The Cost of Ignoring Labor Reform in Japan

Japan’s ambitious economic recovery plan (dubbed Abenomics after Premier Shinzo Abe) has spurred optimism after a long period of stagflation. Since the launch of Abenomics this year, Japanese stock markets have boomed, and recently the International Monetary Fund (IMF) raised its GDP growth forecast for the country. Nevertheless, there are concerns that the framework does not adequately address structural problems at the heart of Japan’s economy. Specifically, reforms in the highly polarized labor market have been conspicuously absent. In a recently released working paper, The Path to Higher Growth: Does Revamping Japan’s Dual Labor Market Matter?, IMF economists Chie Aoyagi and Giovanni Ganelli investigate challenges in the labor market and their implications for growth.

A schism began to develop in the Japanese job market when contractual “non-regular” hiring was facilitated under the 1990s labor law reforms. Traditionally, “regular” workers are hired under Japan’s unique lifetime employment system, which ensures a high level of job security and benefits. But in the aftermath of the 1990’s recession, firms needed flexibility to adjust labor costs and consequently preferred temporary or part-time workers to meet fluctuating demand. During the same period, Japanese women increasingly entered the labor force but sought flexible hours to balance traditional family roles. This fit nicely into firms’ demand for low-cost part-time labor. Since then, the share of non-regular workers in Japan has risen from less than 20 percent to over 35 percent. Notably, women comprise 70 percent of non-regular workers.

Aoyagi and Ganelli’s research points out how duality has become a problem because firms have no incentive to improve the employment terms for non-regular workers. The virtual absence of effective labor unions means that this group has no bargaining power. As a result, less than 10 percent of Japan’s non-regular employees ever enter permanent employment, as opposed to the over 30 percent chance of regularization in other developed countries, such as the UK and Germany.

There are obvious social costs as well. Despite a consistently low unemployment rate of five percent or less, a “working poor” class has gradually evolved in Japan. Aoyagi and Ganelli argue that this could lead to resentment and a perception that growth only benefits a few. The authors believe that it may even elicit political resistance against future reforms.

While the social implications alone should unnerve policymakers, the direct economic loss builds an even stronger argument for reducing duality. Estimates show that non-regular workers are 75 percent less productive than regular workers. Lower productivity results not only from a lack of motivation, but also because firms spend significantly less on training non-regular staff.

Bridging duality entails making job protection more equitable. While this implies increasing security and benefits for non-regular workers, firms cannot be expected to undertake the additional cost burden without economizing elsewhere. Any attempt at reform will thus leave current regular employees worse off, and their loss of job security will need to be compensated.

This research offers some policy alternatives. One proposition is to universally introduce single open-ended contracts that link job protection with years of service. This concept has not yet been tried anywhere in the world, but studies have found that such contracts could significantly reduce duality in the labor market.

Regular employees’ lifetime employment contracts can also be modified by compensating them with other incentives for the loss of job security brought about by reform. Soft measures, such as reducing overtime, ending involuntary transfers, and increasing time off, could be effective. Finally, the research proposes increasing unemployment benefits to reduce the need for high severance payments by firms.

The Japanese economy is on the eve of its most crucial reform in decades. Nonetheless, ignoring labor issues at this stage could keep Abenomics from reaching its full potential. As this research highlights, inequitable employment practices not only carry the obvious social costs, but also have a significant and quantifiable impact on labor productivity. The good news is that reforms need not be radical; even small changes in the right direction can yield a more productive workforce.

Feature Photo: cc/(Stefano)