Why aren't the Japanese getting raises?

There's something screwy with the Japanese economy.

One of the most fundamental rules in economics is that wages rise as unemployment falls. It's basic supply and demand: If there are more job offers than workers, people have greater leverage to demand raises.

But in Japan, it's not working out that way.

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According to many metrics, Japan is fairly close to employing every single person it can. Yet wages and inflation are both growing at rates just a hair above zero. This is strange, and it should worry Americans almost as much as the Japanese. America's unemployment rate isn't as low as Japan's, but it's still the lowest it's been in roughly two decades. Yet rates of wage growth remain meager in the U.S. too.

So what's happening? Well, there are a few variables that could explain why Japanese wages aren't rising, particularly productivity growth and demographics.

Let's start with the Japanese workforce. Japan's unemployment rate is a mere 2.5 percent. More importantly, its labor force participation rate — the denominator for the unemployment rate — has shot up to 77.5 percent. That's about where America was during the late '90s boom, and we've fallen significantly since.

That's important, because if you have low unemployment, but also low labor force participation, then you have a lot of "shadow workers" who could be employed but just aren't being picked up by government statistics. That's arguably what's going on in America, and it's been cited as a potential reason for the country's low wage growth. But Japan doesn't have a labor force problem, and their wages are still in the doldrums.

This brings us to the question of productivity growth. When everyone has a job and labor markets tighten up, workers' bargaining power increases, allowing them to demand a bigger cut of the wealth the economy produces. But if the economy just isn't producing wealth that fast, there's not much to demand. And Japan's rate of productivity growth is abysmal, barely above zero. In fact, Japan's wage growth rate is about what you'd expect if you combined its inflation and productivity. Maybe there's no mystery here.

One theory of productivity growth is that it's largely out of policymakers' hands; it depends on the nature of technological development and the vagaries of history. Maybe the whole world is just going through a period when new technology, as exciting as it is, isn't actually helping us create more wealth with less work. America's productivity growth is pretty terrible. Same for the rest of the developed world.

But there's another theory. Namely, that tightening up labor markets will increase productivity. Once companies run out of new workers to employ, they have to figure out how to do more with less.

While Japan's labor force participation and its prime age employment rate are both quite high, they only recently reached their heights after steep climbs in recent years. Presumably, if running a hot economy increases productivity, you'd need to maintain it on a sustained basis. In which case, if Japan can keep its labor market at this level of tightness for a few years, it would see productivity rise — and wages along with it.

Prime Minister Shinzo Abe arrived in 2012 promising to juice Japan's growth with a new set of economic policies. But while Abenomics involved pretty easy monetary policy, it's been a mixed bag on fiscal stimulus. Japan passed a big consumption tax hike in 2014, and its actually been shrinking its deficits recently. That's the opposite of what you'd do if you were trying to stomp on the gas and run the economy as hot as possible.

This is also an international problem: America hasn't attempted much big public investment since the 2009 stimulus, and the Federal Reserve is slowly tightening monetary policy. The eurozone is still a mess as well. China's economy might be slowing down. As interconnected as national economies are these days, everyone's bad policy choices are feeding everyone else's malaise.

Now what about demographics? The portion of Japan's population that's elderly is very big and growing at a rapid clip. Even if Japan's economy is growing, money that could go into bigger paychecks for workers is getting siphoned off for retirees instead. The country cares for its elderly through a combination of pension systems and health-care insurance, which are funded through a combination of taxes and premium contributions. And all those costs are eating away at Japanese paychecks. To some degree, this is a challenge facing all advanced economies as birth rates slow. But the problem is much, much more severe in Japan.

Here in America, employers also have to fork over ever more money to cover the rising cost of health insurance for their workers. Ironically though, Japan actually does a much better job than America of controlling its health-care cost inflation. But its retiree population is growing so fast that whatever savings it gets from cost control are lost to increasing volume.

In fact, the productivity and demographic problems dovetail with each other. The faster Japanese productivity grows, the less of a worker's paycheck gets siphoned off by retirement programs. The slower productivity grows, the more the programs siphon.

Ultimately, there are several things going on with Japan's economy that could explain why wages and prices are still sluggish despite its high employment rates. Some of those things are unique to Japan, and some mirror problems in other advanced economies like America, albeit in complicated ways.

There is a final, more disturbing possibility: Maybe workers don't really get to ask for more after all. It is rather odd to assume the laws of supply and demand apply as cleanly to workers as they do to shoes and wrenches. And the whole relationship between wages and employment rates is based on just a few decades of data. In the end, maybe the idea that there's such a thing as "the labor market" is a convenient fiction?

If that's the case, the solution won't be better policy, per se. It'll be better politics. More specifically, politics in which workers win more fights, and the bosses win fewer.