From the US–China trade war to tensions in the Taiwan Strait and the economic fallout of the Russia-Ukraine War, geopolitical risk has returned to the centre of global economic policymaking. Governments are increasingly calling for ‘friend-shoring’, ‘de-risking’, and supply chain resilience. Firms, meanwhile, face mounting pressure to reassess where they produce, source inputs, and invest.

A growing literature has begun to quantify and interpret these risks. Caldara and Iacoviello (2022) develop a widely used Geopolitical Risk (GPR) index based on newspaper coverage of geopolitical tensions, showing that geopolitical shocks have measurable macroeconomic and financial effects. Freund et al. (2022) demonstrate that major shocks such as natural disasters can trigger large-scale supply chain reorganisation, encouraging firms to diversify sourcing networks to mitigate future risk exposure. More recently, Gopinath et al. (2025) document the growing threat of geoeconomic fragmentation, in which rather than pure economic fundamentals, geopolitical tensions are reshaping global trade and investment patterns along political alignments.

While these studies highlight the macroeconomic consequences of geopolitical shocks and fragmentation, we still know relatively little about how firms adjust supply chains at the micro level. In a recent paper (Doan et al. 2025), we address this gap using new firm-level evidence on Japanese multinational corporations (MNCs) operating across East and Southeast Asia from 2009 to 2022. Our analysis shows that firms are not retreating from globalisation altogether. Instead, they are diversifying supply chains away from China toward ASEAN economies – without fully relocating production or reshoring on a large scale.

Measuring geopolitical exposure at the firm level

To understand how geopolitical risk reshapes supply chains, we combine Caldara and Iacoviello’s (2022) GPR index and confidential government survey data on Japanese MNCs. These include parent–affiliate-matched data on capital investment, trade flows, and foreign direct investment (FDI). This allows us to construct firm-specific exposure to geopolitical risk with respect to China, based on two key channels: (i) dependence on imported inputs from China, and (ii) production and sales exposure through Chinese affiliates. Firms that rely more heavily on China – either as a production base or a sourcing hub – face greater vulnerability when geopolitical tensions rise. As a result, they have stronger incentives to diversify or adjust their global footprint.

Figure 1 illustrates the number of Japanese foreign manufacturing affiliates located in China and ASEAN countries, conditional on parent firms maintaining at least one manufacturing affiliate in China. The figure reveals a gradual yet persistent increase in the number of affiliates in ASEAN countries, particularly after the 2012 China-Japan Senkaku/Diaoyu Islands dispute. This suggests that, while China remained a core manufacturing hub for Japanese multinationals, geopolitical tensions likely incentivised firms to adopt diversification strategies. Rather than fully relocating operations, firms appeared to expand incrementally into ASEAN markets, thereby reducing over-reliance on China while maintaining their existing production bases.

Figure 1 Number of foreign manufacturing affiliates in China and ASEAN

Notes: The figure displays the number of Japanese foreign manufacturing affiliates in ASEAN countries, conditional on parent firms having at least one manufacturing affiliate in China, for fiscal years 2009 to 2022. The first vertical red line marks the 2012 China–Japan Senkaku/Diaoyu Islands dispute, and the second vertical red line marks the onset of the US–China trade war in 2018.
Source: Authors’ compilation based on the Japanese Ministry of Economy, Trade and Industry’ Basic Survey on Overseas Business Activities (BSOBA).

Diversification rather than decoupling

Our first key finding is that geopolitical risk significantly increases supply chain diversification. Firms exposed to rising geopolitical tensions are more likely to (i) add new import sources outside China, and (ii) establish manufacturing affiliates in ASEAN countries. These responses are economically significant. Figure 2 reports the estimated coefficients for the geopolitical risk exposure variables, i.e. the interaction terms between changes in China’s GPR index (ΔGPR) and lagged firm-level trade and FDI variables. For example, a one-standard-deviation increase in GPR exposure through imports from affiliates in China increases the probability of import diversification by approximately 0.96% to 1.39%, which is about 37% to 53% of the average import diversification probability (2.6%).

Figure 2 Geopolitical risk exposure and supply chain diversification

Notes: The figure reports the effects of geopolitical risk (GPR) exposure through imports and FDI on the probability (%) of supply chain diversification at the firm level. All GPR exposure variables are standardised. The sample period spans fiscal years 2009 to 2022. A full set of parent-firm, industry-year, and prefecture-year fixed effects is included in all estimations

This diversification behaviour is consistent with a theoretical framework in which firms weigh relocation costs, the insurance value of avoiding disruption, and productivity differences across locations. When geopolitical risk rises, diversification – not relocation – often becomes the optimal response. This pattern also aligns with what policymakers and business leaders often describe as a ‘China plus one’ strategy: firms maintain operations in China while building parallel capacity elsewhere.

Limited evidence of full relocation

While diversification is widespread, our second key finding is that full relocation is rare. We examine two forms of relocation: (i) production relocation, i.e. closing Chinese affiliates while opening new ASEAN facilities; and (ii) investment reallocation, i.e. shifting capital expenditure from China to ASEAN. Across both measures, the evidence for large-scale relocation is weak. Geopolitical risk does not systematically predict wholesale withdrawal from China.

Why not? Relocation is costly. Firms face sunk investments in existing Chinese facilities, established supplier networks, skilled labour pools, and infrastructure advantages. Even when geopolitical risk rises, these structural advantages make full relocation economically unattractive. Instead, firms appear to adopt incremental risk-hedging strategies – diversifying production geographically while preserving their Chinese footprint.

Entry, exit, and regional investment dynamics

We also examine how geopolitical risk affects foreign affiliate entry and exit patterns. Three stylised facts emerge.

• Geopolitical exposure does not significantly increase the probability that firms divest from China. Firms deeply embedded in the Chinese market may face higher exit costs or perceive a continued commercial opportunity.
• By contrast, geopolitical risk significantly raises the likelihood of new investment in Southeast Asia – especially for firms heavily reliant on China.
• The adjustment margin operates mainly through new investment rather than withdrawal. In other words, firms expand elsewhere without abandoning China.

Reshoring: More rhetoric than reality?

A central policy question concerns reshoring – bringing production back home. Here, the evidence is nuanced. We find little systematic evidence of production reshoring from China to Japan. There is evidence of some increase in domestic investment, particularly among firms heavily exposed to Chinese sales. This suggests that firms may strengthen domestic capabilities, especially in high-value or strategic segments, without dismantling overseas production. Thus, reshoring appears to be complementary to diversification, rather than a substitute.

Policy implications

These findings carry important implications for governments seeking to enhance supply chain resilience.

1. Resilience does not equal reshoring. Calls for wholesale reshoring may be economically unrealistic. Firms prefer diversification because it preserves cost advantages while reducing geopolitical exposure.
2. ASEAN’s strategic role is rising. Southeast Asia is emerging as a key stabilising hub in global production networks. Infrastructure investment, trade agreements, and industrial policy in the region will shape the future geography of the supply chain.
3. Exposure matters. Policies should recognise firm heterogeneity. Companies deeply embedded in China face different adjustment constraints from those with diversified footprints.
4. Fragmentation will be gradual. Rather than abrupt decoupling, the global economy is likely to experience slow, layered reconfiguration.
5. To safeguard supply chain stability, countries need to work toward reducing geopolitical risks.

The post-Cold War era was founded on the assumption that geopolitics would remain peripheral to economic integration. That assumption no longer holds. Firms now operate in a world where geopolitical risk is a core strategic variable – shaping investment, sourcing, and production decisions. Evidence from Japanese multinationals shows that globalisation is not reversing. It is being rewired away from single-country dependence, toward multi-node regional networks, and balancing efficiency with resilience. Understanding this transition is essential for policymakers designing trade, industrial, and security strategies in an increasingly fragmented global economy.

Editor’s note: The main research on which this column is based (Doan et al.2025) first appeared as a Discussion Paper of the Research Institute of Economy, Trade and Industry (RIETI) of Japan.

References

Caldara, D and M Iacoviello (2022), “Measuring geopolitical risk,” American Economic Review 112(4):1194–1225.

Doan H T T, A Ito, C Luo, and H.Zhang (2025) ,“Geopolitical Risk and Supply Chain Diversification: Evidence from Japanese Multinational Firms,” RIETI Discussion Paper 25-E-112.

Freund, C, A Mattoo, A Mulabdic and M. Ruta (2022), “Natural disasters and the reshaping of global supply chains,” IMF Economic Review 70: 590–623.

Gopinath, G, P-O Gourinchas, A Presbitero, and P Topalova (2025), “Changing Global Linkages: A New Cold War?”, Journal of International Economics 153: 104042.