Commentary / Japan

Labor reforms can’t wait

by Yumiko Murakami

As Prime Minister Shinzo Abe nears the end of his second term, the prospect of him serving a historic third term is getting close to reality. Consistent strategy and steady execution of economic policies are possible only under stable government — a bitter lesson Japan learned when the country experienced six prime ministers in six years until Abe returned to power in 2012. Given the hardships Japan’s leadership underwent back then, one would hope that the current government is not taking the political stability for granted. Slow progress on structural reforms, however, begs the question: Is too much time and money on Abe’s hands hurting Japan now?

Let us step back and revisit the much-hyped “three arrows” of Abenomics. We have seen some degree of success with the first and second arrows, namely, bold monetary easing and fiscal stimulus. In contrast, the third arrow, structural reforms, has so far missed the bulls’-eye by a big margin. Structural reform is undoubtedly the most critical component of Abenomics.

The faltering third arrow initiative manifested itself once again last week with the Diet stalemate over the “work-style” reform legislation. The measure to expand the scope of discretionary labor scheme — in which employees are paid on the basis of a fixed number of hours they’re presumed to work, instead of the actual time spent at work — has been removed from the reform package. Abe seems unwilling to spend his political capital to push through this controversial part of the labor reform legislation. Opposition parties are now turning up the heat and questioning the validity of the entire merit-based compensation scheme, which has been designed to incentivize workers to improve labor productivity.

At this point, it’s unclear when the legislation will be enacted or how comprehensive it will be. But one thing is certain; a sense of urgency is lacking. The breathing space created for the Japanese economy via the first and second arrows will be soon running out. The liquidity injected into the financial system by the Bank of Japan and fiscal spending by the Finance Ministry has produced morphine-like highs for business.

The high-flying stock market and record high corporate profits are not the end goal of the Abenomics by any means. But they can give us the illusion that the ailing economy is on the right path to recovery. This is a very perilous state of affairs. A morphine-like shot to the economy is effective in kick-starting the healing process but it does not actually cure the underlying ailment. The zero interest rate environment and multi-trillion yen stimulus packages will not lead to sustained economic growth without structural reforms. The work-style reform, if implemented fully, can trigger a landscape change in the labor market, but it can also mean painful adjustments to traditional Japanese corporate culture.

Even though the work-style reform alone will not be sufficient to transform the economic structure to a full extent, it is an essential element of the change Japan needs.

The benefits are obvious. By relaxing labor regulations, work-style reform can create a higher level of mobility in the job market. It can also make it easier for companies with low or no growth expectations to exit their market while new companies enter the market.

Results-driven promotion and compensation can enhance employees’ engagement and productivity. Meritocracy, rather than seniority, can drive more efficient allocations of human resources within companies, as well as in the entire economy. More flexibility in the workplace can help the longevity of professional lives of many people, particularly senior citizens and women facing “life events”

In essence, structural change of the labor market, including work-style reform, is a powerful medicine to heal a stagnant economy plagued by low labor productivity.

This medicine, however, can taste extremely bitter for some people. A dynamic human capital management approach, if adopted fully by Japanese companies, will disrupt the rigid nature of the seniority-based lifetime employment system. The level of job security is likely to be reduced for salaried men who would otherwise enjoy, under the traditional system, steady paychecks from their employers for their entire working lives. It is also conceivable that the unemployment rate as well as the bankruptcy rate will spike, at least temporarily, as workers and companies struggle to meet the rapidly changing needs in a competitive global business environment.

Pain will be felt. But this is precisely why morphine comes in handy, as long as it is applied with great care and discipline. The cash piles companies are accumulating as well as increased tax revenues from the strong corporate sector, if used wisely, can provide a cushion to absorb the shock while Japan transforms itself into a knowledge-based, high productivity economy.

More specifically, both the government and companies should take proactive steps to re-train workers and provide opportunities for them to learn new skills at all stages of their careers. Regulations should be loosened to encourage workers to migrate toward growing segments of the economy, while the safety net should be strengthened for those who need extra help to re-skill themselves during the economic transformation. Most importantly, these actions need to be implemented urgently before the effect of the monetary stimulus starts waning and the pain becomes unbearable.

It is too early to tell if Abe will remain in office beyond this September when the Liberal Democratic Party leadership election is held. But if he does become Japan’s longest-serving prime minster, he will definitely not be able to use a shortage of time or money as an excuse for why the economy is struggling. Instead, some may argue that too much time and money on hand is to blame for the failure of Abenomics.

While government debt continues to balloon on back of expansionary monetary and fiscal policies, it seems as if not much attention is being paid to the fact that monetary morphine is highly addictive if used for an extended period of time. To prevent the economy from becoming overly dependent on the painkiller, Abe needs to shoot the third arrow as quickly and forcefully as possible.

Yumiko Murakami is head of the OECD Tokyo Centre, where she engages in policy discussions between the OECD and governments, businesses and academia in Japan and Asia, covering a wide range of economic policy issues.