Toward Expanding Sluggish Inward Foreign Direct Investment in Japan
1. Inward foreign direct investment in Japan is at a low level
Inward foreign direct investment in Japan has been on an upward trend, with some fluctuations, since the 1990s (Figure 1). In the 1990s, investment remained around 1 billion dollars every year before the Asian currency crisis in 1997, and then began to increase in 1999 in response to the economic recovery after the crisis. Entering the 21st century, inward foreign direct investment into Japan was supported by the steady growth of the global economy and remained above the previous level. However, it started to decrease in 2005, and in 2006 recorded a negative inflow (the amount of withdrawals exceeded the amount of new investment). The trend reversed to rapid growth in 2007 when it exceeded 20 billion dollars. This level was maintained throughout 2008, but it turned to a downward trend from 2009, and in 2010 saw a negative flow. One of the causes was the change of reinvestment income from positive to negative, reflecting the decline in corporate profits since the financial crisis.1 Significant fluctuations year to year are characteristic with foreign direct investment partly because of the scale of each foreign direct investment; however, the level of foreign direct investment in Japan is low compared to other developed countries and China. In fact, looking at the amount of inward foreign direct investment, the ratio Japan accounted for globally as of 2010 was 1.13%, which is extremely low compared to the ratio of GDP which is 8.64%.2
2011-2012 JIIA Research Project: Policies Needed to Ensure Japan’s International Competitiveness
Figure 1 Inward foreign direct investment flows
Source: UNCTAD, UNCTADstat online
In order to see the significance of inward foreign direct investment to the economy, the ratio of inward foreign direct investment amount to GDP is calculated as of the end of 2010 (Figure 2).
Japan's ratio of inward foreign direct investment to GDP is 3.9%, which is the lowest among the countries in the figure. The ratio for the U.K. is 48.4%, more than 10 times higher. The ratio of other major developed countries, such as the U.S. and Germany, is around 5 to 6 times higher than Japan. Compared to China, India and South Korea, as well, Japan's ratio is materially low, at about one third of their ratio. China actively accepted foreign capital through preferential policies for foreign capital since the reform and door-opening policies in 1979 until recently, and thus it is expected that the inward foreign direct investment to GDP ratio is considerably higher than Japan.
South Korea and India, on the other hand, adopted more hesitant policies toward inward foreign direct investment compared to China until recently, and as a result it is unexpected to see their ratios at a considerably higher level than Japan, indicating the low level of foreign direct investment in Japan.
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Figure 2 Ratio of inward foreign direct investment to GDP: 2010
Source: Calculated from UNCTAD, UNCTADstat online and World Bank, World Development Indicators online
Foreign direct investment comes in two forms: green field investments to establish new companies and M&As to purchase existing companies. The trend is that expansion into developed countries tends to be more through M&As, while expansion into developing countries tends to be more through green field investments. In such a context, M&As in inward foreign direct investment in Japan are at a low level compared to other developed countries. For example in 2010, Japan accounted for only 1.1% of the acquired companies in M&As worldwide, which is considerably lower than the U.S. (18.6%), the U.K. (14.8%), Germany (4.0%), etc.3
Let us look at the investing countries and the recipient sectors of the foreign direct investment in Japan (Table 1). As for the investing countries by region, Europe and North America accounted for a large proportion, with 43% and 34%, respectively. Asia accounted for 11%. By country, the ratio of the U.S. was overwhelmingly high at 34%, followed by the Netherlands (17%) and France (9%).
Within Asia, Singapore was sizable at 6.5% of the total. The notable increase in investment in Japan from Asia is a feature in recent years. Although the amount of foreign direct investment fluctuates significantly year to year, as mentioned earlier, the amount of foreign direct investment
2011-2012 JIIA Research Project: Policies Needed to Ensure Japan’s International Competitiveness
from Asia increased about three fold between 2009 and 2010.4
Table 1 Foreign direct investment in Japan (Balance as of the end of 2010)
Source: Bank of Japan "Direct Investment Position by Region and Industry"
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As for the sectors that received investment, non-manufacturing industries accounted for 65% and manufacturing industries 35%. Within the non-manufacturing industries, the finance and insurance industries accounted for an overwhelmingly large portion, which was 44% of all the sectors and 68% of the non-manufacturing sector. In the non-manufacturing sector, the finance and insurance industries are followed by the wholesale and retail industries, which accounted for 7.5% of all the sectors. In the manufacturing sector, a large share is formed by electric machinery and apparatus, transport machinery and apparatus, chemical and pharmaceutical industries, each accounting for 11.7%, 9.1% and 7.7% of all sectors, respectively.
Let us examine the aim of foreign companies in investing in Japan by looking at the function of the business they established in Japan. In Figure 3, the functions of business set up by foreign companies are grouped into 5 categories: sales and marketing, research and development, manufacturing and processing, distribution, and back-office; and the number of business establishments by function per foreign company is shown. The figure shows that an overwhelming number of business establishments are carrying out marketing and sales, both in manufacturing industries and non-manufacturing industries. This observation confirms that foreign companies are coming into Japan in order to expand sales in the Japanese market. As for other functions, manufacturing companies have a relatively large number of business establishments with manufacturing and processing functions, as one would expect. Compared to non-manufacturing industries, more companies have business establishments with research and development functions in manufacturing industries.
Figure 3 Number of Offices of Foreign Affiliates in Japan by Function (Average per Company)
2011-2012 JIIA Research Project: Policies Needed to Ensure Japan’s International Competitiveness
Source: The 44th Survey of Trends in Business Activities of Foreign Affiliates, by the Ministry of Economy, Trade and Industry, FY2009 results
From the perspective of foreign-affiliated companies, Japan is becoming less attractive as a base for various functions in conducting business in Asia. Table 2 shows the results of surveys in 2007 and 2009 where European and American companies evaluated the attractiveness of countries in East Asia by function. In the survey results in 2007, Japan was the most attractive country as a base overseeing business in Asia and for R&D, while China was most attractive for manufacturing, back office and as a distribution base. In the 2009 survey, however, China was evaluated as the most attractive country for all functions, while Japan only made it to No. 2 for R&D, and not even to 3rd for the other functions. In order to increase inward foreign direct investment, Japan needs to improve its attractiveness as an investment destination (as a location to establish a business base).
Table 2 Level of attractiveness from the perspective of foreign-affiliated companies by location in 5 main countries and areas in East Asia
Note: Each responding company selected a country/region for each base.
Note: 209 companies responded for the 2007 survey, and 180 for 2009.
Source: “White Paper on International Economy and Trade 2011” by the Ministry of Economy, Trade and Industry