Toward Expanding Sluggish Inward Foreign Direct Investment in Japan
2. Significance of inward foreign direct investment for the Japanese economy
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
economic growth has a spillover effect on other companies and industries through the "input-output relationship" where the subsidiary procures raw materials such as parts from other companies and the goods produced by the subsidiary are used as input goods in production by other companies, thereby amplifying the effects of the promotion of economic growth. The level of impact by overseas subsidiaries on imports and exports depends significantly on the purpose of establishing the overseas subsidiaries. Overseas subsidiaries as export bases will have a significant effect on export expansion, but those established for sales in the host market will not have an impact on export expansion. Many of China's foreign direct investments were to establish bases for export, and therefore the ratio of export by overseas subsidiaries of foreign-affiliated companies reached a high level of about 50%.
The aim of foreign direct investment is to operate a company overseas, thus foreign direct investment transfers not just investment funds but also management expertise that is essential to management, and technology is also transferred abroad. These transfers occur in two stages. The first stage is a transfer from the parent company that makes foreign direct investment to the subsidiary that is established overseas, and the second stage is from the overseas subsidiary to other local companies. The transfer of management expertise and technology in this form is called a spillover, which works out in more concrete terms by local workers utilizing skills gained by working for the overseas subsidiary in other local companies they then moved to or in their own companies they establish.
Management expertise and technology are transferred via foreign direct investment, but the transfer is not automatic and the existence or non-existence of such a transfer or its degree depends on the intention and ability of both investors and the recipients of investment. According to existing research, with regards to the transfer of management expertise and technology from parent companies to overseas subsidiaries, the degree of transfer is higher the higher the ratio of investment by the parent company into the subsidiary is. Management expertise and technology are a source of competitive power for companies, and therefore they seek to avoid them becoming known by other companies. As a result, when the overseas subsidiary is 100% wholly-owned by the parent company, the chances are high for management expertise and technology to be transferred.
On the other hand, the chance of management expertise and technology to be transferred is low when the overseas subsidiary is a joint venture with another company. The degree of transfer of management expertise and technology also depends significantly on the recipient. Even when a foreign company wants to transfer management expertise and technology to an overseas subsidiary,
2011-2012 JIIA Research Project: Policies Needed to Ensure Japan’s International Competitiveness
the transfer does not take place if the personnel employed by the overseas subsidiary are less able.
Similarly, the spillover of technology from overseas subsidiaries to local companies takes place when the workers at local companies are able, but the transfer does not progress if their ability is low.
There is also a high possibility that the establishment of overseas subsidiaries by foreign companies intensifies competition in the host market, which acts as a stimulus to improve the efficiency of local companies. More specifically, the manufacturing efficiency increases for the overall economy as a result of cutting out the unnecessary use of production factors such as labor and capital to face competition, or tackling the development of new products and new technology in a more proactive manner.
So far, the effect of promoting economic growth in the countries that receive foreign direct investment has been examined; however, it is also possible that the entrance of more competitive foreign companies will drive away domestic companies, leading to the formation of monopolistic situations by foreign companies and damage as a result of monopolization. Such damage may occur in developing countries with small markets, but such a possibility is small for a country like Japan where economic development is advanced and the market is large. In light of these points, let us examine the effect of foreign direct investment on the countries that receive investment.
On the basis of the above discussion, let us examine the significance and the role of inward foreign direct investment for the Japanese economy. First of all, let us examine the ratio of foreign- affiliated companies in major economic activities such as employment, capital investment, imports and exports, and research and development. Table 3 shows the number of permanent employees working for foreign-affiliated companies in 2009 by industry. The number for all industries was 510,000 employees. Since the total number of permanent employees in Japan in the same year was 38.9 million,5 the number of permanent employees working for foreign-affiliated companies accounted for only 1.3% of all permanent employees. However, the definition of foreign-affiliated companies in the Survey of Trends in Business Activities of Foreign Affiliates by the Ministry of Economy, Trade and Industry was a company of which one third or more of the shares are owned by a foreign company. If the 10 % ownership, which is the definition of foreign direct investment for balance of payments statistics by the International Monetary Fund (IMF), is applied, the number and ratio of foreign-affiliated companies in terms of the number of companies and the number of permanent employees will be larger. I would also like to point out that the number of permanent employees has significantly increased compared to the past. More specifically, the number of
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permanent employees in 2002 was 290,000.
Table 3 Number of people employed by foreign-affiliated companies
Source: The 44th Survey of Trends in Business Activities of Foreign Affiliates, by the Ministry of Economy, Trade and Industry, FY2009 results
2011-2012 JIIA Research Project: Policies Needed to Ensure Japan’s International Competitiveness
By industry, 329,000 people are employed by foreign-affiliated companies in non-manufacturing industries and 184,000 in manufacturing industries, which account for 65% and 35% of all industries, the same ratio of the investment amount examined in the previous sector. By industry, wholesale, finance and insurance, services, retail and information and communication are the sectors that create a lot of jobs in non-manufacturing industries. In manufacturing industries, many jobs are created in transport machinery, information and communication equipment, pharmaceutical goods and chemicals.
In terms of capital investment, foreign-affiliated companies invested 575 billion yen (in FY2009), while the figure for all incorporated businesses was 33.09 trillion yen, hence the foreign-affiliated companies ratio to all incorporated businesses was 1.7%. This ratio is high compared to the ratio of foreign-affiliated companies in terms of permanent employees, indicating that foreign-affiliated companies are carrying out more capital intensive activities compared to Japanese companies.
As for trade by foreign-affiliated companies, imports exceeded exports in FY2009, with exports at 4.8111 trillion yen and imports 6.756 trillion yen. The total exports and imports in Japan for the same year was 59.0078 trillion yen and 53.82 trillion yen, respectively; therefore, foreign-affiliated companies' trade accounted for 8.2% and 12.6% of the total exports and imports, respectively. The foreign-affiliated companies' ratio in Japan's trade is higher than the ratio in terms of employment and capital investment, indicating that they are more trade-oriented than Japanese companies.
However, in this Survey of Trends in Business Activities of Foreign Affiliates, the trade amounts reported by foreign-affiliated companies are likely to be duplicated; therefore, the trade amount in this survey is likely to exceed the real trade amount. The reason for this problem is because, when trade from a manufacturing company goes through a trading company, the same trade amount is likely to be reported by both the manufacturing company and the trading company. However, even allowing for this issue of overestimation, accepting inward foreign direct investment contributes to the expansion of Japan's trade. Since the position of trade in the Japanese economy is relatively low compared to other countries the expansion of foreign direct investment into Japan contributes to not only foreign direct investment but also the globalization of the Japanese economy through trading.
Let us compare foreign-affiliated companies' performance in Japan compared to Japanese companies. The rate of return and productivity are used as indices that indicate the level of performance. These generally show a correlative relationship, i.e., more productive companies have a higher rate of return if the other conditions are the same. However, a higher rate of return does not always mean the productivity is also high. For example, if a company holds market power due to
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protection by the government, etc., its rate of return will be high but not necessarily its productivity.
With this in mind, let us proceed with the examination.
Figure 4 shows the ratio of ordinary profit to sales (profit margin) of foreign-affiliated companies and all business corporations. Foreign-affiliated companies are grouped into American, European and Asian. The figure shows that the profit margin of foreign-affiliated companies exceeded that of all business corporations (mostly Japanese companies) throughout the analysis period. Among foreign-affiliated companies, the profit margin of American companies is especially high. On the other hand, the profit margin of Asian companies is considerably lower than that of all business corporations. However, these profit margins are the average rate and do not include any consideration of the areas of activities and the scale of the companies; as such, it is suggested that American and European companies have been achieving high performance, although the analysis is not strict. This analysis result is consistent with Fukao and Amano's (2004) analysis of Total Factor Productivity. Fukao and Amano compared the various economic activities of foreign-affiliated companies and Japanese companies in all manufacturing industries between 1994 and 1998 using data at the corporate level. Their analysis demonstrated that foreign-affiliated companies are at a higher level than Japanese companies with statistical significance in terms of TFP and the ratio of ordinary profit to sales. This analysis result shows that foreign-affiliated companies are achieving high profit margins because they are more efficient than Japanese companies. Their analysis also shows that foreign-affiliated companies have higher levels of wages and R&D intensity than Japanese companies. The above observation indicates that foreign-affiliated companies are successfully transferring management expertise and technology from parent companies to subsidiaries in Japan; however, it is difficult to comment on the spillover from their Japanese subsidiaries to other Japanese companies, as such an analysis was not made. Analysis of technology spillover is a challenge for the future. This analysis of foreign-affiliated companies in Japan indicates that foreign-affiliated companies have a favorable effect on the Japanese economy by bringing in efficient management expertise and technology, although foreign-affiliated companies occupy only a small position in the Japanese economy.
2011-2012 JIIA Research Project: Policies Needed to Ensure Japan’s International Competitiveness
Figure 4 Changes in Ordinary Profit to Sales Ratio
Source: The 44th Survey of Trends in Business Activities of Foreign Affiliates, by the Ministry of Economy, Trade and Industry, FY2009 results