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The Determinants of Foreign Direct Investment from Japan and the United States to East Asian Countries, and the Linkage between FDI and Trade 1

December 1998
Shin-ya Nakamura
Tsuyoshi Oyama

Views expressed in Working Paper Series are those of authors and do not necessarily reflect those of the Bank of Japan or Research and Statistics Department.
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The financial crisis of East Asian countries has again played up the importance of foreign direct investment (FDI) as a source of capital inflow into developing countries. FDI has long been considered to be conducive to the economic growth of developing countries, partly owing to its relative immobility and consequent high stake in the long-term profitability. Developing countries' dependence on FDI among total capital inflows, therefore, can often be a good indicator of the robustness of their economies against external shock.

This paper focuses on the macroeconomic determinants of FDI from Japan and the United States into East Asian countries, and the linkage between FDI and trade, and other macroeconomic variables. In this area, Goldberg and Klein (1998) published an excellent study, in which they presented the determinants and impacts of FDI from Japan and the United States into some Southeast Asian and Latin American countries using panel data analysis. Our analysis is based on their study but differs in the following points: 1) we adopt a longer sample period and more sample countries in East Asia (but exclude Latin American countries) for the purpose of evaluating the factors behind the recent movements of FDI into the region in a quantitative manner. 2) We focus more on the structural differences among East Asian counties and classify them based on statistical tests of fixed effects models using panel data. This examination helps to clarify how Japanese and American multinational firms position their production bases in East Asian countries within their world marketing strategies. 3) In order to avoid the problem of simultaneity among variables, we examine simultaneous equation models to confirm the validity of panel regression results.

Our study finds that East Asian countries can be classified into four groups depending on FDI from Japan and other elasticities to macroeconomic variables, and this grouping almost coincides with their economic development stages. Moreover, we confirm that FDI from Japan into all the groups are strongly affected by changes in real bilateral exchange rates, but this is not always the case for FDI from the United States. Among different country groups, FDI into group 1 (Taiwan and Korea) responds positively to the Japanese capacity utilization, indicating their industries' integration with the Japanese economy. Group 3 (Indonesia and the Philippines) shows that Japanese FDI is buoyed up by the yen's appreciation against the U.S. dollar. FDI into group 4 (China and Malaysia) and, to a lesser extent, group 2 (Singapore and Thailand) are oriented more toward capturing local markets compared to the other groups. We also find that Japanese FDI has strong trade expansion effects, which is rarely seen for U.S. FDI.

This paper is organized as follows. Section 2 provides a brief overview of theories which attempt to explain the determinants of FDI. Section 3 presents recent developments of FDI from Japan and the United States into East Asian countries. Section 4 examines the macroeconomic determinants of FDI from Japan and the United States into East Asian countries using panel data analysis, and classifies sample countries into several groups which share common FDI elasticities to macroeconomic factors. Section 5 extends the analysis to examine linkages between FDI and trade. Based on the analysis in Sections 4 and 5, Section 6 presents a simple simultaneous macroeconomic model focusing on linkages between FDI and other macroeconomic variables. Chapter 7 presents a summary of the principal findings.

  1. Paper prepared for the Pacific Basin Central Bank Conference to be hosted by Banco de Mexico, November 7-11, 1998. Views presented here are those of the authors, and not necessarily those of Bank of Japan.