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Worry About Hollowing Out for the Right Reasons – Liquidity of resources is important to quickly fill empty spaces after companies leave

Globalization and foreign direct investment of companies

We can begin to think about this from the first step.

Corporate activities are globalized in two ways: international trade and direct investment. Until the 1970s, the globalization of Japanese companies was overwhelmingly centered on international trade. Japan imported energy and raw materials, which it lacks, and manufactured industrial products and exported them. Production bases were located in Japan, and the imported products centered on those Japan cannot produce domestically. Therefore, hollowing was not a topic of discussion.

Globalization of Japanese companies has continued to deepen since the 1980s as they have come to deploy operating bases across borders for their corporate activities such as production, sales, and research and development. These activities can be understood by looking at the behavior of foreign direct investment. Foreign investment can be divided into direct investment and indirect investment.

Direct investment refers to that to manage foreign companies by acquiring their shares (merger and acquisition [M&A]) and engage in production by constructing plants (Greenfield investment). Indirect investment refers to simple investment in shares and securities with no intent of managing foreign companies. The behavior of direct investment is a main indicator of companies’ economic activities across borders.

Direct investment is increasing worldwide, acting as an underlying trend. The table below shows a comparison of growth in GDP, international trade and direct investment around the world since the latter half of the 1980s. Growth in international trade is seen to generally be higher than that in GDP, and growth in direct investment is even higher than that in international trade. However, growth in direct investment has been slowing or sharply declining since 2000, presumably due to negative factors such as the subprime mortgage loan problem and the Lehman Brothers collapse. The fact that international trade is growing more quickly than GDP means that ties between countries have been further deepened through export and import, and the fact that direct investment is growing even faster still indicates that the globalization of corporate activities themselves has been advancing at an even higher speed than international trade.

Table: Growth in GDP, International Trade and Direct Investment in the World (compound annual growth rate, %)

Source: “World Investment Report 2010,” UNCTAD

Foreign direct investment from Japan has also been showing high growth (however, since this is a net value after subtracting inward direct investment from outward direct investment, we cannot simply compare this with worldwide values). After the appreciation of the yen following the Plaza Accord in 1985 the growth became particularly high, and the amount of foreign direct investment from Japan increased from 1,400 billion yen in 1985 to a peak of 10,700 billion yen in 2008.

As corporate activities have been expanding across borders as mentioned, the ratio of overseas production of Japanese companies has been trending higher. The Annual Survey of Corporate Behavior conducted every year by the Cabinet Office shows that the ratio of overseas production of the manufacturing industry in Japan (ratio of overseas production to overall production of companies) rose from 4.6% in FY1990 to 11.1% in FY2000 and 18.0% in FY2010. Particularly for the processing industry, the ratio has been climbing up from 6.5% to 15.9% and 25.1%, respectively.

This globalization of corporate activities should be actively promoted. Free movement of human resources, physical assets and capital beyond borders is a global trend. If Japanese companies stay in their country in this environment, they will end up losing chances for their own development. We can clearly see what this will result in if we think what would have happened had Japanese companies not allocated their operating bases overseas. Since the mid-1980s, Japanese companies have been going overseas to survive as the exchange rate of the yen rose. Adhering to the way of manufacturing products in Japan for export without going overseas would by now have lost them their market share to foreign companies across the board.

Direct investment by Japanese companies was also a key in the development of Asia as a whole. Japanese industries that were caught up to by competitors in emerging countries have been transferring the low value-added areas of their production overseas while cultivating high value-added industries in Japan. This helped transfer industries that Japan had been fostering until then to Asia, and Asia resultantly developed. In fact, Asia grew in earnest after the latter half of the 1980s when Japanese companies advanced into Asia. This is a concept of the so-called dynamic international division of labor.

A Japan that leads Asia hands over some of its industries to other Asian countries and shifts itself to higher value-added industries. In Asia, such industry handover has been implemented in the order of Japan then to newly industrializing economies (NIEs) and regions, ASEAN and China. This has resulted in a more sophisticated industrial structure for Asia as a whole.

It is wrong to delay the pace of globalization of corporate activities because of fears of hollowing out.