outlook by households and market professionals
Source: BOJ, Nikkei Quick, Consumer Affairs Agency, MIC, Cabinet Office, Goldman Sachs
Japan’s deflationary mindset can also be seen in the fact that firm-specific labour unions have a strong preference for job security over higher remuneration. This means less pressure to increase wages, despite tight labour market conditions.
2017 “Shunto” wage negotiation result
Source: MHLW, MIC, Goldman Sachs
Thirdly, as the chart below demonstrates, the proportion of the highest paid workers (aged 40-54) in the total workforce has risen by 4.2% over the last ten years. Japanese companies have therefore been forced to flatten the age-wage curve to offset the higher costs associated with this increase in well paid middle-aged workers.
Flattening age-wage curve
Source: Naohiro Yashiro, Showa Women’s University, Wage Census by MHLW
The impact of this trend can also be seen on the following chart, which shows that net wages have been falling for middle-aged workers.
Net wage increases by age in 2006-2016 (1000 yen)
Source: MHLW, Wage Census
Wage declines for middle-aged workers are also due to the changing composition of the Japanese labour market, which has seen a decline in highly-paid males and a corresponding increase in lower-paid females. If this trend persists, it will exert continuous downward pressure on average wage growth in the coming years.
Similarly, the proportion of workers in the generally low-paid fields of health care and care giving has risen continuously to 13% of the total labour force. As the graph below shows, employment in this sector has increased by over 50% since 2004. At the same time, wages in the sector have declined by some 10%, while nursing insurance benefits have been curtailed, reflecting government budget constraints.
Index of wage and employment (2004=100)
Another factor that helps to explain the lack of wage growth in Japan is the continuous increase in employers’ social security contributions. This raises the overall cost of employment, placing further downwards pressure on wages.
Compensation of employees (billion yen)
Finally, recent changes in the enforcement of a ceiling limiting the number of overtime hours have further reduced incomes.
Companies are not only cautious about raising wages, but also about increasing cap ex. While company profits are at record levels, cap ex has hardly risen. As can be seen below, this has resulted in companies stockpiling cash.
Corporate profits (ex. financial institutions and insurance) and capex
Corporate capex vs. savings (flow)
Source: Cabinet Office, Goldman Sachs
Corporate balance sheet by asset type (stock)
Source: Cabinet Office, Goldman Sachs
Inflation in Japan has been consistently close to zero over the past 20 years. Given our assessment of the labour market above, we expect only a very gradual improvement in Japanese core inflation. Indeed, without further increases in commodity prices or a pickup in wages, it is difficult to see why inflation should rise at all.
perhaps unsurprising. After all, it is difficult to achieve both reflation and
reform at the same time. Reform measures are by their very nature
disinflationary as they are intended to improve the productivity of labour and
capital. Thankfully, limited wage gains in Japan should mean a benign
environment for corporate profitability. Meanwhile, improved capital discipline
suggests that more of these profits will be returned to shareholders in
dividends and buybacks.