Sunday, January 21, 2007

Weak Yen Key Reason For Japanese Wage Squeeze

One of the seemingly most surprising economic facts are the stagnation in real wages in Japan. While Toyota and other mayor Japanese corporations are seeing rapidly rising profits, real wages have been stagnating. Given the fact that unemployment in Japan is a mere 4,0%, much lower not only than Western Europe, but also lower than in the United States, you would have thought that there would be some upward pressure on wages. But wages have remained weak while corporate profits have boomed. Especially given the shrinking work force, you would have expected employers to bid up wages, but they haven't.

What is the explanation for this apparent puzzle? Well, there are several contributing factors, not just one. One explanation is that the causal relation have been in the other direction, i.e. the wage squeeze have contributed to increased employment. Also, the increase in the relative share of national income going to corporate profits is a global trend caused by the massive increase in the supply of labor from countries like China and India, that we've also seen in the United States and Europe. And as Japan is closer geographically to China and India than the United States and Europe means that the effect is likely to be bigger. On the other hand, Japan's extremely restrictive immigration policy means that no downward pressure on wages from immigrant labor exist.

But one overlooked factor behind the wage squeeze is the weak Japanese yen. The Japanese yen have continued to fall in recent months despite already being undervalued. It is now at multi year lows against not only European currencies, but also against the U.S. dollar and the Chinese yuan.

What does this have to do with the wage squeeze? Well, the falling yen will have a direct positive effect on profit margins of Japanese companies as companies selling finished goods usually at least initially adjust to exchange rate rate changes by adjusting their profit margins rather than their selling prices. However, commodity prices, being traded on global financial markets, usually adjust immediately. And as Japan have virtually no commodity exports, while having a significant commodity content in its import, this will enhance the shift in relative share of national income from labor to capital.

Given the recent meltdown of Bank of Japan authority, it seems as though it is likely that the yen will continue to weaken in the short term despite being fundamentally undervalued.


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