Japan: High Employee Bonuses in Manufacturing Until Inflation Picks Up

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Spend Matters welcomes this guest contribution from Irene Lauro, senior economist at IHS Markit.

In Japan, labor shortages and rising productivity are not leading companies to increase ordinary wages.

Signs of a Japanese economic recovery have started to appear in rising corporate profits and falling unemployment. A meaningful pickup in wage growth, however, is not in the cards, as corporates are reluctant to lift ordinary earnings because of uncertainty about the economic outlook.

Real GDP growth accelerated to 1% year on year (y/y) in the first quarter, driven by sustained export strength. This is the first time that the Japanese economy has grown for five consecutive quarters since 2005.

The surge in exports since mid-2016 has significantly boosted firms' profitability. Corporate profits in the manufacturing sector surged to a record, rising by 70% in the first quarter and marking the second consecutive quarter of positive growth.

Lackluster labor productivity growth, which has historically played a dramatic role in holding back wage growth, has recently started rising among employers in manufacturing.

Meanwhile, labor-market conditions are dramatically tightening. Unemployment is at 2.8%, its lowest level in over 22 years, while the job-to-applicant ratio is at a 43-year high.

Labor shortages and rising productivity, however, have had no real bite, and growth in hourly pay has struggled to pick up. Total cash earnings in the manufacturing sector rose at an annual 1.2% rate in April, while ordinary wages increased by only 0.6%. Improving economic conditions and firms' higher profitability have been reflected only in special earnings. As Chart 3 shows, bonuses started growing again in mid-2016. They registered a 21% increase in April.

Despite persistent labor shortages and higher productivity, Japanese manufacturers prefer boosting special earnings rather than increasing ordinary wages, highlighting that the lack of wage growth is mainly attributable to the uncertainty about the durability of the recovery. The prospects for higher wage growth are dim. Bonuses make up less than 20% of total compensation and only a boost in ordinary pay can trigger faster wage growth. IHS Markit believes Japanese manufacturers will remain cautious about wages, however, until a sustained pickup in inflation enables them to transfer higher costs to input prices.

Bottom Line

Although corporate profits have rebounded since mid-2016, labor shortages and rising productivity are not leading companies to increase ordinary wages. A significant pickup in wage growth will only follow a sustained rise in inflation. Until Japanese corporations conclude the economic recovery is sustainable, wage dynamics are likely to remain subdued.

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