Crucial Japanese wage inflation remains elusive

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NipponMarketBlog has made the point several times over the past few months (see here and here) that unless wage inflation takes hold in Japan, thus compensating consumers for the loss in purchasing power recently brought about by the prospect of resurgent inflation, Abenomics runs the risk of outright failure.

The reason for this is simple. Abenomics rests on the assumption that both fiscal and especially monetary stimulus can provoke a decisive change in consumer spending and corporate investment behaviors. The latter is proving difficult to make happen, for the simple reason that Japanese companies are often very risk averse, and prefer to “wait and see” before committing to major fixed investment programs. This means that the former, i.e. consumer spending has to carry the Abenomics program forward, at least for the time being. But without sufficient wage increases above the level of inflation resulting in real wage increases, the Japanese consumer will likely begin to tighten his/her belt yet again, and the economy will almost certainly not be able to sustain the momentum it has exhibited lately, especially if global growth slow again.

The pace of economic growth required for the recovery to become self-sustained has been called ‘escape velocity’, and the Japanese economy simply is not there yet.

Significantly, this point was made by Bank of Japan policy board member Koji Ishida, in a speech earlier this month, where he was quoted as saying:

“Unless income rises in tandem with prices, economic growth will be temporary and not sustainable”.

File picture of Bank of Japan board member Koji Ishida at an interview in Tokyo

We could not have said it better ourselves. The fact that a member on the BoJ policy board is making this statement makes it plain that the BoJ is genuinely concerned about whether wage inflation is taking place or indeed will be taking place in the future. For all its bravado about how well the economy is responding to monetary stimulus, and how it will be able to handle an increase in the consumption tax, the BoJ knows as well as anyone that without wage inflation, Abenomics will be dead in the water.

Wages

However, not only is the government proposing increasing the consumption tax (see this piece), but indications are now emerging that the hoped for wage inflation could be more difficult to achieve than the government initially hoped.

A recent Reuters Corporate Survey shows that companies remain averse to raising base pay, preferring instead to raise bonuses which can easily be scaled back later. In other words, the most important component for consumer confidence, i.e. base pay, remains stubbornly where it is.

266 companies were asked if they would raise wages if the government eventually raises taxes, and around half responded that they would not raise wages thereby helping to preserve consumer purchasing power. Only 13% are planning to offset the tax hike with any pay increases, while 37% do not yet know. The same survey indicated that around 60% of companies were expecting higher profits in fiscal year 2013/2014.

With regard to upcoming salary negotiations, the stance of 60% of companies is currently to only raise bonuses but not base salary, and 24% have already ruled out any pay increase at all.

This makes for quite worrying reading for Prime Minister Abe and BoJ governor Kuroda, who have more or less bet everything on wage increases and corporate investment kicking in and resulting in a self-sustained economic recovery as a result of aggressive fiscal and monetary stimulus.

As we discussed here, now that Japan has gone down the ‘all-or’nothing’ route of massive quantitative easing, there is no realistic way back for the government and the BoJ. Just look at what happens to US (and indeed global) markets whenever the US Federal Reserve even mentions eventually tapering off its own QE program.

So if wage inflation in Japan is not happening to a degree that is sufficient to keep up with rising inflation, and if this in turn is choking off the crucial increase in consumer spending, could the government consider raising wages for public servants to well above inflation rate levels? This could potentially compensate for the private sector’s reluctance to increase wages, and it would certainly make Abenomics play out closer to what was intended, but of course it would also entail an increased burden on public finances and debt, which are exactly what the government is trying to reduce.

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On October 1st, the government will make its final decision about whether to raise the consumption tax from 5% to 8% (and eventually to 10% next year), in an effort to try to mend the frankly catastrophic public deficit and debt situation that Japan finds itself in, and that we have written about in some detail here).

Later that month, it is expected that Abe will flesh out further details about the so-called ‘Third Arrow’ in the Abenomics program, i.e. structural reform which has been attempted several times in the past without success. This could potentially have a significant impact on the health of the economy going forward. However, the Japanese bureaucracy is famously entrenched in its old ways (and they have been blamed for derailing more than one government’s economic initiatives), and so it will be interesting to see what the government believes it can roll out now that is has control of both chambers of parliament.

It seems to NipponMarketBlog that Abenomics has proceeded along a path that probably seemed wide and easily navigable to the government a few months ago, but reality is now beginning to sink in and the path is narrowing, and only one thing is certain. The further down the path Abenomics brings the economy, the fewer options there will be for changing direction. And turning back is certainly now no longer possible.

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