Going back to the past won’t help Japan Inc. protect supply chain

by Teruhiko Mano

The joint declaration adopted Oct. 15 by the Group of 20 finance ministers and central bankers expressed a willingness to take resolute action to deal with the serious downside risks being faced by the global economy. But Japan, beset by the damage caused by the March 11 earthquake, tsunami and nuclear crisis, has posted three consecutive quarters of negative growth since October 2010.

Three consecutive GDP contractions would normally qualify as a recession for most economists, but given the extraordinary factors raised by the calamity, Japan has not officially been declared “in recession.” In fact, the industrial output index for March fell as sharply as 15.5 percent from February but has since swung upward.

The three Tohoku prefectures hit hardest by the natural disasters — Miyagi, Iwate and Fukushima — account for a mere 4 percent of Japan’s industrial production. Still, the massive damage to the industrial infrastructure of the region disrupted the supply chain of the manufacturing sector as a whole, resulting in the 15 percent plunge in March.

It has been reported that the disaster-hit areas exclusively produced more than 500 types of parts and components for Japan Inc. The sudden halt in production of these components severely disrupted output at plants not only in Japan, but also worldwide.

The more concentrated that product, parts and materials manufacturing becomes, the higher the merit scale will be in industrial production. Transportation times and costs will increase in proportion to the distance between producers and users. Toyota Motor Corp.’s world-famous “kanban” just-in-time production system was in fact designed to minimize just such a loss.

On the other hand, there is an ongoing effort to diversify the nation’s production activities to minimize the risk of supply chain disruptions. This has become one of the major challenges of postdisaster reconstruction, along with tsunami-debris disposal (estimated at over 22 million tons), Fukushima fallout decontamination, tsunami defense and nuclear power plant reinforcement.

But this also means that greater efforts to restore Japan to its predisaster state will only fail to lead to reconstruction. Do we need to review the lessons learned from the 1995 Great Hanshin Earthquake?

Production of low-value-added goods had been replaced by imports from Southeast Asia by the time the factories reopened.

And Kobe was the world’s sixth-largest port in terms of container cargo volume before the quake hit. After lagging its competitors in deepening waterways to accommodate larger container vessels, Kobe today stands at around No. 40.

In the meantime, Asian rivals like Busan in South Korea and Kaohsiung in Taiwan have modernized their port infrastructure.

As globalization continues and international competition intensifies, it is essential for Japanese firms to strike the optimum balance between concentrated production and diversified production.

Of course, individual companies are primarily responsible for minimizing the risk to their supply chains. But the government also has a vital role to play, given that uncertainties over the nation’s power supply and the relatively high cost of land and labor are threatening to accelerate industry’s shift to overseas production.

This is because the effective tax burden on businesses and the political risks caused by changes in security and other noneconomic factors are the major points companies weigh as decide where to base their operations.

The discussions on Japan’s participation in the Trans-Pacific Partnership Agreement — which have been on hold since the catastrophe — are not simply an issue of free trade, but a good opportunity to review the question of supply chain vulnerability.

Teruhiko Mano is an international economic analyst.