Japan’s post-COVID-19 approach to supply chains

Author: Yasuyuki Todo, Waseda University

Global supply chains are being reorganized as Western countries attempt to decouple from the Chinese economy and businesses become increasingly aware of the risks of supply chain disruption following COVID-19 shutdowns. COVID-19. Many countries have policies in place to support the restructuring of global supply chains and Japan is no exception.

In 2019, the Japanese government tightened export controls on military and dual-use products and technologies, similar to the United States. Japan has also provided subsidies to companies that buy high-risk digital, green and health-related products. The move lured a Taiwanese border semiconductor producer, TSMC, to Japan with subsidies of up to US$4.5 million.

In May 2022, Japan enacted an Economic Security Law. It aimed to build resilient supply chains of “critical products” by providing financial support to producers of these products and asking them to provide reports on their purchases and production.

One of the main goals of these policies is to reduce Japan’s dependence on China and build more resilient and secure supply chains. The Japanese economy seems a little closer to achieving this goal. China’s share of parts imports to Japan has increased from 29.5% in 2015 to 26.1% in 2021. Australia’s corresponding share has increased from 23.5% to 29.8%.

But despite tighter controls on exports of high-tech products, Japan’s exports to China have not declined. Japan’s total exports to China increased from US$132.8 billion in 2017 to US$163.9 billion in 2021. Even Japan’s semiconductor-related product exports to China showed a trend increasing over the past four years.

Diversifying supply chain partners across countries can increase resilience to foreign shocks from natural disasters and the COVID-19 pandemic. Ignoring national security concerns, easing heavy reliance on China is conducive to economic resilience. China’s share of parts imports from Japan, 26.1%, is still high compared to 2005 (21.8%) and the United States (14.2%). It might therefore be possible to further reduce Japan’s dependence on Chinese inputs.

It is unclear, however, whether Japan’s recent reduction in dependence on China for intermediate imports was largely due to current restrictive policies. The reduction had already started in 2015, a few years before the policies were implemented.

Current policies raise several concerns. Offshoring does not necessarily promote supply chain resilience, as Japan is at substantial risk of natural disasters, including mega-earthquakes and the expected eruption of Mount Fuji that could hit major industrial regions in the near future. Forced relocation can also distort the distribution of production activities between countries and lead to economic inefficiency.

To promote supply chain resilience, policies should aim to diversify partners across countries, rather than just focusing on Japanese territory. The government policy, introduced in 2020, also provides subsidies to Japanese companies that relocate production plants to ASEAN states to reduce their concentration in a particular country. More traditional policies have also provided information on overseas markets and supported business matchmaking for export business and overseas investment by Japanese companies. These policies should be extended.

Attracting foreign high-tech factories such as TSMC using subsidies may not be cost effective, although similar industrial policies exist in the United States and Europe. In Japan, past subsidies that aimed to attract high-tech factories to backward areas of Japan proved unsuccessful because the subsidies only attracted low-productivity factories. Similarly, attracting foreign semiconductor factories to Japan may result in subsidies for non-border factories that cannot facilitate the development of local high-tech industries.

One way to alleviate this problem is to attract foreign direct investment (FDI) that engages in research and development (R&D) activities in Japan. FDI with local R&D activities are associated with technological spillovers on local businesses. TSMC has set up an R&D center in Tsukuba, Japan, which is also subsidized by the Japanese government. Policies should promote FDI with local R&D activities rather than the relocation of production facilities to stimulate innovation. This type of innovation will strengthen the market power of Japanese companies in global supply chains, leading to greater robustness and resilience.

Although Japan must reduce its dependence on China in its supply chains, a complete decoupling of the Chinese economy is costly and unnecessary. Even the United States has maintained or expanded its trade with China while reducing trade in highly sensitive products. Policies should try to minimize the net cost of reducing Japan’s reliance on China in trade.

Policies should limit export controls to targeted products that are genuinely essential to national security. “Essential Commodities” in the recent Japanese Economic Security Law should be carefully defined based on transparent rules for the private sector and international communities.

Yasuyuki Todo is a professor in the Faculty of Political Science and Economics at Waseda University.