Japan’s wages have stagnated despite a historically low unemployment rate of 2.4 per cent just before the COVID-19 pandemic. Labour shortages typically arise not from strong demand for labour, but from a declining supply of workers, which Japan is undoubtedly facing. The population aged 15 to 64 declined by over 10 million between 2000 and 2022, with the percentage of the population aged over 65 now sitting at 29 per cent.

Firms cannot pay higher wages without productivity growth. Low productivity growth comes mainly from sluggish growth in investment caused by large firms moving away from shrinking domestic markets. In the last 20 years, private investment increased by only 12 per cent — a tiny amount when compared with the 5.9 times increase in foreign direct investment abroad.

The flattening of the seniority-based wage structure, mainly due to the ageing labour force, has led to prolonged stagnation in average wages. According to the 2022 Wage Census, the average monthly wage for men has increased by only 6 per cent since 1995. While the wages of the newly employed increased by 16 per cent, both those employed in the same firm for over 30 years and the highest earning group saw their wages decline by 9 per cent.

In his June 2023 economic policy package, Prime Minister Fumio Kishida presented three pillars of labour market reform plans — subsidies for re-skilling senior employees, introducing job-based wages replacing seniority-based wages, and increasing labour mobility in higher wage sectors.

The 2019 ‘equal pay for equal work’ legislation aimed at lowering wage inequality for non-regular employees lacks efficacy as it continues to enforce the ‘seniority’ payment system of regular employees. It obliges equal wages to be paid to regular and non-regular employees of the same seniority level. But these non-regular employees hardly exist due to their fixed-term employment. As a result, this rule has had a limited effect on keeping wages competitive.

Japan also lacks an effective rule for settling individual dismissal disputes. There is an unfounded but widespread belief that dismissal regulations in Japan are too strong. The current law only forces firms to pay a uniform 30 days of wages for dismissal payments. The case law was established to protect employees because this compensation is too low. But court procedures take time and money, so low-income workers must depend on alternative institutions to reach a settlement and generally receive smaller compensations. On the contrary, those who utilise the court are supported by labour unions and receive larger compensations.

Japan should implement a European-style dismissal payment scheme based on years employed to achieve a fair and efficient dismissal settlement process. This will encourage labour mobility by allowing companies to reasonably dismiss low-quality workers and push up wages as firms compete to attract new employees with higher salaries.

But labour market reform alone is not enough, and encouraging the demand for labour through structural reform is necessary.

To achieve better labour mobility, many have advocated to partially remove the tax benefits on lump-sum retirement payouts. As it currently stands, large Japanese firms give intensive on-the-job training to employees while taking a part of their wages and putting it towards a lump-sum retirement payment. This is done to incentivise employees to stay in the firm. As the payment amount accumulates with seniority, those who leave a firm in their 40s and start their career elsewhere are penalised by having their aggregate payments across their lifetime reduced by a maximum of 40 per cent.

While this is based on private employer–employee contracts, the government supports the scheme by offering favourable tax benefits. In his most recent policy package, Kishida has attempted to overhaul the policies supporting these traditional employment practices that protect regular workers with job and wage stability at the expense of labour mobility.

Despite this, the policy measures need to be bolder. The tax advantage on lump-sum retirement benefits has remained in place in order to encourage firms to retain senior employees. It is better to shift to having independently managed pensions — unconnected to specific firms — as this would both remove the incentive to stay with one firm and protect employees against the risk of bankruptcy. With the pension payout incentive removed, companies can attract workers by offering higher wages. 

A growing elderly population is also a serious concern for the government. But while the expanding social security budget is likely to strain government coffers, there is a promising opportunity for the private sector to capitalise off a burgeoning silver market. The baby boom generation is reaching the ages of 70 and above, and their demand for healthcare and nursing services will be significant. These social services are currently heavily regulated, but the government would benefit from giving the private sector more scope to lead in the creation and delivery of new services through technological means.

Nursing care services are a good example. Currently, there are not enough caregivers for the rapidly growing elderly population. Japan established Long-term Care Insurance in 2000, under which the costs of nursing services are automatically reimbursed to patients. Local authorities currently control the prices that care providers can offer through the scheme, resulting in inefficiencies.

If Japan is to effectively address the problem of wage stagnation and labour shortage, a significant overhaul of existing policy will be needed. Sustainable wage growth can only be achieved with a continuous increase in domestic demand and labour mobility through various regulatory reforms.

Naohiro Yashiro is Specially Appointed Professor at Showa Women’s University.