Japan's Deepening Economic Vulnerability to China and the Strategic Case for US Alignment

Japan's economic security has long been intertwined with its trade dependencies, particularly in critical sectors like semiconductors and rare earth elements. However, recent developments underscore a growing vulnerability to China's dominance in these supply chains, even as Tokyo and Washington intensify efforts to diversify and fortify their economic resilience. For investors, the interplay of geopolitical risk and strategic alignment offers both challenges and opportunities.

Semiconductor Supply Chain Disruptions: A Double-Edged Sword

Japan's control over 90% of the global market for high-end photoresist materials and 95% of EUV-grade materials used in advanced chip production has made it a pivotal player in the semiconductor industry. Yet this dominance has also become a strategic liability. In Q4 2025, Japan joined China in weaponizing supply chains, restricting exports of photoresist and lithography services to China. These measures, while aimed at countering Beijing's technological ambitions, have created immediate bottlenecks for Japanese firms like Shin-Etsu Chemical and Canon, which now face reduced revenues and reputational risks. Meanwhile, China's simultaneous export restrictions on rare earth materials have compounded the crisis, disrupting production for industries reliant on both nations. The result is a fragile equilibrium where supply chain interdependence is increasingly weaponized.

Rare Earth Dependencies: A Looming Bottleneck

China's grip on rare earth elements remains a critical vulnerability for Japan. Despite Tokyo's efforts to diversify, China controls 68% of global rare earth mining and over 90% of refining, a dominance that has only intensified since 2023. In April 2025, Beijing imposed export restrictions on seven rare earths, directly impacting Japan's manufacturing of electric vehicles, wind turbines, and high-tech components. While Japan has reduced its reliance on Chinese rare earths from over 90% in 2010 to 58% in 2020, the concentration of refining infrastructure in China persists. This bottleneck underscores the limits of stockpiling and recycling initiatives, as highlighted by Japan's Japan Organization for Metals and Energy Security (JOGMEC).

US-Japan Collaboration: A Strategic Lifeline

The U.S.-Japan partnership has emerged as a critical counterbalance to these vulnerabilities. The 2023 U.S.-Japan Agreement on Strengthening Critical Minerals Supply Chains laid the groundwork for joint efforts to diversify sources of cobalt, lithium, and nickel, essential for EVs and semiconductors. This collaboration was further solidified in October 2025 with the U.S.-Japan Framework for Securing the Supply of Critical Minerals and Rare Earths, which includes measures to accelerate mining permits, mobilize public-private financing, and establish a Rapid Response Group for supply chain disruptions. By aligning with U.S. policies like the CHIPS Act and Inflation Reduction Act (IRA), Japan gains access to incentives for domestic processing and recycling, while the U.S. benefits from Japan's technological expertise in refining and material science.

Investment Implications: Navigating Risk and Opportunity