Tokyo Drift: How Japan’s ICE carmakers lost the race against China’s EV makers

Synopsis: Japan’s automakers built global leadership through stability, government support, and manufacturing excellence, but resisted disruption as the industry changed. Their focus on hybrids and hydrogen delayed a full EV push. China exploited this gap with massive EV investments, fierce competition, and integrated supply chains, emerging as the world’s dominant carmaker.

Japan once taught the world how to build cars better, faster, and cheaper than anyone else. Yet today, the global auto race looks very different, with old leaders struggling to keep pace and new players surging ahead. What went wrong for Japan’s carmakers, and how did their slowdown help China take the lead?

When Japan Set the Gold Standard for Car Making

Japanese car companies have long operated in a system called a “keiretsu.” Think of it like a tightly knit network: at the center is a major car manufacturer, connected to a big bank, and surrounded by a web of suppliers. These suppliers compete with each other, but they’re also loyal to the network. The carmaker drives the business, banks provide the money, and the suppliers deliver the parts. Often, these companies even own shares in one another, which ties them closer together.

This setup had big advantages. Risks were shared across the network, making it easier for members to get loans at low interest rates, both from their own banks and from outside lenders. These connections were built to last, so if the main company hit trouble, its partners could step in. For example, in 2005, Mitsubishi Motors got a USD 5 billion bailout from other companies in its keiretsu. 

The keiretsu system also helped spark some of Japan’s most famous manufacturing innovations, like the Toyota Production System. Instead of making cars and piling them into storage, Japanese automakers started producing only when there were actual orders.

This kept inventories small and costs down. Factory floors ran like clockwork, with workers spotting tiny problems every day and fixing them immediately. These small, ongoing improvements, known as kaizen, made the production process smoother and more efficient over time without major disruptions.

The government played a big role too. MITI, the Ministry of International Trade and Industry, focused on boosting car exports and gave companies cheap loans, tax breaks, and subsidies. Between 1956 and 1966, MITI handed out USD 50 million in low interest loans to parts manufacturers.

Right after World War II, in 1949, the Central Bank of Japan even saved Toyota from going under. The government also protected local companies with tariffs, import limits, and restrictions on foreign investment, while encouraging them to learn from foreign partners, like Nissan’s technical collaboration with Britain’s Austin in the 1950s.

All these moves helped Japan create one of the most efficient and respected auto industries in the world, but the system wasn’t perfect, and it came with its own set of challenges.

The System That Prioritised Stability Over Disruption

MITI didn’t just sit back and let the market decide. Often, it stepped in to guide and sometimes limit competition, even nudging companies toward mergers they might not have wanted. In some cases, this created near-cartel-like arrangements in certain industries.

Despite this, the Japanese auto market never ended up dominated by a single giant. Firms like Toyota, Honda, Nissan, Mitsubishi, Mazda, Subaru, and Suzuki coexisted, often refusing to merge even when the government suggested it. The result was a delicate balance between competition and cooperation. Profits for each company were modest, but the system favored stability over cut-throat rivalry.

This emphasis on stability extended to workers too. Keiretsus offered lifetime employment and generous benefits, creating loyalty and security. Bankruptcy wasn’t seen as a natural way to weed out inefficiency. Instead, struggling companies were restructured with government help, keeping employees on the payroll.

But this approach had limits. By prioritizing stability so strongly, the system set the stage for trouble when conditions eventually changed. And when that moment came, the consequences for Japan’s automakers were unavoidable.

Cracks Beneath The Hood

By the early 1990s, Japan’s economy had slipped into a prolonged recession, and the car-making keiretsus started to show signs of strain. Suppliers began drifting away from their long-term ties, selling parts outside their usual networks. At the same time, automakers themselves were hunting for the cheapest options, whether domestically or overseas, rather than sticking with their trusted partners. Slowly, the keiretsu system’s core strength began to unravel.

As domestic car sales stagnated, companies shifted their focus to short-term cost-cutting and profits. Lean manufacturing, which had once been a source of strength, now tipped into excess. Pressured suppliers struggled to keep up, and quality issues began to rise.

Toyota, for example, faced multiple recalls between 2009 and 2011. Some larger firms, saddled with cheap debt, ended up with fragile financial structures. Nissan, in particular, faced major challenges and in 1999 had to enter a strategic alliance with Renault and Mitsubishi, a partnership later shadowed by financial scandals and embezzlement claims.

Even the government found itself struggling to contain the crisis. Over two decades, Japan tried zero-interest rates and around 30 fiscal stimulus packages, but the auto industry’s troubles persisted.

Why didn’t these measures work? Partly because artificially cheap credit and state spending kept poorly managed companies afloat instead of letting resources flow to productive firms. Additionally, decades of investment in domestic production capacity and a wide range of car models had created structural overcapacity. Cheap loans only worsened the problem.

In the end, Japan was spending heavily but seeing little return. In a bid to revive growth, it raised the sales tax in 2014. The result? Within a year, car sales dropped by 5.5 percent. The Japan Automobile Manufacturers Association (JAMA) publicly criticized the hike, arguing it had hurt demand and slowed the industry’s recovery.

A Missed Turn in the Electric Shift

In the 2010s, the Japanese government shifted its focus, pushing automakers toward greener technologies. It introduced strict fuel economy standards, which made cars more efficient but also raised the cost of ownership for consumers. Alongside these regulations, the state rolled out incentives and subsidies for two main technologies: fuel-cell vehicles and hybrid electric-gasoline cars.

Fuel-cell vehicles, which run on hydrogen to generate electricity, largely failed to take off. Japan invested heavily in promoting hydrogen-powered cars and the infrastructure to support them in the 2000s, but hydrogen is expensive to produce, store, and transport, and fuel cells themselves are costly to make.

As a result, adoption remained minimal with only 8,283 fuel-cell vehicles on the road by July 2023, far short of the 800,000 target for 2030. With demand so low, investment in hydrogen infrastructure stalled, effectively dooming the initiative.

Hybrids, however, were a different story. Japanese carmakers embraced them as a practical route to low-carbon vehicle sales, viewing them as more immediately viable than full battery-electric vehicles. Toyota, for example, adopted a “multi-pathway” strategy, producing a mix of hybrids, traditional fossil-fuel cars, and electric vehicles.

But this success came at a cost. By focusing on hybrids, Japan largely overlooked battery-electric vehicles (BEVs), leaving the country exposed as the global auto industry increasingly pivots toward full electrification.

China’s Fast Lane Moment

Learning from Japan

Interestingly, Japan played a role in China’s rise in the auto industry. As Japanese automakers struggled at home, they looked abroad for growth, and China welcomed them through joint ventures with domestic firms. But China set the rules: access to its market came with the expectation that foreign partners share their advanced manufacturing techniques and production know-how. This exchange helped China quickly build a strong fossil-fueled car industry, laying the foundation for its future dominance.

Betting on Electric Vehicles

While Japan remained focused on hybrids, China made full battery-electric vehicles (BEVs) a national priority. Lithium battery research became a core part of the country’s five-year plans, and between 2009 and 2023, the government poured more than USD 230 billion into subsidies and tax breaks for the entire BEV ecosystem, from battery makers like CATL to fully integrated car companies such as BYD. These investments drove down the cost of lithium-powered battery packs dramatically, giving Chinese firms a decisive edge in electric mobility.

Competition and Supply Chain Advantage

China’s approach to competition sharply contrasts with Japan’s focus on stability. Chinese EV makers operate in a relentless “survival of the fittest” environment, constantly racing to launch new models, improve technology, and outpace rivals.

The government is generally more willing to let weaker companies fail, unlike Japan’s cautious approach. State-owned enterprises played a key role, especially in controlling upstream supply chains for raw materials, while private companies handled car production.

Successful firms, like BYD, adopted high levels of vertical integration, controlling much of their supply chain, cutting costs, speeding up development, and maintaining quality, which is very different from Japan’s keiretsu system.

This strategy paid off. In 1998, Japan produced over one-fifth of global passenger cars (21.6 percent), while China was just starting at 1.4 percent. By 2023, the tables had turned: China accounted for 38.4 percent of global production, while Japan had fallen to 11.4 percent. In just a generation, Chinese automakers had grown from minor players to direct challengers of the Japanese giants.

Conclusion 

Japan’s carmakers once set the standard for building reliable, efficient cars, but their focus on stability and incremental innovation left them slow to embrace the electric revolution. Meanwhile, China raced ahead, betting big on battery-electric vehicles and building tightly integrated, competitive supply chains. Today, the global auto landscape looks very different: the giants of yesterday are playing catch-up, while China’s automakers are steering the future of the industry.

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