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Author: Yasuyuki Todo, Waseda University

Global supply chains are being reorganised as Western countries attempt to decouple from the Chinese economy and firms are increasingly aware of the risks of supply chain disruption after COVID-19-related lockdowns. Many countries have implemented policies to support the restructuring of global supply chains and Japan is no exception.

In 2019, the Japanese government strengthened export controls on military and dual-use products and technologies, following the US lead. Japan also provided subsidies to firms that onshore high-risk digital, green and health-related products. That move attracted a frontier Taiwanese semiconductor producer, TSMC, to Japan drawing subsidies of up to US$4.5 million.

In May 2022, Japan enacted an economic security law. It aimed to construct resilient supply chains of ‘critical products’ by providing financial support to producers of these products and asking them to provide reports about their procurement and production.

One major goal of these policies is to reduce Japan’s reliance on China and construct more resilient and secure supply chains. The Japanese economy appears a little closer to achieving this goal. China’s share of imports of parts to Japan declined from 29.5 per cent in 2015 to 26.1 per cent in 2021. The corresponding share for Australia increased from 23.5 per cent to 29.8 per cent.

But despite the stricter export controls of high-tech products, exports from Japan to China did not decline. Total exports from Japan to China increased from US$132.8 billion in 2017 to US$163.9 billion in 2021. Even exports of semiconductor-related products from Japan to China have shown an increasing trend for the past four years.

Diversifying supply chain partners across countries can increase resilience to foreign shocks due to natural disasters and the COVID-19 pandemic. Ignoring national security concerns, alleviating the heavy reliance on China is favourable for economic resilience. China’s share of Japan’s imports of parts, 26.1 per cent, is still high compared to 2005 (21.8 per cent) and to the United States (14.2 per cent). So there may be room for further reduction in Japan’s reliance on Chinese inputs.

It is not clear, however, whether the recent reduction in Japan’s reliance on China in intermediate imports was largely due to the current restrictionist policies. The reduction had already started in 2015, a few years before the policies were implemented.

The current policies raise several concerns. Onshoring does not necessarily promote supply chain resilience because Japan bears a substantial risk of natural disasters, including mega earthquakes and the expected eruption of Mt. Fuji that could hit major industrial regions in the near future. Enforced onshoring may also distort the allocation of production activities across countries and lead to economic inefficiency.

To promote supply chain resilience, policies should aim to diversify partners across countries, rather than just onshore within Japan. Government policy, introduced in 2020, also provides subsidies to Japanese firms that reshore production plants to ASEAN states to reduce their concentration in a particular country. More traditional policies have also provided information about foreign markets and supported business matching for export activities and overseas investment by Japanese firms. These policies should be expanded.

Attracting foreign high-tech plants such as TSMC using subsidies may not be cost effective, though similar industrial policies exist in the United States and Europe. In Japan, past subsidies that were intended to attract high-tech plants to backward regions of Japan were found unsuccessful because the subsidies only attracted plants with low productivity. Similarly, attracting foreign semiconductor plants to Japan may result in subsidies for non-frontier plants that cannot facilitate the development of local high-tech industries.

One way to mitigate this problem is to attract foreign direct investment (FDI) which engages in research and development (R&D) activities in Japan. FDI with local R&D activities is found to be associated with technology spill overs to local firms. TSMC has set up an R&D centre in Tsukuba, Japan, which is also subsidised by the Japanese government. Policies should promote FDI with local R&D activities more than the onshoring of production facilities to stimulate innovation. This kind of innovation will strengthen the market power of Japanese firms in global supply chains, leading to greater robustness and resilience.

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

Policies should limit export controls to target products that are truly critical to national security. ‘Essential products’ in Japan’s recent economic security law should be carefully defined based on rules transparent to the private sector and international communities.

Yasuyuki Todo is a Professor at the Faculty of Political Science and Economics, Waseda University.

The post Japan’s post-COVID-19 approach to supply chains first appeared on News JU.

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