Ichiro Suzuki Spring is the season for Japan’s labor unions. They negotiate their members’ wages for a new fiscal year that begins on April 1. In recent years, the Japanese government has been pushing management of Corporate Japan hard to give a raise to workers, having been worried about persistently stagnant per capita income for a generation. This year, the union is daring to ask for almost 5%. That sounds aggressive but a 5% hike still doesn’t make workers much better off at a time when inflation is running over 4%. Chances are that they still do not get that much, with their wages being eroded by inflation. Economists forecast a 2.9% hike this spring. Toyota Motor Corporation customarily leads spring wage negotiations. (Labor unions are organized on a company basis, as opposed to industry and/ or jobs-based unions elsewhere.) This year, Toyota has already given everything its workers has asked for. Numbers are not disclosed so that a deal done at Toyota doesn’t give much pressure to management of other companies. Only Toyota can do it, anyway, with its robust finances. It is estimated to be well above 5%. While other Japanese corporations probably would not match Toyota, they would still make every effort to give their employees a raise. Inflation has returned to the Japanese economy that has experienced little price hikes for a quarter century, even if this inflation is not expected to last for a very extended period. It is primarily attributed to supply shocks that are one-off essentially. Social consensus has been formed over the last six months that workers should be paid better. This makes management who wants to be seen socially responsible move toward better pay for their employees. Large corporations are going to do it. A problem lies in small and medium enterprises that employ approximately 70% of working people. They are not really willing to give workers a raise simply because they don’t afford to do it. They are always under intense pressure from their customers, usually large corporations, to reduce prices of their goods and services. They are operating under razor-thin margins and, paying more to workers would almost certainly destroy their delicate profit equations. Employing a large chunk of workers, SMEs account for 99.7% of registered companies in Japan. This structure of the economy implies that SMEs are woefully inefficient. In the mean time, the Japanese government has always been protective of SMEs. They not only employ a large number of people who are voters, but also are owned by people who, with well funded organizations, are solid backers of the Liberal Democratic Party that has ruled the country for much of the post-WWII period. Former Goldman Sachs analyst David Atkinson advocates that a significantly lower number of SMEs would dramatically enhance productivity of the Japanese economy. He is definitely right on this. The problem, however, is that no conceivable solution appears to be available to reduce their count. Unlike the cases of big bad corporations, the government can’t tell SME owners to fold or merge with someone else for the purpose of rationalization, and hence sucking their employees. Mr. Atkinson advocates for higher minimum wages that would squeeze out uncompetitive SMEs. While this may sound good for the economy for a longer-term, SME owners would fiercely oppose it for sure, presenting themselves as victims. Pushing this through hard would be a political suicide for the LDP, since it punishes their support base. It has always been said that SMEs have been treated too nicely by politicians, in terms of taxes and financing. Roughly two-thirds of SMEs do not report profits, and therefore, do not pay corporate income tax. It takes no small financial resources to keep SMEs afloat though they don’t contribute to the government’s coffer. On top of it, favorable policy treatments disincentivizes them to grow out of the SME ranks into a higher bracket of large corporations. Larger SME owners feel it better off to be staying as they are, rather than stepping into a more competitive environment of large corporations. On the other hand, the number of SMEs, especially that of very small ones, has been falling for decades. They have been folding primarily because of succession problems. Owners’ children, notably sons, are not interested in succeeding their dad’s businesses. They don’t like working on greasy factory floors, always pressed hard to pay bills. From another perspective, this represents one aspect of retreat of Japan’s manufacturing industry. While their number is falling, this will not solve the problem of their productivity on a macro basis immediately. In the mean time, small business owners are screaming about shortages of part time workers as their market wages are on an upward pressure, on top of ballooning utility bills and other input costs. They still hesitate to pass rising costs onto customers for fear of alienating them. Unlike large corporations, they are not sitting on a large pile of cash that would enable them to get through the storm. They try to stay afloat desperately, even by reducing their own salaries and drawing down their own private savings, but this would not allow them to go very far.
The Japanese economy still lacks a mechanism to embrace mild inflation and turn it into a positive feedback loop of price and wage hikes. Vulnerability of SMEs is making it harder to achieve the economy-wide wage hikes. Much higher inflation would change the equilibrium at once by crushing those that are vulnerable, albeit with no small political costs. Japan is not there yet, due to abundant external positions. Most likely, wages and salaries would not rise as much as what is hoped by the government and average men and women on the street. They are going to rise on a nominal basis, still failing to keep up with the inflation. About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.