AI Boom: Why Is Japanese Manufacturing "Profiting Without Expanding Production"?

The global investment frenzy in AI has spurred massive demand for semiconductors and electronic components, driving up Japan's export prices. However, export volumes have remained virtually unchanged. In stark contrast to South Korea's strong performance, characterized by rising volumes and prices, Japanese manufacturing appears to be missing a historic industrial opportunity.

According to Zhui Feng Trading Desk, a research report released on August 19 by Kentaro Koyama, Chief Economist at Deutsche Securities, indicates that the root of this paradox is not merely insufficient capital investment, but deeper structural bottlenecks in the labor market—rigid labor markets and short-sighted corporate decision-making jointly hinder the reallocation of labor resources to high-growth industries. The report notes that this structural issue is constraining the ability of Japanese companies to seize opportunities in the AI era.

The report argues that the aforementioned dilemma directly affects the implementation of the Japanese government's growth strategy. The Takachi cabinet has set a goal to channel large-scale domestic investment into 17 strategic sectors, including manufacturing. However, if the structural problems in the labor market are not addressed, these investments are unlikely to translate into genuine capacity expansion.

Divergence in Volume and Price: The Split Between Japan and South Korea

Accelerating AI-related investments are driving global data center construction, leading to a sharp rise in demand for semiconductors and memory chips. Japan, South Korea, and China's Taiwan Province are all key global supply hubs, yet the benefits they derive from this boom vary significantly.

Trade data since 2025 shows that while electronics export volumes from South Korea and China's Taiwan Province have grown substantially, Japan's export volumes have remained basically flat. Meanwhile, export prices in all three regions have trended upward, confirming the existence of genuine market demand. In the category of electronic components, the increase in Japan's export prices has even exceeded that of China's Taiwan Province. Even in integrated circuits, where Japan holds a relative advantage, export values have risen significantly, but export quantities have stagnated.

The divergence in capacity is equally significant. Since 2024, the production scale of electronic components in South Korea and China's Taiwan Province has expanded rapidly, whereas Japan's output remains below its 2021 peak. The report points out that the rise in Japan's export prices precisely proves that its products are indispensable in the global supply chain and possess pricing power, rather than suffering from a lack of demand or obsolete products. On the contrary, Japanese exporters are actively shifting their focus to higher value-added products, adhering to a "low volume, high margin" strategy and deliberately avoiding the "high volume, low margin" route.

Hindered Capacity Expansion: Insufficient Capital Investment Is Only Superficial

On the supply side, the accumulation of capacity issues in Japan's electronic components industry has a long history. Data shows that the capacity index for this industry has been stagnant since the 2008 global financial crisis and has even shown a downward trend in recent years; in contrast, South Korea has continued to expand its capacity investment.

The report believes that Japanese companies' cautious attitude toward production expansion is closely linked to painful historical lessons. In the 2000s, Japanese semiconductor companies made substantial investments, only to suffer huge losses due to subsequent market downturns and price collapses. This memory has left a deep imprint on management. Coupled with uncertainty about the sustainability of future demand, companies' willingness to expand production has been suppressed, reinforcing their inertia in sticking to the "low volume, high margin" route.

However, insufficient capital investment is not the whole story. Even with existing facilities, companies have failed to fully tap their potential—although the capacity utilization rate in the electronic components industry has recovered somewhat since 2025, it remains below historical peak levels, exposing another, more critical constraint.

The Real Bottleneck: Labor Shortages

Data from the Bank of Japan's Tankan survey reveals this deep-seated contradiction: in the electrical machinery industry, the index for excess equipment feeling has remained positive, while the employment judgment index has slid deeply into negative territory, indicating a severe labor shortage. This gap has evolved into a chronic ailment since labor shortages intensified around 2015, with data overwhelmingly pointing to "labor" rather than "equipment" as the primary bottleneck.

The structural root of the problem lies in the very low elasticity of substitution between labor and capital in the electronics industry. According to the Bank of Japan's January 2025 "Outlook Report," the electrical machinery industry ranks among the lowest in manufacturing for capital-labor substitution elasticity, making labor shortages likely to directly suppress capacity utilization. Furthermore, labor style reforms implemented since 2019 have led to shorter working hours, but productivity improvements have not kept pace, further constraining total output levels.

The spread of labor shortages extends beyond individual companies. Tight staffing across the entire supply chain, along with an extreme scarcity of labor in the construction industry responsible for building factories, further drags down corporate production activities through delays in procurement and equipment installation. The Development Bank of Japan's "FY2026 Facility Investment Plan Survey" shows that for non-manufacturing companies, "alleviating supply-side constraints such as labor shortages" is listed as the primary factor for expanding domestic investment. In manufacturing, this factor ranks third in importance, second only to "improved growth expectations" and "technological and talent advantages," even surpassing expectations for government support. The structural dilemma lies in the fact that labor shortages have not incentivized companies to increase investment in labor-saving technologies; instead, they have directly suppressed overall corporate investment willingness.

Structural Ailments of Japanese Companies: Resource Misallocation

The report examines these phenomena from a broader macroeconomic perspective, arguing that Japanese companies' "inaction or inability to act" in the face of opportunities is nothing new. During the period of significant yen depreciation since 2013, Japanese exporters similarly missed the opportunity to lower export prices denominated in foreign currencies to expand market share. Instead, they maintained local currency prices to prioritize profit improvement, resulting in a situation where "the yen depreciated but export volumes did not increase."

The commonality in both scenarios points to Japanese companies' lack of inertia in seizing opportunities for scale expansion, with the fundamental crux lying in the structural inefficiency of labor resource allocation. From a macroeconomic perspective, even if the total labor force continues to shrink, overall economic output can still be increased if labor is transferred from low-productivity sectors to high-productivity industries related to AI. The current AI boom was an excellent opportunity to drive this industrial transformation.

However, in reality, such dynamic cross-industry labor mobility is extremely limited, constrained by two structural factors: labor market rigidity, premised on lifetime employment, hinders cross-industry labor mobility; and a short-term-oriented corporate decision-making culture makes management hesitant to take the risk of attracting talent through significant salary increases amidst uncertain demand prospects. Together, these factors cause the mechanism for reallocating labor resources to growing industries to fail.

Deep Roots: The Triple Dilemma of Demographics, Industrial Structure, and Talent Supply

A horizontal comparison with South Korea further reveals the systemic roots of the labor dilemma in Japanese manufacturing.

In terms of manufacturing employment scale, the number of employees in Japanese manufacturing peaked in 1992 and has cumulatively declined by about 35% since then, remaining basically flat in recent years; South Korea has remained relatively stable since the 1997 Asian Financial Crisis. In terms of deindustrialization trends, Japan and South Korea have moved in similar steps, with the share of manufacturing employment continuing to decline in both countries, reflecting the common pattern that as national income rises, demand shifts from goods to services, and manufacturing automation squeezes out labor.

Regarding demographic structure, Japan's working-age population (aged 15 to 64) peaked in 1995, whereas South Korea did not reach its peak until 2017. Its current working-age population ratio is still comparable to Japan's historical peak level, which partly explains why the decline in manufacturing employment in South Korea has been relatively moderate.

At the level of high-skilled talent supply, the gap is also significant. OECD data shows that the proportion of STEM (Science, Technology, Engineering, and Mathematics) graduates in higher education in South Korea ranks second among OECD member economies, while Japan is below the OECD average. The report thus points out that the labor dilemma in Japanese manufacturing is a deep-seated problem intertwined with demographic trends, the deindustrialization process, and the education system.

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