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Economy

Japan Inc.'s shift to domestic production interrupted by strong yen

Automation offers one answer as companies face higher costs at home

Japanese companies expect to produce a higher percentage of goods at home five years from now.   © Reuters

TOKYO -- Corporate Japan is at a crossroads over domestic production as exchange rates, labor costs, automation and consumer tastes pull companies in opposing directions.

Japanese manufacturers had been steadily moving production of appliances and everyday goods back to Japan over the past few years, but the appreciation of the yen is making domestic production relatively more expensive.

"We have no plan to increase domestic production," said a manager at a Japanese daily goods maker that produces most of its goods in China, citing the gap between production costs at home and those in other countries.

The average cost of production in 20 Asia-Pacific economies last year was 78.6% that of Japan, compared with 80.6% in 2015 and 74% in 2012, a study from Mitsubishi UFJ Morgan Stanley Securities shows.

Foreign exchange rates are a driving factor. The yen was stronger than 80 per dollar in 2012 but began to weaken after the Bank of Japan rolled out its monetary easing policy the next year. The yen softened to around 125 per dollar in June 2015, raising Japanese companies' export competitiveness and the cost of reverse imports from overseas subsidiaries.

Higher labor costs throughout Asia have also pushed Japanese companies to repatriate production. JVC Kenwood partially moved production of its car navigation systems for Japanese vehicles to Nagano Prefecture from Indonesia and China at the end of 2015. Japan's manufacturing ranks returned to the 10 million mark in fiscal 2017 thanks to similar moves by other companies.

But the business environment began to change around 2016 as the yen gradually gained strength amid China's economic slowdown and Britain's decision to leave the European Union. This year, the yen appreciated as far as 104 per dollar in March, compared with about 112 at the start of 2018.

Rising domestic labor costs also factor into executives' decisions to bring production home. Japanese wages in 2018 are set to rise at the fastest pace in 20 years. Higher wages are essential for economic recovery, but it will be difficult to bring more manufacturing home if doing so erodes profitability.

Companies are once again starting to look overseas for production. The Ministry of Economy, Trade and Industry said that reverse import sales by Japanese companies' foreign subsidiaries totaled $27 billion in the October-December quarter, the highest level since $28.2 billion in the July-September quarter of 2011, a few months after the Great East Japan Earthquake devastated the domestic supply chain and strengthened the yen. The tally had not exceeded $25 billion for the most part since 2015.

"The cost difference with Asia will expand further should the yen continue to gain strength," said Hiroshi Miyazaki of Mitsubishi UFJ Morgan Stanley Securities. "Companies may scale back investment in domestic production as factory utilization rates fall."

But automation through innovations like artificial intelligence may reverse the trend once again. Casio Computer is automating a Yamagata Prefecture factory that turns out $20 wristwatches, a move that will allow a domestic manufacturing operation to remain competitive in a low-price area. Production costs will be on a par with Thailand, which is a quarter as expensive as Japan.

A January survey by Japan's Cabinet Office showed that listed companies plan to produce 25% of their goods abroad in five years, the highest level since 26.2% in January 2015.

Another factor keeping production at home has been the high number of visitors to Japan. Almost 30 million tourists came to the country in fiscal 2017. Cosmetics maker Shiseido recently decided to build its first domestic factory in 36 years as foreign interest in made-in-Japan goods grows. Some Japanese companies have decided to boost domestic production in response to popularity abroad.

The yen's strength also appears to be waning for now. "Labors costs are growing in Asia. The current exchange rate will not cause companies to move more production abroad," said Hitoshi Sasaki of the Japan Center for Economic Research. "Domestic productivity can rise further if production lines are improved."

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