Japanese industries are now seriously pursuing the intricate task of relocating their factories and supply chains from China for various reasons. In fact, the Japanese government has set aside $2 billion as incentives for companies shifting production back to Japan, and another $0.22 billion for those seeking to move production to other countries. After Japan and China normalised diplomatic relations and signed the Japan-China Peace and Friendship Treaty in 1978, Japan heavily assisted China for a full two decades (1979-2000). By 1998, Japan was the largest donor country and accounted for over 60 percent of all bilateral aid provided to China.

Of the $267.3 billion in foreign investment that poured into China during the crucial period of 1979-98, Japan’s share was over 8 percent, second to Hong Kong’s 52 percent. Japanese investment was particularly concentrated in Dalian, China’s Liaoning Province owing to its historical presence there before the Second World War. Besides utilising cheap labour to produce goods for its domestic and export markets, Japanese investment improved human resources capacities, inducted newer technology, induced higher productivity, and added to domestic capital formation.

Japan solidly supported Chinese integration into the world economy. A large number of Japanese companies had been gradually located in China, a major constituent of Factory Asia and provided superior Japanese equipment, systems and technologies. According to a 1995 MITI survey, 29 percent of Japanese production in China was exported back to Japan. China’s share in global net foreign direct investment flows steadily increased from 1.6 percent in the 1980s to 5.1 percent in the 2000s, and its share of regional value-added increased from around 15 percent in the mid-1990s to 35 percent in the mid-2000s.

Why the exodus

The factors triggering relocation are attributed to acute United States-China trade disputes thereby making Chinese goods face high tariff walls. From July to September 2018, the US government imposed three rounds of new tariffs on Chinese imports of over 6,840 items covering $250 billion worth of goods. Shrinking domestic demand and increasing labour costs in China increasingly stood critical. The average factory worker in China earns $27.50 per day, compared to $8.60 in Indonesia and $6.70 in Vietnam. Against the ageing population of China, the median age in other relatively low-income countries of the Association of Southeast Asian Nations is much lower than the global 29.7 years. The attractive demographics of manufacturing powerhouses in other parts of Asia, including infrastructure, communications, market access, skilled workforce, legal and tax regimes, cost-effectiveness and economies of scale, have facilitated this ongoing industry migration.

The massive supply chain disruptions witnessed during the Covid-19 lockdown, a clampdown on political freedom and human rights, heavily tilted support to the North Korean regime and the festering Senkaku Islands dispute in the East China Sea with Japan are other non-economic issues that triggered these relocations. However, within China also there has been domestic relocation by prolific coastal manufacturers to the inland provinces to take advantage of lower costs and policy concessions. This phenomenon of internal industrial transfers actually started in the early 2000s.

This 'decoupling' and unwinding of US-China economic ties has already facilitated the likely full or partial exit of a range of global companies from China that primarily focused on US-bound production. These include Apple, HP, Dell, Microsoft, Google, Amazon, Sony, Nintendo, Lenovo, Acer and Asus. A Nikkei survey showed that more than 50 global companies have already shifted or are considering shifting production from China.

Attractive Vietnam

Vietnam, which is poised to record the highest growth of urban population of 3.5 percent during the period 2018-25, is emerging as the most attractive destination and has become an attractive regional logistics hub for global consumer companies. It is now an export-driven economy with high-profile corporations like Samsung alone contributing 25 percent of its total exports in 2018. A Nomura analysis found that between April 2018 and August 2019, only three companies out of the 56 Japanese companies that relocated their production base were relocated to India whereas Vietnam attracted 26, Taiwan 11 and Thailand eight.

A recent JLL Research Report stated that Vietnam, Malaysia and Thailand shared a major portion of the foreign direct investment into the manufacturing sectors in Southeast Asia. It doubled over the last eight years to reach $46 billion in 2018. In the first four months of 2019, exports to the US from Thailand and Vietnam recorded a 25-30 percent year-on-year increase, potentially suggesting they could be the main recipients of relocation of production out of China. It also found that wages in these countries are now about 60 percent lower than in China, compared to 33 percent in 2010. Southeast Asia has a large consumer market due to rising urbanisation, middle-income population and e-commerce adoption.

In this continuum of the first industrial migration of this century witnessed after the financial crisis of 2008, India could be a major attraction. It has distinct advantages in terms of sweeping reforms, liberal and much cheaper labour, well codified legal regimes, improving land acquisition legal regimes and environmental regulations, and a huge domestic market spread over the whole of South Asia. Some of the federal states are in a competitive mode to attract foreign direct investment. However, there are serious constraints too including incomplete supply chains, lowly competitive exporting capability, and dismal ease of doing business and inadequate infrastructure. The strong possibility of a spillover of ongoing India-China border skirmishes could trigger a large number of Chinese companies to quit their production base in India. In such a situation, the most crucial new entrants will be Japanese enterprises coming out of China.

Eastern South Asia consisting of Bangladesh, Bhutan, Nepal and the north-eastern region of India—where Japan has been a crucial development player—provides pertinent, congenial, fertile and cost-effective socioeconomic bastions and flourishing markets. They are backed by the availability of raw materials, relatively lower wages, and an ample supply of skilled manpower and also a vast English-speaking youth population with innovative and organic entrepreneurial knowledge and skills. The relocation will induce cross-border movement of factors of production, and will bring technological knowledge, capital, and other business resources. The absence of political will and sub-regional consensus in all likelihood will avert this prolific opportunity once again.