COVID-19 Prompts Supply Chain Reform

Growing concerns about the risks inherent in supply chains dependent on China have been exacerbated by the COVID-19 coronavirus outbreak. Measures included in Japan’s supplementary budget for FY2020 address these concerns.

Prime Minister Abe holds the 36th Council on Investments for the Future, at which reform of Japan’s supply chains was high on the agenda, March 5, 2020. CABINET PUBLIC RELATIONS OFFICE

Toilet bowls locally manufactured in China have not reached Japan as ordered, delaying the delivery of new homes that are otherwise almost completed. This unusual situation is occurring due to the COVID-19 coronavirus. Homebuyers are being forced to postpone their relocation and are struggling with unexpected expenses. Homebuilders are facing a difficult time looking for replacements in Japan and will face financing risks if the delivery of toilet bowls from China is delayed further. This is because many Japanese manufacturers have shifted production overseas, to places like China, and rely on purchases from local suppliers, namely imports. However, it is impossible to restore production lines in Japan in the short term. This issue is not just limited to toilet bowls.

According to the results of a survey conducted by a private institution on COVID-19 (survey period: March 2–8, 2020), 25.4% of the small- and medium-sized enterprises (SMEs) who responded are experiencing difficulties in purchasing from overseas suppliers.

Under these circumstances, on March 5, 2020, Prime Minister Abe Shinzo held the 36th Council on Investments for the Future at the Prime Minister’s Office. 

Discussions were held on supply chains, tourism and related matters, cashless transactions, productivity increases in SMEs and the environment and energy. Based on the discussion, the Prime Minister said with regard to supply chain policy, “There are some concerns over the impacts of the decline in product supply from China to Japan on our supply chains. In light of that, as for those products with high added-value and for which we are highly dependent on a single country, we intend to relocate the production bases to Japan. Regarding products that do not fall into this category, we aim to avoid relying on a single country and diversify production bases across a number of countries, including those of the Association of Southeast Asian Nations (ASEAN).”

In this connection, the Minister of Economy, Trade and Industry Kajiyama Hiroshi established a council with manufacturers in the automotive sector, and has been encouraging prompt information sharing on the impact to supply chains from the COVID-19 pandemic. The Minister replied to a question regarding cases where the supply of products to Japan is heavily dependent on a single country by saying that he would like to encourage in the future a return to domestic production with respect to high added-value goods and the diversification of production bases across ASEAN. Moreover, Finance Minister Aso Taro commented that the restructuring and rebuilding of supply chains and investment in new fields are significant challenges in strengthening the industrial structure to ensure that it is also resilient in the face of overseas risks.

Noting the impact on the automobile industry, the Japan Automobile Manufacturers Association, Inc. expressed anxiety and concern, for instance with respect to changes in regulations imposed by different provinces of China in each case, difficulties in obtaining information about various regulations, precautions, etc., an uncertain timetable for the full return of Chinese component suppliers and the impact on domestic and overseas production caused by the delay in shipments of parts from China.

Measures Agreed: Domestic Investment and Diversification of Supply

In a recent meeting of the Council on Investments for the Future, discussions concerning the reform of supply chains in connection with the spread of COVID-19 were dominated by the need to return to production at domestic production bases for high added-value products with a high dependence on supply from single countries, and the need to diversify production bases to ASEAN and other areas for other products that are important for the Japanese economy and are highly dependent on supply from single countries. At the same time, support for not only domestic SMEs with an eye to their cash flow situations but also overseas subsidiaries that are affected by production halts, etc. was also discussed.

Reflecting these discussions, the supplementary budget for FY2020 (expenses related to Emergency Economic Package against COVID-19) was determined by the Cabinet on April 7, 2020 (updated on April 20) and came into force on April 30. In this budget, a “subsidy to promote domestic investment for support of supply chain” [¥220.0 billion] and “supporting diversification of global supply chain” [¥23.5 billion] were laid out in order to “develop a resilient economic structure.”

As it has become evident with the spread of COVID-19 that supply chains for Japanese companies are weakening, the purpose of the first measure is to provide support to new facility introduction and similar moves. This will be used for the development of domestic production bases for products, components and materials, which have hitherto been highly dependent on limited numbers of production bases, or for products, components and materials that are important for the health and wellbeing of Japanese citizens. The purpose of the second measure is to provide support to facility introduction, experimental business projects, and investigations for the feasibility of business operations. This will be used to strengthen supply chains through the development of multiple overseas production bases for products, components and materials.

ASEAN and China: Rethinking the International Division of Labor

Japan is an island nation with scarce resources.

Since the opening of the country in 1854, processing trade has kept Japan, as a resource-poor country, alive through the times. In 1968, Japan became the second largest economy in the world. During the era of trade friction between Japan and the United States, which reached peak intensity in the 1980s, the United States urged Japan to increase domestic demand and open up its market. As a result of negotiations and following the implementation of a number of measures, the trade friction subsided. These measures included the removal of quantitative restrictions on import volumes, such as imports of beef and oranges, and the expansion of local production by Japanese manufacturers at newly built factories in the United States. 

On the other hand, since the late 1980s, Japan has been proceeding with direct investment, mainly in East Asia. This has prompted a division of labor between processes in the East Asian region and the development of regional production networks, progress in which increased significantly following the global financial crisis triggered by the subprime mortgage crisis in 2007. Eventually, East Asia exceeded the levels of the Americas and Europe to become the world’s largest production base. The trade value within the East Asian region, which was approximately 100 billion dollars in 1984, peaked in 2012 at 2,400 billion dollars, and was still approximately 2,200 billion dollars in 2016.

Japanese manufacturers have enhanced their competitive edge, having positioned ASEAN countries as important production bases, while at the same time they have contributed greatly to the industrialization and industry accumulation of ASEAN. This was one of the factors that contributed to the so-called “East Asia Miracle,” or the economic development of East Asia from the 1980s. Naturally, the major contributing factors were the rapid rise of China, which together with Southeast Asian countries made rapid progress in advancing market-oriented economic reforms, and the adoption and promotion of external opening-up and internal economic liberalization policies by these countries.   

Subsequently, with China joining the WTO in December 2001, the transfer of production bases from ASEAN countries to China was accelerated. Japan has maintained its economic strength by responding to growth in the Chinese market and other East Asian economies, even after it was replaced by China in 2010 as the second-largest economy in the world.

However, there have been a series of incidents between the two countries, such as the Senkaku boat collision in 2010, which were triggered by the Senkaku Islands dispute in 2012, which led to the introduction of restrictions on exports of rare earths by China, violent anti-Japan demonstrations and acts of sabotage against factories and distributors of Japanese affiliated companies, as well as the detention of civilians and university professors for reasons unexplained. In addition to these incidents, there has been a growing tendency among the Japanese companies who had made forays into China to turn their eyes back to ASEAN countries, spurred by China’s own legal regulations, rising wages and various other factors. 

The COVID-19 outbreak occurred amid these circumstances. According to the result of an online survey conducted by a private institution during the period between February 7 and 16, 2020, the most popular answers about concerns for the future in the wake of the COVID-19 outbreak were “slowdown in consumption and economic stagnation in China” (51%) and “impacts on supply chains” (37%). To the question of how to deal with the situation in the future, the number of respondents who chose the answer of “strengthening procurement from companies located in countries other than China” was the largest (37%). This gave one last push to Prime Minister Abe to make the aforementioned statement at the meeting of the Council on Investments for the Future and the subsequent inclusion in the budget of the supply chain support.

Exports as a percentage of Japan’s GDP, or export dependency, is not high, but free trade is unmistakably the lifeline of the Japanese economy.

Although some argue that the supply chain reform is a hasty decoupling to unravel ties between Japan and China out of fear of COVID-19, in fact “decoupling” is an impossible option. Efforts to stabilize production by dispersing production bases cannot cut off global supply chains that have been developed within the global economy. In the same manner as each of the old IBM’s personal computers and the present-day iPhone of Apple is one complete unit consisting of parts “Made in Asia,” the world exists based on an international division of labor.

MIZUNO Tetsu is a freelance writer.

This article first appeared in the May/June 2020 issue of the Japan Journal.

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