Japan is cheap, not poor

Yen depreciation forces structural change where it matters most - Japan's labor market

September 8, 2022

`The Japanese currency is poised for a parabolic move towards Y150-160/$`. This was the bullet-point summary of my `The Yen`s Fall from Grace` piece published earlier this year. The arguments and conclusions presented then still very much hold, but now that the Yen’s fall has re-accelerated past Y140/$, it is a good time to ask the bigger question: does the weak Yen expedite or impede necessary structural change? Does it boost Japan’s future potential growth rate, or subtract from it? Or perhaps more simply: Is Japan cheap, or is Japan poor?

Well, it has certainly become easier to argue Japan is cheap:

• A Big Mac costs y390 in Tokyo, versus $5.99 in LA, so at Y140/$ your dollar`s purchasing power is basically double this side of the Pacific

• Japanese labor costs are down to $33k, less than half of America’s $69k; South Korea’s workers are now 5-10% more expensive than Japanese ones (using GDP per capita)

• A Tokyo-based software engineer now comes about 35% cheaper than one based in Ho Chi Min City in Vietnam; never mind a de-facto 70-75% `discount` to Silicon Valley

• And yes, at Y160-180/$, a top-level nurse in Manila would earn more than an entry-level one in Tokyo

The Yen floats on water…

Learning from the real world: Philippine nurses and Japan’s future growth potential

Let’s stay with the Philippine nurse for a moment. Her Japan story offers a great launch pad to get us beyond a trader’s typical short-term obsessions: whether the weak yen is good or bad for Japan is not a question of whether exporters’ windfall gains are more (or less) than importers’ cost-push losses (if you need to know, exporters win, hands down; they account for almost twice the weight of importers in the major stock market indexes…).

Instead - for policy makers, like, for example, BoJ Governor Kuroda; and for long-term focus investors, like, for example, the GPIF – the real question is whether the change in relative prices triggered by Yen weakness expedites or impedes the necessary fundamental structural change Japan needs for a more prosperous and sustainable future.

The shortage of nurses is real

Estimates vary -- from 150-250k between now and 2025, or possibly 800k to 1.25 million needed by 2030. Whatever the exact number will be, what matters is that everyone in both the private- and public sector has been agreeing on -- and warning against – a possible collapse of Japan’s healthcare system.

Projecting demand and supply for nurses is not rocket science; but it does offer a crystal-clear focus on Japan’s most fundamental structural challenge – Japan is running out of workers: while demand for health care services goes up sharply as baby boomers enter their last ten years, supply of health care professionals goes down.

The numbers speak for themselves: over the next decade, Japan’s 25-35 years old population is set to shrink by approximately 250k people every year while the over 70 years old population goes up by approximately 400k per year.

Like I said, the potential damage done by of Japan’s demographic destiny has been known for decades; and yes, there were several rounds of deregulation aimed at easing entry into the nursing profession for non-Japanese. The number of Philippine nurses/nurse candidates has jumped more than 10-fold over the past five years, to 3,378 at the latest count. In total, there are approximately 1.3 million registered nurses in Japan, but non-Japanese nurses/candidates still account for less than 0.5% of the total.

Like most professional jobs in Japan, nursing is highly regulated, extremely process- and rules focused, with rigid hierarchies and pecking orders as well as strict enforcement of seniority-based promotion and compensation ladders.

Again, like most professions in Japan, proud traditions are guarded by tight-knight professional associations – de-facto all-powerful, rent-seeking guilds. In this case the Japan Nursing Association and the Japan Medical Association. Both are major political money donors and key allies for national and local politicians to help `bring out the vote`, primarily for the ruling LDP.

Working in a hospital is stressful anywhere in the world but, as in most professions, Japanese work culture has a way of adding layers of complexity which tend to be quite taxing, particularly for non-natives or anyone who has not grown up in the Japanese education system.  我慢 and 平平 work culture is not for everyone.

Be this as it may. What we do know for sure: the weaker the Yen, the less attractive it becomes for our Philippine nurse to consider working in Japan. And the fewer non-Japanese nurses Japan attracts, the poorer Japan will become. The cost of nursing services will go up, and/or the services level will go down.

Make no mistake: Yen appreciation was good for Japan’s longer-term prosperity. It allowed Japan to attract an increasingly scare local resource – labor -- from the world without having to pay up for it. Japan’s consumers, the hospitality providers, and the national budget benefited from stable costs; and our Philippine nurse benefitted by getting effective pay increases in the currency that matters most to her personal future - the remittances sent back to her home country currency savings account kept growing, despite her Yen paycheck barely rising.

In contrast, Yen depreciation now makes both our non-Japanese nurse and the Japanese economy poorer. And if the Yen keeps going down, Manila hospitals will indeed look more and more attractive.

The nursing shortage will get more acute, thus cutting down Japan’s future potential growth potential. Japan will run out of affordable labor sooner. Yen depreciation certainly sends the wrong price signal to global workers.

Of course, Yen appreciation was not all good. The principal loser has been the young generation of Japan: there has been de-facto no growth in starting- or early year salaries for nurses over the past twenty years in Japan. (1)

The coming Brain-Drain of tech workers 

Which gets us from the market for nurses to the one for everywhere-high-in-demand software engineers and technology workers. Here, the potential damage done by Yen depreciation is even more worrying - the weak yen is poised to trigger a brain-drain of Japan’s top talent away from Japanese employers to global ones.

With strict guardrails defended by the Nursing- and Medical association, nursing is a far cry from being a model of a free-market: higher salary offers may not result in greater supply because the test- and licensing requirements are a significant barrier to entry. Moreover, hospitals trying to poach nurses away with better offers are frowned upon. A strong ethos of frugality, self-sacrifice and cost-savings come with the job. The Medical- and the Nurse Association make sure offenders to the code pay an appropriate price. As everywhere in Japan, reputation matters.

In sharp contrast, tech workers are not ensnared by an industry association and act more like free agents. Traditional salaryman loyalty to one company is generally on the decline, with tech workers leading the way. They know their worth, spurred on by being told every day by policy leaders that they hold the keys to unlock Japan’s future potential. The barrier to entry is your own skill set more so than your family or university pedigree; your professional reputation is self-made, not licensed; and by now every techie in Japan has positive role models to aspire to – some of your peers got rich by working either for global pay-for-performance companies, or struck gold in a start-up.

It is a seller’s market for Japanese professionals

Tokyo is already swarming with global- and local headhunters offering hefty pay packages to Japanese mid-career or entry-level techies. A fresh Keio- or Tokyo University graduate may not have quite the depth of skills or street-smart worldliness of a Stanford- or MIT one, but at a 70-75% discount it’s an arbitrage US and global tech companies are eager to take on.

I’m not sure whether the brain-drain of Japan’s best-and-brightest will lead to more Japanese working overseas, or whether we’ll see a boom of inward direct investment, i.e. US and global tech companies and service providers opening shop in Japan or expanding existing operations.

From a breakpoint in the labor market…

However, what is certain is that the global hunt for Japanese talent will force local Japanese companies to not just offer higher compensation, but also change the deeply engrained culture of employment and compensation.

Make no mistake: Yen depreciation will become the catalyst for a fundamental break in Japan`s labor market – not because of METI or Prime Minister`s Office induced top-down rule changes and administrative guidance, but because of raw market pressures and price signals.

…to where the good news starts:

Just last week, several of Japan’s technology companies, led by telecommunications giant NTT, presented tentative plans to shift compensation- and promotion practices away from traditional seniority ladders towards true merit-based career development.

Specifically, the plan is to, from next year, allow promotions even after the employee has served just one-year on the job. This would be a radical break with traditional rules where promotions can only happen after at least three or four years on the job, no matter how outstanding the employee’s performance.

Importantly, the proposed internal reforms would result in younger-age employees becoming the direct report boss for older ones.

…to a productivity boom

Make no mistake – this is how the revolution starts, how, after decades of submission, finally Japan’s youth get empowered, get incentivized to show creativity, ambition, risk-taking and leadership. Economists and policy makers always insist we need a productivity miracle. Well, this is exactly how it can start.

So here we have realistic prospects of Yen depreciation accelerating changes in the labor market that will make cheap and poor Japanese workers rich. And if rich is based on locally employed value-add and productivity, Japan’s future prosperity is poised to go up.

New global realities – America first and foremost

I realize that traditional models of the FX impact on economies tend to focus on exports versus imports, or tradeable goods versus non-tradeable ones, i.e. the goods sector versus the services one.

By those, Yen weakness should usher-in a shift away from imports towards greater exports; or a shift away from services towards manufacturing. There should be a boom of on-shoring in Japan, with both local and global companies rushing to build new production capacity in Japan because it has become cheaper to produce at home.

However, in the here-and-now of current global realities, this is highly unlikely to come about: for starters, the market for goods in Japan will always grow much slower than global markets in general, and especially America’s.

Of course, this dynamic has been enshrined in Japanese corporate growth strategies already of at least three decades: off-shore production capacity has more than doubled since 1995 and now accounts for almost 40% of Japan-owned total manufacturing capacity.

What’s new in 2022 is that

1. confidence in China’s market potential and reliability has dropped

2. America’s newfound `America first and foremost` national economic security priorities have upped significantly the costs of not building new capacity in the US

Clear speak: Japanese fear, quite rightly in my view, that, from here on, anyone who wants to sell to Americans will have to produce in America, period.

Case in point: Toyota, Honda, Panasonic and several other Japanese car- and transportation equipment makers announced plans for almost $20billion of new factory investments in the US within just days of President Biden successfully brokering his `Inflation Reduction Act` into law.

Why? They simply cannot afford to miss out on the $7,500 tax credits for electric vehicles that will be offered only to vehicles assembled in the US.

What has happened is that, for Japanese manufacturers, the risk premium for investing in domestic Japan-based production for exports has gone up much faster than the potential benefits from a structurally weaker Yen - because of America’s new mercantilism.

It is not an exaggeration to argue that the weaker Yen has done little for Japan’s exporters, except raise the cost of future revenue growth for the shareholders of those Japanese companies.

Relentless focus on America

From here, I suspect it highly likely that, in the name of national economic security and climate change countermeasures, de-facto protectionist policies similar to the ones spelled-out in the `Inflation Reduction Act` are poised to find broad-based bi-partisan support in Washington. If so, more and more of Japanese industrial producers will be forced to raise US-based capacity – irrespective of whether then Yen is weak or strong.

Where does this leave us?

The bad news is that Yen depreciation is unlikely to raise Japanese investment in local productive assets; the ugly news is that it accelerates the negative forces of the structural labor shortage; and the good news is that, yes, global capital is more keen than ever to invest in all Japan has to offer – Japan is cheap, and global investors see a profitable opportunity to make Japanese employees richer.

So what to do, Prime Minister Kishida?

The worst thing Japan could do is intervene in the currency market.

Both the rising interest rate differentials and Japan`s trade- and current account deficit command the Yen should weaken. Unless at least one of these trends can be credibly shown to reverse soon, depleting precious FX reserves to buy Yen will do nothing but feed both speculators greed and fundamental investors’ convictions.

Raising rates would also backfire

This is because the BoJ will be humming and huffing about every little basis point, while across the Pacific the Fed will have no qualms to step-on the brakes as hard as it possibly can.

As I argued in the original ‘The Yen’s fall from Grace’, the interest rate differential will only stop to pull the Yen lower when the Fed changes course, i.e. when America’s recession gets real.

Here in Japan, the credibility of both the BoJ and the Kishida administration would take a big hit if the BoJ changed course now: for the former, because there is, still, no evidence of demand-pull inflation or wage growth; for the later because Kishida has been full-on committed to mobilizing fiscal policy to cushion against cost-push inflation pressures.

Changing policy commitments without credible evidence that fundamental facts have changed typically sets course for disaster – capital flight – rather than one towards a safe and trustworthy harbor.

Launch an ‘Inward Investment Doubling Plan’ and let global investors do the Yen buying for you

What Prime Minister Kishida should do is this: instead of letting the FX market dictate your actions, seize the unique opportunity offered by global capital to do your much needed buying of Yen and investment in Japan for you.

Japanese assets are cheap. Every global investor I speak to is keen to buy Japan, and that’s true for all Yen assets classes - public equities, private equity, venture capital, real estate, and labor.

Give global investors some new incentives to buy Japan. Launch an ‘Inbound Investment Doubling Plan’ -- deregulate, privatize, make it easier to buy or partner with Japanese corporations and employ Japanese labor; our Philippine nurse, for one, would almost certainly be more likely to come to Japan if the Nurse- and Medical Association would make it possible to qualify for a license based more on on-the-job evaluation rather than just written exams.

And yes, cut in half both dividend- and capital gains taxes for both domestic and global investors who commit to buying and holding productive assets or equities for at least five years.

Again, Japan’s leaders can achieve two goals with one action - arrest both Yen depreciation and boost the potential growth rate by letting global money do the investing in domestic assets for them.

Importantly, the more attractive Japan becomes for global investors, the greater the probability that Japanese domestic allocators will switch from prioritizing non-Yen security investments to raising allocations into domestic risk assets. Here the GPIF public pension fund is my favorite potential leading indicator – when Japanese savers start buying their own asset markets, Yen depreciation will be over and Japan’s growth potential will rise. 

Unfortunately, chances of a broad-based policy change happening in Japan are about as slim as Germany committing to ramp up nuclear power production.

Private sector corporate leaders rise to the challenge

What will happen instead, in my view, is that Japan’s corporate leaders will rise to the challenge regardless of the lack of pro-active political leadership. Just as the new NTT President Shimada is prepared to break with tradition and tilt the balance between merit and seniority in favor or merit, other corporate leaders will come up with creative ways to retain and empower Japan’s next generation productivity leaders. Partnerships, joint ventures and all forms of global alliances will be forged, both with established global platforms as well as start-ups eager to expand their global reach.

All said, I am hopeful that Yen depreciation ends up forcing long overdue structural change, primarily via the labor market. The faster corporate leaders react to the new global and local realities by introducing merit-based compensation and rewards for aspirational risk taking for the young, the quicker Japan`s potential growth rate will rise.

The longer these actions are postponed, the greater the risks of Japan becoming poor – not just relative to America or South Korea or the Philippines because of the decline of the Yen; but also in local currency absolute terms - real incomes will fall. The time to act is now.

Thank you for reading. As always, comments welcome. Thank you & Many Cheers :-j

(1) PM Kishida, to his credit, did push-through a pay hike of on average around 3% for all government regulated employees, including nurses and care givers, earlier this year).