Hi-Stat Vox No. 11(November 16, 2008)

The Legal Arrangements for Economic Dismissals in Japan: Considerations and Implications

Ryo Kambayashi

Associate Professor, Institute of Economic Research, Hitotsubashi University

Photo : Yukinobu Kitamura

The current global economic crisis has given rise to renewed debate in Japan about the country’s employment system, including laws and practices governing the dismissal of regular employees. In particular, concerns have been expressed whether this system provides too much protection for regular workers and shifts the burden disproportionately onto the young. In fact, many wonder whether the current situation represents a return to the so-called “ice age” of the 1990s when many young job-seekers were frozen out of the labor market. Although the drop in production now seems to have come to a halt, this does not mean that the labor market has turned the corner. According to the Labour Force Survey by the Ministry of Internal Affairs and Communications, the number of unemployed persons in August 2009 stood at 3.61 million (for a non-adjusted unemployment rate of 5.5 percent), close to the postwar peak of 3.85 million (5.8 percent) registered in April 2003. Moreover, the deterioration in the employment situation has indeed particularly affected the young, i.e., those up to their mid-20s. Looking at the unemployment rate by age group in the July 2009 Labour Force Survey, the year-on-year increase in the unemployment rate, at 2.4 percentage points, was greatest for those aged from 15 to 24. Thus, the concerns mentioned earlier are not unfounded.1

An important issue in this context is whether regulations concerning the dismissal of regular employees are responsible for aggravating the job situation for the young. As is well known, a large part of legal regulations concerning dismissals are governed by the Doctrine of Abusive Dismissal and, as a derivative thereof, the Doctrine of Economic Dismissal.2 These Doctrines have become established since the 1970s on the basis of the principle of case law, and especially the Doctrine of Economic Dismissals, with its Four Evaluation Criteria, has been viewed – and presented in labor law textbooks – as imposing strong constraints on economic dismissals. For example, the Four Evaluation Criteria are often interpreted to imply that there are strict requirements to be met before regular employees can be dismissed and that the employer must make wide-ranging efforts to avoid dismissals, such as relocating personnel or ending the employment contracts of non-regular employees, and so on. Based on this stereotypical view, there are many who argue that the result of the Doctrine of Economic Dismissal is that firms have to employ an excessive number of low-productivity middle-aged and older regular employees.

However, this interpretation seems too simplistic when we carefully examine the Tokyo High Court decision on the Toyo Sanso case, which is the leading case with regard to the Doctrine of Economic Dismissal.3 Referred to without fail in textbooks on labor law as the most important judicial precedent, the case was notable because the court ruled that dismissals for economic reasons had to meet certain conditions. Nevertheless, the High Court found that the dismissal of the plaintiffs was valid and the ruling as such does not prevent economic dismissals. The case covered a wide range of issues, including whether a company should give priority to relocating personnel affected by the closure of a factory over the re-hiring on a part-time basis of employees that have reached the mandatory retirement age; the ruling concluded that there was no reason to give such priority. The ruling also negated the requirement to call for voluntary retirement from divisions other than the one being closed before dismissing employees.

Regardless of the employer’s overall victory in the original case, however, the dispute itself ended in a settlement five years after the High Court ruling with the condition that half, that is 6 of the 12 plaintiffs (excluding one plaintiff who had reached retirement age during this period) were reinstated into their jobs. Why has this judicial precedent, which neither denies the right of economic dismissal nor provided a resolution of the actual dispute, been considered an important ruling regulating dismissals? This question is addressed in a book titled The Law and Economics of Dismissal Regulations (in Japanese; published by Nihon-Hyoron-sha Co. in March 2008) that I edited.

Here, I would like to present my own personal view of some of the results of that collaborative study. To begin with, when examining the 54 cases of economic dismissal during the 1970s and 1980s, we found that they display a strong sense of antagonism over unfair labor practices. Especially on the side of labor, it is likely there coexisted parties with different political convictions, and a major reason for disputes was that dismissals were interpreted as being for the purpose of getting rid of specific groups of workers. Moreover, having interviewed several of the companies that were involved in court cases at the time, we found that although all of them implemented economic dismissals in the 2000s, this did not give rise to any disputes. However, the reason is not that the knowledge and experience related to those court cases were directly handed down within their personnel departments. Rather, the reason is that these companies improved the sharing of information between management and labor, explaining the situation of the company on a routine basis, and agreed on the importance of obtaining the understanding of employees. Moreover, while in the court decisions in the 1970s and early 1980s, judges treated the Four Evaluation Criteria as more or less equally important, more recently they have put greater emphasis on ensuring that the correct procedures were followed in lay-offs, and especially that strict criteria were followed in the choice of which employees were to be laid off, thus ensuring that individuals affected by economic dismissals were not selected arbitrarily. Our study therefore concluded that, since the 1980s, as a result of this corporatism involving management and labor, internal political confrontation within labor groups has disappeared, and companies, through the advance sharing of information on their business circumstances with workers, have created an environment in which they can easily gain employees’ understanding should dismissals become necessary. The actual legal doctrine in Japan with regard to economic dismissals thus can be said to have nudged firms in a direction that promotes consent between labor and management so as to avoid that dismissals, should be they become necessary, are perceived as arbitrary.

If we interpret the role of judicial precedent in this way, then it probably cannot be said that the Doctrine of Economic Dismissal imposes prohibitively high costs on firms for dismissal for business reasons. In practice, the number of workers that have lost their job due to corporate restructuring during and after the second half of the 1990s – the “ice age” for job seekers – is quite substantial. For example, according to the Survey on Employment Trends of the Ministry of Health, Labour and Welfare, in 2001, the number of regular workers “dismissed for business reasons such as downsizing and rationalization” (including those that applied for voluntary retirement) exceeded 500,000 persons. This is a substantial number considering that the number of job separations because of the expiry of fixed-term contracts was in the range of 700,000 and the number of graduate job seekers in the range of 300,000.

What is extremely interesting is that in contrast with the increase in the number of persons laid off, the ratio of dismissals that resulted in litigation decreased. This is illustrated in the figure below, which depicts the annual number of dismissal lawsuits filed in district courts per 10,000 people laid off taken from the above-mentioned Survey on Employment Trends. (It should be noted, though, that the official statistics used here did not allow a distinction between normal and economic dismissals or taking into account the number of interventions or the duplication of temporary injunctions and lawsuits.)

Source: Adapted and revised from R. Kambayashi (ed.), The Laws and Economics of Dismissal Regulations, Figures 6-10.
Note: The number of dismissals is calculated from the Ministry of Health, Labour and Welfare’s Survey on Employment Trends as the sum of job separations due to a “fault of the employee” and job separations due to “business reasons,” excluding “transfers” and “returns from transfers.”

Looking at the figure, the first thing it shows is that until the mid-1990s, there is a strong positive correlation between the ratio of dismissal lawsuits and the unemployment rate. Generally, for workers that have been laid off, the opportunity cost of lodging a lawsuit declines in times of recession. The positive correlation therefore shows that economic rationale is one aspect of dismissal litigation in that bringing a lawsuit is associated with costs and benefits. The second feature is that from the second half of the 1990s onward, the dismissal litigation ratio tends to follow a downward trend. Of course, at first glance, it appears as though from 2001 onward, there is a strong reversal in this trend. In fact, however, the sudden jump reflects the introduction of free-of-charge “general labor consultation corners” by prefectural labor bureaus in October 2001. If we set the number of cases recognized at such labor consultations as warranting the opinion of and discussion with a specialist third party, we find that the ratio of cases in which differences between employers and employees could not be overcome and ended in a lawsuit steadily declined. Considering that in recent years the ratio of cases in which workers have won in dismissal lawsuits has been around 50 percent, that regional differences in litigation behavior, which were substantial in the 1980s, have been disappearing, and the favorable beginning of the recently introduced industrial tribunal system, it seems fair to say that in the period from the latter half of the 1990s onward, the Doctrine of Abusive Dismissal and, by extension, the Doctrine of Economic Dismissal, has provided a stable judicial norm.

The above considerations suggest that in recent years a modus vivendi has established itself in Japan’s labor market in which employers undertake layoffs based on the legal regulations that check against arbitrary dismissals, and workers, as a result of this, do not raise great objections. While this is only personal speculation based on limited empirical evidence, I would conjecture that this modus vivendi, in turn, probably reflects complementary choices in many different areas such as the technologies and organizational forms that firms choose, workers’ skill formation, national regulations such as tax rules, and norms regarding the family, that make up the “Japanese employment system.” And although the Japanese employment system has been around for a long time and increasingly looks out of date in the current era of globalization, looking only at the trend in dismissal disputes, it appears to remain essentially intact. Given that Japanese employment practices value firm-specific experience and little use is made of the external labor market, and taking, moreover, into account that among the young the supply of university graduates has grown rapidly, then the fact that the brunt of the current deterioration in the labor market is borne by the young is not merely the result of legal regulations, but of the various complementarily reinforcing components of Japan’s employment system.

At this point, it is useful to briefly recall some of the characteristics of Japan’s employment system. First, the formation of norms mainly came about through the courts which made conflict resolution between the parties the top principle; second, Japan’s employment system respects the autonomy of management and labor and came to place trust in the discovery of norms through micro consensus building at the workplace and within firms. These norms that were formed and discovered are very likely to be rational in their context and have the characteristic that they reinforce the Japanese employment system. On the other hand, it can also be argued that this way of norm formation may have led to an ex ante selection of stakeholders so that they could reach agreement easily.

It is often readily asserted that what distinguishes regular and non-regular employees is their social status. As the discussion here has shown, Japan’s labor law has played an important role in shaping such a distinction through the emphasis it has placed on the autonomous formation of norms by the parties concerned (i.e., management and regular employees). This arrangement has given rise to a form of corporatism where the parties concerned consist of relatively homogenous agents with a common interest in upholding such norms. That is, by dividing workers into regular employees (insiders) and others (outsiders), management and labor have established norms that foster mutual trust and as such, dismissal practices in Japan are a typical and rational example of the construction of norms that facilitate the adjustment of labor input with little conflict.

However, as the experience of recent years shows, it is becoming increasingly important to create more effective mechanisms to deal with more diverse and sometimes conflicting interests. While arguments – in the media, for example – are often couched in terms of a simple dichotomy between the young on the one hand and middle-aged and older workers on the other, or between regular and non-regular employees, in practice, those belonging to the same age group or falling under the same employment status these days no longer necessarily share common values and interests. Therefore, what is really needed is a debate on the way norms in the labor market and at the workplace are formed, on the parties involved in the formation of these norms, and on the consensus principle.

1. On the other hand, in August 2009, the year-on-year increase in the employment rate for the young, at 1.4 percentage points, was rather low when compared with other age brackets.
2. These legal regulations concerning dismissals have been codified since 2008.
3. The case was brought by employees who sought a temporary injunction against a notice of dismissal that in line with work regulations cited “unavoidable business circumstances.”