Sharpening Abenomics’ third arrow: Labour-market reform in Japan

Giovanni Ganelli

The third arrow of Abenomics aims at reviving growth in Japan. This column presents research showing that revamping Japan’s dual labour markets to increase productivity should be an important component of the growth strategy. An increase in the level of employment protection of regular workers tends to increase duality, while an increase in the protection of temporary workers has the opposite effect. Reducing the difference in the employment protection would help to reduce the labour-market duality, and reducing the duality results in a higher growth. This would lead to a decrease in unemployment, and could help to exit deflation.

The share of non-regular workers in Japan, which was below 20% before the burst of the bubble in the early 1990s, has now reached 35% (see Figure 1). The status of regular versus non-regular worker is based on the de facto relationship between workers and their employers, rather than on legal grounds. Regular workers are those who are:

Hired directly by the employer

Work full time

Have an open-ended contract

Workers who satisfy these three conditions are referred to as ‘sei-sha-in’, a word composed of three Kanji ideograms (正社員) which can be roughly translated into English as a ‘proper-company-member’. Various combinations of failing to meet these three conditions correspond to different typologies of non-regular workers. Compared to regular workers, non-regular workers have a much lower level of job security and career prospects, and are paid lower wages and receive significantly less social insurance.

Figure 1. Annual change in share of workers

Source: Ministry of Internal Affairs and Communications, IMF staff calculations

Note: Feb.1985-2001, 2002-2012 Jan.-Mar. average

Is the duality good or bad for Japan?

Japan’s labour market duality has some positive aspects. For example, it can help satisfy demand for flexible work arrangements, thus bringing new ‘voluntary non-regular’ workers into the workforce. The possibility for firms to hire a growing part of the labour force with more flexible contracts can also help lower overall unemployment. Even during the 2009–2010 global economic crisis, Japan’s unemployment rate remained just slightly above 5%, compared to the 8% average in OECD countries, partly due to firms’ reliance on non-regular contracts.

Despite these positive aspects, international evidence and macroeconomic studies suggest that the overall impact of excessive labour-market duality on total factor productivity (TFP) and growth is likely to be negative (for example, Dolado and others 2011 and Damiani and others 2011). This negative effect is probably magnified by working involuntarily as a non-regular employee, which can adversely affect morale and job effort, thus lowering labour productivity. In this regard, Fukao and others (2007) estimate that Japanese part-time workers are 75% less productive than full-time ones. Limited training opportunities for non-regular workers are also likely to reduce productivity. IMF (2013) stresses that firms tend to invest little in their temporary workers in countries with dual labour markets. This is confirmed by a survey of 1,066 Japanese companies, which shows that while 92% of the companies provided training for regular workers, only 42% did so for non-regular workers (Kawaguchi and others 2006).

Options for reforms

A recent IMF Working Paper (Aoyagi and Ganelli 2013) looks in detail at the determinants of labour market duality in OECD countries. On the basis of its empirical results, the study also suggests some options for reform in Japan. The study uses econometric panel data techniques to assess how various economic, demographic, and policy factors affect the degree of labour market duality, proxied by the share of temporary workers.

A key finding is that an increase in the level of employment protection of regular workers, as measured by the aggregate OECD index of employment protection, tends to increase labour-market duality, while an increase in the level of employment protection of temporary workers has the opposite effect. Furthermore, the impact of these variables on labour market duality is statistically significant.

One policy implication of the findings by Aoyagi and Ganelli (2013) is that reducing the difference in the degree of employment protection between the two categories of workers can go a long way in reducing duality in advanced economies, with positive effects on TFP and growth.

For Japan, Aoyagi and Ganelli (2013) estimate that such a reform could bring the share of non-regular workers close to, or below 30%, from its current level of about 35%. The study also stresses that these estimates are based only on ceteris paribus first-round effects. If, as expected, the reduction in labour market duality results in higher growth, this would reduce unemployment, and help exiting deflation. According to the econometric results presented in the study, a fall in unemployment and an increase in inflation would result in second-round effects of the initial reform, which would further reduce duality.

Since the share of non-regular workers is large amongst women in Japan (see Figure 2), reducing duality would also increase the number of women in regular positions, creating synergies with reforms aimed at increasing female labour participation, which are important to raise potential growth (see Steinberg and Nakane 2012).

Figure 2. Share of non-regular workers among female employees

Sources: Ministry of Internal Affairs and Communications, IMF staff caluculations.

In practice, an effective way to reduce the difference in the degree of labour protection amongst different workers in Japan could be replacing all regular and non-regular contracts currently offered to new hires with a single open ended contract (SOEC). Under the SOEC employment protection would increase gradually and severance pay would rise with tenure. The SOEC would imply lower job security compared to current regular employment, but higher job security compared to current non-regular employment.

A possible first step to implement the recommendations given in Aoyagi and Ganelli (2013) could be a wider of use of limited regular (‘gentei seishain’) contracts. In Japan, employees who are classified as limited regular workers still enjoy regular worker status and benefits, but with limitations on one or more of the following: job content, working hours; and mandatory relocations. Contracts of this kind implicitly introduce lower job protection, compared to traditional regular workers, most notably in cases in which the limited regular position is cancelled for economic reason. For currently non-regular workers, on the other hand, the possibility to transition to such limited regular contracts would imply an increase in employment protection and in career and training prospects.

Labour-contract reform could be complemented by a shift towards the so-called ‘flexicurity’ model, in which the focus is on protecting workers rather than jobs. In this regard, increasing unemployment insurance benefits, and strengthening programs which help the unemployed to upgrade their skills, would be relevant for Japan – were occupational skill mismatches important determinants of the unemployment rate (Shibata 2013).

Conclusions

As stressed in the last IMF Article IV Report on Japan, the labour market reforms aimed at reducing duality discussed in this article should be a key component of Japan’s strategy to revive growth and exit deflation. Other important reforms in this regard should include raising female labour participation, deregulation in the agriculture and service sectors, financial sector reforms to achieve a more efficient allocation of credit, and relaxation of immigration requirements to address labour shortages. Reviving growth and ending deflation would be beneficial not only for Japan but also for the rest of the world.

Author's note: The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management.

References

Aoyagi, Chie, and Giovanni Ganelli (2013), “The Path to Higher Growth: Does Revamping Japan’s Dual Labor Market Matter?,” IMF Working Paper 13/202 Washington: International Monetary Fund.

Damiani, Mirella, Fabrizio Pompei, and Andrea Ricci (2011), “Temporary Job Protection and Productivity Growth in EU Economies,” Quaderni del Dipartimento di Economia, Finanza e Statistica 87/2011 Perugia: University of Perugia.

Dolado, Juan Jóse, Salvador Ortigueira, and Rodolfo Stucchi (2011), “Does Dual Employment Protection Affect TFP? Evidence from Spanish Manufacturing Firms,” Economics Working Papers 11-37 Madrid: Charles III University of Madrid.

Fukao, Kyoji, Ryo Kambayashi, Daiji Kawaguchi, Hyoeg Ug Kwong, Young Gak Kim, and Izumi Yokoyama (2007), “Deferred Compensation: Evidence from Employer-Employee Matched Data from Japan,” Hi-Stat Discussion Paper Series No. 187, Tokyo: Hitotsubashi University.

International Monetary Fund (IMF) (2013), “Jobs and Growth: Analytical and Operational Considerations for the Fund” Washington: International Monetary Fund.

Kawaguchi, Daiji, Ryo Kambayashi, Young Gak Kim, Hyeog Ug Kwong, Satoshi Shimizutani, Kyoji Fukao, Tatsuji Makino, and Izumi Yokoyama (2006), “Are Wage-tenure Profiles Steeper than Productivity-tenure Profiles? Evidence from Japanese Establishment Data from the Census of Manufacturers and the Basic Survey Wage Structure,” Hi-Stat Discussion Paper Series No. 189 Tokyo: Hitotsubashi University.

Shibata, Ippei (2013), “Is Labor Market Mismatch a Big Deal in Japan?” IMF Working Paper 13/196, Washington: International Monetary Fund.

Steinberg, Chad, and Masato Nakane (2012), “Can Women Save Japan?” IMF Working Paper 12/248, Washington: International Monetary Fund.