ECONOMY MARCH 15, 2011
Not many people in the American electronics industry had ever heard of the Japanese town of Niihama before the summer of 1993. That changed overnight when a small specialty chemical factory there was knocked out by a fire. Obscure though it may have been, this factory accounted for 65 percent of the world's supply of epoxy cresol novolac, a resin essential in making most semiconductors. As shockwaves shot through the world electronics industry, prices of some kinds of semiconductors doubled in days. The crisis soon became so acute that the Clinton administration weighed in with a public plea to the Japanese government to take emergency action to restore supplies.
The episode illustrates in microcosm a problem that may confront many key global manufacturing industries on a much larger scale in the wake of the Japanese earthquake: shortages of highly rarefied but critical materials, components, and capital goods. Even as the death toll mounts and rescue teams race to dig out survivors, the world's supply chain chiefs are bracing for major disruptions in the availability of many so-called "producers' goods," in which Japanese companies have built up dominant or even monopoly positions. Just how gravely will these shortages impact the world economy?
Experts on industrial logistics point out that, as world manufacturing has become more technologically advanced, it is more likely that a single supplier, or even a single factory, can be critical to a whole industry. And we know that, in this vein, Japanese corporations enjoy monopolies or oligopolies in a host of crucial niches in supplying advanced materials, components and production machinery for industries like electronics, cars, and aerospace. In two books in the 1990s, I made a sustained effort to track Japan's more important manufacturing "chokepoints," as they are known to customers. I succeeded in identifying close to 100. Some are well known, such as the YKK Company's global lock on zip fasteners and Shimano's dominance in bicycle gears. Many have hithero gone largely unnoticed, but are actually much more important to the smooth functioning of the world economy: A good example is semiconductor-grade silicon—a highly purified not-an-atom-out-of-place material that only a couple of companies worldwide can make. The leading suppliers, Shin-Etsu and Sumco, are both Japanese and, as far as I can tell, there are no significant suppliers left in either Europe or America. If any of their factories or suppliers have been affected by the earthquake, the entire global electronics industry will be quickly feel the impact. The dangers now looming after the Japan quake recall the old adage, "For want of a nail the shoe was lost. For want of a shoe the horse was lost. For want of a horse the rider was lost."
Tim Cracknell, a partner in the London-based JLT risk consulting firm, believes many in the global supply chain of industrial goods have been caught off guard by the disaster. Supplies from Japan, he says, could be disrupted for months. And Jim Handy, an executive at the semiconductor research firm Objective Analysis, has said he expects "phenomenal" price swings and large near-term shortages as a result of the quake.
Several American analysts have expressed particular concern about supplies of so-called NAND flash memories, which are crucial components in products like Apple's iPhone and iPad. Japanese producers are known to control nearly half the global market in these devices, and, though it is not clear that any of these producers is located in the region most affected by the quake, there are fears that the general dislocation in Japan may delay supplies. Another product category causing concern is so-called microcontrollers, which are computer-on-a-chip devices used in everything from car engines to heart implants. Two major microcontroller makers, Freescale Semiconductor and Renesas, do have large operations in the devastated north.
There are undoubtedly many more crucial supply chain items whose principal source of production is in the north. But their identity may emerge only after a delay of days or even weeks. Indeed, it is difficult to guess where the biggest problems will emerge. For one thing, Japanese companies are generally not forthcoming about details such as market share. Moreover, in the case of large corporations such as Hitachi or Toshiba, it is difficult to identify which, out of hundreds of factories located throughout Japan, are responsible for any particular item. (Japanese corporations are not subject to the sort of disclosure expectations taken for granted in the United States.)
To be sure, Japan has had major earthquakes before, and the effects on industrial supply chains have been muted. The quake that devastated Kobe in 1995, for instance, did not have a major impact. Another piece of luck—if one can such a word at time when so many lives have been devastated—is that Tohoku, the northern region worst hit in the disaster, is, by Japanese standards, something of an underpopulated backwater. It is quite agricultural, its economy famous mainly for such commodities as rice and peaches. It is also known for fishing villages and tourist attractions, and its major city, Sendai, is an educational center, boasting no less than half a dozen significant universities. Had an earthquake this big struck close to Tokyo or Japan's other megalopolis, Osaka, the cost would have been many times greater, not only in lives but in economic dislocation and damage to Japan's industrial backbone. "They dodged an enormous bullet with this one," Marcus Noland, a Washington-based Japan watcher, has commented to the Wall Street Journal.
Even so, the industrial impact this time is likely to be far greater than in 1995. Last week’s destruction was greatly exacerbated by one of the biggest tsunamis in Japanese history, which destroyed everything in its path. Moreover, industry has changed dramatically in the last two decades. Technological progress and globalization have both tended to encourage increasingly specialized production. In a world where national markets are no longer protected, the toughest competitors with the newest production processes, as well as the most patient shareholders and bankers (like the Japanese), have tended to win—while others fall by the wayside, unable to finance the move to the next stage of technology. This concentration is risky: Because of it, the Niihama incident, in which a fire in a single Japanese factory brought an entire industry to its knees, could be repeated a hundredfold.
Eamonn Fingleton is the author of In Praise of Hard Industries: Why Manufacturing, Not the Information Economy, Is the Key to Future Prosperity.