US President Joe Biden, left, and Fumio Kishida, Japan’s prime minister, during a state dinner in the East Room of the White House in Washington, DC, US, on Wednesday, April 10, 2024. Photographer: Yuri Gripas/Abaca/Bloomberg via Getty Images

TOKYO — Faced with an aging workforce, an ailing supply chain and a shrinking defense industrial base, Japan is taking steps to revitalize its defense industry and entice new entrants into the sector, a representative of Japan’s acquisition agency told Breaking Defense.

In June 2023, Japan’s National Diet passed landmark legislation known as the “Act on Enhancing Defense Production and Technology Bases” meant to reinvigorate the Japanese defense industrial base by creating new mechanisms to inject cash into the country’s arms manufacturers and their supply chain.

Japan has inked about $10 billion yen — or about $64 million — in contracts to troubled suppliers since the implementation of that legislation in October, said Ryota Nakatsuji, principal senior coordinator for the Ministry of Defense’s (MoD) department of equipment policy, told Breaking Defense during an interview at the MoD headquarters in Tokyo.

Up until the passage of this legislation, Japan’s MoD was restricted to contract only with its prime contractors, giving it poor visibility into the supply chain and difficulty addressing problematic suppliers, Nakatsuji said. Under the new policy, the ministry can award funds to prime contractors as well as companies deeper within the supply chain that submit proposals to the MoD laying out plans to improve cybersecurity or manufacturing.

For example, a company could win money “to heighten the resilience of the supply chain” by “shifting some parts from import from foreign countries to domestically produced ones,” Nakatsuji said. “This can reduce the risk from the Japanese company’s perspective.”

“Many companies are submitting a plan to introduce a newer production line in order to heighten their production efficiency,” he said. “Many people are happy with this because before, suppliers or even major defense contractors didn’t have any means to solve problems related to their suppliers.”

Another key aspect of the new policy allows the Japanese MoD to build inflation adjustments into contracts, Nakatsuji said. It also financially incentivizes defense primes to meet cost, schedule or performance targets by bringing profit margins from 5 percent up to a possible 10 percent — addressing a longtime concern of Japanese companies that has led some firms to leave the defense sector altogether.

Over the past 20 years, more than 100 major Japanese companies have downsized or withdrawn from the defense industry due to weak profit margins that at times do not outweigh the costs of technology development, Miki Matsuo, a former visiting fellow with the Center for Strategic and International Studies, wrote in a paper this May.

Another reason for the exit of companies from the defense sector is that the Japanese government has increased acquisition spending on foreign technologies over the past decade, thereby constricting its indigenous industry, said Yuki Tatsumi, director of the Japan program at the Stimson Center.

For Japan’s major defense primes such as Mitsubishi Heavy Industries or Kawasaki Heavy Industries, defense contracts are only a small fraction of the company’s overall revenue, which is overwhelmingly commercial, Tatsumi said. But while those commercial sales cushion Japan’s defense primes and allow them to weather some financial instability from low earnings on defense contracts, second and third tier suppliers feel defense budget fluctuations much more acutely.

“The Japanese defense industry as a whole is really hurting from the hollowing out of those second tier and third tier suppliers,” she said. “I would describe it [the Japanese defense industrial base] as very poor, very vulnerable. And left to its own devices, I just don’t think it’s sustainable long term.”

While the new policy “is definitely helpful,” Tatsumi said the ideal window for such reforms was between 2000-2010, when Japan still boasted the world’s second-largest economy and the strategic landscape was less volatile.

But the Japanese MoD could have a new opportunity to entice second and third tier suppliers back into the defense sector, she added. During Japanese Prime Minister Fumio Kishida’s visit to the White House in April, Washington and Tokyo announced a new “Forum on Defense Industrial Cooperation, Acquisition and Sustainment,” or DICAS, that will evaluate opportunities for Japan and the United States to collaborate on weapons production and the sustainment of ships and aircraft. The first DICAS talks, which ended on Monday, involved discussions between US and Japanese defense officials and private companies from both countries, reported The Japan Times.

If Japan is able to capitalize on those coproduction and co-sustainment opportunities, it may be able to generate the demand signal necessary to bring suppliers back to defense projects, Tatsumi said.

“This is where the Ministry of Defense can put some level of investment into those companies for infrastructure to shoulder the upfront cost of starting up those [production lines],” she said. “Those [policies] could be super helpful when you try to convince those second and third tier companies to come back.”

Bad Reputation

The shrinking nature of the Japanese defense industrial base isn’t its only problem. Other challenges mirror those being tackled by the United States and other nations striving to modernize their defense industry.

Like the US, Japan’s manufacturing industry at large is grappling with labor issues as a generation of skilled blue-collar workers are retiring or have already departed the workforce during the pandemic, leaving companies with a smaller, less experienced employee base. In Japan, this challenge is exacerbated by its rapidly aging population, making it likely that its defense industry will have to contend with a labor force shortage “at some point,” Tatsumi said.

At the same time, technologies like artificial intelligence, robotics and digital twins — common in the commercial world among top technology firms — have yet to be fully incorporated in the production of many defense products.

“That’s why it’s very important to introduce more efficient machines, production lanes, et cetera. Or maybe we need to be more dependent upon AI or some new technologies,” Nakatsuji said. “We need to depend not only on traditional defense industry, but also maybe newcomers to the defense industry, including startup companies.”

The Japanese MoD met with about 200 startups in June 2023 to encourage them to take on defense projects, Japan’s Nikkei news agency reported then.

But Nakatsuji cautioned that the Japanese MoD’s engagements with startups was in the early stages, and that the government will have to overcome concerns from commercial business owners who are concerned about alienating customers who object to Japan’s increased defense spending and heightened involvement in global security matters.

“This is not limited to startups, but generally speaking, doing defense business in Japan is sometimes recognized as risky for private companies in terms of their reputation,” he said.