Analysis of US’s and EU’s FDI in Japan

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Last updated: April 19, 2019

Figure 1 demonstrates the FDI inward stock in five countries between 1980 and 1999. Obviously, since1980, the total value of FDI in Japan increases dramatically. However, compared with US and other European countries, the FDI inward stock in Japan still remains at a low level. And, the ratio of FDI/GDP is also low in Japan (see Figure 2).

US is the most important investor in Japan (see Figure 3), followed by UK, Germany and France.Many reasons were given out by researchers to explain why the FDI value is relatively small in Japan. Among those, six explanations have become consensus now, 2 of which are relevant to the reduced attraction for foreign firms to invest in Japan, and the rest are about the entry barriers, due to the distinctive way adopted by Japanese firms and industries, they will confront in Japanese market.Reduced attractionLess attractive factor priceLow factor price in overseas markets is an important incentive for firms to invest abroad, especially when they concern much about the cost of production. The main factors that influence FDI are capital and labour. Usually, we assume that if the home currency is depreciated, the domestic firms will reduce FDI; if the factor price in the home market rises, the domestic firms will prefer FDI. In Table 1, changes of exchange rate and wage rate in both Japan and US are shown. According to these assumptions, it is easy for us to draw the conclusions from the data: the high appreciation of the Japanese yen and the rising wage rate both have negative affects on US’s FDI in Japan.

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Low profitabilityProfitability is another determinant for foreign firms to invest in Japan. However, the relatively low profit rate in many Japanese industries discourages foreign investors. This low profit is subject to a kind of unique relationship between Japanese firms: keiretsu, meaning of ‘corporate group’. In these groups, main banks provide the member firms with easy access to capital at a higher interest rate than non-members.

Thus, these member firms enjoy higher capital usage at the expense of higher capital costs that decrease the profitability inevitably.Though unfavourable factors still exist in the Japanese market, the FDI into Japan rise year by year. The actual stimulation for foreign firms to invest in Japan is its strategic status in the world market: a market full of mature and high-income consumers and a quick access to the Asian market.Entry barriersRegulations in industriesFor a long time, FDI into Japan was constrained a lot in order to protect and promote domestic infant industries after World War II. Since 1980, the control of FDI by Japanese government has been liberalized step by step. The Foreign Capital Control Law was abolished and the Law of Foreign Exchange and Trade Control was amended. From then on, the FDI inflow into Japan has increased rapidly.

But the whole level of FDI still remains low because of other regulations within industries. These government rules are not discriminating to foreign firms but costs them more than Japanese domestic ones. Take insurance industry as an example. Ministry of finance prevents insurance companies from competing through offering less expensive policies and creating inventions for insurance companies to compete along other dimensions, in other words, eliminates price competitions. Moreover, insurance companies provide stable shareholding to maintain long-term relationship with their policyholders. Thus, it is very difficult for foreign insurance firms to penetrate Japanese market even though they offer more attractive products to consumers.Paucity of M;ANormally, firms adopt M;A or greenfield operation to invest in overseas market.

To some extent, M;A is considered to be a more effective way for nowadays FDI due to its distinctive advantages: rapid market entry, avoidance of start-up problems, buying package assets and non-disturbance of competitive structure. However, it is hard for foreign firms to merge with or acquisition of existing companies. Even among Japanese domestic firms, M;A occurs rarely because of the specific Japanese management system. Japanese managers prefer stable shareholders who support daily management and won’t sell their rights to a third party.

Japanese less frequency of involving in M&A, compared with US and EU, reduces the possibility and increases the costs for foreign firms to enter into Japanese market successfully (see Figure 4).Distribution problemsJapanese distribution consists of a large number of very small wholesalers and retailers. Many of them organized together into a few large groups to distribute goods along the vertical line. In this field, government regulations also play an important role through the Large-scale Retail Law that restrict large stores to operate in various areas. This law not only limits domestic distributors but also add difficulties to foreign firms.Labour issuesThe difficulty for foreign firms to hire high quality employees in Japan is another barrier to the increase of FDI. In Table 2, we can find obviously that the gap between the number of workers in Japanese domestic companies and in foreign owned ones is much wider thanks to the unique employment system in Japan.

Japanese firms provide their employees with long-term trainings and typically pay little at start and then, towards end of employees’ careers, raise salaries rapidly. So, an experienced worker’s salary reflects not only marginal productivity but also a return on investment previously made, which keeps the worker with the firm for a long time. While, foreign firms are unable to offer employees the same trainings and wage policies. Hence, the majority of Japanese people choose their domestic firms with the tradition permanent employment system.

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