Japan and East Asia Asia as Economic System

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					            September 19,2003
                                                  @ Symposium at Korea University

              Japan’s Direct Investment in China and
                  the Hollowing-out Problems

                              Toshihiko Kinoshita1

    Most of East Asians tend to talk rather optimistically about East Asian
solidarity in distant future. For instance, few would disagree if someone says that
majority of East Asian economies could be one Community like EU2 with one
single currency within 30-50years. However, they would be pessimistic if someone
proposes to establish an East Asian Community with one single currency, say in
10 years. What makes the difference? In the former case, we can be merely
economists if we wish, but in the latter case, we must be political economists.
    On the possibility of establishing Korea-Japan FTA in a few years, however, I
am rather optimistic. I can not be optimistic to establish Sino-Japan FTA in 10
years. Why? It is because the Korea-Japan political relation on top of economic
relation has improved a lot in the past few years. However, there are still many
barriers to be conquered on FTA between China and Japan in 10 years,to our
regret. But by mutual efforts, more on Japanese side, I believe we can solve those
problems in the long run, as we did between Korea and Japan.
    Let the history problem aside. Japanese side must conquer two big problems
if we wish to realize Sino-Japan FTA sooner or later—(1) how to avoid
protectionism of domestic interest groups, that related to agriculture in particular,
and (2) how to reduce obsessions by minority groups or vested interests that
their businesses or industries of their provinces are and will be hollowing out by a
continuous, and quick expansion of inflow of very cheap products made in China
based on one of the world-cheapest wage, less than 2% of an averaged wage in

  Professor, Graduate School of Commerce, and School of Commerce, Waseda University
   Tel & Fax 81-3-3204-8230 Email:
  See for instance Ippei Yamazawa, Toshihiko Kinoshita and C.H.Kwan, “Japan and East
Asia: Asia as Economic System- How Do We Meet the Globalization Challenge Together?,” a
paper made for Japan International Forum (Draft), September 2003. The three authors
visited three Asian countries and discussed on the paper at Chulalongkorn University
(Thailand), Nankai University(China) and Yonsei University(Korea) in the early September
    Americans, or its special interest groups, had similar fears or concerns on the
strong competitiveness of Japanese products, though not based on cheap labor,
and abundant Japan money, especially in the 1980s. In fact, the U.S. protected
itself3 by forcing Japan to observe voluntary export restraint on textile (in 1960s),
steel, and even voluntary import restraint of American semi-conductors on top of
the political solution to revalue Yen’s exchange rate vis-à-vis U.S. Dollar in a
secret meeting, named as Plaza Accord in 1985. Japanese has no idea to do the
same to China.
      Despite of the lost decade, Japan is still the second largest economy in the
world( its GDP is equivalent to the combined GDPs of Germany, France and Italy).
However, amid the depressed economy over a decade, a nightmare that Japan’s
supremacy in East Asia will be eventually taken over by China once caught minds
of many Japanese. The feeling of hollowing out due to huge amount of Japan’s
foreign direct investment (FDI) in China or other trade transactions based on
contract, and subsequent excessive import from China may partly be a reflection
of concern/fear on China’s emergence. Let’s examine how many Japanese
perceived the situation and how their perceptions have changed over time.
     To make long story short, most of Japanese intellectuals began to
understand that energies of Chinese spurred by hungry sprits, painstaking efforts
with entrepreneurship, are no doubt beyond theirs under highly aging society, but
that China has also difficult problems like huge amount of non-performing loans
(NPLs) and excessive regionalism. They take it granted now that total Chinese
GDP may surpass Japanese GDP within 20-30 years even though per-capita
China income may not reach to that of Japan in 50 years. They understand that
nothing would happen even if they cry that ‘the wolf will come’. Instead, they
began to consider that this is a real challenge, but it also can be a historical
opportunity for Japan to make good use of China. What they found was the
following two. (1) Number of rich people, say 10% of the whole population of China,
is equal to that of Japan. It is already a big market. (2) Export products in both
countries are largely complementary. So, as I witness, a majority of Japanese
began to understand that the two nations can co-prosper as far as both are clever.
     We cannot deny, however, the existence of the minority group such as
farmers cooperatives or small and medium enterprises (SMEs) particularly in
population- scarce regions, who tend to have un-proportionately big voices in the

3 I never say that the U.S. was more protectionist than Japan. Had it been so
throughout the post-WWII period, there would be no glorious days of Japan. However,
some of the protective measures taken by the U.S. in the 1980s could not be justified
by economic theories. And also it is a fact that no other country but the U.S. could do

political field. They are liable to ask the government for strong protection on their
products against cheap products made in China or other countries. Further, many
Japanese have had frustrations in a depressed economy. Japanese, however,
should not seek any scapegoats abroad and have to solve such domestic problems
for themselves, if we wish to be in good terms with Chinese indefinitely, and
eventually to identify ourselves as good East Asian citizens as well as good world
citizens. Luckily, we have not taken any protective measures except on three
small agricultural items in 2001. The role of intellectuals shall be heavy even
from now so as to lead the country to the right direction.
      But, simultaneously, China is strongly requested to be our good neighbors
as well as good world citizens. Let me clarify those conditions in my concluding
remark. If I may, let me also touch on Korea’s role in this context a bit.
     Lastly, let me touch on Korea-Japan issue a bit, though it is not my subject
today. I wish to call for a new movement to share with our neighbors an identity
as a good citizen in East Asia.

1. Japan’s FDI in China: Recent feature on a micro level
2.1 Japan’s FDI in China
    According to the Japan-MOF’s statistics on outward FDI registration, Japan’s
FDI in China :is listed in Table 1.
     Are these figures big enough or smaller for its size? If you convert the figure
in FY2002 (¥215.2billion), it amounts to a bit less than U.S.$ 2 billion. It is by no
means very big, for an averaged auto manufacturing firm invested in the U.S.
costs around U.S.$ 2 billion and that the U.S. FDI in China has somehow
exceeded that of Japan’s. Many foreign firms including Japanese firms invest in
China through Hong Kong or tax haven such as Virgin Islands by one reason or
another. Such FDI is not included in the table 1. And if Japanese subsidiaries get
necessary funds directly from local banks, branches in China of Japanese firms or
even from Japan, the portion is not included in Japan’s statistics on FDI. In one
word, we can safely say Japan is the main investors ( currently No. 4) in China
with Hong Kong as by far the biggest investor and Virgin Islands as the second
biggest while many Chinese firms in Mainland China reportedly circulate their
monies through Hong Kong or Virgin Islands, and with the U.S. as the third
biggest. We see the figures roughly to know the trend. Cumulative amount is
more meaningful. We try to get detailed information such as expansion on the FDI
in China by industry, by region and sometimes by individual firms to know more

the same to any emerging country.

exactly what is happening in China now.
    Japanese firms as a whole, SMEs in particular, initially invested to take
advantage of local resources such as marine products or human resources, cheap
for their potential/productivity. Textile industries and other labor intensive
industries were typical cases. It was mainly due to the shortage of good young
workers in Japan.
Big multinationals originated from the U.S. and Europe tended to invest in areas
of emerging local market whatsoever: cosmetics, petrochemicals, mobile phones,
autos, medicine, food or whatsoever. American toy manufacturers use foundries,
not FDI.
    While domestic market has grown quickly, western firms are recovering their
investments. Japanese manufacturers or service industries, having recognized the
big potential of local market, began dynamically in China in a recent few years.
SMEs began to examine a feasibility study to make horizontal division of labor.
We witness sometimes people in villages or towns/cities in rural areas collectively
do businesses with their counter part in China. It is interesting to see how the
things go on in a coming decade.

1.2 Why remarks on micro-level come first?
     China became the world’s largest recipient of FDI in 2002. The amount on
realization basis exceeded U.S.$ 50.0 billion, having surpassed the FDI in the
United States which fell drastically due to September 11 incident in 2001 and a
burst of IT bubble. Foreign firms are expected to continue to make huge FDI in
China, which will continue to be a strong engine of its fast growth
    Let me begin with talking on the feature of micro-level cases of FDIs in China.
Macro-level argument is somewhat controversial. In macro-level, someone win
and someone lose.
    Not a small number of people of the world may consider that Japan is slowly
dying, with structuring process stagnant for a long time. Japan is often compared
to a steamed frog. We use the word very often to give warnings to our own people.
However, it is not the whole story.
    To my knowledge, Japanese are pragmatic by eventually and many have
gradually adjusted themselves to the new situation in the world. Sure,
government’s reform process goes too slow, which frustrates people at large, but it
is not the case of many private firms. Many of them are still excellent companies
of the world and have recoded the historically highest profits. Take Toyota, for
instance. The market value of its total stocks exceeded the combined market
values of the Big Three. Other than Toyota, tens of companies as Honda, Nissan,

Kyosera, Canon, Sharp, Epson, Sony, Takeda, Fuji Film, Mitsubishi Shoji, Kao,
Shiseido, Eizai, Kikkoman, Nikon---are regarded as excellent companies in the
world market. The are actually big investors in China. When such typical
companies go well, macro-economy of Japan is not going well, though slight bright
light is just on. Such phenomena was not seen in the post-WWII period. What is
happening, then? It will be talked later.
     By the late 1990s, Japanese recognized that Chinese as individuals are
extremely painstaking, individualistic and entrepreneurial, but, they thought as a
corporate system, SOEs would continue to be least efficient and could not be their
rivals in a foreseeable future. There were exceptional warnings that a little
dragon would grow to be a big and strong dragon soon or later. In fact, big changes
had undergone silently in China since Open and Reform policy was taken since
1979. Huge FDIs continued to flow in China from all over the world, looking for
cheap wages and growing domestic market, the pace of which Japanese could not
correctly predict.
    Dramatic transformation of China in a short time gave shock to Japanese
toward the end of the 20th century. Most of Japanese firms were at a loss. At the
initial stage, their product differentiation strategies, a long-time success model in
the world, looked unsuccessful in China. Chinese did not seem to pay high prices
comparable to high value products until a few years ago. They did not wish to sell
cheap products to compete with local products. Other two big problems were (1)
how to collect cashes from local sales on credit, (2) pirating of IP. Copies of their
brands or counterfeit merchandises of their products were rife in whole China and
overseas. So, Japanese firms changed strategies. They made every effort to create
new business models to co-prosper by which they may be able to get profits by
trade with, and FDI in, China. Let me introduce later how they muddled through
their ways and realized some success.

   A footnote note on Made in China by FDI or other methods
(1) Difference of types of FDI by home country
   It may not be necessary to repeat the significance of FDI. FDI is not only a
transfer of money but rather a transfer of managerial resources. Managerial
resources reflect at least to a certain extent a culture, technology level at large,
consumers’ behavior at home country of an investing country. It seems natural
that MacDonald hamburger or Citibank’s global banking system were originated
from the U.S. and not from Japan, China or Korea. Anglo-Americans could not
establish Toyota’s or Samsung’s corporate cultures. Japanese could not nurture an
educational system of Indian software engineering. It is not a problem of good or

bad. Briefly, there are some similarities among multinationals by their origins.
Otherwise, I could not generalize the trend of FDIs in China by Japanese firms.
However, managerial resources of a firm is peculiar and limited, though
expandable. What’s the matter of the limitation? Indeed, they must invest a
certain percentage of their profits to R&D or make M&A to expand them. More
important implication is that time is the most important element for decision
making to for FDI either at home or overseas. Under the mega-competition, there
is no such fixed rule of the game as many Japanese firms used to enjoy at home.
Namely, what counts is how to allocate available time to targets in the best use of
limited managerial resources of a firm. That naturally requires a strategy.
Japanese firms tended to be less conscious on time element or strategy, although
they used the word strategy every day. To follow the general trend was largely
their strategies. Over-competition among rivals and general lack of the sense to
increase ROI or ROA for shareholders accelerated the bandwagon-type FDIs.
They also hesitated to make M&A freely even at home, with some small number
of exceptions. Are they changing behaviors? Yes and No. Global business climates
have changed completely and they began to change their behaviors gradually.

(2) Other methods of transfer of technology
    If you wish to assemble TV or computer of your own brand in China, you can
use other cheaper methods than FDI.
    Foundries mushroomed in South China. EMS in western countries and
Taiwan set up many subsidiaries in whole China, which changed the business
model in producing electronic products. Quality of cheaper products made in
China by foreign firms and by local firms improved considerably4.
    Thus, foreign electric/electronic firms use local foundries by contract or can
also use subsidiaries in China of American/European or Taiwanese EMS
(electronic manufacturing service)5 to design, to manufacture, to inspect and to
pack easily. There are thousands of industrial clusters of that sort in South China.
Many Japanese firms in electric/electronic industries are doing the same way.
Those products are mostly sold overseas under the consigner A’s brand
name—‘made in China under licensing of Co. A’. Logically, therefore, the impact of
overseas production by FDI (own subsidiaries) and by local foundries/subsidiaries
of foreign EMS under licensing agreement upon home country’s economy will be

4 There were some success stories in Japan, however. First Retailing, an apparel
dealer of Japan, whose brand name is UniQulo, was one of them.
5 OEM (original equipment manufacturing) or even ODM(original development

manufacturing)-- conventional jargons---are included in EMS.

equal if the same percentage of those products are sold at home with same quality.
So, don’t consider that FDI is the only way to transfer managerial resources to
produce locally.
     It is believed that foreign firms can trust more own subsidiaries and can
transfer technology more thoroughly. It is basically true. Otherwise, no firm will
invest in China at its own risk. But that does not necessarily mean products made
or assembled by local foundries or subsidiaries of foreign EMS are always inferior
in quality to those made or assembled by foreign subsidiaries. That depends
largely on the technology in real use and inspection process. Dell computer is
made by trustable local foundries/EMS, for instance.
     However, you cannot produce cars or semi-conductors in such a way. Japanese
experts like Prof. Takahiro Fujimoto analyzed the types (technological patterns) of
product architectures. He classified them as integral, modular, closed and open
type architectures. He concludes that car manufacturing is integral, more or less
closed architecture while computer assembling is typical modular, open
architecture, which more likely invite cut-throat competition. No.1 maker last
year may be No.10 this year. He gets a policy implication on which industry
Japanese industries should invest more in the long run. According to his idea,
products of modular, open architecture may well be consigned to local foundries or
EMS6. But, foreign auto firms must make sizable amount of FDI if it wishes to
locally assemble or manufacture for local sales or export.
    Nest, let me introduce recent cases of FDIs in China by Japanese forms, taking
up most popular two areas, namely, auto and auto parts and electronics.

(1) FDIs by Japanese auto-assemblers and auto-part manufacturers
     Next table shows FDIs in China made by auto manufactures after 2000.
While Japanese auto makers are generally late starters in China and that the
demand of passenger cars on top of commercial cars has been on a quick rise. The
current active FDI trend by Japanese auto makers will no doubt continue in a
coming decade, regardless of the business cycle in China. Expansion of demand
for passenger cars has been spurred by the dramatic reduction of custom duties on
cars and the high growth of incomes of the rich and emerging middle income
classes. Export from their plants in China will be minimal compared with
domestic demand for the time being, although China is expected to grow to be one

6 The things are not that simple. Roles of local subsidiaries are not limited to
assembling. And how to keep IP is also an essential matter. So, may a foreign firm
up local subsidiaries for assembling and manufacturing PCs.

of the big car exporters in the world in two decades. The most important factor
influencing foreign investors in auto industry is the industrial policy of Chinese
government how to nurture auto industries. If the Chinese government approves
foreign firms to import their cars made at home or overseas to China freely, rather
than producing in China, by removing quota, there may be little room to expand
local production so quickly. True, an averaged cost of production per car is still
very high in China compared with that in major auto production countries like
Japan. Restructuring of the industry by reducing the number of assemblers seems
imperative, therefore. Japanese individual auto assemblers make decision on FDI
in China through consideration of these factors as well as strategies of rival
    The prospect of local production in the long run is very bright. For car
manufacturing tends to be done at a place near the consumers, partly due to
rather heavy weight of cars, partly due to the difference of tastes of consumers in
individual countries. In that sense, we can safely conclude that car manufacturing
in China with huge potential consumers is a typical infant industry which
deserves some protections at an early stage. But it should be opened as quickly as
possible as its industry matures. Otherwise, such products will not have price and
quality competitiveness in the world market.
    Japanese car parts manufacturers have also made active FDIs in China in
recent years, reflecting the FDI strategies by foreign auto assemblers. By 1996, 17
cases of FDIs were made by Japanese auto parts manufacturers, followed by 30
cases from 1997 to 2000. In 2001, additional 17 cases were invested. They have to
meet the requirements by assemblers for globalization, modularization and
digitalization. And there is no prior guaranty by assemblers to procure their
locally-made products. They must endeavor to reduce cost to the minimum, while
keeping quality of products internationally competitive.
    It is likely that the share of passenger cars of Japanese brand will raise sales
share in a next decade. Cut throat competition will continue indefinitely as
Americans, Germans and Koreans have invested sizably in auto production while
custom duties will continue to fall and market integration will gradually proceed.
The key issue for foreign firms is how to find good local partners, given the
current auto manufacturing policy by Chinese authorities.

(1) Recent FDI in China by Japanese auto manufacturers
Name    of Establis Beginning    Capital       Japanese    Production       Annual
Firms      hed Year of           Amount        Share       Item             Production
           of JV    Operation    (mil US$)     (%)                          Capacity
Isuzu         2000      2000       30.0         49         Large size bus    1000

Toyota 1     1998       2000       67          45       Coaster            10,000
Toyota 2     2000       2002       97          50       Vios               30,000
Toyota 3              P 2005       850                  Camri, Crown       50,000
Nissan 1                2000                            Blue Bird etc.
Nissan 2     2003       2003      2,000        50       Sunny, etc.        220,000
Hino         2000       2000       61          24       Middle/large bus
Honda 1      2003       2004                                                50,000
Honda 2      2003       2004       193         65       SUV                >20,000
Matsuda                 2001                            Familia, etc.       20,000

(2) Japanese FDIs in electric/electronics industry in China
   Japanese electric/electronic manufacturers have actively invested in China for
many years. They are relatively early starters and it makes a good contrast with
Japanese auto industry. The Beijing factory of Matsushita (Panasonic), for
instance, is famous for its continuation of operations even on the day of
Tiananmien Incident in 1989. When Chinese government requested Mr. Konosuke
Matsushita, the founder, to invest in China, he pleasingly accepted. Sanyo,
Matsushita, Hitachi, Toshiba and NEC have used many foundries in South China
and have invested heavily in whole China. How technology transfer of TV
manufacturing by these individual firms was minutely traced by a Chinese
scholar stationing in Japan. In the area of standard type of electric home
appliances such as collar TV, refrigerator, oven, washing machine and air
conditioners, main players are neither Japanese nor Korean manufacturers
currently. Hundreds of local firms have mushroomed in the past 10-15 years and
have shown cut-throat competition. Haier, TCL and Chan Hong are a few leading
manufacturers in this areas. Japanese electronic assemblers and its parts
manufacturers had actively invested in the area of VTR, DVD players, car stereos
and electronic devices. To avoid too severe competition with local manufacturers,
Japanese subsidiaries have taken dynamic differentiation strategies under new
stage carefully. They produce some items locally and import-and-sell high value
added plasma TVs, large size LCD, ion-equipped refrigerators, for instance.
Global networking is their crucial task. In this context, therefore, their
subsidiaries will increase export to and import from subsidiaries in ASEAN,
depending on the economic theory of scale.

1.4 New success models of Japanese firms with China as a good partner
   As the general fear on China’s emergence as the Factory of the World fades
away in Japan, we began to observe new success models of Japan. Let me
introduce some of them. See Figure 5. There is four spaces. In one space, Japanese
firms may well produce at home and export to China. In other spaces, they better

produce in China, sell overseas and import like that. Mix the differentiation
strategies depending on the technological superiority/brand value of a firm and
strategies of its rivals, and combine its subsidiaries in other countries in Asia and
others with this chart. Then, you can understand how successful Japanese firms
such as those under-mentioned are doing in China, at home and the rest of the
world. Individual firms have taken different strategies.

--Mabuchi Motor:      No factory at home; foundries +own factories; Export,
                    demand; brand strategy
--First Retailing: No factories at home; foundries; Import to Japan, local sales
                    began recently
--Honda Motor:      Bought an old factory in Gwanjou from Peojout (France),
                    renewed machine; brand strategy; made a JV with a local
                    company which once copied Honda’s motor cycles for domestic
                    and export markets
--Shiseido:        Brand strategy with local production
--Matsushita:       Strategic alliance with TCL, local company; import cheaper
                    products from TCL under Matsushita license, and export
                    Matsushita’s high value-added products to sell locally through
                    TCL’s sales network       (See Figure 5)
--Sharp:           Brand strategy (Only One products); concentrated production
                    facilities of different production items to draw synergy
--Controversial cases: digital camera cases: 11-12 Japanese digital camera makers
                  with a few foreign rivals; even No.1 Japanese maker could not
                  raise in 2002; the situation changed dramatically in a year.

2 Macro-economic perspective and perception----FDI and hollowing out
2.1   It is true that the increase of success stories of Japanese FDI, etc.
contributes to the reduction of the fears/concerns on the quick increase of products
made in China, which may bring about the hollowing out of Japanese industries,
it has little to do with it precisely speaking. Anyway, an individual firms cannot
solve such problems, if any.
      According to the calculation by Dr. C. H. Kwan on the complementary effect,
there is tiny area in duplicating or competing each other among export items of
both countries 【Figure 3】
      However, the calculation includes all exports whether they are related to

FDI. According to an econometric model calculation done by Dr. Kyoshi Fukao7, a
type of FDI aiming at replacing export from home country (Japan) or import of
products made by subsidiaries in Asia in use of cheap labor or another type of FDI
aiming at jumping trade barriers is to decrease domestic production at home. So,
if we define such effect as hollowing out, then such FDI may not be desirable. He
added, however, FDIs directed to local market or in use of local resources are to
increase the production at home. This is not on FDI in China.
       It is likely that while domestic market of China expands quickly, and that it
absorbs huge FDIs, the total effect may be most probably positive.
       And what we have to consider is that shouldn’t we de-industrialize over time.
If we take consideration, we will get more positive conclusion. Some say that the
pace of import from Japan is too quick and it is dangerous. But this argument is
nonsense in the world of international economics. We should look at the
aggregated amount of trade/current account balance. Hence, if Japan can record
sizable current account surplus due to high savings, there will be no problem.
History repeats itself. We should not repeat similar illogical argument we had to
listen from USTR in the 1970s-90s. Those messages were political messages, not
right diagnosis based on economics.

2.2 What is the hollowing out and when do people feel it in the most serious
       Here I will take up the word hollowing out again to get some implications for
the future. Standard textbooks of international economics, dealing with FDI and
external trade, do not touch on the jargon hollowing out. The authors often use a
jargon---de- industrialization. They conclude it is a natural evolution that the
manufacturing-       centered     economy      moves     (develops)    to      services
industries-centered economy as manufacturing sector replaces agriculture sector
in the primary process of industrialization.
      They believe in the change from the lower stage to higher stage of economic
development is as logical as the theory of the survival for the fittest. In other
words, the more intellectual software is included in an economy (GDP) of a nation
state, the better. The concept proves to be correct in most of industrial countries
and it has also been warmly accepted by developing countries, for by the
de-industrialization of developed countries, they can find new room for growth in
manufacturing. However, we need some footnotes here.
      Few Japanese felt regrettable when oil industry replaced coal industry. They

7   Kyoji Fukao et al.(2001) ,” Japan’s Direct Investment and Hollowing Out”

welcomed the oil revolution. Oil was cheaper, easy to handle, less smoke, and so
on. Those who lose jobs in coal industries could find new jobs in a new dynamic oil
and oil-related industries sooner or later. But they will be at a loss, if a rather
sophisticated electric/electronic industry be taken over by China in a short time.
    The jargon hollowing out, not de-industrialization, includes an nuance that
the evolution of that sort may be not good, though inevitable. The Nihon Keizai
Shimbun (Economic Journal of Japan) reported that the number of enlisted firms
which reported closures or plans of closures of factories in 2001 amounted to 69
firms and the number of the factories closed or to be closed reached 124., some
three-hold compared with that in 2000, while they increase FDI in China.
Japanese readers took the news seriously, considering that hollowing-out of
manufacturing sector is quickly undergoing without any assurance that new
industries will emerge soon or later. I consider that many Germans tend to think
the same way. Japan and Germany (and Korea) became rich countries with strong
manufacturing sector prospering. They tend to feel that Anglo-American model,
multi-cultural American model in particular, is more fitted to services industries
like an advanced IT software-embedded system such as banking, security,
insurance businesses. Japanese tend to consider they can get good hints for future
while manufacturing something. So, they tend to fear the complete shift of
production sites overseas and loss of the special craftsmanship of related SMEs
will deprive Japanese of great chances to find new road to walk on. The bottom
line for them is to keep laboratories. Japanese traditional business model (bank-
centered Keiretsu system, life-long employment, motivation to better technologies
rather than to seek just money and to raise a target level of ROE) sustained the
conventional corporate and individual behavior and culture until say mid-1990s.
    A majority of Japanese economists, however, do not support the fatalism that
a partial death of an industry (manufacturing) will deteriorate its economy.
However, they may be more sympathetic on manufacturing sector than ordinary
western economists. They tend to consider that due to past legacy, it will take long
time for Japanese to fit better with IT software industry rather than conventional
hardware industry and for its young people to start venture businesses more
    Economics text books teaches that, by the comparative advantage theory, new
jobs may be created more easily as far as the market mechanism works well. That
means that everyone accepts that his/her salary or wage will be automatically be
decided in labor market. If so, jobs will be created more easily. Labor market is
not that flexible (complete) in the real world. Social security system is a
supporting system to keep the bottom line. But what if a structural change of the

business cycle of home country makes it difficult to maintain the sound fiscal
policy? That is the situation which Japan is facing. Japanese workers once
enjoyed higher social welfare more equally rather than those in the U.S. or the
U.K. It is the very reason why Japan’s life long employment system has to be
changed just now wholly/partially. As the success model lasted for a long time,
many Japanese have resisted to change their social security system.
      . People tend to think most pessimistically when they lost confidence (See the
case of Japan in Figure 2). Japanese refused to reform its conventional
fiscal/monetary/corporate systems an initial stage of the lost decade. Gradually,
which is the salient feature of Japan, the system has undergone transformation,
including pension and insurance system. When economic indicators of Japan,
stock prices and GDP figure in particular, however, has turned out to be a bit
bright, people became somehow optimistic on its future and the arguments of
hollowing-out has steadily faded away. High growth of its recent export to China
is one of the reasons.
       Let’s consider why venture businesses have not prospered in Japan? It is
related to its social norm and its education system.
       Japanese tend to consider that if you have some foothold like an factory, you
may begin a new business rather easily. If you lose everything all of a sudden,
they assume, it is far from easy to begin any business. We may well recall the
word hysteresis effect., which means if the business conditions change for some
time, you cannot recover your business even if the same business conditions
appear later. It is often said that if Japanese lost all documents on high level
technology on zero-fighter manufacturing developed during the War time, they
could not produce excellent cars later. Having said that, most of the things go as
economic theories teach. Government officials to envisage industrial policy should
be wise enough to distinguish which is which.

2.3    How to get rid of the perception of hollowing out .
      Under the society and situation where adjustment of industrial structure
does not be made quickly, people have to endure the hollowing out situation for a
long time. It will take some more time that Japan model change enough while
having internationally competitive. Japanese felt very comfortable with being in
an egalitarian society, living peacefully without much arguments as is often
quoted that Japan is the most successful socialist country in the world. The main
reason for this, as I assume, is that Japan remains to be a homogeneous and
Confucius-influenced nation. Globalization after the Cold War has made, therefore,
a real challenge for Japanese.

    FDIs in auto industries in China plus FDIs in North America, which shares
the largest FDI from Japan, however, have not decreased auto production at home,
say 10 million units. Naturally, percentage of overseas production, reaching 7.5
million in 2002, has gradually caught up production at home.

2.4 Important role of the education
    Here I wish to touch on the role of education. In a world today, technology
transfer is done at far quicker pace than before, partly due to the fact that many a
necessary information can be acquired easily by internet, air travel or whatsoever
and partly due to the invention of such as 3-D CAD and industrial robots. So if
you wish to keep superiority in technology, you must invest more and more money
to R&D and education. Large Japanese firms have kept high R&D ratio despite
long-time economic stagnation, which keeps their technology level the second
highest only next to the U.S.. However, situation in general education in Japan,
including business schools, is dangerously retarded. There seems little
consideration on the part of the competent ministry on the concept of
international competitiveness of universities, for instance. Japanese have to
hasten drastic reform in this respect.

2.5 Emergence of China: Opportunity, Risk and Task
   Next, let’s study to which way China will direct from now and what are the
agendas for China to solve? That will influence the decision–making of foreign
investors as a whole.
    Since the reform and open door policies started in the late 1970s, China has
attained high economic growth at about 8-9% a year and significantly improved
its living standards mainly in coastal areas. Many believe that high growth will
continue at least until 2010. With its industrial power rising by huge influx of
foreign capital and subsequent growth of local firms, China is now quoted as the
Factory of the World. Indeed, China is in a great boom, making a good contrast
with Japan. China’s real estate business seems to be somewhat in a bubble.
Peoples Bank of China has warned but in vain. Under such a boom, however,
competition has become keener, and the low efficiency at SOEs has become more
apparent, aggravating the NPL problem of state-owned banks. There doesn’t exist
a rule of exit for them. So, heavily indebted SOEs continue investing to expand
their productive facilities without sure feasibility studies, which accelerated
falling prices of their products such as TV and other home electric appliances.
Those products easily become just ordinary commodities. Good local companies
are trying to establish their brand names under such circumstances. It is not easy,

though. On the other hand, various discriminations on loans to private firms have
posed obstacles to their sound development. In addition, the income gap (as well
as stock gap) between the rich and the poor became the largest agenda for the
leaders of the new government. But for those who wish to sell high value-added
products, the high growth of incomes of the rich creates new niche markets.
Rising unemployment rate and very low income for farmers are destabilizing
Chinese society in the long run, promoting deflationary impact. But this may
assure   that   low   wages   will    continue   indefinitely   for   those   managing
labor-intensive industries.
   To sustain rather high growth, say 6-7% a year, not to mention 8% or more,
China needs to build a fair and competitive market, to observe rule of law and a
proper system to protect intellectual property (IP), and a social security system.
   In 2003, the Chinese economy has faced severe problems. SARS prevention
efforts restrained human exchanges for three months and have also undermined
economic activities. In addition, the United States and some other nations have
exerted pressures for a stronger Yuan. Having said that, various researches being
made recently on potential investors show that they seem to continue to make
new FDI or expand their facilities.

2.6 Japan Model revisited
   I should touch on Japan model, which once brought about Japan’s success
stories but has also brought about a crisis under globalizing world. Keiretasu
system is being dissolved gradually, life time employment system underwent
transformation, calculation method of bonuses changed, firms pursue higher
ROE---. So, we can safely say that the last 10-13 years were not completely lost
may well be said as a prolonged adjustment period. Here I wish to have your
attention on excessive competition among Japanese rivals while there are
different world of cartelizing (Dango) like general constructors. Taking up digital
camera makers in Japan, there are 11-12 Japanese makers, and they share some
90% of the world share. However, last year No.1 maker with the biggest share did
not get nay profits. Since the world market is quickly expanding at faster pace
that expected this year, most of them can earn profits. Similar phenomena has
been often seen. Manufacturers of ship building, car manufacturers, electronics
manufacturers,-----have behaved in the similar way---they don’t feel any fear if
they cross the street, shaking hands each other, or in an bandwagon way.
   It creates energies among staffs and stakeholders, but this will not accumulate
capital comparable to multinationals. While M&As are not so popular in Japan,

over-competition among competitors still continue. That is one of the reasons for
increasing outgoing FDIs. Most of digital camera makers have invested in China
to reduce costs and to sell at local market.
    Now that Japanese stock prices ( NIKKEI average) went up sharply in the
past half year from some ¥7,600 to in April (bottom) to some ¥11,000 recently.
People seem to feel the worst time has passed. If so, the Japan model, half
amended, will sustain for some time at least. I cannot give good answer on this
issue what is the best. Anyway, it would deserve studying further whether the
Japan model is sustainable indefinitely.

Concluding Remarks
1. We can safely conclude that emergence of China is a real challenge for all
and individuals in Japan (and Korea as well) but it also poses an opportunity to
all. It will require wisdom to make it a fruit. The private sector will seek all
possibilities for their own sakes and at their own risks. It is all right. But, there
should be a role of the government for both Japanese firms dealing with Chinese
authorities/ firms, and Japanese nationals at home. China has made much effort
to reduce barriers for FDI or business as a whole, especially after it entered WTO.
However, there still exist many visible and invisible problems, among others, how
to observe IP. It is not easy for foreign firms to tackle such problems when
Chinese government does not listen their complaints. In such a case, Japanese
government should help them, tax payers, and to improve business climates. with
concerned parties in China how to get proper solutions.
   On this opportunity, let me ask Chinese friends and authorities to tackle with
more determined way with IP rights problems, although we understand that it is
far from easy, given the very wide land and the existence of many poor people. The
effort, however, is not only for foreign capital but also for local companies to level
up their indigenous technology. By keeping it fairly and in a transparent manner,
foreign countries feel easy to provide new technologies in China and can suppress
domestic protectionism effectively.
   At home, Japanese government’s role is to hasten the structural reform of
sunset industries. While the productivity of Japan’s export-oriented industries
generally exceeded the averaged productivity of the U.S. by some 20% in 1999,
those of services sector, retails, construction, etc. are only half of the former. This
fact may be the reason why the former always say that they cannot but make FDI
overseas due to high cost economy, otherwise will stay at home. Making FDI is no
problem. But if they select Japan as a target for their new investment for high

value added products, that will be better for the nation. Structural reform should
be strongly pursued for this purpose. Another role for the government is to
supplement market failures. When big FDI is made, many people may be fired at
home. If business conditions are not that bad and labor market does work well,
they will get new jobs. It is inevitable in a market economy. However, if the
market cannot work efficiently by one reason or other, the government should
support to improve them, for instance, by re-training them for other jobs. We in an
advanced country can and should take care of the minority or losers in such a way.
Otherwise, protectionism would hover, making everyone miserable eventually.

2. This paper does not touch on Japan’s FDI in industrial countries . How should
we evaluate them in comparison with those in China? Many Japanese firms, big
or small, have actively made and expanded their business operations overseas
especially after the Plaza Accord. While bigger firms, auto industries in particular,
have invested heavily in North America (and Europe to a certain extent) and less
in East Asia including China, SMEs largely concentrated their FDIs in
neighboring countries, China in particular. However, notable is that many big
firms enjoy significant profits (in term of dividends and associated exports of high
value added items) from their FDI in North America (and in Europe to some
extent) as well as at their facilities in Japan, which enable their huge R&D
investment at home. This pattern should continue for some more decade.
Otherwise, Japanese firms will lose their superiority in technology, which enables
dynamic FDIs in East Asia.
    However, we are observing new trend that big firms began actively making
new FDIs or expanding their existing facilities in China to meet quickly
expanding China’s domestic market on top of those for export. Thus, FDIs to
domestic demand in China shall be compared with those in North America,
though value-added included in products made in China may be smaller than
those in the U.S. for the moment, reflecting the gap of averaged incomes between
the two countries. But some firms have successfully set up new business model in
China. So, it is expected that evaluation on their FDIs in China will gradually
change for better.
    Having said that, adverse effects might be yielded somehow if more and more
Japanese large-scale corporations continue to make huge FDIs and not much at
home to simply seek maximization of their profits from their microeconomic
perspective. I never wish to deny the freedom of Japanese firms to try to get as
much benefit as possible by finding optimum business locations for their
international business activities. They can do so under the rule of the game we

take for granted. As I mentioned, Japan’s FDI in China will generally benefit both
    However, what if improper macroeconomic policy at home deteriorates
domestic business climates? And what if regulations, taxes and other burdens on
firms make their costs of operation or investment at home prohibitively high (and
actually we criticize such a situation)? Then, Japanese industries and firms that
could otherwise have kept comparative advantage at home must shift their
operations overseas, which will result in an undesired outcome for the nation. In
this sense, proper macroeconomic policies and regulatory reforms are imperative
at home. In other word, we need to improve our business conditions to be
internationally competitive. It is neither protection nor unfriendly actions to our
two neighbors. In the same context, Japan should also encourage inflows of FDI
and other managerial resources from foreign nations. Last year, PM Koizumi
announced a plan to double direct investment inflow in the next five years. If and
when Japan get international competitiveness in business condition, it can
successfully invite much FDIs from overseas.

2. Lastly but not least in its significance, if I may, let me touch on a Korean issue
in a second. Korean economy has revived in a miraculous way after the
currency/financial crisis. We admire it. There are many lessons for Japanese. On
this opportunity, let us talk how to overcome the barriers to realize Korea-Japan
FTA. Before then. Let’s consider how to increase incoming FDIs in Korea? Not
much FDIs have not been made from overseas. In fact, unlike China, both Korea
and Japan face the same problem in this respect. I assume that Korean problem
on incoming FDI basically stems from the fact that business climate in Korea is
not that good, particularly due to intractable labor movements these days. Japan
experienced the severest labor movements back in the 1960s and put a complete
period at its peak. I believe Korean people can solve such problems in the same
manner. What I wish to stress here is that both Japanese and Koreans could learn
and help more effectively with each other on various issues, for instance, how to
open mutual market, how to deal with IP issues, and how to set up best practices
of investment climate. Thus we could reach our target of FTA. We will get success
if only we keep our heads cool with warm hearts.

【Figure1】 Map of China

Figure 2

            Can Japan set up competitive,
            new business model?

Japan‟s          •Globalization         Japan:        Revitalization
Glorious         •IT networking         Lost          of Japan by
Dacades          •Burst of „Bubble                    setting up new
 1970-80s                               Decade
                 economy‟                             business model
                                                      ----If possible,
of Japan‟s
model                        China‟s

               End of                    U.S.‟s economic
                                         recovery Neo
              Cold War                  Anglo- American Model       19
【Figure 3】Competition Between China and Japan : Degree of Overlap in
Industrial Exports


                                                              Product Sophistication Index ($)
                           Shoes           TV          Semiconductor
                          Low-tech Products              High-tech Products

*Products are ranked from low-tech products to high-tech products along the horizontal axis, while the
vertical axis represents the value of exports corresponding to each export item. A country’s exports can
then be represented by a distribution ranging from low-tech products to high-tech products. The
distribution for Japan’s exports is larger than that of China, reflecting its larger volume. It should also be
located more to the right, reflecting the fact that high-tech products make up a larger portion of Japan’s
total exports. The area of the two distributions that overlap one another (C) as a proportion of each
country’s total exports (A for China and B for Japan) serves as an indicator of the degree of competition
between the two countries. The greater the area of overlap between the two distributions as a percentage
of Japanese exports (that is, C/B), the more China is a competitor of Japan. Conversely, the smaller the
overlap, the more likely that China has an export structure complementary to that of Japan. Using US
imports statistics that cover 10,000 manufactured goods, we find that only 16% of Japan’ s products
competes with China’s products in the US market.
( Sources: C.H.Kwan )

【Figure 5】Business Models for Japanese firms Vis-à-vis China : With
                    Production Base and Market as Axes

                                 Production advantage

                 Production in China,               Production and sales in
                 reimport to Japan                  China

                  The w orld’s factory
                                                                                       Market advantage
         Japan                                                                 China

                 Production and sales in            Production in Japan,
                 Japan                              export to China

                                                    The w orld’s market

(Sources: C.H.Kwan)

【Figure 5】
                                                           Game machine for families
  Strategic                                                      Nintendo
   Alliance                                                                             Sankyo
             Home appliances                                                            Seiki
             (white goods and                                              Mini-motor
                   HDD                                                     conditioner
  Toshiba                               Matsushita
                                                                   Parts sales
                                        (Panasonic)                                         TCL,
                 LCD/CRT                                             TV
                                                                   Spare parts of
                                           Mobile                                 LG electronics
                                           phone                CRT

                                             NEC                                 Thomson

            (Source) Toshihiko KINOSHITA(2003)

  【Figure 6】                            FDI in China
 14   (Contract basis, U.S. Billion) no. of cases

【Table 1】Japan’s FDI in China
          FY             Number of Registered Amount
                         cases       (billion yen)
               1993        700           195.4
               1994        636           268.3
               1995        770           432.9
               1996        365           282.8
               1997        258           243.8
               1998        114         137.7
               1999         78           84.9
               2000        105         111.2
               2001        189         180.8
               2002        263         215.2
            (Source) Ministry of Finance, Japan

【Table 2】Carte of Japan
                          Early Stage in Last Stage in (In Recent Days)
                          Bubble Years   Bubble Years
                              1985             1989          2002
Real GDP Growth Rate               4.20%           4.90%             0.30%
Nominal GDP Growth Rate            6.60%           7.50%          ▲1.3 %
Consumer Price increase            2.40%           2.70%          ▲0.9 %
Worker’s     Household  ・          1.80%           3.50%           ▲1.3 %
Consumption Expenditure
Unemployment Rate                  2.60%           2.20%             5.30%

Plant & Equipment Investment                5.10%               14.9%                 ▲3.7 %
(Private Demand)

New Housing Starts               1,250,000      1,670,000                          1,150,000
Company’s Current Profit                 ▲5.7 %                   8.5%                  16.4%

Aggregate Market Value at the      183 Trillion Yen    611 Trillion Yen        248 Trillion Yen
First Section of the Tokyo
Stock Exchange
Aggregate Market Value of Land   1003 Trillion Yen    2136 Trillion Yen      1350 Trillion Yen

Treasury Budget /GDP                                             2.50%                 ▲7.9 %
Percentage of Treasury Bond                  23.2%               10.1%                  36.9%
Sales /Total Annual
Government Revenue
Borrowing outstanding of           205 Billion Yen     254 Billion Yen          705Billion Yen
National and Local Government
Number of Bankruptcies of                        1                   1                      29
Listed Companies
Balance of Current                           3.8%                2.1%                    2.7%

* Aggregate Market Value and Unemployment Rate are as of end of the year. Borrowing Balance is
  as of end of the fiscal year. Others are year-on-year. Aggregate Market Value of Land is a
  prediction of Mitsubishi Securities Co., Ltd. Consumer Price is based on Tokyo Price. Ships and
  Electricity are not included in Private Demand.
(Source) Bank of Japan, Financial and Economic Statistics Handbook、July 2003,
Nihonkeizai Shimbun, April 12th, 2003


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