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28 Jun 2013

Japan looks overseas

Izumi Devalier

by Izumi Devalier

Economist, HSBC

Japan looks overseas (Getty Images/Trevor Williams)

Recently Japanese companies have flocked to Vietnam and India

Japan’s foreign direct investment was initially a way to circumvent trade restrictions. Firms increasingly looked abroad to take advantage of cheap labour and robust emerging-market growth.

While capital flows have been volatile, Japanese foreign direct investment (FDI) has been a one-way street over three decades. In the mid-1980s, Japanese companies ramped up US manufacturing in response to rising bilateral trade friction and a strengthening yen. In the early 2000s, China’s World Trade Organisation membership made it the factory of the world and Japanese firms quickly shifted low value-added, labour-intensive manufacturing there to take advantage of cheap wages and economies of scale. And FDI outflows surged again in 2011-2012 as Japanese companies embarked on a Mergers & Acquisitions spree in developed markets.

Japanese foreign direct investment has been a one-way street over three decades

Today, China receives the lion’s share of Japan’s FDI. But the ASEAN region has also seen a boost as Japanese firms seek to diversify their manufacturing supply chains. More recently, Japanese companies have flocked to Vietnam and India. Combined investments in those two countries grew from practically nothing in 2005 to USD5.4 billion in 2012.

In smaller countries such as Thailand, FDI can be 5 per cent of local investment spending. Malaysia, Philippines and Vietnam are also high, suggesting local growth will continue to benefit from Japan’s FDI push.

But the flipside to Japan’s aggressive foray abroad has been stagnating investment at home with loss of employment opportunities at home. With Abenomics now pushing the yen to multi-year highs against the dollar, some policymakers hope a weaker currency will compel manufacturers to bring production back to Japan.

Graph

However, we think a reversal is unlikely any time soon. Wage differentials remain wide. Even allowing for differences in productivity, Asia is still a cheap place to do business. And despite the rising costs, these investments are an increasingly important source of profit for Japanese companies. Further, Japanese firms increasingly see emerging Asia as a consumer market in its own right.

Reflecting the shifting role of Asia as a production base to an end-user market, FDI into the region is increasingly becoming service-oriented. In Australia, these gains can be attributed to a rapid surge of investment in the mining sector, but elsewhere there have been strong flows to non-tradable goods sectors such as communication, retail, finance and insurance, real estate, and other services. There is still room for Japanese FDI to grow.

Finally, under the Prime Minister Shinzo Abe, Japanese FDI is becoming a part of a national push to strengthen the country’s economic links and secure resources abroad. His diplomatic itinerary, spanning 12 countries in his first six months, reflects a strategic effort to export Japanese infrastructure and secure a foothold for Japanese companies.

This research was first published on 21 June 2013.
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