Annual Report on

The Japanese Economy and Public Finance


- No Gains Without Reforms V -

Cabinet Office

Government of Japan

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Section 3 The Demographic Wave and Business Competitiveness

    From the perspective of both households and companies, the Dankai generation's arrival at the mandatory retirement age of 60 will also have a significant impact on the labor market. For households, the retired Dankai generation workers will have stronger influence as consumers of goods and services, which includes asset investment financed by retirement allowances and higher consumption for recreation such as tourism and entertainment. These retirees will also enjoy a wider range of lifestyle options that will enable them to stay active in the labor force, including continued employment with the same company using the skills they have honed over their careers, initiating business ventures, or pursuing activities with non-profit organizations (see Column 5).
    For business firms, on the other hand, Dankai generation workers correspond to principal component of labor costs, accounting for about 13% of all employees and about 16% of total wages across all industry sectors. In Japan, where aging of the labor force is a conspicuous trend, it is difficult to deny that employment of people in this generation has dampened youth employment (i.e. cloud out) by putting upward pressure on labor costs. An interest is whether this dampening effect will diminish as the Dankai generation approaches mandatory retirement and is expected to lead to an increase in youth employment in the future. On the other hand, the mandatory retirement of the Dankai generation will place an inescapable burden on company management by draining off of experienced workers' skills and knowledge and will increase the burden associated with retirement benefit plans, including an increase company pension benefits paid as well. This section first examines the diverse effects on companies of the Dankai generation's arrival at the age of mandatory retirement. These include the impact on the labor cost burden and company earnings, its significance in terms of youth employment and the problem of succeeding the skills of experienced workers, particularly in manufacturing industries. The section then discusses another issue associated with the Dankai generation's retirement and retirement benefit plans.

1. Impact on Employment and Wages

 Dankai generation workers as the "principal component" of total wages
    First, in order to ascertain the impact that Dankai generation workers have on labor costs, their proportion of the number of people employed and their share of the amount of wages paid (total cash wages base) compared with other age groups will be examined (Figure 3-3-1). As will be seen, Dankai generation workers aged 50-54 in 2000 occupied the central position in companies' labor force composition and the amount of wages paid. This trend was particularly strong in manufacturing industries and to a lesser extent in non-manufacturing industries, with workers aged 50-59 accounting for a high percentage of employees in traditional business sectors, such as textiles, leather, steel, metal products, ceramics, stone and clay, food products, paper, pulp and lumber in the former, and real estate and transportation in the latter (Appended Table 3-24). Overall, the wage curve has shown a tendency to flatten out (Figure 3-3-2), and Dankai generation employees have also probably been affected by this trend (Appended Figure 3-25). However, because this group of workers constitutes a larger population than the neighboring generations, the number of workers in this group is a factor that probably works to push up the labor cost burden by virtue of sheer numbers.
Figure 3-3-1 Time series trends in total wages paid by age group
Figure 3-3-2 Changes in wage profile by industry

 The impact of Dankai generation workers on the plateauing of the labor share
    To some extent, the wages of the Dankai generation probably have been a factor in the plateauing of the labor share through upward pressure on labor costs. To examine this point, calculations were performed to determine the Dankai generation workers' contribution to changes in companies' total wage base. When wages paid to Dankai generation workers change from one point in time to another, the change is caused by the following effects: (i) the effect of numerical changes in the composition of workers (employee composition change factor), (ii) the effect of moving upwards in the wage curve as age rises to at least 50-55 (wage change factors). For (ii), it should be kept in mind that a strict separation between rises in wages due to economic growth (rise in overall wages) and simple movements in the wage curve is not possible. Nevertheless, the contribution of the Dankai generation to changes in total wage costs indicates that in the 1990s, two factors, i.e., the increase in number of employees and the increase in wages, worked to push up total wage costs by about 20%, and in 2000, the factor of employee numbers pushed up total wage costs despite the fact that wages were stagnant. In additional, in 2003, structural wage factors such as wage cuts throughout the economy and the downward shift in the wage curve as the Dankai generation reached their late fifties worked to reduce total wage costs. On the other hand, the factor of employee numbers continues to push up total wage costs (Table 3-3-3). These trends indicate that the rise in wage costs of Dankai generation workers has acted to increase the labor share by 0.2 to 0.9 percentage points from 1990 to at least the start of the 2000s.
Table 3-3-3 The contribution of Dankai generation workers to the increase in the wage base

 Curbing of the labor cost burden from 2007 to have a favorable impact on company earnings
   From 2007 to around 2010, members of the Dankai generation will reach the mandatory retirement age, and the question arises as to what impact this demographic event will have for companies in terms of decreasing labor costs. To ascertain how wage payments will change, estimates were made under the following assumptions: (i) the wage profile by gender and by form of employment will be the same as in 2003, (ii) the proportion of people employed by age group (number of people employed / population) will be the same as in 2004, and (iii) the ratio of regular workers to non-regular workers by age group will be the same as in 2004.(37) According to this estimation, drawn in terms of the percentage change from the preceding year, wage costs will rapidly decline from 2007 to 2009 at the start of retirement of the Dankai generation, and afterward the rate of decline will slow. In particular, of about the 2.6% overall decline in total wages up to 2009, the contribution to the decline in total wages of the 55-59 age group as of 2004, which includes the Dankai generation, will be at about 7.4%, surpass this percentage, exerting a positive effect on corporate earnings (Figure 3-3-4).
Figure 3-3-4 Medium-term trends in labor costs taking into consideration the retirement of the Dankai generation
    As from 2009, the next major phase will be the aging of the population aged 30-34 as of 2004 including the Dankai Jr. generation. Assuming the present wage curve, the proportion of the 45-59 age group whose wages correspond to the peak of the wage curve will bottom out around 2010 after the retirement of the Dankai generation, and then turn upward. Therefore, between 2015 and around 2020 when the Dankai Jr. generation reaches 45 years of age, it is expected that the rate of decline of wage costs will slow down temporarily.

 Decline in employment of new graduates as regular employees after the latter half of the 1990s
   As seen above, the weight of employees in the younger age group, particularly those in their early twenties including new graduates, as a proportion of company employees declined between the 1990s and recent years (Figure 3-3-1 above). While a portion of this decrease can be attributed to the effect of declining birth rates and the aging of the population, the results of cohort analysis focusing show that the labor force ratio and the employee ratio of the youth generation up to the Dankai Jr. generation have been declining,(38) and that the younger the age group of this generation is, the higher the unemployment rate tends to be. As pointed out above, this trend suggests that the large wage burden of employees in the relatively higher age group, particularly the Dankai generation, may possibly have exacerbated the decline in employment of this younger age group amid the economic downturn from the latter half of the 1990s (Figure 3-3-5). The following discussion examines this possibility.
Figure 3-3-5 Cohort analysis of the proportion of persons employed, etc.
    First, it is found that after the mid-1990s, there was a major decline in the ratio of new graduates among employees between 1997 and 1998 in the wake of the financial crisis, with a continual decline as moderate pace afterwards, which suggests that the hiring of new graduates during this period was severe (Figure 3-3-6). In the manufacturing, transportation and construction industries, the downtrend trend in the ratio of new graduates among employees has continued, and this decline, as pointed out above, could be a consequence of the higher-age employees, particularly those in the Dankai generation, in labor costs. In the wholesale and retail industries, the ratio of new graduates among employees has rebounded, but this reflects the uptrend in the ratio of part-time employees in these industry sectors since the beginning of the 2000s. In consequence, new graduates excluding part-time workers as a proportion of all people entering the industry declined from more than 27% in 1995 to about 16% in 2004. In addition, an analysis of the trend in people entering the industry by employment history reveals that that there has been a long-term downtrend in the number of new graduates hired, which declined from about 960,000 in 1995 (about 30% of the total number of people entering the industry) to about 690,000 in 2004 (about 19% of the total number of people entering the industry). On the other hand, the number of job-changers has shown a steady upward trend, increasing from about 1.67 million in 1995 (about 51% of the total number of people entering the industry) to 2.18 million in 2004 (about 60%). This means that since the latter half of the 1990s, companies have restricted the hiring of new graduates, and, have hired people from the market of job-changers or lower-paid non-regular workers such as part-timers as an immediate boost when they required labor force.
Figure 3-3-6 Trends in the ratio of new graduates among employees, etc.

 Possible decline in the ratio of younger employees stemming from a rising sense of over-employment due to the large proportion of elderly employees
   Second, the discussion will focus on the relationship between companies' sense of over-employment and the proportion of employees by age group. To begin with, an analysis of the relationship between the ratio of elderly workers (50 years and older) and the sense of over-employment taking into account characteristics for each industry sector yielded a strong positive correlation whereby if the ratio of elderly workers rises by 1 percentage point, the sense of over-employment increases by 2 percentage points. According to the analysis presented in Chapter 1, a 2 percentage point increase in the sense of over-employment corresponds to over-employment of about 290,000, and thus the impact is decidedly not small. Next, in examining the relationship between the ratio of younger employees (15-24 years or younger) and the sense of over-employment, it is observed that a 1 percentage point increase in the sense of over-employment is associated with about a 0.2 percentage point decline in the ratio of younger employees (corresponding to more than 100,000 employees) (Figure 3-3-7). It can be concluded, then, that there is some degree of correlation between the high ratio of elderly employees and the low ratio of younger employees. This demonstrates that there is a causal relationship whereby if the ratio of elderly employees rises, the sense of over-employment from a cost standpoint rises, leading to a decline in the ratio of younger employees through a dampening of hiring of new graduates. It should be noted, however, that this relationship includes at the same time another causal relationship whereby the decline in the ratio of younger employees itself results in an increase in the ratio of elderly employees.
Figure 3-3-7 The relationship of the ratio of elderly workers to the sense of over-employment, and the relationship of the ratio of younger employees to the sense of over-employment

 Peaking out of the Dankai generation's dampening effect on employment in recent years
    In order to circumvent these statistical problems, Genda (2004) examined the causal relationship between the high ratio of employment of elderly workers and the low rate of change in employment in a certain business establishment by conducting a regression analysis using a business establishment list of an employment trend survey, with the ratio of employment of elderly workers in the business establishment at the beginning of a given year as the explanatory variable and the ratio of change in employment in that year in that business establishment as the dependent variable.(39) Here, following this line of approach, a regression analysis using the ratio of Dankai generation employment as the explanatory variable was performed using the business establishment list of employment trend surveys conducted in 1995, 2000, and 2003. Results indicated that in the years up to 2000, during which the Dankai generations's wages moved upwards in the wage surve, the coefficient of the ratio of Dankai generation employment was negative and statistically significant and that the absolute value of the coefficient was large. For example, in a business establishment where the ratio of Dankai generation employment was 1 percentage point higher, there was a 0.08 percentage point decline in the rate of change in employment, indicating a dampening effect (Figure 3-3-8). In addition, the coefficient of the ratio of Dankai generation employment in 2003 was negative and statistically significant, and the growth rate of the absolute values declined compared with 2000. A variety of factors can explain these findings. For one, as discussed previously, it is thought that some of the workers in the Dankai generation may have shifted to the group in which wages as expressed by the wage curve declined.(40) In addition, calculating the rate of change in employment dividing workers into regular and part-time workers shows that the ratio of Dankai generation workers does not have a significant relationship with changes in the number of part-time workers, and the same result is found in the relationship between regular workers and the total number of employees. These findings suggest that as the upward pressure exerted on wage costs by the Dankai generation declines, the marginal impact on reducing employees, especially regular employees, becomes smaller, indicating that as this generation approaches mandatory retirement, a positive impact on regular employment centering on the younger age group can be expected in the future.
Figure 3-3-8 State of employment dampening due to the Dankai generation

 Youth recruitment emerges and mid-career recruitment steadily moving up
    An increase in hiring of new graduates in anticipation of the Dankai generation's arrival at the age of mandatory retirement has already begun. To give an example, the Bank of Japan's Short-term Economic Survey of Enterprises in Japan (TANKAN Survey) examined plans for hiring new graduates and found that, in FY2005, companies in all industries intended to hire at a rate exceeding that of FY2004 when the rate of increase turned upward year-on-year. A breakdown by industry sector reveals that the increase in hiring will surpass last fiscal year's figure in such manufacturing industries as electrical machinery and transport machinery and in such non-manufacturing industries as finance, real estate and services. Although plans for FY2006 call for a reduction in the hiring growth rate, hiring of new graduates should also continue to increase, principally in the finance and IT industries (Figure 3-3-9). The TANKAN report also examined the situation regarding non-regular employees such as part-time workers. A questionnaire survey of major corporations (Nihon Keizai Shimbun, Inc.) found that plans for the hiring of new college graduates in FY2006 call for a large increase overall for the first time in 17 years, since FY1989 during the bubble era. These and other findings point to a major increase over the current fiscal year's hiring.(41) Increases are forecast particularly in the finance sector, which has achieved a remarkable performance recovery, and in manufacturing industries, etc., where the highly-skilled workers of the Dankai generation are approaching mandatory retirement, suggesting an overall increase in the propensity to hire.
Figure 3-3-9 State of plans for hiring new graduates
    To determine what sort of companies are enthusiastic about hiring younger people including new graduates, an analysis was performed using a special aggregate of the Annual Survey of Corporate Behavior (2004), Cabinet Office. According to this survey, hiring plans for the next three years will turn upward for the first time since the bubble era, and more than 70% of the companies whose plans call for the largest increases in regular employees stated that they will hire mostly from the 20 and under age group. This finding indicates that companies' plans to increase employment focus on increasing regular employees including new graduates (Appended Figure 3-27). In addition, a regression analysis was performed using indexes expressing whether or not companies intend to increase hiring in the next three years and indexes expressing the business sentiment of companies and whether or not they have restricted hiring of young people over the past three years. The results indicated that the better business conditions are and the more companies restricted youth employment in the past, etc., the more likely they are to have plans to increase employment (Table 3-3-10).(42) On the other hand, companies with a strong sense of over-employment of people in their fifties including the Dankai generation showed little likelihood of increasing employment in the future, and companies saddled with over-employment do not appear likely to increase employment in the next few years. However, interest will focus on the high motivation, even among these companies, to increase employment of young people 20 years and younger.
Table 3-3-10 Impact on the employment plans of companies for the next three years
    According to this survey, there is an increasingly strong tendency among companies to recruit mid-careers, a trend being driven by three factors: (i) because the population of people from 15 to 24 years, which is the pool of new graduate hires over the long term, is expected to decline steadily, it will be difficult, from the standpoint of supply constraints, to secure such personnel for the economy as a whole, (ii) companies are have a tendency to cut education and training costs, and are not placing as much emphasis on the hiring of new graduates as they did in the past because of the relatively high education costs required, (iii) the growing desire to hire young workers is raising the value of these workers, relatively increasing their share of wages and flattening out the wage curve. Thus, the expanded recruitment of mid-careers is being fueled by increasing movement of labor between companies and between industries, and over the mid- to long-term, the employment of young people in mid-career who are ready to work should continue.(43)

 The problem of succession of the skills of Dankai generation workers
    It is argued that one of the sources of Japanese companies' technological development capacity is the advanced level of ability present in development and production sites. This capacity is supported by the technical workers of the Dankai generation, a solid labor force with many years of continuous service, and the retirement of this generation, it has been pointed out, has raised concerns about the succession of skills to the next generation of workers.
    To ascertain employee levels in different occupational categories the business establishment list of the employment trend surveys described above were again used. Employees were divided into professional, technical and clerical workers, and employee vacancy rates by category for each business establishment were calculated. Then, a regression analysis was performed on the proportion of young employees (15-34 years old) and Dankai generation employees in these business establishments. The results indicated that in 2003, the higher the employment ratio of Dankai generation workers was, the lower the vacancy rate for professional and technical personnel, and the higher the proportion of young workers was, the higher the vacancy rate for professional and technical personnel (Table 3-3-11). This reflects a problem that professional and technical workers are disproportionately distributed in the Dankai generation compared to the younger generations.
Table 3-3-11 The impact of the age composition of employees on vacancies for professional and technical occupations
    According to a company survey, employees in the current working generation voice the concern that when the Dankai generation labor force withdraws, impediments to accomplishing current work operations will arise, and the majority believes that the knowledge and skills of these workers must be transferred to the succeeding generation. In another survey, over 40% of managers thought that because of the retirement of the Dankai generation, the transfer of company knowledge will be problematic. These surveys indicate that there is a strong sense of crisis both among company management and worksite employees.(44)
    This development raises a question: The retirement of what type of workers among the Dankai generation arouses a sense of crisis? According to an analysis by Higuchi, et al. (2004), among blue-collar technicians involved in manufacturing, technical workers in the younger generation will drop in numbers more sharply than those in the Dankai generation, which suggest that securing these technical workers by some means will be a major challenge. Among white-collar workers such as clerical and management employees, however, a major decline in the number of workers in the generation succeeding the Dankai generation was not seen, which implies that the sense of shortage of white-collar workers is not as strong.
    Many companies in the manufacturing sector are coping with the problem of the aging of technicians in manufacturing industries through measures such as extending the employment of critical workers, using them as instructors, or increasing recruitment of mid-careers and young workers.(45) According to a company survey by the Cabinet Office (see the next section for details) concerning research personnel and knowledge workers who can contribute to advancing R&D and innovation, those companies that employ researchers that were not concerned about the retirement of Dankai generation researchers constituted less than 40%, and in R&D departments, as well as at manufacturing worksites, the aging of Dankai generation employees is regarded as a problem. To cope with this situation, companies are placing emphasis on employment continuation through measures such as reemploying or extending the retirement of research personnel, and many are focusing on supplementing staff by increasing mid-career recruitment.
    Thus, companies are already taking the initiative in transferring the skills and knowledge of Dankai generation workers through measures such as extending the employment of critical elderly workers. Meanwhile, other measures are being taken to curb decreases in the workforce population from declining birth rates and aging of the population, one of which is creating environments in which elderly persons who wish to continue working can use their knowledge and experience to stay active in the workplace. Toward this aim, the revised Employment Security Law for Older Workers was established in June 2004. This revised law requires that employers that establish retirement plans take one of the following measures after April 1, 2006: (i) raise the age of mandatory retirement up to 65 in stages to coincide with the age at which pension benefits begin, (ii) introduce in stages a continuing employment system up to age 65, or (iii) abolish mandatory retirement rules.
    Looking at the status of companies' retirement plans before the revised law enforces, over 90% of companies have established an age of mandatory retirement, which is usually 60. Of the companies that have established uniform mandatory retirement plans irrespective of type of occupation, over 70% are introducing a continuing employment plan that either extends employment or uses a reemployment system. As stated above, however, since most of these companies have set limits on the employees eligible for continued employment, if the employment of elderly persons or wage costs increase to a substantial degree through the revised law, there probably will be some degree of effect on corporate profits.(46) In this regard, a challenge for corporate sectors is to curb the impact on corporate profits on the one hand, and to secure the employment of skilled and motivated elderly workers as well, for example by: (i) reviewing their salary or personnel management systems, or as discussed in the following section, reforming their retirement benefit plans when extending the age of mandatory retirement, and (ii) incorporating greater flexibility in work content or format to match the employment needs of elderly persons when using a continuing employment plan.

Column 5

Diversification of Work Formats after Retirement among Dankai Generation

    While the Dankai generation is approaching at the mandatory retirement age the labor force ratio of Japan's elderly have a long-term downward trend due to reasons including the decline in independent business proprietors. Overseas, however, the labor force ratio of elderly remains high. For Japan's elderly, the ideal age of retirement is from about 65 to 70, which means in comparison with other industrialized countries, the work motivation of Japan's elderly is extremely high. This applies to the Dankai generation as well: a survey of people in their fifties in Tokyo found that the majority of workers in the Dankai generation and the generations in front of and behind it have a volition to continue working after mandatory retirement. While some may wish to continue work because they need a purpose in life and would like to participate in society, economic reasons, such as uneasiness about income because of an inability to live on a pension alone, remain a persistent motivation.
    At the same time, the lifestyle preferences of people after mandatory retirement are diversifying. According to the Awareness Survey Concerning Consumption and Savings Activity and Citizens' Burden (2005), Cabinet Office, more than 60% of office workers desired to continue working in some form after retirement, but of these people, more than 60% wanted to work part-time. Another trend seen today is an expansion of work tied closely to the local area such as through "Silver Human Resources Centers." In addition, a survey in Tokyo also found an entrepreneurial spirit aloft among people in their fifties, with about 20% expressing the desire to start their own ventures ("silver venture") or to work alone in their own company. In fact, of those people who wish to start a business, the proportion of those in comparatively high age groups such as over 45 or over 60 is at the highest level in the past 10 or more years, and it seems that businesses start-ups based on the use of previous work experience and knowledge are expanding.
    One mode of living in which the Dankai generation has considerable interest in after retirement is participating in the volunteer activities of non-profit organizations (NPOs). Particularly among women in the Dankai generation, the desire to join volunteer activities is, like health-consciousness and travel, high compared with men in the same generation and with women in the generations in front of and behind them. It is therefore expected that enthusiasm for participating in NPO activities among this group of women will grow in the future as well.

Column Figure 5 Modes of Living of Post-retirement Dankai Generation

2. Impact of Aging on Retirement Benefit Plans

    As described in the preceding paragraphs, the retirement of the Dankai generation that will gradually start at the beginning of 2007 will be a factor that works to increase corporate profits by reducing companies' labor cost burden, provided that other conditions do not change. At the same time, however, the retirement of the population "bulge" represented by the Dankai generation will, for companies, also mean upward pressure on retirement benefits, such as retirement allowances and company pensions..

 Retirement benefit plans hitherto a factor dampening corporate profits
    The payment and cost burden relating to retirement benefits consists of the following: (i) payouts of retirement allowances at the time employees retire, (ii) companies' burden of contributions to company pension plans, (iii) costs posted to profit and loss statements that reflect changes in currently-generated retirement benefit debts, and the debt associated with retirement benefits.(47) These costs are usually included in welfare expenses (of labor costs) in the "Statistics of Corporations by Industry" of the Ministry of Finance. The employer's contribution to social insurance premiums (fringe-benefit cost stipulated under law) is a major component of welfare expenses, but according to the National Accounts,(48) the company pension contribution and retirement allowance components of welfare expenses have been on an uptrend with the increase in retirees and the aging of employees, etc. (Appended Figure 3-28).
    The discussion will now focus on the trend in costs relating to retirement benefits in accounting terms. It would be instructive to first examine the trend in retirement benefit debts of 1,016 listed companies for which data can be ascertained covering the business years from March 2001 to March 2004. After peaking during the period from 2002 to 2003, retirement benefit debts have been on a downtrend due to the effect of the special factor presented by the (future) refund to the employees' pension funds, but remains at a high level, mainly reflecting (i) the aging of the employee composition and increase in number of pension recipients, and (ii) the decline in the discount rate (i.e. interest rate) for calculating retirement benefit debts (Figure 3-3-12). In contrast to this, the pension assets that companies are reserving externally declined up to 2002 due to stagnating investment earnings ratios, but later, in the middle of 2003, they slightly increased due to the rally in stock prices, and by the end of FY2003, they had made a modest increase. A comparison of these figures shows that pension assets account for only slightly more than 50% of retirement benefit debts, and the reserve shortfall, calculated by subtracting pension assets from retirement benefit debts, remains at a high level.
Figure 3-3-12 Trends in retirement benefit debts and pension assets
    Those retirement benefit debts that are treated as "unrecognized debts," such as the reserve shortfall generated by the inability to forecast asset investment results and discount rates,(49) are posted off the books. Consequently, even though it is not necessary to post these debts to expenses immediately, they are treated as write-offs extending over the future. The increase in retirement benefit debts and the amount of unrecognized debt written off, etc., are posted each fiscal year as "retirement benefit costs" on profit and loss statements. Recently, these retirement benefit costs have been leveling off.(50) At the end of FY2003, however, they stood at a level of about 30% relative to ordinary profits, which means the retirement benefit costs are having an impact on corporate profits that cannot be ignored (Figure 3-3-13).(51)
Figure 3-3-13 Negative contribution to corporate profits

 Impact of the retirement of the Dankai generation
    Examining the impact on companies of retirement benefit plans as outlined above leads one to consider the impact of the mandatory retirement of the Dankai generation to arrive beginning 2007. Assuming current retirement benefit plans, retirement allowances after 2007 will undergo a temporary sharp increase, and it is forecast that pension benefits, because they extend over the long term, will experience an uptrend upon retirement and thereon into the future. On the other hand, the payment of retirement allowances to retirees of the Dankai generation will be a factor that works to temporarily reduce these retirement benefit debts, but the retirement benefit debts associated with pension benefits will probably follow a long-term uptrend.(52) Since the number of companies that have adopted retirement allowances as their sole retirement benefit is declining, concerns have arisen that retirement benefit debts associated with company pensions will have an impact on corporate profits in the mid- to long-term because of the increase in retirement benefit costs.
    Holding down or eliminating the currently excessive retirement benefit reserve shortfall will not only require an improvement in investment earnings but, in some cases, an increase in companies' contribution burden to a certain extent. The cost burden associated with eliminating this retirement benefits reserve shortfall will have an impact on the capital investment behavior of companies by decreasing corporate profits. In a simple calculation performed here concerning a case where the reserve shortfall associated with retirement benefits will be eliminated by 1,016 listed companies in about 10 years, an estimate was made to determine the extent of costs that would be required as a proportion of the capital investments made by each company given certain assumptions concerning the yearly growth rate of retirement benefit debts and the investment yields of pension assets. It was observed that about 40% of the companies required costs of less than 10% of capital investment in order to eliminate the reserve shortfall, but, on average for all companies, about 47% of the capital investment outlays was required (Figure 3-3-14). This means that special attention must be given to the possibility that the increase in the retirement benefit burden will hinder capital investment by placing downward pressure on profits.
Figure 3-3-14 Potential costs of elimination of reserve shortfall (relative to capital investment)

 Progress in the reform of company pension plans up to now: (1) Decline of traditional defined benefit plans
    As the full-scale increase in pension recipients upon the retirement of the Dankai generation approaches, there is concern that without a major change in existing retirement benefit plans, a significant impact will be exerted on corporate profits. This impact is particularly worrisome in the case of company pension plans using the traditional defined-benefit scheme, such as employee pension funds and Tax-Qualified Pension Plans, because in these plans the nominal amount of pension benefits is fixed, which means that the risk of increases in retirement benefit costs as investment earnings rise and/or discount rates deteriorate due to a decline in interest rates cannot be eliminated.
    In order to deal with this risk, reform of company pension plans was initiated in 2001, which brought the following principal changes: (i) refund to the government of the portion of employee pension funds managed by companies in place of government was realized, allowing employee pension benefit funds to be converted to a new defined-benefit company pension; (ii) the Tax-Qualified Pension Plans would be abolished and transferred to another system by March 2012; (iii) a new defined-contribution pension system would be established.(53) In addition, the introduction of cash balance plans that can ease the risk of interest rate fluctuations relating to defined-benefit company pensions including employee benefit funds was realized in 2002.
    Responding to these system reforms, companies have implemented reforms of their own retirement benefit plans. Looking at the number of funds and number of agreements of the traditional defined-benefit plans, it is observed that for the Tax-Qualified Pension Plans, to be discontinued from March 2012, both the number of agreements and number of subscribers has declined rapidly. With regard to employee pension funds, moreover, the number of funds and number of subscribers has declined due to refund to the government (Figure 3-3-15). These changes have been accompanied by a decline in the contribution income of employee pension funds in recent years. Although benefit costs are only rising slowly because of the decrease in recipients, these costs will continue on an upward trend reflecting the existence of already promised benefit payments.
Figure 3-3-15 Trend to convert from employee pension funds to the new defined-benefit company pension

Column 6

The Historical Development of Japan's Company Pension System

    Japan's retirement benefit system comprises both retirement allowances and pensions because nearly all company pension plans represent a changeover from retirement allowance plans. Therefore, an understanding of the trend in company pensions requires a close examination of retirement allowances. The retirement benefit system is said to have originated in the Edo era (1603-1868) with a practice called "norenwake" exercised when a user of a shop became independent. This practice was soon modified, and following the Meiji Period (1868-1912), a retirement allowance system was widely adopted as a measure to retain experienced workers. However, with the subsequent sharp increase in the number of retirees and retirement fund amounts, equalizing the retirement allowance payment burden by means of a pension system attracted the interest of company management. Against this backdrop, the Tax-Qualified Pension Plans was established under the tax system in 1962, which clarified the handling of company pensions within the tax system, and provided for such advantages as tax-deferred pension contributions. In 1965, amid the expansion of the government's employee pension system, the employee pension fund system was established, in which companies paid a portion of the government's contribution and which allowed companies to independently set their own added benefits. This portion of employee pension fund contributions paid by the company was advantageous to companies in an era in which fund investment yields were at a higher level than the expected yield of employee pensions.
    For nearly 40 years afterwards, Japan's system of company pensions continued on through the close association between these two systems. However, upon introduction of retirement benefit accounting in the business year ended March 2001 as one reform measure of the accounting Big Bang, Japan reached a major turning point. The introduction of the new accounting system required market value assessments of defined-benefit system debts (retirement benefit debts) and assets, and consequently, in view of the long-term decline in interest rates, companies were strongly in favor of the establishment of a defined-contribution pension system as a means of curbing the risk of increases in retirement benefit debts. As a result, the Defined-Contribution Pension Law and the Defined-Benefit Company Pension Law were put into effect in October 2001 and April 2002 respectively. The former enabled companies to avoid increases in retirement benefit debts while the latter enabled companies to refund the portion of employee pensions they managed in place of the government, which had become disadvantageous to them because of the slump in yields on investment. It was also decided to abolish tax breaks for the Qualified Employee Retirement Pension Plan at the end of March 2012, and then to eliminate the system.

References: Wakariyasui Kigyo Nenkin ("Company Pensions Made Easy") Kazuyuki Kubo, "Basic Data Concerning Company Pensions," Pension Fund Association

 Progress in reform up to now (2): Introduction of new systems
The introduction of new pension plans is proceeding at a rapid pace. The number of "defined-benefit company pensions," which were the depository for employee pension funds after the refund to the government, has increased to 1,142 as of April 2005, and of these, about 60% were transferred from employee pension funds. In addition, the introduction of cash balance plans into defined-benefit company pensions is also expanding, and as of June 1, 2005, about 470 defined-benefit company pensions had introduced these plans. Cash balance plans are a scheme whereby even though a minimum benefit amount of a defined-benefit company pension plan is determined, the pension source fund fluctuates in accordance with movements in economic indicators that serve as the benchmark for market interest rates and the like, which allows the risk of increases in retirement benefit debts due to low interest rates to be controlled.(54) According to the Nikkei Company Pension Status Survey, cash balance plans have received an enthusiastic welcome, introduced by 45% of defined-benefit company pensions and 21% of employee pension funds. Clearly, then, there is strong interest in adopting this system for the purpose of stabilizing retirement benefit debts (Figure 3-3-16).
Figure 3-3-16 Introduction of cash balance plans
In addition, the number of agreements for company-type defined-contribution pensions as of the end of April 2005 had risen to 1,422 while the number of subscribers reached 1.26 million (preliminary figure at end of March 2005), and the number of subscribers to private-type pensions increased to 47,000 (Figure 3-3-17). The most frequent instance of establishing company-type defined-contribution pensions is when pensions are established based on the transfer of assets from to-be-abolished Tax-Qualified Pension Plans, but there are also many instances where a pension is newly established without transfer of assets from other systems. Defined-contribution pensions are sometimes used in combination with other systems, most frequently with employee pension funds, though more than half are not combined with other company pensions. According to the "Nikkei Company Pension Status Survey" mentioned above, company-type defined-contribution pensions are the preferred choice for company pension plans, the main reason being that new retirement benefit debts are no longer generated. From this overview, it is clear that defined-contribution pension plans are being widely introduced to allay concerns about the impact of pension plans on corporate finances.
Figure 3-3-17 Trends in the number of agreements and subscribers to defined-contribution pensions
    As a result of these initiatives by companies, gradual changes begin to appear in companies' balance sheets relating to retirement benefits. In figure 3-3-18, while per-person retirement benefits debts and per-person pension assets at each company could be on the 45 degree line, assuming 100% reserves, comparing these values at the end of FY2001 immediately after introduction of retirement benefit accounting with those at the end of FY2003 shows that in both cases the result falls below the 45o line, with no major change in the status of the reserve ratio, which remained at about 50%. During the past two years, however, the variation in these values contracted and the relation between retirement benefit debts and pension assets has overall moved from the upper right quarter toward the origin. This trend probably reflects initiatives to reform companies' retirement benefits plans such as the refund to the government by employees' pension funds.
Figure 3-3-18 Relationship between per-person retirement benefit debts and pension assets of various companies

 Challenges concerning company pensions
    To take an overall look at trends in retirement benefits systems, costs associated with retirement benefits have been rising due to the aging of the composition of employees and the influence of the existing seniority-based salary system, and there is concern that these costs could cause the labor share to plateau and place downward pressure on corporate profits. Through the introduction of new systems such as defined-contribution pensions, which has been allowed since 2001, and cash balance plans, companies have implemented reform of retirement benefits plans from the perspective of their own personnel and financial policies. On the other hand, retirement benefits plans are a part of companies' management plans and also have a major impact on the state of the household sector in terms of work formats and post-retirement lifestyles. This means that companies' reforms of retirement benefit plans are required not only from the standpoint of reducing costs but also in order to take into account the relationship to retirees and to a broad range of current and future workers whose interests are involved. The following is an elaboration of this idea.
    First, from the viewpoint of post-retirement income, the weight of company pensions in the disposable income of households has up to now risen to about 2% (6% if retirement allowances are included), but remains at a low level compared with the 13.5% figure for public pensions. In addition, unlike in the United States and Germany, the percentage of elderly in Japan who consider private pensions including company pensions as their main source of income is relatively low (Figure 3-3-19). In the future, public pension benefits will surely be reduced to some extent through application of the macroeconomic slide, and as a result, the relative importance of retirement benefits including company pensions will inevitably grow.
Figure 3-3-19 International comparison of main income sources for the living expenses of the elderly
    Second, at a time when workers are being presented with a growing range of options for working, including changing jobs, company pension plans that are neutral to employment formats must be incorporated in order to facilitate portability of pension assets. More portability is required because the traditional retirement allowance is, in a sense, a holding of the employee, and because the size of allowances depends on the number of continuous years of service it is disadvantageous to job-changers. In recent years, this shortcoming of the system has been corrected by introducing the point system and other results-based retirement allowances where the allowance is calculated based on employees' ability, degree of contribution and number of continuous years of service. As before, however, these systems are not neutral with respect to voluntary resignation or job changes. Although, as will be discussed later, some issues remain concerning company pensions, the 2004 pension revision permits the transfer of assets, which hitherto was not possible, when changing jobs, beginning October 2005. This revision should greatly expand portability between company pensions.

 Future challenges in expanding defined-contribution pensions
    Defined-contribution pensions constitute an important option when considering the appropriate direction for the expansion of company pensions. Defined-contribution pension plans shifts to individuals the investment risk hitherto shouldered by companies under defined-benefit pensions. Defined-contribution pensions systems are superior to other systems because retirement benefit debts are not posted to retirement benefits accounts and portability is enhanced as mentioned above, and thus they have advantages for both companies and workers. At present, however, although some progress has been made in the introduction of defined-contribution pensions, only about 2% of employees are covered by these pensions including both the private-type and company-type pensions, which means the system has scope for wider use.(55) The current obstacles to the expanded use of defined-contribution pensions are discussed below.
    First, third-insured persons of national pensions (i.e. full-time housewives) and employees of companies that operate other company pension plans cannot join defined-contribution pension plans. This means that because there are people who, by regulation, cannot contribute to the system, the amount of future benefits provided by the system will be small for people who, for example, have contributed for only a short time and resign to become full-time housewives.
    Second, the receipt of benefits in mid-career when a subscriber resigns is not allowed in principle, but as a result of the 2004 pension revision, the conditions for receipt of lump-sum withdrawal payments will be relaxed in October 2005. In addition, defined-contribution pensions assets are managed on an individual basis for each subscriber and defined-benefit company pension plans and other plans which do not have individually-managed accounts cannot be transferred to other systems.
    Third, the use of the defined-contribution pensions can be expected to grow as a company pension system in the service industry, where inter- and intra-industry transfers of workers are frequent. However, a look at the present status of the introduction of defined-contribution pensions by industry sector indicates that this prediction is not necessarily being translated into reality(56) (Appended Figure 3-30).
    Fourth, there are problems involving the maximum amount of contribution. With defined-contribution pension plans, upper limits are set whose amounts vary depending on particulars such as whether it is a company-type or private-type plan, whether the subscriber is an independent business or an employee, or whether the company has other pension plans. For example, regarding company-type plans, the maximum amount of contribution, which was raised in October 2004,(57) is 23,000 yen monthly (18,000 yen prior to the increase) for companies that have other company pension plans, and 46,000 yen monthly (or 36,000 prior to the increase) for companies that do not have company pensions. Since little time has passed since the system's introduction, the actual contribution per employee in company-type plans is not at such a high level. Nevertheless, most upper limits set by companies are in line with legally-prescribed amounts particularly among comparatively large companies and companies with other company pensions (as of the end of September 2004), which suggest that the potential demand for defined-contribution pensions is high (Figure 3-3-20). An analysis of the distribution of contribution amounts for private-type plans reveals that for second-party insured persons (employees) almost half have set payments near the upper limit. For first-insured persons, nearly 10% contribute near the upper limit, although about 60% pay a low amount of less than 20,000 yen in contrast with the upper limit of 68,000 yen. Based on the principles of companies' freedom in the choice of pension systems under labor-management agreements, and taking into account the future trend in contributions, consideration will be given to a further increase in the upper limits and the introduction of matching systems such as additional contributions by the subscriber for company-type pensions that are not recognized under the current system or additional contributions by the employer for private-type pensions.
Figure 3-3-20 Proportion of agreements for which the upper limit of contribution has reached the maximum amount (company-type defined-contribution pensions)

Column 7

Defined-Contribution Pensions and Household Asset Portfolios

    One of the anticipated benefits of the wider use of defined-contribution pensions is an increase in stocks and other risk assets in the financial asset portfolios of households. In the United States, the introduction of defined-contribution pensions such as 401(k) plans has spurred a rapid increase in stock holdings through these pension systems along with a change in the risk preference of households. To determine whether or not the introduction of defined-contribution pensions from FY2001 has stimulated similar changes in asset portfolios in Japan, households' financial asset holdings ratio as given in fund flow statistics, corrected in terms of the asset composition of pension funds was examined. It was found that at the end of FY2004, the ratio of risk assets, which was only about 13% before correction, reached about 20%, which does not represent a major change from the situation prior to the introduction of defined-contribution pension plans.
    A comparison of the portfolios of Japan and US defined-contribution pensions reveals that, in Japan, the proportion of assets with secured principal is high at 50%, while the weight of risk assets (investment trust type) was low. This pattern is attributable to the fact that the lower the understanding of investors regarding the characteristics of the financial product, the higher the weight of principal-secured type investments. In addition, these investors are hesitant about varying the distribution of assets. It has also been pointed out that in the US, the portfolio choices of subscribers to 401(k) plans are not based on rational decisions. With defined-contribution pensions, the asset investment is not performed by companies but by individuals at their own discretion, and under the Defined-Contribution Pensions Law, companies are required to provide education concerning the particulars of the system and the scheme and characteristics of financial products. Another important priority for promoting (confident and intelligent) asset investment is expanding investment techniques to include practical investment methods, risk preferences and approaches to formulating a lifetime investment plan.

Column Figure 6 Corrected Portfolio from the Standpoint of Fund Flow
Column Figure 7 Defined-Contribution Pensions Portfolios in Japan and the United States

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