In the age of AI, why is Japan's manufacturing industry "only making money and not expanding production"?

Deutsche Bank stated that amid the global AI boom, Japan's semiconductor and electronic component industry is experiencing a "flat increase in prices and volume" phenomenon, with capacity expansion significantly lagging behind South Korea. The fundamental problem lies in the structural shortage of labor and resource misallocation: the market rigidity caused by lifetime employment, the extremely low elasticity of capital-labor substitution, and the insufficient supply of STEM talent have jointly constrained companies' willingness to tap into their potential and expand production, making it difficult for them to translate AI opportunities into actual production capacity.

The global AI investment boom has fueled enormous demand for semiconductors and electronic components, causing Japanese export prices to soar, but export volumes have remained virtually unchanged. Compared to South Korea's strong performance with both increased volume and price, Japanese manufacturing appears to be missing out on a historic industrial opportunity.

According to a research report released on August 19 by Kentaro Koyama, chief economist at Deutsche Securities, the root of this paradox lies not simply in insufficient capital investment, but in a deeper structural bottleneck in the labor force— a rigid labor market and short-sighted corporate decision-making, which together hinder the reallocation of labor resources to high-growth industries. The report points out that this structural problem is restricting Japanese companies' ability to seize opportunities in the AI era.

The report argues that these difficulties directly impact the effectiveness of the Japanese government's growth strategy. The Takachi Cabinet has set a target to channel large-scale domestic investment into 17 strategic sectors, including manufacturing; however, if structural problems in the labor market are not addressed, these investments may struggle to translate into real capacity increases.

Price-volume divergence: the difference between Japan and South Korea

AI-related investments are accelerating the construction of data centers globally, leading to a surge in demand for semiconductors and memory chips. Japan, South Korea, and Taiwan are all key global supply hubs, yet the benefits they derive from this economic boom vary significantly.

Trade data since 2025 shows that South Korea and Taiwan have seen significant increases in electronics exports, while Japan's exports have remained relatively stable. Simultaneously, export prices in all three regions have trended upwards, confirming the existence of genuine market demand. Among electronic components, Japan's export price increases even surpassed those of Taiwan. Even in integrated circuits, where Japan has a relative advantage, while export value has risen sharply, export volume has stagnated.

The divergence in production capacity is equally significant. Since 2024, South Korea and Taiwan have seen rapid expansion in electronic component production, while Japan's output remains below its 2021 peak. The report points out that the rise in Japanese export prices precisely demonstrates that its products are indispensable in the global supply chain and possess pricing power, rather than being due to a lack of demand or outdated products. On the contrary, Japanese exporters are proactively shifting their focus to higher value-added products, adopting a "small volume, high profit" strategy, and actively avoiding a "large volume, low profit" approach.

Capacity expansion hampered: Insufficient capital investment is the symptom.

On the supply side, Japan's electronic components industry has long suffered from overcapacity issues. Data shows that the industry's capacity index has stagnated 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 argues that Japanese companies' cautious approach to capacity expansion is inextricably linked to painful historical lessons. In the 2000s, Japanese semiconductor companies invested heavily, only to suffer huge losses due to market downturns and price collapses—a memory that has left a deep imprint on management. Coupled with uncertainty about the sustainability of future demand, this has suppressed companies' willingness to expand capacity and reinforced their inertia in adhering to a "low-volume, high-profit" strategy.

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

The real bottleneck: labor shortage

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

The structural root of the problem lies in the extremely 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 has one of the lowest elasticities of substitution between capital and labor in the manufacturing sector, making labor shortages highly likely to directly suppress capacity utilization. Furthermore, labor reforms implemented since 2019 have led to shorter working hours, while productivity improvements have failed to keep pace, further constraining overall output levels.

The labor shortage is not limited to individual companies. The entire supply chain is experiencing manpower shortages, and the construction industry, responsible for building factories, is facing severe labor shortages, further hindering corporate production activities through delays in procurement and equipment installation. The Development Bank of Japan's "2026 Fiscal Year Equipment 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 the manufacturing sector, this factor ranks third in importance, after "improved growth expectations" and "technological and talent advantages," even surpassing expectations for government support. This structural dilemma lies in the fact that the labor shortage has not only failed to incentivize companies to increase labor-saving investments, but has also directly suppressed their overall investment willingness.

Structural problems of Japanese companies: resource misallocation

The report examines these phenomena from a broader perspective, arguing that the inaction or inability of Japanese companies to act in the face of opportunities is not new. During the period of significant yen depreciation since 2013, Japanese exporters similarly forwent opportunities to lower export prices denominated in foreign currencies and expand market share, instead prioritizing maintaining local currency prices to improve profits, resulting in a situation where "export volume did not increase despite yen depreciation."

Both scenarios point to a lack of inertia among Japanese companies when faced with opportunities for expansion, with the fundamental problem stemming from structural inefficiencies in labor resource allocation. From a macroeconomic perspective, even with a continued contraction in the total labor force, shifting labor from low-productivity sectors to high-productivity industries such as AI-related sectors can still boost overall economic output. The current AI boom presents an excellent opportunity to drive this industrial transformation.

However, in reality, such dynamic cross-industry labor mobility is extremely limited, constrained by two major structural factors: a rigid labor market based 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 when demand prospects are uncertain. The combined effect of these two factors leads to the failure of the mechanism for reallocating labor resources to growth industries.

The underlying cause: a triple dilemma of population, industrial structure, and talent supply.

A horizontal comparison with South Korea further reveals the systemic roots of Japan's manufacturing labor shortage.

In terms of manufacturing employment, Japan's manufacturing workforce peaked in 1992 and has since declined by approximately 35%, remaining largely stable in recent years. South Korea's workforce has remained largely stable since the 1997 Asian financial crisis. Regarding deindustrialization, Japan and South Korea are moving in similar directions, with both experiencing a continuous decline in the share of manufacturing employment. This reflects a common pattern: rising national income, a shift in demand from goods to services, and the displacement of labor by manufacturing automation.

In terms of demographics, Japan's working-age population (15 to 64 years old) peaked in 1995, while South Korea did not reach its peak until 2017. South Korea's current working-age population ratio is still comparable to Japan's historical peak level, which to some extent explains why the decline in manufacturing employment in South Korea has been relatively moderate.

The gap is equally significant in terms of the supply of highly skilled talent. OECD data shows that South Korea ranks second among OECD member economies in the proportion of STEM (science, technology, engineering, and mathematics) graduates in higher education, while Japan is below the OECD average. The report thus points out that Japan's labor shortage in manufacturing is a deep-seated problem resulting from the interplay of multiple factors, including demographic trends, deindustrialization, and the education system.

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