By Yoko Takeda —
After two “lost decades,” Japan’s first policy priority to ensure its future economic growth and competitiveness should be to replenish and enhance its human capital through comprehensive labor market reforms.
Over the course of World War II, Japan lost 86 percent of its physical capital stock. Despite this, Japan entered a long period of rapid growth beginning shortly after the war, rising to become the world’s second-largest economy. The prime factors that enabled this enormous increase in Japan’s prosperity were an ample urban labor force (previously pooled in rural provinces); the high quality of said labor force (which was broadly well-educated and diligent); and active entrepreneurial activities and innovation.
However, as Japan approached the income level of the United States and advanced European economies its growth slowed. In turn, Japan found itself being pursued by emerging Asian economies and seeing former strengths turning to weaknesses.
For many years, Japanese experts have called for fundamental reform of the country’s industrial structure and institutional reforms to help Japan respond to the intensifying trends of globalization, IT innovations, and rapid aging. Unfortunately, the necessary reforms have been postponed. As a consequence, entrepreneurship failed to grow, labor markets remained rigid and illiquid, and firms lost their appetite for risk. The absence of reforms (unintentionally) encouraged rent-seeking, rather than innovation: corporate turnover was not stimulated; underinvestment in human capital continued; adjustment to globalization dawdled; and uncertainty regarding future income rose for firms and households. All of these developments have undermined Japan’s productivity and growth.
Bearing these issues in mind, proposals designed to achieve “Five D’s” could reinvigorate the Japanese economy going forward: deleveraging in the public sector; decentralization (encouraging agglomeration in local cities); destructive innovation; workforce diversity; and dynamic labor markets. Here I will focus on this last “D” of dynamic labor markets, the key area where reforms are most needed for Japan’s economic revitalization.
Building a dynamic labor market offers prospects for many positive economic outcomes. A dynamic labor market would help the Japanese economy adapt to globalization, encourage risk-taking and startups, stimulate inward FDI, revitalize Japan’s regional economies, and increase labor force participation among seniors and women.
This perhaps makes labor market reforms sound like the “elder wand” of Harry Potter lore. However, this powerful magic wand cannot be acquired easily. To obtain and wield it – labor market reforms – will require concerted efforts to effect multiple changes. These changes would affect complicated labor market institutions, uncodified conventions, and the mindset of Japanese society as a whole.
To achieve comprehensive labor market reform, status quo employment practices and conventions need to be entirely rebuilt. The systems to be reformed include: (i) the lifetime employment system and current dismissal restrictions; (ii) the seniority-based wage/retirement and allowance/pension systems, which create disincentives for employees to leave their first jobs for new opportunities; (iii) simultaneous recruiting of new graduates; and (iv) polarization of the regular and non-regular workforce. The basic idea is to change Japan’s labor market from a rigid membership-based employment system to a flexible skill-based job system, and to create an environment in which innovators and entrepreneurs can flexibly pursue their goals. This means workers need to have more choice regarding where to work, how to work, how long to work, and whether to join firms or start a business and constitutes an essential response to the pressures – and opportunities – of globalization and Japan’s demographics.
To complement these reforms and supply the labor market with a globalization-ready workforce, the current education system also needs a full-fledged review. At tertiary levels, the current system is distorting incentives. Alongside a rapidly decreasing youth population, the number of Japanese universities and colleges has been paradoxically increasing. The oversupply of tertiary schools and the resulting deterioration in the quality of the average college graduate must be rectified.
Relatedly, Masayuki Morikawa suggests that to raise total factor productivity (a crucial component of long-term growth), Japan must keep abreast with the world’s top-level students. To a certain degree, this calls for more concentration in human capital investment, such as promoting the globalization of universities and incentives for highly capable young talents.
One idea is to introduce programs designed to create several different pools of students with different curricula in order to foster both global competitors and contributors to local economies. Of course, equal opportunities in education must be provided to everyone, but equal opportunity does not mean that every student should always take the same classes. More customized curricula based on student aptitude could raise the probability that everyone will obtain a better job.
The efficiency with which workers – particularly second-job seekers – are matched with employment opportunities also needs to be enhanced to achieve labor force reallocation without raising unemployment. To this end, the policy agenda could include (i) more practical vocational training, (ii) reinforcing interactions between industries and universities, and (iii) revising current tax and subsidy systems to encourage higher rates of labor force participation.
Japan is still combating the deflation of the lost two decades in the midst of strong headwinds, including an unprecedented decrease in the working-age population and rapid population aging. Whether Japan can raise its per capita growth rate and maintain a high quality of life while overcoming these demographic challenges ultimately depends on getting the five D’s right. Creating a dynamic Japanese labor force would be an excellent start.
Ms. Yoko Takeda is Chief Economist at the Mitsubishi Research Institute, Tokyo. In 2015, she was a Visiting Scholar with the Japan and Simon Chairs at the Center for Strategic and International Studies in Washington, D.C. Ms. Takeda’s essay is part of CSIS’s Strategic Japan Working Paper Series featuring Japanese scholars addressing pressing issues in Japanese foreign and economic policy.