The jury is still out regarding the Abe government’s decision to allocate 243.5 billion yen (about $2.25 billion) from its stimulus package to help Japanese firms move manufacturing supply chains out of China. Why do it when the world is suffering a pandemic-induced shutdown affecting all major economies? Will decoupling supply chains from China work? And why put at risk the diplomatic rapprochement with China that has been occurring since 2019?
There are still few details at this early stage, and we will not know for some time whether the Japanese policy will be a wise or counterproductive one. But the intent and timing might well prove inspired.
To be sure, the American success in repatriating supply chains from China has been modest. The 2017 reduction in corporate tax rates, meant to encourage American multinationals to bring home offshore accumulated profits, led to about $500 billion entering the country in 2018 alone. However, much of it was used for stock buy-backs and increased dividend payouts rather than investing in new supply chains within the country.
Indeed, it seems that international firms have long baked-in considerations of the political, institutional, legal, and regulatory risks associated with the Chinese political economy, which are offset by short-term rewards. Even at the height of U.S.-China economic tensions, global foreign direct investment into China continued to increase by around 3 percent annually which is for the previous five years. In late 2019, a in China revealed that 87 percent had not relocated supply chains away from China and had no immediate plans to do so.
The reasons to stay in China are not difficult to understand. It is often mandatory to invest in Chinese-based supply chains to seek access to its large and growing domestic market. According to one recent more than three-quarters of U.S. firms say they are doing better or as well in China compared to overall operations globally.
Won’t the same dynamic constrain Japanese firms? One can make the case that the Abe government’s policy and timing might be more successful and serendipitous.
First, geography suits Japan better than it does the United States. East Asia has emerged as the leading integrated zone for manufactured goods in the world. This is most noticeable in the computer/electronics/electrical sectors, which accounts for up to half of the total value of exports for Japan, South Korea, and the ASEAN economies. It is more feasible for a Japanese firm to move some supply chains out of China and back to Japan (or to Southeast Asia) than it is for a U.S. firm to move operations to the United States. In moving more supply chains out of China, Japanese firms can still tap into the beneficial manufacturing clusters in the region in a way that U.S.-based firms cannot.
Furthermore, the rapid technological progress in manufacturing-related technologies such as robotics, automation, artificial intelligence, and 3D printing – all technologies in which Japanese firms have invested heavily – reduce the need and cost of labor inputs and even shrinks the size of land required for manufacturing. This suits Japan’s skilled but shrinking population and limited availability of land on which to base operations. Indeed, Japan ranks in the world for robot density — a measure of robots per 10,000 workers — behind South Korea, Singapore, and Germany. Japanese firms can easily invest far more in advanced manufacturing capabilities.
Bear in mind that China can still force Japanese and other firms to base operations in the former to serve the Chinese market. But diversification away from China, if not decoupling, is still conceivable for Japanese companies.
Second, and with respect to timing, the pandemic has severely disrupted regional and global supply chains. Combined with a slowdown in demand, which removes the urgency to produce at full capacity, now is an opportune time to reassess and reorganize supply chain operations.
Third, the political environment is also right for the Abe government to contemplate such supply chain shifts. The post-COVID-19 world will be rife with fury and recriminations, especially in the United States against China. Japan will always have an economic foot in China. But Japanese firms reliant on Chinese supply chains might find themselves the target of U.S. economic sanctions and restrictions. Better to hedge by diversifying before that occurs.
Furthermore, China already has its hands full managing its tensions with the United States and these tensions will deepen when we are past the worst of COVID-19. Beijing will hardly have the bandwidth to focus on Japanese attempts to economically distance itself from China.
Abe has made some bold strategic and economic gambles since he assumed the prime minister’s post for the second time in 2012. Evidenced by his longevity and emergence as a leading statesperson from the region, most of these have paid off. This latest move has a fighting chance of proving as successful.
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