Japanese FDI inflow

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Last updated: March 27, 2019

Japan has traditionally been one of the top regional and global outward investor for decades with substantial magnitude of capital abroad in the form of direct investments in plants overseas, foreign government bonds, securities in foreign countries and real estate.

On the other hand, Japan’s share of inward FDI were incomparable to other industrialised countries, accounted for only 0.5% of global FDI inflows in 1990. At this point, net inward investment into Japan was some 28 times lower than outward investment by Japan. (Francis, S), signalling a marked imbalance between inward and outward FDI.there are also economic forces creating barriers for MNEs to invest in Japan in the form of FDI. For decades, Japan was arguably ranked the least FDI-friendly among developed countries. Even in the 1980s, when there was a dramatic increase in global FDI with significant increase in inflows to the US and Europe, FDI inflows into Japan were much smaller.As discussed before, the normal motives behind FDI can be loosely classified under three broad categories:1.

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Desire for market access (Market seeking)2. Cost reduction – Access to cheap labour and other factor costs (Efficiency seeking)3. Attempt to control raw materials (Resource seeking)Since Japan has virtually no raw materials of its own and is generally regarded as a high-cost country, this leaves only one key motive for FDI in Japan which is to achieve market access.

In fact, Japan’s high costs and limited natural resource endowments are partially important reasons explain Japan’s active role in pursuing outward FDI. Being the world’s second largest single-country economy, Japan accounts for roughly 13% percent of the world’s GDP (1998 figures, quoted in BTI, 2000:7). In theory, the fact that it is a high-income country with a large domestic market should make Japan an attractive location for FDI. However, the Bradford research group (..

…) contended that it was not locational factors that disfavour Japan as a target for FDI, it is internationalization factors. (Mirza et al, 1996:43 – emphasis in original) They also subsequently identified five factors which deter foreign companies from investing in Japan by way of imposing high costs and inhibiting the internalization process:1. Cultural barriers – difficulties in language, customs and business procedures, buyer behaviour, complicated distribution system, and stringent Japanese standards and norms.2. Immobile labour market – loyalty of Japanese workers to long-established employers and distrust of unknown foreign entrants3.

Close interrelation of Japanese companies through vertical and horizontal keiretsu which makes it difficult for foreign firms to establish a stable supply base and links with major purchases since the bank’s close links with the keiretsu make local financing more difficult4. Entry has to be made by building from scratch owing to cultural barriers to take-overs5. Difficulty of export access makes it difficult to test the market and to justify the fixed set-up costs of direct investmentLow rates of return on capital, persistent appreciation of the yen, geographic distance from potential investors also collectively work against foreign investment, especially M&As.

In addition, for European firms, the frequent need for ‘two-stage’ entry is another significant factor raising the cost of FDI in Japan. Since most companies entered Japan through joint ventures, but then encountered major problems in gaining sufficient ownership when the Japanese partner was unwilling to sell its stake. This would result in the need to make a second entry, driving the cost of investment to rise.Despite those inhibiting factors, foreign investors have showed a high level of commitment to Japan, particularly among the European nations and the U.S in recent decades. This was particularly reflected by the surge in inflows in 1992 and their subsequent linear growth during 1996-1999 which led to a massive drop in this gap between inflow and outflow to as low as 1.8 times in 1999.

This rapid rise in inward FDI into Japan can be related to the following three phenomena occurring simultaneously. First has been abundant resource endowments that are the ultimate attractions to vast types of MNEs, like skilled human resource, sizable market, highly developed infrastructures; the second has been the ongoing corporate and financial restructuring in Japan as a result of the deregulations and liberalisation initiated by the government. Last but not the least is the increased competition and industrial reorganisation occurring at the global level across many industries. While there are both domestic and external factors stimulating this process, the following sections will focus on those domestic factors driving the rise of FDI into Japan.Robust economic determinants1. Market and consumersIt is already mentioned that vast literature treated economic elements as the most robust FDI determinants, despite that motives of MNEs may vary. Especially market size and economic growth are highly significant and positive in virtually all the studies, since this is where MNEs can gain economies of scale from.

As an island nation, Japan is not big in absolute market size, however this does not mean that Japan is lack of attractive market features to MNEs. Quite oppositely, as the world’s second-largest economy with 15% of world’s GDP, Japan is a promising market, with a market scale ranking among the top of the developed nations. High income levels supported by a strong balance between savings and consumption, the Japanese market promises a high level of personal consumption in the future as well. It is believed that lively business activity and flourishing personal consumption made Japan to be an extremely attractive destination for FDI.2. Skilled labour resourceLimited by a shortage of natural resource endowments, Japan might not seem attractive for an investment involving exploitation of minerals. However, it displays superior advantages for certain types of resource-seeking MNEs, for instance, those who seek skilled labour resources.

It is recognised that while low-cost labour remains a significant locational advantage, the increasing sought-after advantages are competitive combinations of wages, skills and productivity (UNCTAD, 1998a). That means investors are increasingly required not to solely place value on labour wage rates, particularly in the case of service investment, such as telecommunications, retail, insurance and consumer finance.This recent trend places Japan in a favoured position due to its possession of abundant educated human resources who support high-level R&D, reflected by statistics that in year 2000, Japan had the highest ratio of R&D budget in GDP with 3.2%, while the United Statement being the second with 2.

7% (The White Paper for Science and Technology 2002). In addition, employment practices in Japan have experiencing an undergoing change from seniority-based to merit-based compensation model induced by legal reforms. This has a positive impact on expanding permissible workforce incentives, thus improving workforce mobility and benefiting lateral hiring. Furthermore, the role of Japanese women who constituted a valuable untapped reserve of human resource has gradually transforming, suggesting an opportunity for foreign investors to achieve competitive advantages by proactively exploring the advantage of women workforce who are showed by various research as more receptive than men to accepting foreign practices.3. Advanced technologies and intellectual propertySufficient literature has shown that over the last two decades, MNEs have been frequently motivated by strategic considerations, this has led to a propensity for them to increasingly engage in higher-ordered (e.g.

, innovatory) activities and also a deepening of value chains of their foreign affiliates (Dunning, J). In light of this dynamic trend, Japan undoubtedly becomes one of the most popular FDI recipients, especially for small and medium enterprises, including high-tech start-up ventures that are seeking additional funding, opportunities for growth; since the potential returns of certain resource-seeking investors can be significantly enhanced by effective use of the competitive advantages that Japan has successfully established over the past decades in advanced technologies and intellectual property.It is well known that Japan possesses the second largest portfolio of issued patents in the world and is a world leader in product design and engineering. It also has extraordinary achievements in technologies for robotics and other machine tools, wireless telecommunication, nanotechnology, electronic devices and components, computer games, and a variety of others, like branding, animation, entertainment media that are immensely popular in the world. Investing in Japan provides those investors an opportunity to generate value by tapping into Japanese intellectual property resources that are relevant to the strategies and operations of the enterprises that they acquire. In Japan, improvements have also been made in the process of acquiring patent protection, bringing foreign investors benefits when seeking to capitalize on their own technology related to their FDI transactions there.

4. Developed infrastructureIt may be true that MNEs are inclined to invest where resources are available at the lowest real cost, however the role of complementary assets along the value chain necessary may be no less relevant (Dunning, J) Numerous field studies have identified the transportation infrastructure and communication cost as core variables in the decision process of MNEs, due to the fact that higher level of physical infrastructure leads to greater competitiveness of a country’s overall economic conditions. In the case of Japan, its sophisticated infrastructure facilities are certainly an attractive element.

In addition to its world-famous transportation network, Japan’s infrastructure is developed to a high standard for information and communication technology (ICT), logistics and other purposes, fostering a positive environment for continuous development of advanced information business and logistics systems based on these infrastructures.Business facilitation determinantsA considerable amount of evidence amassed from extensive research shows that foreign investors are also likely to benefit from comprehensive business facilitation services available to reduce the complexity of investment activities in Japan. As a government-supported organization, Japan External Trade Organisation (JETRO) is implementing a broad range of support activities through its network of 80 overseas offices to promote mutually beneficial trade and investment relations, including inviting companies that are candidates for investment to Japan, establishment of six national business support centers offering free office space and consulting services with experts etc. With the awareness that incoming FDI has an increasingly important role to play in the revitalization of the Japanese economy, JETRO strives to improve its one-stop information services and will continue to host seminars and other activities aimed at developing a better appreciation of M&A activities in Japan.

(what benefits ultimately brings to FDI investors)Recent reforms enhancing investment environmentThere has been a growing realization in Japan that ultimate FDI determinants have to co-exist with appropriate corporate structure and government policies, excessive regulations and disincentives entails higher initial investment costs for foreign investors, and thus hinders their enthusiasm in transferring capital to the market.In Japan, the presence of a wide range of regulations and practices that have been integral to the Japanese corporate and financial systems, historically created significant barriers to entry and operations of foreign investors. For instance, the stringent rules for land development approval under multi-layered land use in registering companies significantly increased costs for foreign corporations. After the burst of the asset bubble, Japanese government initiated unprecedented deregulations of inward FDI policies from the early nineties; having realized that only inward FDI can bring about the necessary economic restructuring required in the Japanese economy and revive production growth.As a result, the Import and Inward Investment Promotion Law were enacted in 1992, under which tax incentives and credit guarantees are provided for foreign companies that meet certain requirements; the revision of the Foreign Exchange Law improved transparency and openness.

In addition to that, the Foreign Investment in Japan Development Corporate (FIND) was established in 1993 to support both foreign companies working to make an entry into the Japanese market and foreign-capital corporations already in Japan. In response to the formal liberalisation of regulations, there was a certain surge in FDI inflows into Japan; however they did not translate into a consistent growth in inflows until more comprehensive reforms in banking, capital market, insurance and accounting standards, which directly impact on M&As took place.In general, M&As dominated FDI into Japan, mainly in electronics & IT equipment, automobile, pharmaceuticals, finance and telecommunications. Only extensive deregulations and reforms in those sectors will shift Japan from the main characteristics of its traditional corporate environment such as bank-centered financial intermediation, insider-dominated board of directors, etc and boost the performance of Japanese inward FDI.

For example, in the telecommunication industry which was a sector characterized by strong government protection and strict regulations for security purposes, the revision of telecommunications business law, connections to international circuits and deregulations of domestic public telephone networks has attracted numerous foreign international telecommunications companies entered and undertook operations in Japan.These recent legal changes and regulatory reforms simplify the procedures for inbound FDI transactions, expand permissible techniques of corporate finance, modernize corporate law to strengthen the role of directors and the rights of shareholders, improve corporate governance and financial transparency, and provide greater flexibility for structuring and consummating mergers and acquisitions (Edward H, 2002), coherently turning Japan a more attractive FDI recipient.To further enhance the magnitude of foreign investments attracted to Japan, ‘location tournaments’ was used, namely accompanying policy adjustments with the simultaneous application of promotional programmes, incentive regimes. This was demonstrated when the Japanese government started pursuing initiatives to introduce incentives for venture capital, diversify the domestic capital markets, reduce capital gains and other taxes, and continue implementing legal and regulatory reforms affecting participation and competition in numerous sectors of the Japanese economy.

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