Backward Vertical Linkages of Foreign
Manufacturing Aliates: Evidence from Japanese
Multinationals
REN
E BELDERBOS
Maastricht University, Maastricht, The Netherlands
GIOVANNI CAPANNELLI
University of Malaya, Kuala Lumpur, Malaysia
and
KYOJI FUKAO
*Hitotsubashi University, Tokyo, Japan
Summary. Ð We examine the determinants of backward vertical linkages established by multinational ®rms in host economies through an analysis of the local content ratio of 272 Japanese electronics manufacturing aliates in 24 countries. Host country factors promoting vertical linkages are the quality of infrastructure and the size of the local components supply industry, while restrictive trade policies have a detrimental eect. Local content regulations have a positive impact but do not stimulate procurement from locally owned suppliers. Experienced aliates, joint ventures and acquired aliates, andÐin less-developed economiesÐaliates of less R&D-intensive ®rms exhibit more extensive vertical linkages. Firms belonging to Japanese vertical industrial groups (keiretsu) show higher procurement from local clusters of aliated Japanese suppliers. Ó 2000 Elsevier Science Ltd. All rights reserved.
Key words ÐJapan, world, vertical linkages, foreign direct investment, subcontracting, electronics industry
1. INTRODUCTION
The extent to which foreign direct investors establish backward vertical linkages with host country suppliers has been a focus of policy concern in both less-developed and industrial-ized countries. Several less-developed and
newly industrializing countries in Asia and Latin America have instituted formal local content requirements for foreign investors, while others have made preferential investment status conditional on local content, or have put informal pressure on foreign investors to extend their vertical linkages (Japan Machinery
2000 Elsevier Science Ltd. All rights reserved Printed in Great Britain 0305-750X/00/$ - see front matter
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*This research was conducted as part of the project ``Economic Analysis Based on MITI Survey Data'' in liaison with the Institute of International Trade and Industry (ITI) and sponsored by the Japanese Ministry of International Trade and Industry (MITI). We are grateful to the ITI for the data compilations. We are also grateful to Ashoka Mody, David Wheeler, and Krishna Sriniva-san for providing the Business International data. Helpful comments were received from two anonymous referees,
Center for the Trade & Investment, 1997; Commission of the European Communities, 1998). Although the use of local content rules in industrialized countries has ocially been banned after conclusion of the Uruguay Round of the GATT, in practice local content rules for foreign investors are present in several guises. In the European Union, local content rules are embedded in anti-dumping law and aect foreign investors whose exports to the EU have previously have been targeted by EU anti-dumping actions (e.g., Belderbos & Sleuwae-gen, 1997). In the United States, local content rules embedded in rules of origin regulated with the establishment of the North American Free Trade Association (NAFTA) have aected the less integrated manufacturing operations of foreign-owned ®rms. 1 In both the United States and the European Union, subsidies granted by regional governments to (foreign) investors are often made conditional on direct and indirect employment generation. Implicitly or explicitly these conditions establish required local content levels.
The concern about backward vertical link-ages arises because the potential bene®ts of foreign direct investment (FDI) in terms of technology transfer and spillovers to the host economy2 can be enhanced considerably
through extended vertical linkages (e.g., Bran-non, Dilmus, & Lucker, 1994; Lall, 1995; Turok, 1993). If increased backward vertical linkages, as measured by the local content of manufacturing operations, are achieved by sourcing materials and components from local suppliers, this may involve transfer of know-how to, and promote growth of, the local supplying industry.3 If backward vertical linkages are extended, on the other hand, through increased vertical integration of manufacturing operations (by sourcing more components from in-house plants or from related component suppliers established locally), it may be associated with an upgrading of employee skills, in particular if the produc-tion of components is more technology and know-how intensive. In either case, increased vertical linkages are likely to enhance the local employment and trade balance eects of the investment project. A potential additional advantage may stem from the fact that vertical linkages are achieved through country-speci®c investments in building up relationships with the local economy. This makes it more costly for highly integrated foreign ®rms to divest in the future and increases the long-term viability
of FDI. In a recent paper, Schmitz and Nadvi (1999) conclude that backward vertical linkages and supplier±buyer cooperative relationships are of increasing importance in the formation and growth of industrial clusters in developing countries. Such relationships are associated with frequent information ¯ows, which allow for quality improvements, reduced delivery times, and fast upgrading of designs in response to changing demand conditions for ®nal prod-ucts. Cooperative supplier±buyer interaction is one of the major forces behind sustained competitive advantages of a regional or national cluster of ®rms (e.g., Porter, 1990).
Given the importance of backward vertical linkages, there is relatively little empirical evi-dence on the factors determining their estab-lishment. A number of studies have examined the extent and characteristics of backward vertical linkages in the context of speci®c industries and countries (e.g., Lim & Fong, 1982; Kelegama & Foley, 1999; Brannonet al., 1994; Turok, 1993). O'Farrell and O'Loughlin (1981) and Reid (1994) statistically examined the determinants of local procurement levels for cross-sections of foreign-owned plants in Ireland and the United States, respectively. The focus of all these studies on a single country has, however, precluded a more comparative analysis of the establishment of backward vertical linkages in response to dierences in host country environments and policies.
the same time controlling for the impact of aliate and parent ®rm characteristics such as research and development (R&D) intensity, establishment mode and investment motives. 4
The focus on Japanese ®rms is an interesting one since Japanese ®rms are often found to be less inclined to establish such vertical linkages but to rely on imports of components and materials from Japan (Capannelli, 1997; Froot, 1991; Graham & Krugman, 1990; Murray, Wildt, & Kotabe, 1995). A number of expla-nations have been put forward to account for this pattern. It has been argued that Japanese ®rms' lower local procurement may be caused by the relatively recent establishment of their manufacturing plants, in comparison with European or US ®rms (e.g., Graham & Krug-man, 1990; Westney, 1996). Since it takes time to establish relationships with local suppliers and to secure reliable delivery of components, the later ``vintage'' of Japanese aliates may leave them still more dependent on existing suppliers in Japan. Another explanation relates to a more idiosyncratic practice of Japanese ®rms: the reliance on long-term relationships with suppliers in Japanese vertical industrial groups (or keiretsu) (e.g., Mason & Encarna-tion, 1994).5 Hackett and Srinivasan (1998) argue that Japanese ®rms face higher supplier switching costs because of their relationship-speci®c investments associated with the intensive use of cooperative subcontractor relationships with established Japanese suppliers, in partic-ular suppliers within vertical keiretsu. These tangible and intangible investments include cooperation on, and transfer of, new product and component designs, the use of specialized machinery, and the organization of just-in-time (JIT) delivery systems and components quality control. The sunk character of these invest-ments imply substantial costs of switching procurement from these longstanding suppliers in Japan to suppliers in host countries. A third possible explanation relates to the motivation for the rapid increase in Japanese overseas investments in the late 1980s and early 1990s. In industries responsible for a major share of Japanese foreign investment, such as electron-ics, machine tools, and automobiles, an important motive has been to ``jump'' trade barriers erected against Japanese exports. There is convincing evidence that voluntary export restraints and quota, high taris, and antidumping measures have induced invest-ments substantially over and above levels that would have been reached in the absence of such
trade policies (Belderbos, 1997b; Blonigen, 1998). If investments are merely a response to trade barriers, they are not a ®rst-best mana-gerial decision based on manufacturing cost and eciency. Limiting investment to relatively simple assembly tasks while sourcing compo-nents from abroad may be the most cost-eec-tive response. Hence, the role of restriccost-eec-tive trade policies in motivating Japanese invest-ments may also contribute to the explanation of the observed lower level of backward vertical linkages (Belderbos, 1997a). Our dataset on Japanese electronics aliates is well suited to test the validity of these hypotheses. The elec-tronics industry is the largest Japanese investor abroad and has been an important target of restrictive trade policies, electronics ®rms make extensive use of subcontracting relationships within verticalkeiretsu, and electronics aliates show a large variety in establishment dates (ranging from the late 1950s until the early 1990s).
The remainder of this paper is organized as follows. The next section reviews the previous literature on backward vertical linkages, inter-national sourcing, and local content. Section 3 develops hypotheses concerning the determi-nants of the local content of aliates' manu-facturing operations and describes the empirical model. Section 4 presents the empir-ical results and Section 5 concludes the paper.
2. BACKWARD VERTICAL LINKAGES, INTERNATIONAL SOURCING, JAPANESE SUPPLIER NETWORKS,
AND LOCAL CONTENT RULES
Since there is no well-de®ned theory of local procurement, we develop our empirical model after reviewing previous studies in a number of related ®elds including the literatures on back-ward vertical linkages, strategic (international) sourcing, Japanese subcontracting relationships and keiretsu ties, local content rules, and Japanese FDI.
levels. The only recent attempt to provide a more comprehensive explanation of local sourcing decisions in this tradition is Reid (1994), but this study is primarily concerned with the eect of JIT delivery systems on the spatial clustering of suppliers. Reid found that the use of JIT systems by Japanese-owned manufacturing plants in the United States was positively associated with the proportion of material inputs procured at the county level, but not at the state or national levels.
Other evidence concerning the extent of vertical linkages by (Japanese) investors and factors having an impact on these linkages is provided by a variety of case studies. In an early study, Lim and Fong (1982) interviewed three foreign electronics producers in Singa-pore, one of which was Japanese-owned. They found that while the Japanese ®rm used subcontractors in Singapore most extensively, these linkages were predominantly with Japa-nese-owned ®rms established there. The authors argued that technology transfer and stimulation of local entrepreneurship would bene®t more from the establishment of supply linkages with locally owned suppliers. A more recent study by Capannelli (1993, 1997) exam-ining sourcing practices of Japanese electronics manufacturers in Malaysia found that the role of locally owned ®rms in the supply chain was still limited. A study of the subcontracting and sourcing relationships of a number of Japanese television and VCR assemblers in Asia and Europe by Hiramoto (1992) also found that Japanese assemblers have often failed in their attempts to establish long-lasting subcontract-ing relationships with local parts suppliers. Major obstacles were the suppliers' lack of a strong attitude toward continuous improve-ment, the buyer's emphasis on quality and reliability, the dominant position of the buyer, and the buyer's preference for the use of rela-tively ambiguous contracts. Turok (1993) investigated local sourcing by foreign-owned ®rms in the Scottish electronics industry (``Sil-icon Glenn'') in 1992 and generally found low levels of vertical linkages. He suggested that sourcing rates would have been even lower in the absence of EU local content requirements. Kelegama and Foley (1999) examined the impediments for backward linkages in the garment industry in Sri Lanka. Their analysis suggested that the capital intensity and scale economies of upstream fabric and accessory production impeded entry by local ®rms, while FDI in upstream manufacturing was rendered
unattractive given the poor quality of the local (energy) infrastructure. They also found that existing international supplier linkages of multinational ®rms in some cases discouraged procurement from local suppliers. Brannon et al. (1994) and Lowe and Kenney (1999) looked at supplier linkages of the ``maquiladora'' plants set up by foreign multinationals in Northern Mexico. One impediment to the development of backward vertical linkages with Mexican suppliers were US and Mexican tari (exemption) policies, which gave US investors important incentives to import components from the United States. Other major impedi-ments were the export orientation of the foreign plants, which was incompatible with the tradi-tional domestic market orientation of suppliers, the lack of proximity of Mexican suppliers to the clusters of foreign investors at the Northern border, and a lack of plant-level autonomy concerning purchasing decisions.
of know-how and more intense communica-tion. These were found to be correlated with faster design changes, improved quality, and increased return on investment. Asanuma and Kikutani (1992) and Okamuro (1995) empha-sized the risk-sharing function of subcontract-ing relationships in the Japanese automobile industry and found evidence that the intensity of long-term supply relationships was positively correlated with the stability of performance.
The role of Japanese supplier and subcon-tractor linkages has also been studied in the context of Japanese ®rms' decision to invest abroad and the location of these investments. Belderbos and Sleuwaegen (1996) found that vertical linkages between ®rms were an impor-tant factor in the decision to invest in Asia: subcontractor ®rms within vertical keiretsu were more likely to invest in Asia if the parent ®rm operated a large number of plants in the region. Using location data on Japanese manufacturing aliates in the United States, Head, Ries, and Swenson, 1995 found that Japanese plants were more likely to be set up in a state, the greater the number of existing Japanese plants in that state in the same industry. The existence of plants set up by parent ®rms or suppliers in the same vertical automobile keiretsu exerted an additional positive eect on the location decisions by ®rms in the keiretsu. There is also evidence that Japanese automobile manufacturers have actively assisted their keiretsu component suppliers to set up plants near their assembly operations abroad (Cusumano & Takeishi, 1991). A recent study by Hackett and Sriniva-san (1998) found that the strictness of local content regulations in host economies exerted a stronger negative eect on Japanese FDI than on US FDI. They posited that the close supplier±buyer relationships (in particular within verticalkeiretsu) characterizing Japanese procurement practices imply greater costs of switching to host country suppliers. The necessity to increase local sourcing in case of strict local content requirements pushes up the cost of local manufacturing relatively much and this discourages Japanese investment. On the other hand, the Japanese investments that do occur are also more likely to induce existing suppliers in Japan to follow suit and invest in local component plants in order to replicate existing supplier relationships abroad. Hackett and Srinivasan also found a positive and signi®cant eect of the existing stock of Japa-nese FDI on new JapaJapa-nese investments, which
is consistent with the ®nding of strong cluster-ing eects in Japanese FDI reported by Belderbos and Sleuwaegen (1996) and Headet al. (1995). The net eect of local content rules on inward Japanese FDI depends on these two opposing forces but is dicult to sign.
Finally, the popularity of local content rules among policy makers has in¯uenced a now substantial body of literature analyzing the welfare eects of local content rules under various market structures (e.g., Richardson, 1993; Belderbos & Sleuwaegen, 1997; Lopez-de-Silanes et al., 1996). The eect of local content requirements is found to depend, among others, on the market power of local parts suppliers, the cost competitiveness and level of vertical integration of local competitors in the assembly industry, and on whether the requirements induce FDI in component production. With the exception of Hackett and Srinivasan (1998), however, there has been no empirical investigation of the actual impact of such rules.
The literature reviewed above suggests that a variety of factors are important for the creation of backward vertical linkages by Japanese investors. At the country level, characteristics such as local content rules, infrastructure, and the availability of and proximity to local suppliers are important. In addition, aliate characteristics such as the ``vintage'' eect and the market orientation of investment aect backward vertical linkages. Finally, parent ®rm characteristics such as the strength of existing long-term supplier linkages within vertical keiretsuand the possibility of induced cluster-ing eects through investments by keiretsu suppliers are also expected to in¯uence vertical linkages. We incorporate these factors in the empirical model described below.
3. HYPOTHESES, EMPIRICAL MODEL AND DATA
particular bene®ts to the host economy, and our main analysis therefore focuses on the local (host country) content of the electronics manufacturing aliates, rather than on local procurement alone. 6 On the other hand, it would be of interest to make a distinction between procurement from locally owned unrelated suppliers and related suppliers, since the former is likely to be associated with greater technology transfer and the stimulation of local entrepreneurship (e.g., Lim & Fong, 1982). Unfortunately, our data do not allow us to measure the importance of procurement from locally owned ®rms. 7As a second-best option, we do report robustness tests of the empirical model in Section 4 with the local procurement to sales ratio substituted as the dependent variable.
The local content ratio is measured as sales of the aliate minus components and materials imported from abroad, divided by aliate sales.8 This ratio encompasses value added created by the aliate, a measure of in-house vertical integration, and the value of local procurement of components and materials.9 Since the dependent variable is restricted within the interval 0,1] two-limit Tobit analysis is used to relate the local content ratio to a set of explanatory variables. Below we will discuss the hypotheses and corresponding explanatory variables. The section concludes with a brief description of the data set.
(a) Hypotheses and explanatory variables
A Japanese ®rm's decision concerning the sourcing of components and materials for its foreign manufacturing operations can be subdivided into two decision problems: (i) whether to procure components in-house (or intra-keiretsu), and (ii) whether to procure the components in Japan or abroad (e.g., Cavusgil, Yaprak, & Yeoh, 1996). The ``internalization'' decision of (i) re¯ects the tradeo between quality and reliability bene®ts of in-house production of components of proprietary design versus cost-reducing sourcing of stan-dard components. If a ®rm chooses external sourcing of components to maintain a competitive cost structure, it will be more likely to choose components produced in low-cost locations abroad (produced by locally owned ®rms or independent Japanese transplants). If a ®rm chooses proprietary components manu-facturing, it is still possible that overseas manufacturing activities reach high local
content levels. A condition is that the overseas manufacturing location allows for cost eective production of the components within the assembly plant or in a dedicated components manufacturing aliate established by the assembler or its related component suppliers. Factors aecting local content levels will therefore be related to both the importance of transaction costs associated with arm's length trade and the attractiveness of foreign locations for components manufacturing. For conve-nience, we distinguish between determinants at the parent ®rm, aliate, and country level in the remainder of this section.
(i) Parent ®rm level determinants
follow the assembler abroad,keiretsu®rms may be able to reach higher local content than independent ®rms. Hence, we are not able to sign the eect ofkeiretsumembershipa priori. Since there are substantial dierences in the importance of supplier networks within dier-ent vertical keiretsu, membership of a vertical keiretsuas such is not a very distinctive char-acteristic. Instead, we devised a measure of the intensity of supplier±assembler relationships within keiretsu. We used Toyo Keizai's publi-cation ``Nihon no Kigyou Guruupu'' (Japanese corporate groups), to establish for each Japa-nese investor whether it belonged to a vertical keiretsu. Then we proxied the intensity of supplier±assembler relationships for keiretsu members by taking the ratio of the size (measured by paid-in capital) of all keiretsu -aliated manufacturing ®rms to the size of the ``core'' ®rm of the keiretsu in Japan. We call this variable keiretsu intensity (KEIRINT). KEIRINT reaches higher values the more the ``core'' ®rm relies on components sourcing from other manufacturers within its keiretsu. The values for KEIRINT corresponded well to our intuition concerning the strength of supplier networks, with, for example, the highest ratios for Matsushita and Fujitsu and the lowest for Sharp.
We posit that the R&D intensity of the parent ®rm (R&DINT) has an impact on the local content of its foreign aliates. R&D-in-tensive ®rms make greater use of proprietary designs and in-house know-how. They possess more intangible assets related to manufacturing capabilities of nonstandardized high-technol-ogy components. They are less likely to transfer component production to external suppliers. Since production of components developed in-house is generally human capital and technol-ogy-intensive, it is less likely that foreign manufacturing locations provide substantial cost advantages over production in Japan, which is relatively abundant in these factors. The attractiveness of foreign investment in technology-intensive component production positively depends on the technological capa-bilities and human resources, or the ``absorp-tive capacity'' (Cohen & Levinthal, 1990), of host countries.10 Hence, the greater these capabilities and resources, the less we expect a negative impact of the ®rm's R&D intensity on local content. We therefore not only include the variable R&DINT, but also a cross-eect with a measure of economic and technological development of the host country. As an
imperfect proxy for the latter we include GDP per capita (GDPCAP). We expect a negative sign of R&DINT and a positive eect of R&DINT*GDPCAP.
(ii) Aliate-level determinants
At the aliate level, the experience in manufacturing in a country is likely to be an important determinant of the extent of vertical linkages. Finding suitable local suppliers and establishing links with these ®rms is a time-consuming process, in particular if the suppliers have to adapt to the demands of the Japanese assemblers in terms of quality and delivery schedules. In other cases, redesign of the product is necessary to allow for the use of locally made standardized components. As foreign ®rms learn through time how to develop relationships with local suppliers and how to adapt products to local markets, local procurement is expected to increase. O'Farrell and O'Loughlin (1981) found a positive eect of operating experience on the level of local procurement by foreign-owned aliates in Ireland, but Reid (1994) could not establish a similar eect for Japanese ®rms in the United States. One reason for the latter result may be that no distinction was made between green-®eld establishments and acquisitions. In case the Japanese investor acquired the local ali-ate, it is natural to assume that the aliate is relatively deeply embedded in the local econ-omy at the time of the acquisition. Hence, the number of years of operation under Japanese ownership is not likely to have an important additional impact on local content.11 We
include two experience variables, EXPER_ GRE and EXPER_ACQ. EXPER_GRE measures the number of years since operations started in newly established (green®eld) manu-facturing aliates; EXPER_ACQ measures the number of years since acquired aliates came under Japanese control. Because we expect a relatively strong increase in local content in the ®rst few years of operating in the host country and a smaller eect of additional years of experience for older aliates, we include EXPER_GRE and EXPER_ACQ in logarith-mic form. We hypothesize a positive eect of EXPER_GRE but no eect of EXPER_ACQ.
of local content than wholly owned aliates. This is because the local joint venture partner or its related ®rms may have accumulated expertise in either electronics components manufacturing or components procurement from local suppliers. Taking the wholly owned green®eld aliate as the base case, we include two dummy variables in the model, ACQUIS in case the aliate was acquired, and JV in case the aliate was established as a joint venture with a local partner. We hypothesize positive signs for both variables.
A feature of the overseas operations of Japanese electronics ®rms is a certain dichot-omy between the main motivation for the establishment of the aliates (e.g., Ernst, 1997). One group of aliates is established to access available pools of low-cost labor and is export oriented, while another group of ali-ates is primarily established to improve access to local customers and sells predominantly on the host country market. The motivation for investment and the associated market orienta-tion may have an impact on vertical linkages of the aliate in a number of ways (e.g., Lowe & Kenney, 1999; Kelegama & Foley, 1999). If the aliate's primary markets are local, it is more likely to adapt products to local tastes and circumstances, which involves local procure-ment or local developprocure-ment of components. Second, competitive price pressures may be lower on the local market compared with export markets, in particular if the local market receives some form of protection through tari or nontari barriers. This may allow local market-oriented producers to use local components even if these come at higher costs. Third, aliates selling on the local market have an incentive to reduce reliance on imports from Japan given the associated vulnerability of pro®tability to an appreciation of the Yen. Fourth, if the aliate is located in less-devel-oped countries and sells locally, it will produce and sell relatively mature and low-priced products. In that case, it is of greater impor-tance to use the low-cost standardized compo-nents that are more likely to be available locally. In sum, we expect that aliates with higher local sales ratios have higher local content. LOCSALES measures the percentage of aliate turnover destined for the local market. We expect this positive eect to be smaller the more developed the host economy. We therefore include the cross-eect of LOCSALES and GDPCAP and expect a negative sign.
There is evidence that the establishment of a substantial number of Japanese aliates has been speci®cally motivated by the need to circumvent trade barriers, such as antidumping duties, targeting Japanese ®rms' exports to the host economy (Belderbos, 1997b). If the main motivation for setting up the manufacturing aliate was to circumvent trade barriers, the investment was not a ®rst-best managerial decision based on manufacturing cost and e-ciency. Limiting investment to relatively simple assembly tasks while sourcing components from abroad may be the most cost-eective response. In particular when trade policy measures are seen as temporary (e.g., given the ®ve-year duration limit for antidumping measures or the prospects of tari reductions due to GATT negotiations or regional inte-gration initiatives), ®rms may also wish to limit their resource commitment, facilitating the relocation of investment when measures have expired. Hence we expect less extensive vertical linkages if manufacturing investments were primarily induced by trade barriers. The level of trade barriers varies substantially across products (e.g., taris) and trade protection is often targeted at speci®c products (e.g., through VERs and antidumping measures). The role of trade barriers is therefore preferably measured at the product or aliate level. Although we could not obtain detailed product information for the aliates, we could measure the ``tari jumping'' motivation directly, by utilizing a question in the MITI survey concerning the motivation for the aliate's establishment. If the aliate chose ``trade fric-tion'' from among the alternatives, the dummy variable TARJUMP takes on the value 1. A negative sign is expected.12
these industries by including three industry dummies: TELCOMP, PARTS, and CONSU-MER, and taking other electronics (OTHER-IND) as the reference case.
(iii) Country-level determinants
The most obvious country characteristic determining backward vertical linkages is the availability of locally established component suppliers. We include the variable SUPPLI-ERS, which measures the dollar value of elec-tronic parts and components production in each country in 1992. The variable SUPPLI-ERS measures the availability of locally produced components and will also generally re¯ect the attractiveness of a country to estab-lish components manufacturing operations. From both perspectives we hypothesize a positive eect on local content.13
The extent to which Japanese suppliers play a role in the local components industry is also expected to aect vertical linkages. By using longstanding suppliers from Japan established near the overseas manufacturing base, ®rms can avoid switching costs and emulate best practice in Japan. There may also be important economies of agglomeration once a substantial number of Japanese suppliers have set up local manufacturing aliates. For instance, reduced input costs can result from increased special-ization and training of local personnel. We include the variable JSUPPLIERS, which is a measure of the role of Japanese ®rms in the local components industry, and expect a posi-tive sign. Since the presence of Japanese suppliers is most likely to allow keiretsu®rms to avoid switching costs,keiretsumembers are expected to increase their local content most. We include the cross eect of JSUPPLIERS and KEIRINT and expect a positive sign. JSUPPLIERS is de®ned as the number of Japanese plants producing electronic compo-nents and materials in the country, divided by SUPPLIERS. A comprehensive data source on Japanese electronics production abroad (Denshi Keizai Kenkyujo, 1994) was used to calculate plant counts. To incorporate dier-ences in plant scale, we counted each compo-nent manufactured in multicompocompo-nent plants separately.
The cost advantage of using a local network of suppliers also depends on the quality of the infrastructure. A good infrastructure facili-tates physical transport of components within the country and communication between assembler and suppliers (Lowe & Kenney,
1999). The quality of infrastructure has also been found to exert a signi®cantly positive impact on inward investment (Hackett & Srinivasan, 1998). As a proxy for the quality of infrastructure we include the variable INFRA, which measures the number of tele-phone lines per capita (International Tele-communication Union, 1995). We expect a positive sign.
An important issue is to what extent local content rules directed at increasing the local content of (foreign-owned) manufacturing operations are successful in increasing back-ward vertical linkages. We include a country variable, LCR, which measures the severity of local content regulations in host countries. LCR is taken from a survey among US multi-national ®rms conducted by Business Interna-tional Corporation (1989) and measures the severity of such regulations on a scale between 0 and 10. We expect a positive sign. As noted before, a certain level of local content is often required if investing ®rms wish to bene®t from tax grants and other incentives schemes oered by national and regional authorities in the United States and Europe. In less developed countries there often is a similar preferential treatment to foreign investment projects contingent on local content (among other requirements). Malaysia, for instance, grants ``Pioneer status'' (entitling to tax exemptions) to investments which meet a number of condi-tions, among which local content requirements (Commission of the European Communities, 1998). These incentive schemes and their conditions vary per investment project, intro-ducing a degree of discretion in the application of local content rules. This implies that there could be an important ®rm-speci®c element in local content regulations. We therefore also include a measure of local content requirements at the level of the individualaliatein addition to the country variable LCR. LCR_AFF is a dummy variable taking the value one if the aliate indicated in the MITI survey that local content rules are aecting its manufacturing operations.
(b) The data set
in the electronics industry had sucient infor-mation on the local content ratio and the explanatory variables.14
Table 1 shows the distribution of aliates over countries and the average (unweighted) local content ratio of the aliates. The local content ratio is relatively high at 80% in the largest developed economy, the United States. Local content in European countries is lower in general. The lowest ratios are recorded in ASEAN countries (with the exception of Singapore), China, and Ireland. In India and Brazil, two countries known for strict regula-tions on multinational ®rms, local content is relatively high, which appears to provide some indication of the role of local content regu-lations. Caution should be exercised, however, in drawing conclusions from simple tables such as Table 1. Characteristics of aliates, such as whether they are acquired or not, vary across countries and have an important impact on local content. More accurate insight into the role of country, aliate, and parent ®rm characteristics is provided by the multivariate empirical analysis reported in the next section.
4. EMPIRICAL RESULTS
The results of ®ve models explaining the local content ratio of Japanese aliates are presen-ted in Table 2. Model 1 ®rst tests the explana-tory power of the independent variables if Japanese supplier linkages and keiretsu membership are not taken into account. The model generally performs well. All explanatory variables with the exception of LCR_AFF have the expected sign and most variables reach conventional signi®cance levels. In addition, robustness tests showed no evidence of heter-oskedasticity or correlated error terms.15
As hypothesized, R&DINT is signi®cantly negative while its cross eect with GDPCAP is positive and signi®cant at the 10% level (two-tailed test). Technology-intensive parent ®rms operate aliates with lower local content but this eect is smaller if the aliates are located in developed countries. The estimated coe-cients imply that R&DINT no longer has a negative impact if GDP per capita exceeds US$17,500, a level reached by the United States, Canada, and a number of Western European countries. The operating experience of newly established aliates EXPER_GRE is positive as predicted, and signi®cant at the 10% level. The estimated coecient implies, however, that a doubling of experience years (equal to roughly 10 years extra experience in the sample mean) leads to an increase in the local content ratio of no more 0.032 points.16 Clearly, this magnitude of the experience eect is rather small, and the results can only provide partial support for the ``vintage eect'' expla-nation for Japanese ®rms' procurement behavior. The coecient of experience for acquired aliates, EXPER_ACQ, is negative but has a very large estimated variance. The hypothesis that operating experience plays no role for acquired ®rms cannot be rejected. The results show the importance of making a distinction between entry modes when assessing the impact of experience in the host economy. A very large and signi®cant eect is estimated for the ACQUIS dummy. It can be calculated that an acquired aliate has a 0.47 point higher local content ratio than a newly established wholly owned aliate, ceteris paribus. The coecient of the joint venture (JV) dummy is signi®cant but its value is about seven times lower than that of ACQUIS: joint ventures have a 0.07 point higher local content ratio than green®eld aliates. The percentage of local sales in total sales of the aliate,
Table 1. Number of Japanese manufacturing aliates and average local content ratio by country
# Aliates Local content ratio
United States 44 0.81
Canada 5 0.71
United Kingdom 19 0.66
Germany 7 0.57
France 5 0.50
Spain 4 0.73
Belgium 2 0.80
Netherlands 2 0.65
Ireland 2 0.49
Hong Kong 6 0.63
South Korea 20 0.63
Singapore 24 0.68
Taiwan 34 0.74
Indonesia 5 0.72
Malaysia 36 0.56
Philippines 4 0.54
Thailand 27 0.53
India 4 0.87
China 7 0.54
Mexico 2 0.95
Brazil 10 0.86
Venezuela 1 0.60
Australia 1 1.00
LOCSALES, has the hypothesized positive eect and is signi®cant. The cross eect with GDPCAP has the predicted negative sign but just fails to reach conventional signi®cance levels. 17 The negative and signi®cant coe-cient of the TARJUMP dummy con®rms that
aliates established to circumvent trade barri-ers establish fewer vertical linkages. This negative eect is relatively large: tari jumping motivation reduces local content by 0.14 points. This result provides support for the hypothesis that the role of trade barriers in
Table 2. Determinants of the local content ratio of Japanese manufacturing aliatesa
Model 1 Model 2 Model 3 Model 4 Model 5
R&DINT )1.370 )1.540 )1.522 )1.532 )1.480
)2.154 )2.443 )2.412 )2.446 )2.353
R&DINT*GDPCAP 0.079 0.074 0.075 0.082 0.079 1.851 1.750 1.756 1.927 1.866
log EXPER_GRE 0.035 0.042 0.042 0.038 0.038
1.913 2.339 2.307 2.078 2.083
log EXPER_ACQ )0.021
)0.449
ACQUIS 0.510 0.467 0.463 0.442 0.436
2.186 4.71 4.648 4.484 4.416
JV 0.074 0.067 0.067 0.071 0.073
2.342 2.165 2.169 2.318 2.366
LOCSALES 0.249 0.237 0.233 0.232 0.229
4.002 3.852 3.773 3.793 3.747 LOCSALES*GDPCAP )0.008 )0.007 )0.007 )0.006 )0.006
)1.523 )1.453 )1.430 )1.252 )1.263
TARJUMP )0.149 )0.154 )0.152 )0.149 )0.148
)3.520 )3.656 )3.617 )3.569 )3.550
INFRA 0.003 0.003 0.003 0.002 0.003
1.974 2.239 2.243 1.742 1.800
SUPPLIERS 0.001 0.001 0.001 0.001 0.002
0.933 0.836 0.844 1.014 1.058
LCR 0.025 0.029 0.028 0.025 0.024
1995 2.220 2.210 1.989 1.886
LCR_AFF )0.008 )0.003 )0.002 0.006 0.006
)0.233 )0.085 )0.068 0.180 0.177
KEIRINT 0.085 0.072 0.085 0.062
2.663 1.745 2.696 1.401
JSUPPLIERS 0.001 0.001
1.068 0.712
KEIRINT*JSUPPLIERS 0.001
0.472
JSUPPLIERS*DRATIO 0.009 0.007
1.932 1.278
KEIRINT*JSUPPLIERS*DRATIO 0.006
0.749 CONSUMER )0.020 )0.045 )0.045 )0.047 )0.048
)0.448 )0.979 )0.981 )1.037 )1.057
TELCOMP )0.040 )0.061 )0.064 )0.073 )0.076
)0.628 )0.975 )1.009 )1.151 )1.207
PARTS )0.024 )0.003 )0.006 0.014 0.009
)0.541 )0.072 )0.131 0.287 0.179
CONSTANT 0.330 0.318 0.324 0.328 0.338
2.435 3.451 3.484 4.027 4.102
Log-likelihood 15.233 19.042 19.153 20.321 20.601
Observations 272 272 272 272 272
aThe omitted industry is other electronics, the omitted entry mode dummy is green®eld with full ownership.
*Signi®cant at the 10% level.
**
Signi®cant at the 5% level. ***
inducing Japanese FDI contributes substan-tially to the explanation of Japanese ®rms' relatively less developed vertical linkages.
Among the country and industry variables, the quality of the host country's infrastructure, INFRA, is positive and signi®cant at the 5% level. The coecient for SUPPLIERS (the value of electronic parts production), on the other hand, is positive but not signi®cant. A possible explanation is that investing ®rms, confronted with a small local supplier base, compensate reduced local procurement with extended intra-aliate vertical integration in case the investment climate (as indicated by the quality of the infrastructure) is supportive. Hence, we expect a more pronounced eect of SUPPLIERS on the local procurement part of the local content ratio (we explore this issue further below). The strictness of local content regulations in the host country (LCR) has the predicted positive and signi®cant eect on the local content ratio. Given that the indicator of local content regulations varies between six (for Brazil) and zero (for Hong Kong among others), the maximum eect of local content regulations is about 0.13 points. After controlling for the eect of country dierences in local content rules, it appears not to matter whether individual aliates indicated that they were confronted with such rules. LCR_AFF has a counterintuitive negative sign but is not signi®cant.18 The industry dummies neither reach statistical signi®cance, suggesting that there is not much systematic variation in local content across industry segments.
Model 2 introduces two new explanatory variables: KEIRINT and the measure of the importance of Japanese suppliers in the host countries (JSUPPLIERS).19The positive and signi®cant eect of KEIRINT suggests that ®rms that have built up intensive supplier linkages within vertical keiretsu operate ali-ates with higher local content. The relative importance of local component production set up by Japanese ®rms, JSUPPLIERS has the expected positive sign but is not signi®cant. Overall, the ®t of the model improves mark-edly once the two variables are included. Several other coecients reach higher values and are estimated with a smaller variance, while the log-likelihood increases signi®cantly. This demonstrates the importance of taking keiretsu supplier linkages into account. Since the switching cost perspective predicted that any positive eect of keiretsuintensity should impact through increased procurement from
related Japanese suppliers within the group, we added the cross eect of KEIRINT and JSUPPLIERS in model 3. Its sign is positive as expected but the coecient is not signi®-cant.
The reason for the insigni®cant eects of JSUPPLIERS in models 2±3 may be the dichotomy in investment motivation and market strategy of Japanese electronic compo-nent producing aliates. In particular in East Asia, a substantial number of aliates are established to serve export markets (for instance, in case of assembly and testing of semiconductors) and the components that are manufactured are less likely to match the speci®cations of demand by the local electron-ics industry. Other components manufacturing aliates are speci®cally established to service an expanding local electronics manufacturing industry. If there are systematic dierences in the share of export-oriented versus local-mar-ket oriented aliates across countries, it will be dicult to estimate a robust eect of the importance of the relevant Japanese supplier base. In models 4 and 5 we therefore test as an alternative (but narrower) hypothesis that the size of the local Japanese supplier base with a local market orientation has a positive impact on the local content of Japanese manufacturing aliates. We multiply JSUPPLIERS with DRATIO, the weighted average share of sales by Japanese electronic component producing aliates in the host country directed to the host country market (MITI, 1994). In Model 4, JSUPPLIERS*DRATIO indeed has the predicted positive eect and easily passes the 10% signi®cance mark. Hence, the presence of Japanese component manufacturers does have a positive impact on local content once we control for their sales orientation. On the other hand, the cross eect of JUSPPLI-ERS*DRATIO with KEIRINT remains insig-ni®cant in Model 5.
component supplier base and the presence of Japanese suppliers, primarily aect the local procurement part of local content. Hence, we expect a stronger impact of these variables on local procurement than on local content. This hypothesis is con®rmed by the results of two models explaining the aliates' local procure-ment ratio reported in Table 3. In both models
the value of electronics components production in the host country, SUPPLIERS, has the expected positive and signi®cant eect on local procurement. Both KEIRINT and JSUPPLI-ERS*DRATIO are positive and signi®cant at the 10% level in the ®rst model, con®rming the importance of keiretsu membership and the strength of the local Japanese supplier base. In the second model in Table 3, the cross eect of KEIRINT and JSUPPLIERS*DRATIO is positive and signi®cant at the 5% level, while neither KEIRINT nor JSUPPLI-ERS*DRATIO reach statistical signi®cance (KEIRINT even has a negative sign). Hence, the primary eect of keiretsu membership on the local procurement ratio indeed is through its interaction with locally established Japanese suppliers. These ®ndings suggest that keiretsu members are able to increase local procurement by replicating existing supplier linkages within keiretsu networks overseas. Although the higher local procurement and local content levels of keiretsu ®rms provide bene®ts to the host economy, the implication is also that these bene®ts do not extend to locally owned suppliers.
Most other explanatory variables in models 1 and 2 in Table 3 have similar estimated eects as in the local content analysis, but a few contrasting results are noted. The JV dummy and the quality of infrastructure INFRA have the expected positive sign but are no longer signi®cant. A counterintuitive result is obtained for the cross eect of R&DINT and GDPCAP. The estimated coecient is negative and signi®cant, which suggests that R&D-intensive ®rms procure fewer compo-nents locally in more developed host econo-mies. The apparent explanation is that R&D-intensive ®rms in industrialized coun-tries have a relatively strong preference for intra-aliate vertical integration into the production of proprietary components. They exhibit substantially higher value added but relatively lower local procurement levels.20 Most notable is the negative (but insigni®cant) eect of local content regulations. While we found that local content rules increase local content levels of Japanese aliates, this apparently does not involve increased procurements from suppliers in the host country. The investing ®rms'response is primarily one of increasing in-house produc-tion of parts and components. This suggests that local content rules are less eective in developing the indigenous supplier base.
Table 3. Determinants of the local procurement to sales ratio of Japanese manufacturing aliatesa
Model 1 Model 2
R&DINT 0.299 0.452 0.450 0.682 R&DINT*GDPCAP )0.079 )0.086
)1.758 )1.930
log EXPER_GRE 0.032 0.033 1.695 1.733
ACQUIS 0.279 0.264
2.727 2.599
JV 0.024 0.029
0.749 0.905
LOCSALES 0.161 0.154
2.497 2.413 LOCSALES*GDPCAP )0.002 )0.002
)0.339 )0.387
TARJUMP )0.095 )0.092
)2.146 )2.104
INFRA 0.001 0.002
0.960 1.138 SUPPLIERS 0.003 0.003 1.704 1.849
LCR )0.011 )0.014
)0.798 )1.071
LCR_AFF )0.007 )0.008 )0.199 )0.210
KEIRINT 0.059 )0.008
1.798
)0.181
JSUPPLIERS*DRATIO 0.008 0.002 1.712 0.360 KEIRINT*JSUPPLIERS*
DRATIO
0.016
2.123
CONSUMER 0.020 0.017
0.419 0.368 TELCOMP )0.051 )0.061 )0.774 )0.940
PARTS )0.031 )0.046 )0.626 )0.934
CONSTANT 0.062 0.092
0.724 1.078
Log-likelihood )2.922 )0.691
Observations 272 272
a
The omitted industry is other electronics, the omitted entry mode dummy is green®eld with full ownership. *
Signi®cant at the 10% level. **Signi®cant at the 5% level.
5. CONCLUSION
This paper examined the determinants of the extent to which multinational ®rms establish backward vertical linkages in host economies through an analysis of the local content ratio (the ratio of local procurement and intra-af-®liate value added over sales) of 272 Japanese electronics manufacturing aliates in 24 countries. Strict local content regulations in the host country have a positive, while rela-tively modest, impact on the local content ratio. The results also suggested that this increase in local content is primarily achieved through intra-aliate component production (vertical integration) and not through increased procurement from host country suppliers. Hence, there is no evidence that local content rules help to develop the locally owned supplying industry. Other host country factors with a positive impact on backward vertical linkages are the quality of infrastruc-ture and the size of the host country's components supplying industry. On the other hand, trade barriers (e.g., antidumping measures) induce import-substituting invest-ments that generate substantially fewer back-ward linkages.
A variety of aliate and parent ®rm char-acteristics were also found to have an impact on the establishment of backward vertical linkages. The entry mode of the aliate was found to have a major impact on vertical linkages as green®eld aliates recorded signif-icantly lower local content ratios than both joint ventures and acquired aliates. Acquired aliates in particular, showed much higher local content levels due to their pre-acquisition embeddedness in the local economy. The motivation of investment and associated marketing strategy of the aliates was also found to aect the creation of backward verti-cal linkages. Aliates established to access the local customer base and selling a larger share of output on local markets recorded higher local content ratios than aliate established to sell in export markets. A local sales orientation makes it more likely that products are adapted and re-designed to suit local consumer demand, in the process of which the availability of local supply sources is taken into account. The parent ®rm's R&D intensity was found to negatively aect local content levels in less developed countries. R&D-intensive ®rms make greater use of nonstandardized and technology-intensive proprietary components often developed and
produced by the ®rm in Japan. In less economically advanced countries the condi-tions for production of such components are less favorable. Operating experience of the aliate exerted a positive though relatively small in¯uence on local content. This providesÐlimitedÐevidence for the ``vintage eect'' hypothesis that lower levels of local procurement by Japanese ®rms abroad are a result of their limited experience as multina-tional ®rms. We did not ®nd evidence that longstanding ties between suppliers and assemblers within vertical business groups (keiretsu) led to lower local content levels. On the contrary, a robust result was that aliates of which the parent ®rm belongs to a vertical keiretsu with intensive intra-keiretsu supplier relationships reach signi®cantly higher local content levels. We found preliminary evidence that this is achieved through coordinated investments in overseas manufacturing opera-tions by the ``core'' assembling ®rm and its suppliers within the keiretsu. Although we could not establish thatkeiretsu®rms primarily reach higher local content levels in case the host economy has a relatively large cluster of Japa-nese-owned component suppliers, we did ®nd that localprocurementis signi®cantly higher in these circumstances. This suggests that attracting investments by large ``core'' ®rms may provide bene®ts in the form of follow-up investments by their keiretsusuppliers and the resulting deepening of vertical linkages. The bene®ts to the host economy again do not extend to locally owned suppliers because vertical linkages remain intra-group.
multinational ®rms is that such investment is much less likely to result in extensive back-ward vertical linkages. The same holds true for restrictive trade policies that attract import-substituting investment. Local content rules can only alleviate this problem to a limited extent, as no evidence was found that they help to increase procurement from local suppliers. More important, there is evidence that such local content rules negatively aect the volume of (US and in particular Japanese) manufacturing investment Hackett and Srini-vasan (1998), which implies that their overall eect on the development of the local supply-ing industry may even be negative. This suggests that more informal policies that speci®cally reward foreign investors for estab-lishing cooperative relationships with locally owned suppliers may be more eective in developing the local supply base (Brannon et al., 1994).
The results also allow us to judge what the main reason is for the relatively weak incli-nation of Japanese ®rms to establish vertical linkages in comparison with European and US multinationals, as observed in previous studies. The greater importance of a ``tari jumping'' motivation for Japanese manufac-turing investment appears the most likely explanation for this dierence. Yet another factor, which has not been emphasized previously, may be equally important: Japa-nese ®rms' traditionally strong reliance on green®eld investments to expand manufactur-ing operations abroad. Given the much deeper backward vertical linkages of acquired ®rms, higher local content levels reached by EU and US multinational ®rms may well be a
consequence of a greater preference for acquisitions. Future comparative work on procurement practices should attempt to control for these and other aliate charac-teristics.
Also high on the research agenda is an extension of procurement analysis to include the second half of the 1990s. There is emerging evidence that procurement practices by (Japanese) aliates abroad have under-gone major changes in this period. Baba and Hatashima (1995) and Chia (1995) argue that Japanese ®rms are moving away from the use of ®rm-speci®c components developed inter-nally or within the verticalkeiretsutoward the open purchase of standard components. Greater competitive pressures have forced the ®rms to redesign products in order to facili-tate the procurement of cheaper mass-pro-duced components. Similarly, Ernst (1997) suggests that Japanese ®rms are increasing their backward vertical linkages in Asia in order to remain competitive by increasing the speed to market for new product designs and to make better use of the growing techno-logical and industrial capabilities in Asia. Furthermore, there are indications that the increased costs of components imported from Japan due to the depreciation of Asian currencies has spurred Japanese aliates to increase local procurement.21 More insight into the procurement strategies and local vertical linkages of Japanese ®rms may be obtained by investigating changes in vertical linkages throughout the 1990s, for electronics and other investing industries. We hope to be able to contribute to research in this area in future.
NOTES
1. The NAFTA rule of origin for automobiles, for example, implies that cars assembled in NAFTA coun-tries can only be traded duty-free within the region if at least 62.5% of value added is generated within the trade bloc. This rule de facto aected the operations of Japanese ®rms in a discriminatory way (Lopez-de-Silanes, Markusen, & Rutherford, 1996).
2. The empirical literature on the impact of inward FDI on developing countries' (productivity) growth has not been unambiguous. For instance, Haddad and Harrison (1993) did not ®nd evidence of productivity increasing technology spillovers from foreign-owned
3. For instance, Kinoshita (1996) studied the impact of Japanese FDI on the productivity of locally owned ®rms in China and found that productivity growth was positively aected by the presence of supplier linkages with foreign-owned ®rms. Weaker results have been obtained for productivity growth by US automobile component suppliers selling to Japanese-owned assem-bly plants in the US (Okamoto, 1999).
4. The analysis builds on Belderbos, Capannelli, and Fukao (forthcoming), which focused on aliate and parent ®rm in¯uences on procurement practices in nine Asian countries.
5. Vertical business groups are groups of subcontrac-tors, satellite ®rms and trading ®rms around major large-scale assembly-type manufacturers such as Toyota and Hitachi. The ``leading'' or ``core'' ®rm usually exerts control over the management of the other ®rms in the group, enforced by shareholding, ®nancial ties and the dispatch of managers.
6. In addition, there is conceptually little dierence between intra-aliate production of components (intra-aliate vertical integration) and procurement from nearby plants set up by the same parent ®rm or its aliated ®rms. The latter may represent a sizeable share of measured local procurement for larger ®rms that habitually establish separately incorporated aliates for overseas component production. In contrast, measured local procurement is systematically lower for ®rms choosing to establish component plants within the legal boundaries of existing assembly operations. Such dier-ences in legal boundaries make the distinction between local procurement and intra-aliate value added arti®-cial. It is dicult to assess the extent of this problem. The correlation coecient between the local content ratio and the local procurement ratio reaches 65%.
7. The MITI data do allow for a distinction between procurements from suppliers owned by the same parent ®rm as the aliates (``intra-group procurement'' in the MITI terminology). There is no distinction, however, between procurements from third country, Japanese or locally owned suppliers, and the question on intra-group procurement has a low response rate.
8. Some aliates were also engaged in import and wholesaling activities besides their manufacturing activ-ities. Since we are interested in the local content of manufacturing operations, we corrected for the distort-ing eect of the import business by makdistort-ing a distinction between import of inputs to the manufacturing process and imports of ®nished goods destined for wholesaling. We subtracted the value of imports of such ®nished
goods from both the total sales value and the total import value, which leaves the local content of manu-facturing operations.
9. We note that there is a strong, but not a perfect, correlation between the degree of intra-aliate back-ward vertical integration and intra-aliate value added, since measured value added is also aected by pro®t-ability and wage levels, for example. We do not, however, expect a strong or systematic bias arising from this measurement imperfection.
10. There is some evidence for this assertion: Fukao, Izawa, Kuninori, and Nakakita (1994) found that R&D intensity has a signi®cantly negative impact on the stock of foreign direct investment in Asia by Japanese electronics ®rms but a positive impact on investment in Europe and the United States.
11. It is even conceivable that under Japanese owner-ship a restructuring of manufacturing activities takes place that involves a switch to the use of components made in Japan.
12. On the other hand, if countries that frequently use anti-dumping and other trade restricting measures also erect systematically higher import barriers for compo-nents, tari-jumping ®rms may be forced to increase the local content of their operations.
13. The proximity of these suppliers to the Japanese investors (cf. Lowe & Kenney, 1999) will also in¯uence local procurement. Unfortunately, no data are available on the distribution of component production across regions within countries. We did attempt to correct for the largest potential dierences in proximity by including population density (number of inhabitants per square km) as an explanatory variable. The higher this density, the more geographically concentrated component production is likely to be and the easier local procure-ment linkages are established. For instance, Singapore's component production is clustered in an extremely small geographic area, while component production in China is spread along various coastal provinces and the Beijing area. In our estimates, the density measure never reached statistical signi®cance, either included as a separate variable or as a moderating factor for SUPPLIERS, while its inclusion left the other estimates in Tables 2 and 3 largely unchanged. The results are not shown here because of space limitations.
15. We re-estimated the models allowing for the most general form of multiplicative hetereskedasticity with the variance dependent on all right-hand side variables with the exception of the constant term: rirec0z
(Greene, 1997a, p. 968; Greene, 1997b, p. 598). We employed a log-likelihood ratio test comparing these models with the original models, but the hypothesis of homoskedasticity could not be rejected. For instance, for model 4 thev2-distributed test statistic of 18.72 was
below the critical value at the 5% signi®cance level of 27.6, which implies that c0 cannot be rejected. We also tested whether error terms were correlated across aliates of the same parent ®rms by regressing the error terms on a set of large ®rm dummies. In addition, the hypothesis that all coecients were jointly zero could not be rejected, implying that there is no evidence of such correlation.
16. The coecients in the two-limit Tobit model cannot be directly interpreted as magnitudes of the eect of the explanatory variables. We calculated the impact eects (derivatives) of the explanatory variables in the conditional mean (Greene, 1997b, p. 588). Because the predicted value of local content only reaches the censoring limit 1 for few observations, the calculated derivatives deviate only marginally from the coecients reported in Tables 2 and 3. The coecients reported in the tables can therefore be interpreted as rough estimates of impact eects.
17. Including GDPCAP as a separate explanatory variable neither produced signi®cant results.
18. On the other hand, the negative sign for ACQ_AFF may also stem from a reporting bias in this variable, which occurs if aliates that faced the largest diculties in raising local content to required levels (aliates with a low level of local content ex ante) are more inclined to report the presence of local content rules. We are not able to assess the extent of this bias.
19. EXPE_ACQ is omitted in models 2±5 since the hypothesis that there is no experience eect for acquired aliates was con®rmed.
20. Indeed, in a model with value added over sales as dependent variable (not shown), R&DINT*GDPCAP turned out to have a strongly signi®cant positive eect.
21. For example, Hitachi Consumer Products in Thai-land reportedly planned to raise the local content of its washing machine manufacturing operations from 43% (in early 1998) to 85% within a year. See ``Local Procurement up in Southeast Asia'',Nikkei Weekly, 27 July 1998.
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