Introduction

In recent years, the escalating confrontation between the U.S. and China has prompted Western nations and Japan to implement policies reducing economic ties with China. These measures include export controls on advanced technologies like semiconductors and restrictions on inward and outward direct investment. Governments are increasingly concerned about supply chain disruptions for essential goods such as electronics and pharmaceuticals. In Japan, a 2022 Cabinet Decision stated that the government must not rely excessively on market forces regarding economic security and should be more involved through public supports and regulations. This led to the Economic Security Promotion Act, which provides subsidies to private companies in exchange for reports on the procurement and inventory of critical products.

Supply chain resilience

Theoretical research suggests that market equilibrium in supply chains is often not socially optimal. Models such as those by Acemoglu and Tahbaz-Salehi (2024) indicate that creating supply chain relationships is costly and specific, leading to productivity gains that are not fully internalised by individual firms. Consequently, supply chain ties are constructed at sub-optimal levels. Furthermore, Grossman et al. (2023b) argue that firms underinvest in resilience because they do not consider the social returns of their investment. This vulnerability is exacerbated by the difficulty private firms face in predicting security-induced shocks compared to natural disasters. Policy support is therefore justified for governments to collect and disclose information on security risks to the private sector to bridge the gap between market equilibrium and social optimum.

Empirical studies stimulated by the 2011 Great East Japan Earthquake (GEJE) and the COVID-19 pandemic confirm that economic shocks propagate significantly through supply chains. For instance, research by Inoue and Todo (2019) estimated that production loss caused by the GEJE through supply chain disruptions was about 100 times larger than the direct production loss in affected areas. However, data indicates that diversifying and internationalising transaction partners can mitigate these impacts. Ando and Hayakawa (2021) found that sourcing intermediate goods from diverse countries helped build resilience during the pandemic. Simulations suggest that if 80% of imports from China were disrupted for two months, Japan’s value-added production (GDP) would decrease by approximately 40%.

Dealing with economic coercion

Economic coercion involves a country using economic means to pressure others and influence policy decisions. Recent examples include China’s 2010 ban on rare earth exports to Japan and the 2023 ban on Japanese seafood imports following the release of treated water from the Fukushima plant. Analysis shows that China targets products where the partner is highly dependent but often limits the scope to items with relatively small trade values to minimise self-inflicted damage. For example, during the 2023 seafood ban, Japan’s dependence on China for scallop exports was 56%, while China’s dependence on Japan for its scallop imports was 97.4%. To curb coercion, it is recommended that countries diversify trade partners and strive to become indispensable partners in terms of technology and size, rather than just market share.

Industrial policy

To strengthen supply chains, many countries are implementing industrial policies to bring production back to the domestic economy. Theoretical findings suggest these can be effective if an industry has economies of scale and the government can foster it to a size that enables international competitiveness. A prominent example is the Japanese government’s decision to lure a TSMC production plant to Kumamoto with a subsidy of 476 billion yen in 2022. This policy leverages the existing industrial cluster in the Kyushu region, making it more likely to succeed than previous regional development policies like Technopolis, which failed by attempting to attract high-tech firms to areas lacking such clusters.

Another major initiative is the support for Rapidus, which aims to manufacture next-generation 2nm semiconductors, receiving a subsidy of about 1 trillion yen until FY2024. While Rapidus faces the disadvantage of being located in Hokkaido, where there is no existing industrial agglomeration, it may succeed through international research collaboration with entities like the National Semiconductor Technology Center (NSTC) in the US and IMEC in Belgium. It is recommended that the government promotes face-to-face joint research by facilitating long-term stays for foreign researchers in Japan, as remote collaboration is less likely to generate breakthrough innovations.

Conclusion

Economic security necessitates a shift in how governments and firms approach supply chain resilience and industrial policy. The research highlights that while diversification and internationalisation are essential for resilience against shocks and coercion, targeted industrial policies can also be effective. To maximise effectiveness, these policies should build upon existing industrial clusters and foster deep industry-university-government collaborations. Governments must also play a more active role in collecting and disclosing national security risk information to ensure that private sector decisions align more closely with the social optimum.