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Insights into a Recent Increase in Foreign Direct Investment in Japan

- Theoretical Explanation and Research Based on Actual Developments -

October 2000
Ryoko Takahashi
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.
Questions and opinions on the working paper should be e-mailed to each author whose address is indicated in the document.

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  1. Foreign direct investment (FDI) into Japan, which were extremely low in comparison to other advanced nations traditionally, has showed a dramatic increase over the past few years, largely owing to growth in Out-In M&A (foreign company's acquisitions of Japanese companies). In terms of the industrial distribution, Out-In M&A implemented in the finance, machinery and telecommunications industries as well as greenfield investments (establishment of brand-new subsidiaries or affiliates by foreign parents) in the retail, service and software industries accounted for a large share of the FDI inflows in Japan.
  2. The growth in FDI inflows is not a typical phenomenon of Japan, having occurred in many advanced countries in recent years. Global consolidation that is proceeding in various industries and multinational companies' strategic emphasis on worldwide reallocation of resources are the two major factors behind the growth in global flows of FDI.
  3. FDI has two distinctive features: one as a function of capital transfer from a country with abundant capital to a country facing lack of capital, the other as a international movement of a package of resources from an investors' home economy to the host economy. Such resources include tangible and intangible assets, such as management skill, technology, operating franchise (brand loyalty), funding ability, etc. As for the former, even if the nation has ample capital as does Japan, any impediment to the nation's ability to supply risk capital could promote inflows of FDI as an alternative supply of risk capital.
  4. FDI to Japan can be classified into the following five groups, i) rescue-type M&A, ii) restructuring-purpose M&A, iii) deregulation-driven M&A, iv) industry consolidation/market integration seeking M&A and v) IT-led greenfield investments. The first four groups, which are carried out through Out-In M&A, have rapidly increased over the past few years, while the last group, "IT-led greenfield investments" started to increase earlier, at the beginning of the 1990s.
  5. Given the increasing globalization of the economy, the spiral of "FDI to Japan" and "the ongoing structural changes in the Japanese economy" are the major factors influencing the recent growth in FDI to Japan. That is, structural changes in Japanese industry stimulate FDI to Japan, while FDI to Japan accelerates the speed of structural changes. Concretely, such structural changes include 1) changing the safety-net mechanism in the financial system, 2) changes in corporate governance of Japanese companies triggered by changes in the financial system (increasing share of foreign equity holders --> a rise of required rate of return for the Japanese firms --> a shift to the globally accepted "level playing field"), 3) Japanese companies' recent focus on business restructuring for the purpose of improving profitability (e.g., Japanese companies' increasing interest in introducing new management know-how developed by foreign firms and restructuring business portfolios through M&A), 4) increasing transparency of Japanese companies as a result of reinforced disclosure requirements, 5) a series of deregulation initiatives lowering or eliminating barriers to new entrants.
    In addition to these Japanese specific factors, ongoing global consolidation accelerated by increasing integration toward a single global market and intensifying international competition have been stimulating FDI to Japan.
  6. Given the structural changes in the Japanese economy as well as worldwide consolidation in various industries, FDI to Japan is expected to increase over the long term. "External pressure", which occurs as a result of foreign companies' entry, is expected to accelerate the speed of structural change in Japan, and will accelerate drastic restructuring that would not be accomplished through the efforts of existing stakeholders. The expected increase in FDI inflows may create deflationary pressure over the short-term; however, from a long-term perspective, growing inflows of FDI are likely to lead to a strengthening of the growth potential of Japan's economy by improving productivity of various industries, especially regulated industries, and helping develop globally competitive business practices as well as corporate governance.