Dragoman Digest

Japanese companies curb investment in China

Japan Inc is confronting intense competition and a gloomy economic landscape

Japanese investment in China has fallen over the past couple of years, as its manufacturers lose market share. Japan’s Ministry of Economy, Trade and Industry reports that investment by local Japanese subsidiaries in China declined for the seventh straight quarter to US$950 million in Q2 this year. The figure represents a 16.2 percent year-on-year drop. The share of Japanese investment by subsidiaries in China (13.6 percent) is now below that of Europe, despite China’s status in Japan as a much larger export market and import destination than Europe.

Japanese automakers in China are facing acute difficulties. Honda and Nissan both announced plans to close Chinese factories in the past few months and significantly reduce production capacity. This comes as Japanese automakers fall further behind their Chinese competitors in producing EVs. Japan, like most traditional foreign automakers in China, was very slow to adopt EV technology. Due to China’s ultra-competitive EV market, many local companies are able to increase production efficiency and cut costs to a far greater extent than their Japanese counterparts. At the same time, Japanese vehicle manufacturers have been hit by China’s lower consumption rates amid its recent economic turmoil.

The subdued level of investment from automakers has had a knock-on effect on other Japanese companies. Honda supplier J-MAX, for instance is planning to sell part of its Guangzhou factory and cut production in Wuhan. Even Nippon Steel, which helped to modernise China’s steel industry in the 1970s, is quickly pulling back on its investments in the country – largely because Japanese automaker buyers have reduced China sales. Its production capacity in China is expected to drop by 70 percent as a result. In response, many companies are looking to shift production elsewhere. Taiheiyo Cement is just one company that is in the middle of shifting production to India and Southeast Asia.

South Korea adds to competition for immigrant workers in ageing East Asia

Japan and Taiwan will need to respond

South Korea is attempting to attract foreign workers, and engaging in fierce competition with Japan and Taiwan. Korea, Japan and Taiwan are experiencing labour shortages due to diminishing working age populations and traditional cultural reticence towards immigration. For their part, Japan and Taiwan have long provided incentives for foreign workers to immigrate – with little success. South Korea has recently made more efforts to compete for foreign talent. This year it began offering significantly higher pay for low skilled workers, expanded annual caps for work permits and provided subsidies for foreign housekeepers. South Korea hopes to attract 165,000 foreign workers in 2024, up from 60,000 in 2023.

In 2023 South Korea’s population grew for the first time in three years - due to a 10.4 percent increase in arrivals of foreign nationals. Foreign nationals are forecast to make up 5.76 percent of South Korea’s population by 2024. Korea’s efforts may well prompt competitive responses from Japan and Taiwan. Japan has challenges attracting expatriates due to the weak yen, which has reduced the value of remittances. Intensified competition for labour between greying East Asia ultimately stands as a significant opportunity for countries with high youth unemployment rates like Indonesia, the Philippines and India.

US allies step up efforts to finance critical mineral supply chains

Initiatives form only the tip of the iceberg for efforts required to dent China’s dominance

Western governments are intensifying efforts to promote critical mineral and battery supply chains, seeking to challenge China’s dominance in the sectors. Last month, the Minerals Security Partnership (MSP) – a collection of 14 countries and the EU – launched a financing network. Through the MSP, the US International Development Finance Corporation is considering loans to BHP’s Kabanga Nickel Project in Tanzania. Canada announced last month that it will establish a US$74 million rare earth processing centre in Saskatoon. The facility will be one of only three rare earth refineries outside of China. Furthermore, the US Department of Energy last month awarded US$3 billion in grants to 25 battery manufacturing projects across the country. Critical minerals are used to manufacture EV batteries, wind turbines and semiconductors – among other strategic products.

The scale of the efforts is symptomatic of the outstanding challenge Western governments face in competing against China. The country controls over half of the world’s processing capacity for nickel, lithium and cobalt and 90 percent of processing capacity for rare earths. China has been able to gain its leading position due to a mix of targeted subsidies and a long-term investment in the sector. Confronting China’s leading position will come at a massive cost to Western countries. In addition to the sheer size of capital investment required to build new mines and processing facilities, governments may need to help companies swallow the fluctuating price of critical minerals – sometimes artificially controlled by China to dissuade competition.

Key German hydrogen projects encounter delays and cancellations

Potential customers and producers struggle to reach agreement on price

A number of hydrogen projects in Germany are facing major setbacks, undermining a part of the country’s decarbonising ambitions. Norway’s Equinor last month withdrew plans to produce hydrogen from natural gas in Norway and export the fuel to Germany via an offshore pipeline. The cancellation preceded news from the Danish government that it will delay by three years another proposed transmission pipeline to Germany. That pipeline will carry hydrogen produced from renewables. To make matters worse, German energy company Uniper last week delayed its target to invest €8 billion (US$8.7 billion) in green energy sources (including hydrogen) by 2030. Berlin hopes to use hydrogen as a replacement for natural gas to decarbonise its energy-intensive industrial sector and shore up its energy supplies. It is aiming to fill 70 percent of its hydrogen demand by 2030 from imports.

The difficulties faced by the hydrogen projects are reflective of the lack of substantial market demand. Equinor, Uniper and the Danish government all cited an absence of long-term contracts as a key reason for the delays and cancellations of their projects. Potential customers have been hesitant to sign on largely due to the fuel’s high price. Natural gas currently costs below $32 per MWh in Europe, while the cheapest hydrogen costs $150 per MWh before transport and storage. Producers face a wicked chicken and egg problem in reducing prices. Hydrogen projects need to be operating at large scale for prices to fall, but potential customers require prices to be lower before they commit to contracts.

India fills gap created by Washington’s solar tariffs

Washington’s tariffs have provided an opportunity for India

Washington’s tariffs on Chinese solar cells have created a gap in the market that India has begun to fill. In May, President Joe Biden doubled tariffs on Chinese solar cells to 50 percent. The Biden Administration also imposed new tariffs on solar components from Vietnam, Cambodia, Malaysia and Thailand, setting initial tariffs at 2.85, 8.25, 9.13 and 23.06 percent, respectively. These new tariffs may be hiked after an anti-dumping investigation. Imports of Indian panels have increased from US$250 million in 2022 to US$1.8 billion in 2023.

The recent US tariff hikes follow a campaign by two of the largest US solar manufacturers, First Solar and Qcells. The four targeted Southeast Asian countries and China account for 90 percent of solar industry supply. Most Southeast Asia exporters are Chinese companies working around tariffs.

Tariffs on Southeast Asian solar components have incentivised US solar developers to find cheaper alternatives. India has emerged as a primary beneficiary. Tata Power began commercial production of solar cells in early September, a significant development for Indian industry. Both the US and India have very little solar cell manufacturing capability, with most activity focusing on assembly. Both nations have taken substantial interventions – subsidies as well as tariffs - to foster domestic PV production.

China-US technology interventions are escalating

Following on from the US announcement in late September of a proposed rule that would ban imports of Chinese EV technologies, China has posted a surprising and potentially existential test to Intel’s China access.

On 16 October the Cybersecurity Association of China (CAC), an agency of the Government, called for a review of Intel’s access to China. China accounts for about 27 percent of Intel’s total revenues (which are about US$54 billion annually).

The CAC critique was both specific and highly damaging. According to the Association, the cybersecurity review of Intel was required because of:

• Frequent security vulnerabilities: Intel's CPUs had been repeatedly exposed for severe security vulnerabilities (such as Downfall, Reptar, etc.), which put users' sensitive data and system security at risk. Intel had been slow to respond and continued selling problematic products after being aware of vulnerabilities.

• Poor product reliability and disregard for user complaints: Since the end of 2023, users had reported frequent crashes with Intel's 13th and 14th generation Core i9 processors. Intel allegedly deflected responsibility in response to user complaints, delaying acknowledgment for six months before providing a fix, seriously affecting user experience and product stability.

• User surveillance risks in remote management: The IPMI technology and BMC module designed by Intel and other manufacturers contained security vulnerabilities, and Intel had integrated outdated third-party components with significant security risks into its products. This exposed users' networks and data to substantial threats.

• Hidden backdoors that jeopardise network security: Intel's Management Engine (ME) is accused of having backdoor functions, allowing remote access and control of systems. This posed a potential security risk for global users, especially with suspicions of collaboration with the NSA, thus creating a significant threat to critical information infrastructure.

• Harming China's interests: Intel had suppressed Chinese companies on Xinjiang-related issues and incorrectly listed Taiwan in its financial reports. Its alignment with U.S. government policies to suppress China's semiconductor industry raised concerns, prompting the recommendation of a cybersecurity review to safeguard China's national security and consumer interests.

Last year, CAC barred domestic operators of key infrastructure from buying products made by US memory chipmaker Micron Technology Inc, deeming the company’s products to have failed its network security review.

Rising levels of demarcation by the US and China on technology trade and data controls are creating serious problems for the companies directly involved and, increasingly, for those in the supply chains affected. CAC’s intervention on Intel was surprising, not least because Chinese authorities had been actively encouraging foreign technology companies to engage with Chinese markets.