Country of the month: Japan

Japan’s economy seems rosy, with eight straight quarters of economic growth, its lowest unemployment rate in 25 years and companies reporting strong earnings. Yet labour shortages, an aging demographic and low inflation rates continue to challenge the world’s third-largest economy.

Labour challenges

With an unemployment rate of 2.5% in March and a jobs-to-applicant ratio of 1.59:1, Japan’s labour market is tight. Eighty-six percent of Japanese employers had difficulty filling jobs in the last two years, according to the 2016-2017 “Talent Shortage Survey” by ManpowerGroup.

Most of the workforce is composed of regular workers who have jobs for life, command high wages and earn generous benefits (e.g., in the auto and electronics manufacturing sectors). That job security means they are reluctant to look for work elsewhere, says Tuuli McCully, head of Asia-Pacific economics at Scotiabank, making the labour market inflexible.

About 35% of workers are non-regular, working part-time or on contract for lower pay and fewer or no benefits (e.g. retail workers). Companies prefer to hire non-regular workers, who don’t have to receive benefits and are easier to lay off during downturns. These workers don’t have any bargaining power for wages and few opportunities for training, adds McCully.

Low wage growth and the wide wage gap between regular and non-regular workers makes it harder for Japan’s economy to grow, she says.

Wage stagnation has also dragged on the Bank of Japan’s ability to meet its 2% inflation target. Higher pay would entice workers to spend more money, which would also put pressure on prices to rise.

Japanese companies increased their wages in March after the shunto, an annual wage negotiation between unions and employers. The Nikkei Asian Review reported that wages were up an average of 2.41% this year, as of April 3. The gain was 0.35% more than last year’s average wage raise, marking the first growth in three years, the news service reported.

The wage gains amounted to a monthly average of ¥7,527 (US$70).

Edward Ritchie, Japan portfolio manager for Manulife Asset Management, is optimistic about real wage growth after the shunto and is forecasting an overall 2.4% increase in wages this year, compared to 1% growth in wages in 2017. He also thinks a government program to persuade companies to raise wages by decreasing their corporate taxes will help boost wages.

The wage growth is contributing to Ritchie’s positive outlook for domestic consumption.

Demographic factors

A significant factor contributing to Japan’s labour shortage is its aging and shrinking population. The country’s population fell for the seventh consecutive year in 2017, the Japan Times reported in April. People aged 65 or over accounted for 27.7% of the total population. (In contrast, 16.9% of Canada’s population were seniors in 2016, according to the census.)

Statistics Japan predicts the country’s population will drop to 106 million in 2041 from the current 126 million.

One solution to the declining population problem is to import more labour through immigration, says Ritchie. But “Japan has been notoriously anti that idea,” he says. “The reality on the ground is that there is more and more immigrant labour working, particularly in places like Tokyo. That is an incremental driver of consumption and demand.”

The country is also allowing people to keep working past the official retirement age of 65, says Ritchie, but that means taking a mandatory pay cut. The reduction in wages is offset by the pension workers start to draw at that age.

Automation and the use of robots to improve productivity and fill in for lack of human labour is one way the Japanese economy is trying to deal with its population decline, Ritchie says.

The drawback of using robots? They don’t spend money. “From the point of view of economic growth, labour is the number one answer to a decline in demographics because you do want people spending money in your economy to grow the economy,” Ritchie adds.

The basics

Official name: Japan

Capital: Tokyo

Government type: parliamentary constitutional monarchy

Population: 126.6 million

Chief of state: Emperor Akihito (since 1989)

Head of government: Shinzo Abe (since 2012)

Currency: yen

Citizenship: by descent only (at least one parent must be a citizen of Japan)

Source: CIA World Factbook

Economy

GDP (purchasing power parity): $5.405 trillion

GDP growth: 1.7% (2017)

Inflation rate: 0.6% (April 2018)

GDP per capita: $42,700 (2017)

Unemployment: 2.5% (April 2018)

GDP by sector

Agriculture: 1%

Industry: 29.7%

Services: 69.3%

Sources: CIA World Factbook and Ministry of Foreign Affairs of Japan. GDP by sector is estimated for 2017.

Taxation

Corporate

Income: 23.4%

Branch: 23.4%

Capital gains: 23.4%

Real estate acquisitions: 3% or 4% (temporarily, 1.5% to 2%)

Real estate registration tax: Up to 2%

Stamp duty: ¥200 to ¥600,000

Consumption tax: 8%

Personal

Income: progressive from 5% to 45%, plus an earthquake surtax of 2.1%

Capital gains: 20% for shares and long-term real estate gains; 39% for short-term real estate gains

Inheritance or gift tax: generally 10% to 55%

Source: Deloitte’s “Taxation and Investment in Japan 2017”

Opportunities for investment

Japan’s stock market has risen this year despite volatility. Strong earnings growth, with most companies exceeding expectations, is contributing to the bull market, says RBC in its Spring 2018 “Global Investment Outlook.” The Nikkei increased 19.1% in 2017, while the MSCI Japan Index gained 24.39% in the fiscal year ending March 31, 2018.

Since the end of 2012, companies have seen strong earnings growth year over year, says Ritchie. He expects companies to continue to report earnings growth in the double digits for the Japanese fiscal year that began in April, with both global and domestic economies supporting that growth.

Wage increases and growing domestic demand contribute to Manulife’s positive outlook for restaurants, real estate and staffing services. An increase in households composed of childless couples and younger people living by themselves, as opposed to the traditional multi-generational household, has led to housing and condo construction in urban and suburban areas.

Top five companies by market cap on the Tokyo Stock Exchange (April 2018)

• Toyota Motor Corporation
• NTT DOCOMO, INC.
• Mitsubishi UFJ Financial Group, Inc.
• SoftBank Group Corp.
• Keyence Corporation

Source: Japan Exchange Group

The return of inflation would benefit “a number of financial sectors which have been quite laggard performers over the last three to four years,” says Ritchie. The financial sector has underperformed the stock market by 40% since 2013, he says, as low inflation and a 0% interest rate hurt earnings.

Specifically, Manulife is positive on the real estate, life insurance and banking sectors. In particular, the real estate sector is benefiting from a 5% annual increase in office rents in Tokyo, the largest increase since 2007, Ritchie says, due to more demand than supply.

Manulife holds positions in the Dai-ichi Life Insurance Company, Mitsui Fudosan (a real estate developer), the Sumitomo Mitsui Financial Group (a bank holding and financial services company) and MS&AD Holdings.

Central bank

In February, Bank of Japan Governor Haruhiko Kuroda was re-appointed to a five-year term.

At the BoJ’s monetary policy meeting in April, the central bank removed its forecast date for reaching its inflation target of 2% from its economic outlook. The bank had previously said that 2% inflation would be reached by April 2019.

Boosting inflation to 2% has been a significant focus of the BoJ’s monetary policy after a long period of deflation from 1999 to 2016, McCully says. Elected in 2012, Prime Minister Shinzo Abe has used monetary easing and structural reform with the goal of raising domestic demand, GDP growth and inflation to 2%

Japan is still struggling to reach its target inflation rate, which dropped from 1.1% in March to 0.6% in April. At its April meeting, the BoJ forecast inflation of 1.8% for fiscal 2019. Scotiabank’s McCully is forecasting the headline inflation rate to be around 1% by the end of 2018.

Also in April, the BoJ reiterated its commitment to keep the 10-year bond yield around 0%, where it has been since February 2016. It also said it would keep the short-term interest rate at minus 0.1%.

Manulife is forecasting a 0.1% hike in the interest rate this year and for it to eventually rise to 0.6% by 2022.