Bending Economic Rules

The Japanese labour market is tight but wages aren't rising. Why? And what could it tell us about the rest of the world?

Having just returned from visiting companies in Japan, several themes were very evident.  One that was spoken about most frequently was quite how tight the labour market is and how it shows no sign of abating.  The standard rules of economics dictate that as the labour market tightens then wage inflation starts to show itself.  So when unemployment gets to 5% (perhaps 4% in Japan) then employment is structurally full and you should see inflation start to accelerate.  This would be the Holy Grail for Abenomics, Prime Minister Shinzo Abe’s set of policies designed to break the 2 decade mentality of deflation. 

Japanese Labour Market Graph

Source: Ministry of Internal Affairs and Communications (data to 31.01.17)

The chart above shows unemployment is around 3% but yet wage inflation struggles to break out of the 0-2% range that it vacillates around as shown below.

Nominal Wage Growth under Abenomics Graph

Source: Ministry of Health, Labour & Welfare, JBRC – (data to 23.03.17)

There are number factors that might explain this anomaly and might shine light on what might happen in other countries as employment tightens.

The participation rate has fallen since the financial crisis but has now started to rise driven by more women starting to work (up 7.2% since early 2012) and more retirees returning to the work place part time.  These are people whose desire to work is partly driven by the need for a work life balance and for the stimulation of work rather than just financial incentives.  They typically work part time and therefore take a significant discount from their full time employed peers – a phenomenon that is more significant in Japan than anywhere else.  It does mean that in spite of Japan’s long term population decline their workforce is actually growing.  Total Japanese employment is up 3.9% since the beginning of Abenomics (having fallen 4.8% since 1997 peak).

Japanese Empoyment Male vs Female Graph

Source: Ministry of Public Management (data to 31.01.17)

Productivity of the workforce has been stubbornly low and worsening for some time.  Of itself it therefore is not much of a shock that the proportion of profits going to labour (as opposed to shareholders or capital expenditure) is at a very low level.  Therefore most employer’s first response to the tighter labour market has been to spend money on improving productivity rather than raising wages.

The owner of 7-11 convenience stores was particularly forthright on this issue.  Their model is based on being able to have stores open and well staffed 24 hours a day.  They are really struggling  to find new staff to work the late night and weekend shifts as – with tight employment - employees can now pick and choose how and when they work.  Their response to invest in machinery to automate a lot of those night time processes (high pressure washing machines for the ovens that were previously washed by hand etc) effectively reduces their need for labour forever.

An increase in the level of automation is an important long term trend that we are arguably only at the beginning of.  The effect it has on the world will be broad ranging but the effect on labour will be one of the most visible.  If it serves to hold wage inflation near zero, even if the recent increase in consumer price inflation is sustained, then you might see an unexpected consumer response.  In Japan this has so far led to an increase in the inclination to save – the opposite presumed effect from inflation.  This may well be an entirely rational response – to save more to fund future life styles when costs go up and income stays flat.  However, it does suggest that the consumer is hurting and therefore raises the question of whether the politicians will allow their voters to be impoverished in real terms, even temporarily, in the name of sustaining inflation.

We wait to see whether they are and what pattern occurs in the rest of the world.

By George Palmer

Risk Warnings

The views and opinions expressed are the views of Waverton Investment Management Limited and are subject to change based on market and other conditions.  The information provided does not constitute investment advice and it should not be relied on as such.  All material(s) have been obtained from sources believed to be reliable, but its accuracy is not guaranteed.  There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information.