For a dozen years, the Bank of Japan, the government, and stockbrokers have all been promising that a labor shortage in Japan will soon push up wages. And that faith is behind the BOJ’s decision that it’s time to normalize interest rates. Here’s the argument. Due to the declining working-age population, companies in 2014 offered 1.2 jobs for every job seeker. By 2019, the ratio had climbed to 1.6 and is now 1.2. So, it is argued: when demand exceeds supply, wages must inevitably rise.

And yet, for the same dozen years, these forecasts have proved false. On the contrary, real annual earnings for a full-time worker were no higher in 2024 than they were in 2014: just $46,500 in real purchasing power parity dollars. In fact, these earnings are barely higher than 36 years ago when the lost decades began.

This apparent paradox leaves only two possibilities. Perhaps the labor shortage is not as severe as some statistics make it look. The alternative is that labor market rigidity prevents the forces of supply and demand from working as expected.

Japan’s leaders and stockbrokers point to the first explanation. BOJ Governor Kazuo Ueda contended that so many women and the elderly entered the workforce during 2012-24 that this offset the decline in the working-age population. The reason for the influx, in my view, is that wages and pensions were so stagnant that more people needed to work just to keep household living standards from falling. Now, argues Ueda, the reserve supply has been exhausted, and from now on the number of employed people will decline (see chart below). Consequently, the BOJ promises that this time the forecast will come true: Japan is headed toward an era of 3% nominal wage hikes minus 2% inflation, leaving 1% real wage growth.

While this explanation may be part of the story, I believe a bigger part is a case of “market failure,” and that this obstacle remains. It’s a staple of orthodox economics that excess demand for workers can only raise wages when workers are free to move to another company paying more. That forces companies into a bidding war. Without such competition, a labor shortage and flat wages can co-exist. I’ll explain the economic theory on this at the end.

In fact, the reason that Japanese employers began creating “lifetime employment” in the late Meiji Era was precisely to end a bidding war. In the 1910s, 80% of blue-collar workers switched jobs every year in search of higher wages. In response, employers created a no-poaching pact: they’d stop luring workers away via a higher wage, or refuse to hire those who left for any reason. To bolster this ploy with propaganda, employers fabricated the story that loyalty stemming from a “feeling of company as family” was an age-old facet of Japanese culture. There were certainly times, e.g., the high-growth era, when the benefits of lifetime employment outweighed its harms, e.g., worker acceptance of labor-saving technology. Today, however, the costs outweigh the benefits. For details, see Chapter 11 of The Contest for Japan’s Economic Future.

Competition For Workers And Wage Hikes

For markets to work, they must be embedded in market institutions, and robust competition is one of the most fundamental of them. Insufficient competition in the labor market explains why Japanese wages remain below free-market levels. Compare the wage hikes between younger workers just starting and regular workers trapped in lifetime employment. As we can see in the chart at the top of this blog, workers in their 20s got nominal wage hikes of 6-7% per year during 2018-23, whereas those in their 30s and early 40s received wages of just 1-3%, and most workers over age 45 suffered wage cuts. The reason is that job changes are far more prominent among younger workers than veterans (see chart below).

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