Japan Echo Web

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

References

*1 Column 3-1 Relationship between Foreign Direct Investment and Domestic Business Investment (Annual Report on the Japanese Economy and Public Finance 2002)

It is widely believed that foreign direct investment symbolizes hollowing out of industry in Japan since it may replace domestic business investment and result in declining domestic production capacity. So what is the real relationship between the two forms of investment?

According to the “Foreign Direct Investment Report” by the Ministry of Finance (1), Japanese firms’ outward direct investment expanded substantially in the latter half of the 1980s as manufacturers stepped up investment in Europe, North America and East Asia in response to the rapid appreciation of the yen after the Plaza Agreement in 1985 and Japan-U.S. trade friction, and as banking, insurance, real estate and services sectors increased overseas investment against a backdrop of domestic business expansion. However, such investment peaked in FY1989 and continued a sharp downturn until FY1993 due to the collapse of the bubble economy in Japan. From FY1994 to FY1997, Japanese manufacturers increased outward direct investment, mainly in East Asia, in order to reduce production costs and explore new markets. But the East Asian economic crisis from the latter half of 1997 led to a downturn in Japan’s foreign direct investment in FY1998. Foreign direct investment rose again thanks to large deals reflecting global industrial reorganization, before falling in both FY2000 and FY2001.

The trend of Japan’s outward direct investment has thus been linked to developments in domestic and overseas economies, as well as the exchange rate. A correlation between outward direct investment on the vertical axis and domestic business investment on the horizontal axis, as shown in Figure 1, indicates that domestic business investment and outward direct investment increase or decrease almost simultaneously, though large deals can result in some irregular moves. As such, we can see that they are not necessarily in a “zero-sum” relationship.

The above explanations cover only Japanese parent companies’ outward investment, but their overseas subsidiaries use not only direct investment from their parent companies but also their own final procurement such as borrowing from local banks and profits from local operations (so-called reinvestment) to implement business investment. When examining the relationship between Japanese firms’ outward direct investment and domestic business investment, we have to take account of their overseas subsidiaries’ local borrowings and reinvestment. Looking at the relative size of overseas subsidiaries’ investments, which include investments implemented using self-raised funds, to total domestic business investment (i.e., overseas business investment ratio) for the manufacturing sector, the ratio has been rising slightly (see Figure 2). In other words, Japanese firms’ overseas subsidiaries have been autonomously expanding their business size through business investment using their own internal reserves and overseas-raised funds. This contributes to a raise in the overseas production ratio for Japanese companies.

Note (1): Outward investment is defined as investment that a resident (direct investor) in a country makes in a firm in another country (direct investment destination) in order to acquire a permanent business interest. Statistically, outward direct investment is deemed an acquisition of a stake of 10% or more in an overseas business. Therefore, we must note that outward direct investment figures cover not only Japanese companies’ investments in their overseas subsidiaries but also business transactions involving Japanese firms’ minor stakes in foreign companies. In interpreting outward direct investment results in the MOF’s “Foreign Direct Investment Report,” we should acknowledge (i) that they cover deals exceeding ¥100 million and do not include smaller deals, and (ii) that they are based on reports submitted upon investment and fail to exclude investment returns or deals that were suspended after reporting.

*2 Column 2-3: Impact of Intention to Expand Overseas Production on Employment Prospects (Annual Report on the Japanese Economy and Public Finance 2011)

While we focused attention on the relationship among overseas sales ratio (overseas sales ratio = exports + overseas production – reverse imports), expected growth rate and income distribution, here we look into the impact of the overseas production ratio on employment. There is a concern that the expansion of overseas production will result in hollowing out of domestic industries and, in turn, job losses; but is this really true (columns 2-3 in the figure)?

According to the Annual Survey of Corporate Behavior of the Cabinet Office, companies that intended to increase their overseas production ratio had a larger negative value on their employment prospects than those intending to leave unchanged or decrease the overseas production ratio in the FY2003 survey when the sense of excess employment was comparable to the present level. By industry, this trend was noticeable in basic materials industries with the high reverse import ratio (ratio of exports to Japan overseas production). It is conceivable that the fact that companies that were forced to reduce costs transferred their production bases overseas where personnel costs were lower in many cases adversely affected their employment prospects.

In the FY2010 survey, however, companies that intended to increase their overseas production ratio had a larger positive value on their employment prospects than those intending to leave the ratio unchanged or decrease it. By industry, this trend was noticeable in basic materials industries that significantly lowered their reverse import ratio. There is a possibility that, unlike 2003, since companies that establish production bases overseas have been increasing in recent years in response to robust growth in overseas demand, their employment prospects have been more bullish associated with the strengthening of headquarters operations in order to take a complementary role in overseas production bases.
 

Translated from “Kudo-ka ha tadashii riyu de kenen shiyo,” Nikkei Business Online, August 24, 2011. (Courtesy of Nikkei Business Publications, Inc.)