Why Are Wages Stagnant in Japan?: Strengthening the third arrow of Abenomics (growth strategy) is the true path toward revitalizing Japan's economy(No.179)

◆Economic outlook revised: In light of the first preliminary Jul-Sep GDP release (Cabinet Office), we have revised our economic growth outlook. We now forecast real GDP growth of +2.6% y/y for FY13 (previous forecast: +3.0%) and +1.0% for FY14 (+1.2%). We have revised our economic outlook downward mainly in view of the economic growth rate for Jul-Sep 2013 coming in lower than anticipated.

◆Why are wages stagnant in Japan?: The need to increase wages has become a leading political issue in Japan. In this report, we provide a multifaceted examination of the reasons why wages have stagnated in Japan and present our outlook going forward. First, an international comparison of real wages demonstrates that wages are stagnating in Japan not because labor’s share is low, but because there are issues involving labor productivity and corporate competitiveness. Thus the key is to increase labor productivity and improve corporate competitiveness by strengthening the third arrow of Abenomics (growth strategy) in order to raise real wages in Japan. Second, a simulation of the future direction of wages reveals that wages are likely to gradually trend upward as the economy undergoes a cyclical recovery. It is also highly likely that regular payments will continue to grow at the macro level given an improvement in the supply-demand balance for labor. However, the increase in per-employee wages will be limited if it is based solely on a cyclical economic recovery. For wages to exceed their former peak, it will be crucial for the government to (1) strengthen the third arrow of Abenomics (structural reform of non-manufacturing and medical and nursing care sectors) and to (2) address the problems associated with non-regular employment. Companies will also need to accelerate the pace of wage increases as much as possible to avoid the “fallacy of composition”.

◆Will a virtuous circle actually take hold in Japan’s economy as intended by the government?: First, from a wage perspective, an increase in wages will have a positive impact on non-manufacturing sector. In particular, higher contractual cash earnings will invigorate personal consumption, centering on durable goods. However for the virtuous circle to be sustained, a key issue will be whether or not the increase in wages can be passed through to output prices. Second, from a capex perspective, a tax cut for capital investments could invoke more such investments in the future. However, given Japan’s sluggish capacity utilization rate, the ability of capex to recover will likely to be weak. The moderate downtrend of capex’s production inducement coefficient in recent years is also a matter of concern. The capex trend is greatly influenced by growth expectations. Hence, increasing the growth expectations of companies through measures such as cutting the corporation tax and drastic deregulation is the true path towards the recovery of capex. Finally, we examine the effects of corporation tax cut and present a quantitative simulation of economic trends.

◆Main scenario for Japan’s economy: After hitting bottom in November 2012, Japan’s economy has entered a recovery phase. We believe it will continue to expand steadily supported by (1) increases in exports based on the backs of the US economic recovery, (2) ongoing depreciation of the yen and the rise in stock prices supported by the BOJ’s monetary easing, and (3) economic stimulus measures to offset the effects of the consumption tax hike.

◆Four risk factors facing Japan’s economy: Risks that will need to be kept in mind regarding the Japanese economy are: (1) turbulence in emerging economies, (2) China’s shadow banking problem, (3) a reigniting of the European sovereign debt crisis, and (4) a surge in crude oil prices stemming from geopolitical risk.

◆BOJ monetary policy: The BOJ is likely to purchase additional risk assets (ETFs and other assets) in Apr-Jun 2014 and beyond in part to mitigate the adverse impact of a higher consumption tax rate.

【Our assumptions】
◆Public works spending will grow +11.7% in FY13 and –0.9% in FY14; the consumption tax rate will be increased in April 2014
◆Average exchange rate of Y99.7/$ in FY13 and Y100.0/$ in FY14
◆US real GDP growth of +1.5% in CY13 and +2.6% in CY14