Japan's New Leaders Re-Regulate

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Japan has always tried to do more than most developed economies to smooth out the rough edges of free markets by protecting domestic businesses and workers from volatile economic cycles through worker subsidies and restrictions on competition. Now the ruling Democratic Party, which took the reins of government in September amid widespread discontent with the Japanese economy, is looking to add new protections in the midst of the current steep downturn, including banning companies from hiring workers on a temporary basis. The government is hoping to spur more long-term, meaningful employment, but if the recent past is any guide, the government's actions may accomplish the exact opposite.

Japan's experience over the last 20 years shows just how difficult it can be to manage an economy and its national workforce from the top down. Although Japanese consumers didn't run up heavy debts or make bad mortgages in recent years, and although Japanese investors didn't snap up toxic securities, the Japanese economy has fallen perhaps further and faster than ours in the last year, erasing several years of modest gains and leaving the country stuck in what some Japanese economists are starting to call a semi-permanent state of recession. A country once known for remarkable social stability and economic equality is becoming more and more of a place of haves (those lucky enough to have jobs with lifetime guarantees) and have-nots (younger workers who can't crack into the full-time workforce), where social indicators like homelessness and suicide rates are rising. It's a remarkable turnabout for a country once seen as the post-war model of the managed but productive economy.

Much of what has shaped today's Japanese economy and society is the result of its defeat in World War II. After the war, its leaders and people looked to rebuild by constructing an economic system that allowed the country to participate in the global marketplace, but with a premium on order and predictability. That included introducing widespread protections for workers in the form of lifetime employment contracts enforced by steep unemployment taxes against employers who laid off workers. It also included strict regulation of the domestic economy that made it difficult for new businesses to challenge established firms at home. It was all part of a plan to minimize the ‘destruction' in capitalism's ongoing process of creative destruction, and by the 1970s, Japan had become a creature of "subsidies and the dampening of competition through regulation," wrote Masaru Tamamoto of the World Policy Institute earlier this year.

The seeming success of that economic and social regime, ironically, led to a sense among the Japanese themselves that they had conquered the unpredictability and volatility of the marketplace, which in turn encouraged domestic speculation in the 1980s, fueling real estate and stock market bubbles. When they burst and the Japanese economy sank, the government reacted with more efforts to minimize volatility and protect workers. Companies virtually prohibited from laying off workers instead employed them at unproductive busy work.

A whole generation of young Japanese has become a casualty of this economic regime. As companies eliminated much of their hiring, young workers went years without meaningful employment until many have become, in the eyes of Japanese firms, unemployable, a so-called ‘lost generation' of workers. Without full-time work these kids lived in their parents' homes through their twenties and into their thirties, derided by the rest of society as NEETs, short for ‘not in employment, education or training."

Stuck in a decade of stagnation, the Japanese government several years ago introduced some modest economic reforms meant to increase the flexibility of the job market, including making it easier for businesses to hire and lay-off workers to respond to changes in demand. But the government also feared widespread liberalization and left many protections in place for permanent workers.

The result has been the emergence of a new class of have-nots, temporary workers who bounce from one job to another yet are never offered full-time employment by firms, which worry they couldn't lay them off once they hired workers in full-time positions. While Japan's full-time workforce is aging rapidly, younger workers who might be getting married, setting up households and planning for their future put off all of those things while hoping for a permanent job that never materializes.

Now a new Japanese government wants to roll back the workplace ‘liberalizations' of a few years ago by prohibiting firms from hiring temporary workers. It's a political response fashioned during the last campaign, when the Democratic Party tapped into discontent by promising to do something about the legions of permanent temporary workers. What the new policy will do, however, is further set back temp workers by making firms even more reluctant to hire.

The government could explore other alternatives, including ending the most extreme protections for all workers and domestic businesses, and cutting Japan's taxes on businesses, the highest among developed countries, and its employment taxes, which raise the cost of hiring and keeping workers. That might encourage more investment, risk-taking and labor mobility. But these taxes support the country's rich health care and pension entitlements, and permanent workers won't allow those to be diminished, at least for now. Class warfare in Japan means the new class of temporary workers versus permanent workers, and right now the permanent workers, who are also older workers, hold the cards, but at a heavy national price.

"Signs of despair are everywhere," Tamamoto observed earlier this year. "We have run out of outside models to imitate. We must start from scratch, embracing an idea of progress that is based on innovation, ambition and dynamism."

As the rest of the developed world struggles with how to adjust its regulatory regimes and protections in the wake of disarray in financial markets, we should be paying very close attention to Japan, which has been ahead (or behind, depending on your perspective) the curve for years.

Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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