Media  Global Economy  2021.01.21

Why Japanese firms are not withdrawing from China despite the spread of COVID-19 ーThey are even repurposing government subsidies for corporate flights to expand their China business

The article was originally posted on JBpress on December 18, 2020

A stir caused by the Japanese government’s program to subsidize firms that bring their production bases back to Japan

In April 2020, the Japanese government announced a subsidy program aimed at helping Japanese firms to transfer their overseas production bases back home or geographically diversify them through relocation to other regions, including the Association of Southeast Asian Nations (ASEAN). The program is part of an emergency economic package that was formulated in response to the spread of COVID-19.

In budgetary terms, the program appropriated 220 billion yen for return-home subsidies and 23.5 billion yen for geographical diversification subsidies.

Applications were sought in two rounds: late June and late July of 2020. A total of more than 1,700 businesses applied for the program. The total applications for the second round represented more than ten times the planned subsidy amount of 160 billion yen.

These figures attracted extensive media attention in Japan. This prompted many to suspect that a lot of Japanese businesses were planning to pull out of the Chinese market or reduce their operations there.

The media coverage caused quite a stir.

Immediately after the program was announced in April, Chinese economists both within and outside of the government, as well as Chinese media outlets, expressed concern that many Japanese firms would transfer their production bases in China to Japan and ASEAN. I was asked repeatedly if that was the case.

Those who paid close attention to where Japanese firms are heading were not limited to Chinese organizations. Questions also came from Europe and North America.

Just recently, in the on-line lectures I gave and the interviews I had in Japan, China and the US, I was asked the same question: Are Japanese firms aiming to withdraw from the Chinese market because of the subsidy program?

The negligible effect on Japanese firms’ investment activities

Prompted by this deluge of questions, I took every opportunity to seek expert and on-the-ground input about recent trends and the future prospects of Japanese firms’ investments in China since April up until quite recently. I asked experts well-versed in this field as well as the managers of Japanese firms doing business in China.

I concluded from their answers that the subsidy program had little, if any, impact on Japanese firms’ attitude toward investing in China.

The investment sentiment among Japanese firms was best described by executives at Japanese mega-banks who have an accurate overall picture of Japanese firms’ investment activities in China. Executives at two banks were almost unanimous in their views.

“There are practically no Japanese firms that have changed their stance on investing in China,” they said.

This conclusion is substantiated by two facts.

First, only a relatively small number of businesses applied for the program.

It is estimated that some 33,000 Japanese firms are doing business in China. Of this total, the 1,700-somethng firms that applied for the program accounted for only five-plus percent.

The percentage closely corresponds to the findings of the annual questionnaire survey of Japanese firms doing business in China that was conducted by the Japan External Trade Organization (JETRO). In the 2017, 2018, and 2019 surveys, 7.4 percent, 6.6 percent, and 6.3 percent, respectively, of such firms answered that they were planning to reduce their operations in the country, transfer them elsewhere, or pull them out.

From this statistical data, it is easy to understand that the number of applicants roughly matches the number of those that were rather reluctant to China business in the first place.

The second fact concerns what the applicants intend to use the subsidy program for.

According to the above-mentioned Japanese mega-bank executives and corporate managers, Japanese firms applied for the program more for business restructuring aimed at rolling out business in China and less for reducing or withdrawing their operations in the country.

Market competition is fierce in China. Local Chinese enterprises are improving their technological capabilities at astonishing speed in some sectors.

To compete with local Chinese enterprises, Western companies generally adopt a discount sales strategy that might entail less profitability. This often results in a rapid and significant drop in market prices of products.

Under these circumstances, some Japanese firms might find it difficult to improve their profitability going forward in some of the sectors that they have tapped into in China. In that case, they have no choice but to reduce their operations there or pull them out altogether as far as such sectors are concerned.

Such reduction or withdrawal does not mean, however, that these Japanese firms have become reluctant to make investments in China. They are just adjusting their strategic business domains to better meet market needs.

It is a common practice for them to reduce or stop their operations in some of the sectors in which they have already been engaged and start or expand their operations in other sectors.

The reality is that many of these firms took advantage of the subsidy program aimed at supporting the return of production bases back to Japan as convenient leverage for such business restructuring.

This usage, which deviates from the original intention of the government, may facilitate Japanese firms’ business restructuring with regard to their strategy of investing in China and help them increase their investment there.

Japanese firms aggressively doing business in China are all blue-chip companies that stand out from the pack in terms of global competitiveness.

The successful expansion of these firms’ business in China would increase their corporate profits and their parts procurement from Japan. This in turn would help push up capital investment, employment, and tax revenues in Japan.

This would salvage the pandemic-hit Japanese economy. Still, a small budget means that the subsidy program will have only a limited impact.

How the world’s leading companies evaluate the Chinese market

In April 2020, Greg Gilligan, chairman of the American Chamber of Commerce in China (AmCham China) told the English-language newspaper China Daily that AmCham China’s latest surveys showed that China remains a “top long-term priority for most US companies, despite slowing growth, wider US-China tensions, long-standing business challenges in the country and the COVID-19 outbreak.”

This view, collectively expressed by US companies, has remained unchanged, according to an executive at a Japanese firm who interviewed a high-ranking official at AmCham later that year.

And this view represents a common understanding among the leading companies competing in the global market, including those based in Europe and Japan.

With this common understanding, the world’s top companies are flocking to China. Only top-notch companies that have survived such fierce competition are continuing their business in China.

It was after 2010 – a year preceded by the financial crisis of 2008 – that the middle-income class in China began to increase remarkably on the back of the steep rise in the national income level and that the allure of the Chinese domestic market came to be appreciated in the world.

Over the past ten years, uncompetitive companies have reduced their operations in China or withdrawn from the Chinese market altogether. The survivors are only companies that boast global competitiveness and assume a significant market share in the countries they are based in.

Most companies with mediocre competitiveness at home are unlikely to survive in the Chinese market.

How best to approach the Chinese market going forward

For globally competitive companies, China is an attractive market that may entail huge profits.

In the situation made severe by the spread of COVID-19 in 2020, the Chinese economy is expected to register a positive growth for the year. No other economic power in the world could emulate China in this regard.

China’s real GDP (gross domestic product) for the most recent October-December quarter will likely bounce back to around six percent, close to the level recorded in the pre-pandemic year of 2019.

The growth rate is projected to reach eight percent for 2021 as it will rebound to post a steep rise for the first half of the year from a year earlier.

Immediately after the 2008 global financial crisis, China implemented the strategy of boosting domestic demand. Economists highly evaluated the strategy, saying that it helped prevent the global economy from plummeting. The fallout lingered, however. China struggled to dispose of bad debts resulting from the strategy for several years.

Learning from the bitter experience, the Chinese government is trying to avoid repeating the same mistake in the latest phase of economic recovery following the steep downturn. Specifically, the government is reining in investment in real estate development and infrastructure construction.

Still, the eight-percent growth for 2021 will generate an additional demand that corresponds to the level that would have been possible if the Chinese economy had grown 24 percent back in 2010. The Chinese economy today is about three times larger than the 2010 level.

The huge demand will have a significant impact on the global economy.

China’s economy will likely sustain a growth rate of five-point-something percent in the first half of the 2020s. Such constant expansion of the already gigantic market is a major allure of the Chinese market.

In this context, an executive at a Japanese large automaker said to me: “When sales increase, people feel happy about working. Both technology and people grow as a result. That in turn boosts people’s morale even further and provides energy for them to take on new goals. ”

“Their mindset changes. That is the power of sheer numbers. This is why leading companies in the world are injecting their resources into the Chinese market. They thus aim to move onto the next level as a corporate entity.”

His comment succinctly explains why the world’s top companies focus on China despite a number of negative factors cited by critics, including the US-China row, the pandemic, and growing anti-China sentiment in Western countries.

The recent thaw between Japan and China provides a golden opportunity for Japanese firms to expand their business in China.

This represents an excellent opportunity for firms that are confident in their competitiveness to venture into the Chinese market for further progress. Hopefully, that will bolster up the post-pandemic recovery of the Japanese economy.