Japan’s smaller businesses are facing significant challenges in sustaining recent wage increases, potentially hindering the Bank of Japan’s (BOJ) plans for further interest rate hikes. While large corporations have readily embraced substantial pay raises, small and medium-sized enterprises (SMEs), which employ a significant portion of the workforce, are struggling to keep pace. This disparity in wage growth sustainability raises concerns about broader economic recovery and the BOJ’s ability to normalize monetary policy.
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Uneven Wage Burden Across Japanese Businesses
The BOJ’s hopes for a consumption-led recovery, fueled by sustained wage growth, are facing headwinds due to the uneven distribution of pay increases across Japanese businesses. Large firms have generally absorbed higher labor costs, driven by a tight labor market and rising inflation. However, smaller companies, often operating with tighter margins and less global reach, are finding it increasingly difficult to match these pay hikes.
For instance, Ito Tekko, a small casting manufacturer near Tokyo, has raised wages by over 11% in the past two years. While accommodating client price adjustments, President Nobuhiro Ito expresses uncertainty about maintaining this trajectory. Necessary equipment investments and the permanent nature of wage increases necessitate a cautious approach to future pay adjustments.
Small Businesses Face Profitability Squeeze
The financial strain on SMEs is evident in data from the finance ministry, revealing that these businesses allocate approximately 70% of their profits to wage costs. This significantly contrasts with the 40% allocation by larger corporations. This disparity highlights the vulnerability of smaller businesses to sustained wage pressures. A recent Japan Chamber of Commerce and Industry (JCCI) survey further underscores this challenge, with many SMEs indicating that rising labor costs are more difficult to pass on to consumers compared to increases in raw material and energy prices.
BOJ’s Rate Hike Dilemma
The sustainability of wage growth is a crucial factor for the BOJ’s monetary policy decisions. BOJ board member Toyoaki Nakamura has voiced concerns about the widening gap between large, high-growth firms and struggling SMEs, questioning the long-term viability of current wage trends. This uncertainty, compounded by external factors like potential U.S. tariff increases, could lead the BOJ to maintain its current interest rate policy in the near term.
Impact on Prime Minister Ishiba’s Agenda
The wage growth issue also carries political implications for Prime Minister Shigeru Ishiba. With rising living costs impacting households, the pressure to deliver substantial and widespread wage increases is mounting. Ishiba’s pledge to significantly raise the minimum wage by the end of the decade faces challenges, particularly for smaller businesses already grappling with profitability constraints. Labor union group Rengo, advocating for a minimum 6% wage hike for SMEs in 2025, further intensifies the pressure on smaller businesses.
Looking Ahead
The ability of smaller businesses to sustain wage growth will be a critical determinant of Japan’s economic recovery and the BOJ’s ability to normalize interest rates. BOJ Governor Kazuo Ueda’s pursuit of higher rates hinges on broad-based and enduring wage increases, ensuring that inflation sustainably reaches the 2% target. The coming months will be crucial in assessing whether this critical condition for monetary policy tightening can be met. The divergence between large and small businesses in their capacity to sustain wage growth will be a central theme in upcoming policy discussions.
