Japan's Still Falling Inflation Rate Signals Need For Labor Market Reform (VOX EU)

Ayako Saiki, 15 June 2013

Abenomics is all the rage. Japan’s GDP grew at an annual rate of 3.5% in the first quarter, the stock market went up by almost 30% since December, and despite some uncertainties, sentiments, consumption, and exports are all picking up. However inflation is at -0.9% and survey-based inflation expectation has remained flat. Is inflation going to happen at all? This column argues the answer crucially hinges upon the implementation of structural reforms, especially in the labour market.

Abenomics is all the rage.

• Japan grew at 3.5% in the first quarter;
• The stock market is up; and
• Sentiments, consumption, and exports are all picking up – even if recent stock-market performance has created some uncertainties.

But negative inflation is still present.

• March 2013 CPI inflation was -0.9% (year on year), down from -0.6% in February.
• Survey-based inflation expectations are flat.

Although the market inflation expectation (break-even inflation rate) had increased from 1.3% in April to 1.9% in mid-May, it recently declined to 1.4% (as of June 6) (Figure 1).

Labour-market reform is the keyAccording to a survey by Reuters in February, 85% of responding firms said they would maintain current wage levels or make further cuts this year. Japanese companies typically resort to wage cuts for workers with so-called life-long employment contracts rather than lay-offs to adjust for cyclical downturns or due to tougher price competition from abroad. As a result, the unemployment rate has been low, but wages continue to decline. Due to the strong protection of permanent workers, firms typically have redundant permanent workers, thus have no incentive to increase their wages. 
Worse yet, only a third of the Japanese labour force (typically older and male labour) has a permanent contract. The majority of the young and female labour force is working under a temporary contract with much lower salary and practically no job security, which creates a kind of caste system in the labour market.

A permanent contract is especially hard to come-by for the younger generation and female workers. The youth unemployment rate in Japan is 8% (the total unemployment rate is 4.8%) as of 2011 according to the OECD, and the wage gap between male and female is the second worst among OECD economies.

Three pillarsAbenomics is comprised of three pillars:

• Aggressive monetary policy easing (Figure 2).
• Fiscal stimulus.
• Structural reforms.

read more: Japan needs labor market reform