More Trouble for Japan

The earthquake and tsunami that struck Japan on March 11 could wreak a long-term transformation of the supply chain of family-owned small and medium-sized businesses that supply the country’s multinationals.

Some Japanese industry officials are forecasting that many SMEs are considering following their multinational counterparts overseas, particularly into China and Southeast Asia. Although it is questionable how many companies would actually move, since most are family operations with 50 to 100 employees, the possibility that they would has become a disturbing topic in Japan.

“The hollowing out of Japanese industry was launched since 15 years ago,” a Japanese electronics industry source told Asia Sentinel. “The earthquake was one of the triggers for Japanese companies to invest overseas. I expect more companies will go out of Japan in the next three years.”

Driven partly by a steeply rising yen, now at ¥77.54:US$1 and partly by what appears to be a long-term energy shortage sparked by the closure of Japan’s nuclear plants, some SMEs are making plans to follow the multinationals that they once supplied domestically. In addition to the strong yen and energy shortages, other challenges to Japanese industry include high corporate taxes, onerous labor regulations, delays in formulating free-trade agreements with other countries and Japan’s commitment to greenhouse gas reduction, industry officials say,

Some 44 of Japan/s 54 nuclear plants remain closed, either by damage or for maintenance. The electricity supply has been cut by 25 percent. The country’s new Prime Minister, Yoshihiko Noda, said on Sept. 2 that it is “unrealistic” to build any new reactors in the wake of the crisis or to extend those at the end of their life spans.

It thus appears that in a country with no natural resources, Japan’s industrial plant is going to have to make do with a permanent reduction in energy. That leaves the country’s tens of thousands of small companies forced to look for alternatives. With their own domestic markets shrinking, those alternatives may well be found overseas, according to officials at a Hong Kong-Japan economic summit, which was co-sponsored by the Hong Kong Trade Development Council on Sept. 2.

The first big wave of overseas investment out of Japan began in 1985 after the signing of the Plaza Accord. The governments of the United States, Japan, France, West Germany and the United Kingdom combined to drive down the value of the US dollar against the yen by 51 percent between 1985 and 1987. A wave of departures began from Japan by some of the country’s biggest multinationals, particularly to Southeast Asia, which at the time was mired in the 1985-1986 economic downturn.

As a result, Japanese investment in the rest of Asia surged so dramatically that it came to be known as the East Asian Miracle, according to Understanding Foreign Direct Investment in East Asia, a June, 2011 research paper written by Willem Thorbeck and Nimesh Salike for the Asian Development Bank Institute, as “Japanese firms lost their price competitiveness and responded by shifting labor-intensive assembly operations to other Asian countries.”

Today, according to Yukio Tada, president of Sojitz Research Institute Ltd of Tokyo in an interview, two thirds of Japan’s current account – the flow of current transactions including goods, services and interest payments between countries – comes from the net foreign assets of Japanese companies overseas. If the production shift offshore extends down to the companies that provide the ancillary parts as a result of the current crisis, it presents questions whether Japanese industry is hollowing out.

Daniel Shao, managing director of the Van Yu Group of Companies in Hong Kong, said he has been working to assist SMEs seeking to move to China, mainly Dalian in Liaoning Province.

“I don’t expect it to be a dramatic migration,” Shao said. “But maybe in phases they will come out, encouraged by the big manufacturers for supply chain security.”

In particular, Shao said, his company has been working with local Japanese chambers of commerce to identify companies wishing to set up operations in China. So far, he said, they include software companies, medical supply companies and others. Van Yu, he said, so far has assisted eight companies in considering relocating to Dalian. During a recent trip to Japan to assess the damage from the earthquake, Shao said, he was told 4,000 companies in the Otaka area in Northern Japan were wrecked. Although their factories are up and running again, many are considering a move, he said.

“There is a desire to diversify various industries to other countries,” Shao said. He and others believe Hong Kong is positioned to benefit from the phenomenon because of its role as the major gateway to China. Hong Kong businessmen, Shao says, know China and have the tools to avoid pitfalls that have entrapped far too many unsuspecting businessmen from other countries.

Given the territory’s familiarity and cultural affinity with China, Shao said, Hong Kong can act as coordinator between Japanese and Chinese SMES, particularly working through the Closer Economic Partnership Arrangement (CEPA) between Hong Kong and China, which grants preferential treatment for trade in goods and services to Hong Kong companies.

Japanese companies, partnering with Hong Kong ones, could thus avail themselves of the territory’s special relationship with China, Shao said.