Japan is paying firms to make things at home. But China's pull is strong

Until July, the Japanese household goods company Iris Ohyama had always made its line of masks at its two factories in China.

But early this year, as the coronavirus was spreading around the world, the Japanese authorities approached the company with an urgent problem. In China, the government had locked down factories that produce most of the planet’s masks and commandeered supplies. With global demand soaring, stocks in Japan were dangerously low.

Could Iris Ohyama start production at home?

Nearly $23 million in government subsidies later, the company is at the leading edge of a push to encourage Japan’s manufacturers to diversify their supply chains out of China.

The pandemic — and Beijing’s increasingly combative behavior during it — has driven home the risks of overreliance on China for the production of a broad range of goods. Japanese policymakers, long wary of Beijing’s economic overreach, are powering up incentives for firms to expand manufacturing at home and in other countries after years of stop-and-go efforts.

Manufacturers are lining up for the subsidies, which are intended to protect important industries and to ensure access to crucial supplies during crises. But the government’s challenge is vast: It is as though Japan is tossing pennies to hold back economic tides.

The allure of China remains hard to resist for companies dependent on its enormous market, cheap but well-trained labor and efficient infrastructure. When the Trump administration tried to overcome these advantages by raising tariffs on Chinese products, few if any American companies moved production home.

It’s not just the United States. Japan’s own growth has been fueled by a booming China. Chinese factories have scooped up Japanese machine tools, high-tech components and know-how. And Chinese tourists eager to spend their newfound prosperity have flooded Japanese stores, hotels and restaurants, adding to Japan’s wealth.

While the United States has responded to its own concerns about China with an increasingly hard-line policy, the idea of an economic “decoupling” is a nonstarter for Japanese policymakers and companies alike.

For Tokyo, “it’s more about how you manage the risk of that relationship than whether you can orchestrate an economic divorce of sorts,” said Mireya Solís, co-director of the Center for East Asia Policy Studies at the Brookings Institution in Washington.

Japan, the world’s third-largest economy after the United States and China, is seeking to manage that risk not just by paying companies to move production, but also through diplomatic channels, including recent discussions with India and Australia about improving the resilience of regional supply chains as a hedge against China’s dominance.

The efforts have steered clear of the grandstanding and finger-pointing coming out of Washington. Instead, Japanese policymakers have sought to placate Beijing by insisting that their efforts are not aimed at any particular country.

Still, that facade has become increasingly difficult to maintain amid growing concerns about Chinese government-sponsored corporate espionage, the use of Chinese components in key infrastructure, China’s crackdown in Hong Kong and the increasing tensions between Washington and Beijing, including a trade war that has battered Japanese exports.

China’s more belligerent regional military presence has not helped matters, either. Increased patrols by Chinese forces near Taiwan and around islands contested by Tokyo and Beijing have drawn rebukes from the United States and have made it harder to keep economic and geopolitical concerns separate.

“In one sense, the Japanese government tried to expand the room for business cooperation with China, but as the most important ally of the U.S. in the Asia-Pacific, Japan must follow American strategic trends,” said Masayuki Masuda, a senior fellow at Japan’s National Institute for Defense Studies.

That means “trying to keep a balance between China and the U.S.,” he said. “If we restrict normal business activities with China, the damage would be very big. So, where is the red line?”

Even Japanese businesses seem more willing than ever to push that line. According to a July survey of 3,000 businesspeople by the economic newspaper Nikkei Shimbun and the Japan Center for Economic Research, more than 46 percent of respondents said that Japanese companies should do less business with China. About 18 percent said the opposite.

“Public and political sentiment in Japan has been turning against China for years, and I think that’s an entirely organic process,” said Kristin Vekasi, an assistant professor of political science at the University of Maine who has studied how Japan has managed economic risk toward China.

Japan has rolled out a number of measures, to mixed success, in an effort to blunt Beijing’s reach.

The country has put strict limits on foreign participation in government procurement projects, throttled foreign investment in publicly traded domestic companies and set up a cabinet-level division tasked with monitoring threats to the country’s economic security.

Japan also tightened rules requiring foreign entities to seek government permission before investing in publicly listed companies that touch on national security, lowering the threshold to 1 percent from 10 percent of a company’s shares.

Conservative Japanese politicians in the governing party believe the measures aimed at China have not gone nearly far enough. Legislative study groups in Japan’s Parliament are considering restrictions on foreign investment in real estate and on Chinese apps like TikTok.

Still, even some of the most vocal advocates are cautious about calling out Beijing by name.

In a recent interview, Akira Amari, a member of Parliament and former trade minister who leads a legislative group on economic security, said that the measures under consideration were not aimed at any one nation, but were intended to reduce economic security risks across the board.

Even so, Mr. Amari allowed that concerns about China had been a major factor in shaping the policies, citing actions in the United States, Britain and India as informing Japan’s thinking. Those countries have expressed security fears over issues like TikTok and Chinese companies’ role in building out 5G networks.

Japan tried having a more open economic relationship with China, and it didn’t work, Mr. Amari said. If China “had the same values as Japan,” he added, “we would have taken a completely different response.”

The repercussions may be less than feared — at least for now. With Washington and Beijing locked in a great-powers struggle, China may need Japan as much as Japan needs it.

“China and the U.S. have been involved in a hegemonic war, so China needs a friend,” said Shujiro Urata, a professor of economics at Waseda University in Tokyo.

“Japan cannot be that friendly to China, the Chinese know that, but they don’t want to jeopardize their relationship with Japan,” he added.

For Japanese businesses, the feeling is mutual. Despite growing concerns about doing business in China, the economic incentives to stay remain too great.

In an interview at Iris Ohyama’s headquarters in Miyagi Prefecture, the company’s president, Akihiro Ohyama, was up front about the fact that opening new domestic production lines wouldn’t have made economic sense without the government’s help.

The company, which sells more than 25,000 products including televisions and microwaveable rice, had already begun opening factories outside China years ago, seeking to reduce shipping costs and to appeal to consumers who wanted domestically manufactured goods. But it had never considered making masks in Japan.

“The government subsidies were a major factor,” Mr. Ohyama said.

Since Iris Ohyama became the first company to accept Japan’s new subsidy offer, more than 1,600 companies have applied for the $2.3 billion that the government earmarked for the program. The vast majority is set aside for increasing domestic production. So far, 56 other firms have received funds for increasing production at home, and an additional 30 have received subsidies for factories in Southeast Asian countries such as Vietnam, the Philippines and Thailand.

On a recent visit to a former snack factory that Iris Ohyama converted to make masks, employees in white scrubs and blue caps quietly tended to rows of machines as they assembled and packaged the goods.

Mr. Ohyama said he had been worried about how the Chinese government would react to a scene like this.

He needn’t have been concerned. The officials weren’t angry; they were nervous that the company planned to leave. In reality, Iris Ohyama plans to deepen its presence in China, where its sales have been growing by more than 30 percent a year.

“We’re expanding in China,” Mr. Ohyama said. But “we’re going to be manufacturing in other countries, too.”