Thinking About Offshore Outsourcing After 3/11

Faculty Fellow, RIETI

One often hears reports that in the aftermath of the Great East Japan Earthquake Japanese companies had trouble in ascertaining and repairing damage because their component procurement and supply webs, or their so-called supply chains, have become so global and complex. In this column I would like to consider this problem, with reference to offshore outsourcing research.

Cross-border outsourcing

Japan has long been proud of the high standards of its manufacturing, but in recent years against a backdrop of an appreciating yen and the development of neighboring nations, the competitiveness of the Japanese manufacturing industry can no longer survive without East Asia. Large Japanese corporations have traditionally outsourced their work to domestic suppliers, but nowadays the recipients of these orders are increasingly overseas companies. The increase in outsourcing is partly due to less of a burden on management compared with foreign direct investment, which involves overseas subsidiaries. According to research on Japanese manufacturers conducted by the Research Institute of Economy, Trade and Industry (RIETI), the number of firms conducting offshore outsourcing is increasing at a considerable rate (Note 1).

In recent years, transnational transactions have been burgeoning not only in intermediate goods, such as components and materials, but in service tasks as well. Even in manufacturing companies, a wide range of service activities including accounting and data processing have been traditionally performed internally. In the case of Japanese companies, it was once considered that the Japanese language functioned as an obstacle or breakwater to make offshore outsourcing of services difficult. But there are recent reports of cases in Japan where, for example, the electronic input of hand-written Japanese documents is being outsourced to China over the Internet (Note 2). If, following on from the collapse of the lifetime employment and seniority-based remuneration system, typical in-house work such as personnel and administration becomes the subject of fully-fledged outsourcing in the future, this will surely deal another blow to the traditional and quintessentially Japanese nature of companies in Japan.

Disaster, supply chains, and open inter-firm networks

The March 31 edition of the Economist, a British magazine, carried an article titled Broken Link, in which it was clearly pointed out that tracing the impact of the Earthquake on companies through supply chains was as difficult as estimating the impact of the Lehman Shock on financial institutions through sophisticated financial products, and indeed, corporate transaction networks are intertwined in a global and highly complex manner. According to the aforementioned RIETI research, the proportion of large and medium-sized Japanese firms directly outsourcing overseas is no more than around one in five, but there is no doubt that substantially more Japanese firms are indirectly linked to offshore outsourcing firms as a part of their supply chains.

Is it possible to jump to the conclusion that the troubled recovery of supply chains following the disaster was due to the fact that the chains extended around the globe or--with the disaster as a breaking point--that a hollowing-out would rapidly snowball? New offshore procurement sources do not necessarily replace domestic factories of the past, and will probably open up new manufacturing possibilities using strengths unique to overseas nations. On the other hand, differences in labor costs between Japan and other developing nations, most notably, China, are already shrinking greatly. Furthermore, the companies that are outsourcing may be thrown into confusion by legal systems and customs different from their home country. The RIETI research also confirms that when Japanese firms decide on their offshore outsourcing, they are taking into consideration an array of factors other than merely cost differences. Outsourcing, in contrast to direct investment, stretches not only across national borders but firm boundaries too, so some serious thought must be devoted to making clear where the final responsibility lies in the event that an unforeseen situation, i.e., one that could not be detailed in a contract, arises, while, on the other hand, offshore outsourcing may enable firms to secure multiple competitive supply sources. Is domestic or in-house supply really more stable? The choice between domestic and offshore sourcing and the choice between outsourcing and intra-firm sourcing are a series of never-ending dilemmas.

The mood in Japan changed abruptly after the terrible events of 3/11. Even so, the global sea change spurred by the dramatic rise of the emerging economies continues to unfold, long after the waves of the tsunami from Eastern Japan have subsided. While the damage caused to the previously established supply chains was no doubt enormous, with regard to the future it is not a problem that can be satisfactorily resolved purely within the boundaries of Japan's high-cost structure, nor by tucking it away into the outdated corporate activities of the "good old" Japanese company. More than four months have now passed since the disaster, but I still feel great distress when I think about the victims. At the same time, Japan is likely to undergo a period of seismic activity for an extended period, and there is no change in the long-run trend of low birthrates, the rising share of elderly people, and a declining population. But perhaps it is in times like these that we might be able to discern the light of the future, kindled by open inter-firm networks that stretch across the boundaries of both nations and firms. I hope to see considerable effort being made to painstakingly listen to the feelings of each and every citizen after the disaster and, in parallel with these efforts, policy debate that takes into account the economic reality of corporate transactions.

(Reference) "Offshore Outsourcing by Japanese Firms: An analysis based on micro data" (Policy Discussion Paper 10-P-020) by TOMIURA Eiichi.

July 14, 2011
  1. The precise details are contained in Tomiura (2011), but since this research was conducted on just one occasion in FY 2006, a more recent study would definitely reveal that offshore outsourcing is becoming widespread among Japanese firms.
  2. In the research just mentioned, the majority of Japanese firms' offshore outsourcing is manufacturing related, but this research concentrates on manufacturing firms.

July 14, 2011