- Tamim Bayoumi, Guy Meredith, and Bijan Aghevli
- Published Date:
- June 1998
Gary Saxonhouse opened his remarks by noting that he had few disagreements with the views expressed in the papers with regard to the role of the current account or the “hollowing out” of the Japanese economy. In common with the staff, he regarded the current account as reflecting underlying macroeconomic fundamentals, rather than the effects of trade policies. If trade barriers were present, so that imports were lower than they would ordinarily be, the implication was that (in the absence of any changes to savings and investment owing to this policy) exports would be commensurately lower. As a corollary, export restrictions would lower imports, which was a point of some importance with regard to the attitudes of some of Japan’s trading partners. Such an approach also implied that the impact of deregulation on Japan’s current account surplus was ambiguous, as it depended upon the impact on domestic savings and investment, which in turn depended upon the specific measures being contemplated. He also agreed that the ebb and flow of Japan’s current account over time was well described by conventional trade equations, although there was also some impact from structural factors. The estimates presented in the research paper looking at the impact of FDI outflows on trade, while using aggregated data and a relatively simple specification, were useful. The result that East Asian countries behaved in a similar manner to other major trading partners was particularly noteworthy, although he wondered if this result could really be believed given the different composition of Japanese FDI outflows across regions. He also thought that the paper could benefit from giving some attention to the impact of FDI outflows on domestic Japanese savings and investment, to explain the domestic macroeconomic changes that paralleled the effect on trade. In conclusion, he noted that the issue of the impact of FDI outflows on the economy would remain an important topic for a considerable period, given that Japanese manufacturing capacity abroad was currently estimated to total only 10 percent of domestic capacity, one-half the level found in studies of the United States.
Masahiro Kawai focused his remarks on the research paper looking at the impact of Japanese FDI outflows on Japanese trade (the full text of his comments are provided as an appendix). He noted that there were two notable results: that there appeared to be no significant difference between the behavior of the East Asian countries and other trading partners; and that FDI outflows had a permanent impact on imports but only a temporary impact on exports. Turning first to the underlying data, he noted that the bilateral FDI data used in the study related to FDI commitments, rather than actual flows. While this was a reasonable choice, as it was the only data available on a bilateral basis, its limitations could have been discussed more thoroughly in the text. He was also somewhat skeptical of the results with respect to East Asia, in part because his own work on this topic had found significant differences in behavior between Japanese FDI to Asia and FDI to other destinations. He speculated that the reported results might reflect the use of aggregate FDI flows and suggested that future work focus on disaggregating flows by industrial sector as well as by location. He also felt that changes in the stock of FDI were likely to have a permanent impact on exports, rather than the temporary impact reported in the main-case results in the paper. Finally, the paper might also have tackled the interesting question of why inflows of FDI into Japan have been so small.
Edward Lincoln led off the general discussion by emphasizing the need to use data disaggregated by sector when looking at Japanese FDI flows, as the sectoral composition varied widely across geographic locations. For example, real estate made up a large proportion of Japanese FDI into the United States, while FDI flows to Asia were much more concentrated in manufacturing. He also mentioned an MITI survey on motives for Japanese FDI, which he felt could be usefully included in the paper, a view supported by Masaru Yoshitomi, who cautioned that FDI motives could not be divided as easily as was done in the paper, as most FDI decisions reflected a range of factors. Koichi Hamada, on the other hand, felt that the MITI survey was of limited use given this very complexity of motives. His own feeling was that the rise and fall in FDI flows over the 1980s and 1990s might be related as much to the exuberance of spirits over the bubble period, and the deflation of this effervescence subsequently, rather than to the economic variables included in the analysis. Finally, Kazuo Ueda thought that an interesting issue for future research was the connection between trade barriers faced by Japanese exporters and FDI flows.
Role of FDI for Structural Change in Japan’s Trade Patterns
The purpose of this session is to understand what determines the behavior of Japan’s trade balance and its trade patterns. While Bayoumi and Lipworth find that the movement of Japan’s trade balance can be well explained by the conventional variables such as relative prices and real income, they also claim that structural changes have played an important role recently in altering patterns and magnitudes of Japanese trade flows. One such structural change is the reallocation of Japanese manufacturing facilities abroad. This has shifted Japan’s exports toward more capital- and technology-intensive products than previously and has raised the proportion of manufactured goods imported from Japanese firms’ foreign affiliates. Bayoumi and Lipworth focus on the role of Japanese FDI in generating such structural changes in Japanese trade patterns.
More specifically, by using a panel of bilateral data on Japan’s FDI outflows and trade flows with 20 major trading partners over the 14-year period from 1982 through 1995, the authors examine the determinants of Japan’s outward FDI flows and their implications for Japan’s trade patterns. The 20 countries studied include those in North America, Western Europe, and East Asia. The basic approach is macroeconomic rather than microeconomic. Consequently, the important factors affecting Japan’s FDI outflows, exports, and imports are real exchange rates and macroeconomic activity.
Their econometric estimation yields several interesting findings. First, the main driving forces behind Japanese FDI outflows are Japan’s domestic conditions, particularly its investment levels and the exchange rate. The distribution of these FDI outflows abroad is determined by the investment climates of recipient countries. Second, the behavior of Japan’s FDI outflows and trade flows with East Asia is quantitatively no different from that with other major partners in North America and Western Europe. Third, in addition to being affected by both the real output of Japan and its trading partners and their respective bilateral real exchange rates, Japan’s FDI outflows affect the export and import levels of Japan itself. The authors include FDI outflows in the trade equations to capture some structural changes owing to FDI expansion. In particular, the authors find that Japan’s FDI outflows have only a temporary impact on exports while they have a permanent effect on imports. They claim that this is consistent with the view that FDI stimulates exports largely through the short-term need to equip new factories.
The paper makes a good contribution to the literature on Japanese FDI and trade. It is a careful work, using several alternative measures of the explanatory variables used to check the robustness of its empirical results. Before presenting my comments on this paper and its interesting results, I will indicate some of the statistical problems associated with Japanese FDI data.
There are two types of FDI time series data in Japan. One set consists of data published by the Ministry of Finance and is based on the practice of prior notification, as required under the Foreign Trade and Foreign Exchange Control Law. The other set is collected and published by the Bank of Japan as part of the balance of payments statistics. Although neither captures retained earnings that are reinvested in host countries, it is generally understood that the quality of balance of payments-based data is better than that of notification-based data. The reason for this is that notification-based data assume that notified investment is always implemented even if firms do not actually make investments. Because these data do not reflect depreciation or decumulation of capital stocks, firms’ withdrawals from the host countries, or bankruptcies, the figures tend to be larger than balance of payments-based figures. The measure of FDI stock based on notifications is simply the sum of past FDI flows. A measure of FDI stock published as part of Japan’s external assets and liabilities, as reflected in the balance of payments, would be of better quality. As a result, although the authors attempt to improve the quality of their data by using an alternative method to calculate the stock of FDI via a standard capital stock measurement using notification-based flows and a certain discount rate, the improvement is not significant.
The real advantage of using notification-based data is that they provide annual bilateral data for a large number of countries with industry disaggregation. The balance of payments-based data do not. Under the assumption that the limitations of the notification-based data are uniform across countries, industries, and over time, it is useful to exploit such an advantage. Using notification-based data but without industry disaggregation, the authors do not fully exploit this strength of the notification-based data. I would like to return to this point later in my comment.
Interpreting the Role of Real Exchange Rate in the FDI Estimation Equation
The authors find that appreciation of the real yen rate, adjusted for GDP deflators, has a significantly positive impact on the real FDI outflow from Japan. The issue here is whether the real exchange rate represents solely macroeconomic factors in the regression equations. To the extent that the secular appreciation of the real value of the yen reflects long-term fundamental changes in the Japanese economy through, for example, the Balassa-Samuelson effect, the impact of the real exchange rate on FDI outflows captures a secular process of industrial structural changes rather than cyclical factors. Given that the ratio of output produced by Japanese firms’ affiliates abroad to output produced by Japanese firms domestically is much lower than the corresponding ratio in some other industrialized countries, the increasing trend in FDI should continue.
A related issue is the use of real FDI outflow as a left-hand side variable in the FDI equation. The real FDI outflow is defined as the nominal FDI outflow in U.S. dollars converted into the respective host country’s local currency and deflated by the local GDP deflator. This amounts to multiplying nominal FDI outflows in U.S. dollars by a factor that resembles the real bilateral exchange rate. Consequently, it is not surprising to see the contemporaneous coefficient of the real exchange rate on the right-hand side to be almost one. It may be more desirable to convert the nominal FDI outflow in U.S. dollars into Japanese yen and deflate by the Japanese GDP deflator.
Is East Asia Different?
The authors conclude that the behavior of Japan’s FDI outflows and trade flows with East Asia is quantitatively no different from that with its other major partners. Using variables defined by first differences, it appears that one cannot reject the null that the behavior of Japanese FDI outflows to East Asia is different from those to North America and Western Europe. In terms of level, however, Japan’s FDI and trade relationship with East Asia may be different from those with other regions in the world, particularly with Western Europe. In fact, as I have presented elsewhere, one should not be surprised to learn that Japan is more closely integrated in FDI and trade with East Asia and North America, the Asia-Pacific Economic Cooperation Council (APEC) region, than with Western Europe. The levels regression with fixed effects summarized in Table 6.2 does not report the F-statistics to test equality of fixed coefficients across countries. I would not be surprised, however, to see significant F-statistics, indicating that the levels of Japan’s FDI and trade with East Asia are significantly greater than those with other regions.
Temporary Versus Permanent Effects of FDI on Trade and the “Hollowing Out”
On the basis of their findings that exports are explained by the flow, not the stock, of outward FDI and that imports are explained by the stock of FDI, the authors conclude that FDI outflows have only a temporary impact on exports while FDI inflows have a permanent impact on imports. If this is a definitive conclusion, I am not convinced. My own research suggests that the stock of FDI has a statistically significant impact on exports as well as on imports. It is true that the impact of FDI on imports is almost always larger than that on exports so that the net effect is a worsening of the trade balance. With this in mind, it may be too early to conclude that the positive impact of FDI on exports is temporary. As long as FDI is motivated by firms’ desire to relocate production processes to take advantage of international differences in factor proportions, FDI will tend to generate continuously intrafirm division of labor and intraindustry trade and will continue to stimulate exports from Japan of capital goods and intermediate products that are both human capital and technology intensive. This may well be part of a continuous process of industrial structural changes in the Japanese economy, which can take different forms over time.
Implications of FDI for Trade Patterns
The authors attempt to examine the determinants of bilateral FDI outflows and their implications for trade without using industry-by-industry, disaggregated data. To examine the structural relationship between the Japanese FDI outflow and trade patterns, it is more important to focus on the relationship at disaggregated industry levels. As I pointed out earlier, such data series are available from the Ministry of Finance. As suggested in the chapter summarizing IMF staff views by Aghevli, structural changes induced by FDI may not have a long-lasting impact on the current account unless they have permanent effects on macroeconomic savings and investment. However, FDI can have important implications for the composition of trade. My earlier paper shows that the impact of FDI outflows on trade are different across industries; FDI tends to have a greater impact on trade in the machinery industry than in other industries. FDI outflows tend to stimulate both exports and imports with the impact on imports seeming to be greater than the impact on exports. The net impact is to worsen Japan’s trade balance, a sign of “hollowing out.” Patterns of “hollowing out” are, however, different across industries. I strongly urge the authors to focus on industry-disaggregated FDI and to try to uncover the impact of FDI outflows on trade composition.
Japan’s Inward FDI
What the authors do not analyze adequately enough is Japan’s inward FDI, which is extremely small. Although FDI inflows to Japan have not had a large impact on trade owing to their extremely small size, it is important to understand the reasons for this and its effect on the structure of the Japanese economy.
It is clear that many foreign firms do not regard Japan as an attractive host for their operations. When Japanese firms in the tradables sector have attempted to relocate their production bases abroad, it is not surprising that only a few manufacturing firms have reciprocated by investing in Japan. Hence, the question is why foreign nonmanufacturing firms have not been finding Japan an attractive place for business, particularly in sectors in which Japanese firms are not very competitive. Several reasons may be provided for the low level of FDI inflows into Japan’s nonmanufacturing sectors: (1) high costs of operations in Japan, particularly high wages and high land prices; (2) explicit and implicit barriers to entry, ranging from government regulations to restrictive business practices such as keiretsu; and (3) lack of effective markets for mergers and acquisitions (M&A) and takeovers of Japanese firms.
It should be noted that once foreign firms are in Japan and successfully operating, their rates of return tend to be high. This suggests the presence of some rent to be earned by incumbents. The authors should address some of these important issues in their work concerning FDI inflows.
My own research on the impact of FDI inflows on exports and imports at disaggregated industry levels indicates that positive linkages again exist between FDI and trade.