What are the Issues Surrounding Hollowing Out of Industry?

Fellow, RIETI

Recently, concerns over the hollowing out of industry in Japan have rapidly intensified. It is not only that domestic production capacity is falling following a transfer of production operations overseas, but also that a grave trend continues with Japan's R&D capacity also continuing to move overseas.

The first time the issue of hollowing out of industry was discussed in Japan was at the end of the 1980s. Given such factors as the rapid appreciation of the yen after the Plaza Accord in 1985, Japan's manufacturing industries' production base swiftly transferred overseas. For this reason, domestic employment decreased and concerns arose that technology levels could take a downward turn, leading to the first discussion of the issue of hollowing out. Since that time although for a period the issue was laid to rest to a certain degree, since the appreciation of the yen beginning in 1993, debate on hollowing out has reintensified (c.f. "What is the Hollowing Out Phenomenon?" in which I analyze and identify the debate that took place in the early 1990s).

In addition, given the emergence of the Chinese economy, and the continuing transfer of production bases overseas, debate has now resurfaced concerning the hollowing out of industry. Given these facts, what can be identified as the nature and root causes of the issue of hollowing out? This paper attempts to provide some clarification on this issue and to offer a prescription for change.

What is the Issue of the Hollowing Out of Industry?

When summarizing the various debates that have taken place to date concerning the hollowing out of industry, we find such discussions as the influence the transfer of manufacturing production bases overseas have on domestic employment and technology levels; discussions on hollowing out leading to only the survival of the service industry in Japan and therefore the fundamental weakening of the Japanese economy; and discussions on the fact that with the transfer overseas of production bases for high-value added products and the continued move out of Japan of R&D bases, industries which traditionally have formed the fundamental pivot for economic growth in Japan could be lost to the overseas markets. At the same time discussions and opinions are also current that such changes are part of the process of Japan's structural reforms and it is unavoidable that such reforms will be accompanied by a degree of pain; and also the opinion that companies, from the point of view of comparative advantage, have made an appropriate allocation of resources and that should the above mentioned negative situation occur it is a phenomenon that cannot be helped.

The reason that companies transfer their production bases overseas is grounded in the quest to maximize profits, based on comparative advantage and there is a possibility that avoiding such a practice would depress the nation's economic welfare still further. However, in cases where these domestic production bases themselves have externality from the domestic economy, should these bases be transferred oversea, it is plausible that the whole country's economic welfare would take a turn for the worse. The crux of the issue of the hollowing out of the manufacturing industry is in the divergence between individual corporate benefit and the broader social benefit.

Is the Hollowing out of Industry a Problem?

The questions therefore arises, in what situations does divergence between individual corporate benefit and social benefit occur? For example, the technical revolution that has taken place in Japan's production bases has, through technical chains and technical spill-over, had significant social benefit in that it has brought about technical revolution in other industries and helped in the development of new industries. As a result of businesses seeking their own individual corporate benefits in transferring production bases overseas, the possibility increase of a divergence in the benefit of individual corporations and the social benefit. However, as we look at this current phenomenon, production bases are being transferred to such countries as the People's Republic of China. In fact, certainly in stark contrast to previous practices, it is no longer only low-value added products that are being produced, but also high value-added products such as digital cameras and DVD players. The focus of mass produced articles is unchanged and there are also many cases where advanced technologies are maintained, through component imports from Japan and technology transfers. At the same time, there are also examples of not only production, but also research and development bases being transferred overseas. This, however, has only been from the perspective of aiming to meet the needs of regions overseas and for the development of products that are attuned to the characteristics of the regional market, where research and development bases have been created using superlative researchers and experts in the given region, through rather than purely replacing Japan's own research bases, instead complementing them. In addition, even though it may be the case that Japanese corporations have lost their competitive advantage and that almost all mass-produced items are now made overseas, efforts are still being made to ensure that at least one "mother factory" remains in Japan as a production base. In this way, in an attempt to be able to respond to the loss of production know-how that is accompanied by the closure of production bases, and in the event that in the future changes in market and technological circumstances result in the reopening of domestic production, corporations are independently undertaking these activities in order to avoid this so-called path dependence. In addition, corporations are making efforts to regain their competitive advantage by producing high value-added goods. When considering the situation as detailed above as a whole, it would therefore appear that the issue of divergence of individual corporate benefit and social benefit is not such a significant issue.

Of course, the transfer of production bases overseas brings with it the specter of employment problems domestically, which would negatively impact on the social benefit. In particular, in regional Japan, given the fact that a large gap exists between the labor market and the kinds of jobs available, it is also more than likely that social costs will rise somewhat. However, to this end, in Japan which claims to maintain a free market structure, activities to maximize profits based on corporate comparative advantage cannot be limited. It is the responsibility of the government to create a minimum safety net to respond to this situation.

What is the Prescription for the Hollowing Out of Industry?

When considering the important perspective of a prescription for the hollowing out of industry, we are faced with the question of to what extent the government should extend its reach. In the past when such kinds of economic issues arose, regardless of whether something could be done or not, the government would always, to some degree, move towards considering a prescription. Currently, in contrast to the period of economic immaturity, Japan is now in the midst of a mature, liberal economy. Moreover, in the past there was a good deal of asymmetry in the information that was passed between the public and private sectors, a situation which has now changed, with the public sector now lacking the knowledge and experience to initiate policies. In addition, the limitations of fiscal policy have become apparent and the scope of policies that can now be implemented by the government is limited. In other words, the role of government is changing with the times and is becoming more limited. Bearing this above situation in mind, the government should now consider a prescription that is within its own means. On this occasion, the government should, above all, strictly eschew a response that would obstruct corporate activities and the progress of globalization. Just as the baseball players Ichiro and Sasaki have come to play an important role in the major leagues in the United States, is it not now time for us to show pride in Japanese corporations for their activities and successes overseas? Given the fact that the hollowing out phenomenon being witnessed in Japan should be regarded as a part of globalization of Japanese corporations, is the real issue at hand that of Japanese corporations taking responsibility for their actions in free economic activities?

Corporations are changing with the times and becoming increasingly globalized, and despite the hollowing out of industry those who are responding have always politicians, be it in government, the Diet or local governments. These entities cannot of course transfer themselves overseas. They must change with the times. What they must do now is to undertake the creation of an appealing business and investment environment that attracts business to Japan.

January 15, 2002

January 15, 2002

Article(s) by this author