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International perspective: the globalization of Japanese corporations: investment in Europe.

Japanese companies have spread their operations outside their own country more than any other nation. In particular, foreign direct investment by Japanese companies has expanded and its traditional destination has shifted to Europe and North America. This article examines Japanese investment in the European Community, a market more fragmented and protectionist than the U.S. The article discusses the nature Of restrictions on Japanese exports to the EC, and then the motives and choice of location for investment within the EC.

IF CORPORATE STRATEGY in the 1980s could be summarized in one word, that word would be "globalization." More than any one else, Japanese companies seem determined to spread their operations outside the boundaries of their country. What makes the case of Japanese direct investment interesting is not only its recent vintage and rapid growth but also the change in its traditional destination.

The rapid increase in Japanese foreign direct investment (FDI) has become a source of friction between Japan and other countries. In the U.S. and the European Community (EC) it is widely believed among policy makers and business leaders that Japanese firms are investing in order to "Jump over tariffs" and to exploit opportunities from "Europe 1992."

While these are not insignificant motives for the presence of Japanese firms in North America and Europe, they belie the fact that Japanese firms are able to survive competition in foreign markets because they are at the leading edge of new technologies. They would invest even in the absence of any barriers of trade, because technological leadership requires them to behave like global companies. It also implies that their rivals must compete with them in all their major markets.(1)

We are witnessing the transformation of Japanese companies from successful exporters into global companies with production facilities in many countries. One way of demonstrating this transformation is to examine investment by Japanese companies in the EC, which has a more protectionist and fragmented market than the U.S. Investment decisions are inevitably affected by the state of trade relations between home and host countries. For multinational companies, exports and investment in production facilities abroad are often alternative strategies for reaching their markets. Their choice between the two depends on how easy or difficult the alternative is. Therefore, in order to understand investment decisions, it is important to put them in the context of the EC-Japan bilateral trade relations.


The EC's trade dependence on Japan is minor. In 1988 Japan accounted for only 4.2 percent of the EC's total imports. In the same year Japan was the destination of a meager 1.6 percent of the EC's total exports. By contrast, the EC received 16 percent of Japan's exports and contributed to 12 percent of Japan's imports. The EC's bilateral trade deficit with Japan amounted to ECU21 billion in 1987.

Although these trade statistics would suggest that the EC would not be overly concerned about its commercial relations with Japan, the opposite is true. The EC's concern arises not only out of Japan's export success but also out of the fact that Japan has so far concentrated its exports in a few sectors. The maJority (53 percent in 1989) of Japanese exports to the EC is accounted by only two broad industrial sectors: electronics and transport equipment.
In 1989 manufactured products accounted for 97
percent of Japan's total exports to the rest of the
world. The composition of manufacturing exports
was as follows:
 Chemicals: 5%
 Basic manufactures: 13%
 (rubber, paper, textiles, iron & steel)
 Machinery and transport equipment: 71%
 - office machines: 8%
 - sound and telecom equip.: 11%
 - road vehicles: 24%
 Other manufactures: 8%
 (precision and optical equip., cameras, watches)

A recent study measuring Japan's comparative advantage found that overall Japan showed stronger export competitiveness relative to the EC in five sectors (ranked in order of importance): electronics, precision equipment, road vehicles, machinery, and musical instruments.(2) Given that protectionist pressure rises when competition from imports increases, it is not surprising that most of the trade friction between the EC and Japan is exactly in those industrial sectors.

Japanese authorities and businessmen believe that the EC Commission has targeted Japanese products for special punitive treatment.(3) Although there may be a grain of truth in this belief, the EC is not protectionist only with respect to Japanese products. If Japan suffers more than other countries, it probably is because Japan is more competitive than other countries. Nor are all the impediments to Japanese exports masterminded by the Commission. For example, the reason for friction in the trade of cars is because exports are restricted by national barriers that are supposed to be swept away by the creation of a single European market.

The Community has several instruments at its disposal for implementing its commercial policy. The most important of these are the common external tariff, customs valuation rules, country-origin rules, import surveillance, antidumping and countervailing rules and the new commercial instrument for dealing with illicit foreign practices (e.g., violations of copyrights and patents). However, imports can be restricted by other means as well. Voluntary Export Restraints In 1987 the EC and its member states accounted for 138 out of a total of 261 known voluntary export restraints (VERs), mostly affecting textiles, steel, agricultural products, footwear, cars and electronic products.(4) Of those 138 VERs, 87 were EC-wide and 51 were arranged by national governments. The majority of EC VERs (68 or 80 percent) covered steel, agricultural products and textiles. Hence, the trade of industrial products is controlled primarily by national VERs. Japan's two most important export sectors, electronics and transport equipment, are both restricted by VERs. It is believed that in 1988 the EC had at least sixteen VERs (of which eleven were at national level) covering different electronics products.(5) Car imports are currently restricted in four EC countries: the U. K. (11 percent of the local market), France (3 percent of the local market), Italy (3000 new cars per year, corresponding to about 1 percent of the local market) and Spain (1-2 percent of the local market). Recent press reports have also suggested that an informal understanding exists between German car manufacturers and their Japanese counterparts to limit the latter's exports to Germany to 15 percent of the market.(6) The overall EC share is about 9-11 percent.

In addition to their own bilaterally negotiated VERs, some member states also impose border restrictions on products from particular third countries (the so-called Article 115 derogations," because they need permission from the Commission in order to depart from their obligation of maintaining free trade with the rest of the Community). At the end of 1988 there were 96 EC-wide quantitative restrictions on imports of manufactured products and 90 national restrictions.(7) Many of them overlapped. Japan was affected by 6 EC and 53 national quotas. Other target countries were South Korea (5/13), state-trading countries (25/4) and developing countries (8/30). The most frequent users of Art. 115 derogations are France, Italy, Spain and Ireland.(8)


Japanese exports have been particularly affected by the EC's antidumping policy.(9) In the nine years between 1980 and 1988, the EC initiated about 350 antidumping investigations. The majority of those investigations have been against products from East European (34 percent of all cases) and East Asian (17 percent of all cases) countries. Much attention and criticism has recently been attracted by the EC's anticircumvention regulation.

In order to prevent circumvention of its antidumping duties, the EC introduced the so-called screwdriver provision ("parts amendment"). This additional regulation enables the EC to impose duties on foreign products assembled within the Community provided that:

1. Assembly began or increased substantially after an antidumping inquiry, and

2. The value-added by components from the home country of the exporter exceeds 60 percent.

Therefore, in strict legal terms and contrary to a widespread belief, the screwdriver regulation is not a local-content requirement for inward investment, because it applies only to few products and because it allows firms to use components of non-EC origin for the remaining 40 percent of the value-added. Of course, a firm that has been affected by antidumping measures may think that it will still remain vulnerable to future antidumping complaints if its products do not acquire enough European value-added in order to be classified as European. The safest, although not necessarily the cheapest, course of action is to manufacture within the EC or purchase components from EC suppliers.

Japanese firms understandably believe that the screwdriver regulation is aimed at them. All cases so far have involved Japanese products electronic scales, electronic typewriters, photocopiers, VCRs, dot matrix printers, ball bearings and excavators). Japan subsequently contested the screwdriver regulation in GATT. In a decision issued in March 1990, a panel of experts found in favor of Japan.

Rules of Origin

Rules of origin are needed because trade barriers are not uniform. Some countries are given preference over other countries. Therefore, rules that confer origin enable discriminatory policies to function effectively. How the national origin of a product is determined is an issue that does influence trade and direct investment, regardless of the intentions of technocrats.

The EC's rules of origin were first implemented in 1968 when a free trade agreement with EFTA countries came into force.(10) The objective of the rules was to prevent trade deflection, i.e., the importation of products from third countries via an EFTA country that happened to have a lower tariff than the common external tariff of the EC. For that purpose, it was necessary to determine the national origin of traded products. The EC follows the general principle laid down in the 1973 Kyoto Convention, which specifies that a product originates in the country where the "last substantial process or operation" takes place.

Until recently there was little international concern about rules of origin. Most discussion took place at a technical level. Concern heightened after the EC added a few qualifications to what the last substantial process meant for photocopiers and semiconductors. It is worth noting that the EC was probably within the limits of its international legal obligations in determining how that general principle was to be interpreted with respect to those two products. The EC has also specified particular rules of origin for twelve other products. The rules for photocopiers and semiconductors are the only ones that were introduced in the 1980s. All the others were introduced in the 1960s and 1970s.

Following an antidumping complaint in 1987 concerning photocopiers from Japan, the EC decided that origin is conferred by- the country in which the heat-resistant drums are manufactured. This decision had a serious effect on Ricoh, which had begun exporting photocopiers to the EC from a plant in California. The new rules effectively denied that these photocopiers were of American origin. Similarly for semiconductors, an antidumping complaint in 1985 led to the rule (in 1989) that origin is determined by the country in which circuit diffusion is done. This rule has accidentally or intentionally favored European producers that carry out the diffusion in Europe and final assembly in other, low wage, countries.

The foregoing review of trade friction between the EC and Japan leads to the following two conclusions:

1. Japan faces trade barriers in the industries in which it is most competitive. At least until 1993, many of those trade barriers will be determined at the national rather than Community level. If investment decisions have been influenced by trade barriers, they are likely to have taken into account these national restrictions.

2. Investment in production facilities within the EC does not necessarily avoid restrictions on Japanese products. Rules of origin and local-content requirements affect the inputs and, therefore, cost competitiveness of certain products.

Given these conclusions three questions arise:

1. Have Japanese firms invested primarily in order to avoid trade barriers?

2. if tariff-Jumping has been their major motive, have they invested in the most protectionist markets?

3. Because local-content requirements make production in Europe more costly than in other countries (i.e., Southeast Asia), have Japanese firms located their manufacturing operations in the low-wage areas or areas that offer the highest regional subsidies?

The answers to all three questions are negative. Available evidence analyzed in the following section indicates that minimizing labor costs does not appear to have been the major objective of Japanese subsidiaries. Such observed behavior is consistent with the globalization hypothesis. Producing in low-wage regions is of relative little importance to global companies with high-tech products. What is more important to them is close contact with the changing technical requirements of their clients and the changing tastes of consumers.


Since 1985 Japan's total outward direct investment has increased by more than 500 percent. In the 1985 fiscal year $12 billion was invested abroad. By 1989 overseas investment reached $67 billion annually, half of it going to the U.S. while the EC received more than a fifth of it ($14 billion).

At the end of 1989 the book value of the stock of Japanese investment in the EC was $42 billion. Table 1 shows the allocation of that investment among EC member states. The U.K. has received almost 40 percent of investment in the EC and 35 percent of investment in the whole of Europe. The four largest member states account for 73 percent of investment. A reason for this concentration is that most of Japanese FDI has been in services and especially financial services. Naturally, London and Luxembourg have attracted a relatively large proportion of that investment.

Table 2 shows the industrial distribution of Japanese investment. Services account for 76 percent of total investment and financial services alone represent 49 percent of that total. The most important manufacturing activity, which is only a quarter of manufacturing investment, is the production of electric and electronic goods (4.3 percent of total investment)

Several popular explanations have been offered for the spectacular growth in Japan's outward direct investment. The major causes are believed to be the 1985 appreciation of' the yen, the low cost of borrowing in Japan and the need to avoid trade barriers.

Although these explanations may have some merit, they are seriously incomplete. A currency appreciation by itself cannot stimulate investment. Foreign assets may look cheaper but the return to investment will be correspondingly lower when expressed in home currency. An appreciation may stimulate investment only when a subsequent depreciation is expected, so that the returns, expressed in home currency, are higher than before. If exchange rate fluctuations could account significantly for direct investment, a reversal in capital outflows from Japan should have occurred already.

The low cost of borrowing is also an unsatisfactory explanation. In a world of integrated financial markets, non-Japanese companies should also have been able to benefit from the cheapness of Japanese capital. What is even more puzzling is that Japanese subsidiaries abroad do not always borrow from Japan when they expand their operations. There is also investment from other countries into Japan. If FDI would flow only from the low interest rate countries to high rate countries, no FDI would take place in Japan.

There is an element of truth in the view that some Japanese investment has been undertaken in order to avoid trade barriers. But like the two previous popular accounts of Japanese corporate exodus, it is an inadequate explanation. The majority of investment, which is in services, has not been prompted by any significant increase in protectionism. If anything, capital flowed to the countries that liberalized their markets (e.g., U.K. and Luxembourg). Moreover, Japanese companies have not invested greater amounts in the more protectionist markets. According to recent studies, the EC is more protectionist than the U.S. and, within the EC, France, Italy and Germany are more protectionist than the U.K.(12)

The concentration of FDI in the U.K. may be explained on the grounds that countries such as France and Italy also have barriers against investment. But, this implies that the tariff-jumping" hypothesis ignores the possible existence of other protectionist policies. On the other hand, it may be argued that in an (almost) integrated market, nationally determined external barriers are irrelevant and Japanese firms would locate their operations in the countries with the cheapest labor or highest incentives to investment.

Undoubtedly, some Japanese firms have invested in order to produce behind the tariff walls of the EC. There are, of course, other good reasons why Japanese firms invest in markets they are more familiar with through their exports. They reduce the risk of failure by undertaking investments in markets whose laws, regulations and customs are relatively better known to them. Furthermore, their larger share of the local markets achieved through exports is likely to provide them with more information about local consumer tastes. But above all they would not have been able to withstand local competition had they not been global players with state-of-the-art technology.

A more general and credible explanation of the increase in Japan's outward investment is that Japanese companies that aspire to a global status, like American companies forty years earlier, need to have a presence in their major markets. Thus they forge strong links with their customers and local business communities. These links help them to establish and defend their corporate image and brands. Not surprisingly, the majority of Japanese manufacturing investment has occurred in those sectors in which Japan has been a successful exporter: machine tools and equipment, electronics and cars.

Investment in services can be explained by their own low tradeability. Initially, a sizeable proportion of Japanese investment was undertaken by trading companies. Their purpose was to channel exports into new markets and send back to Japan foreign products. Still today more than half of Japanese exports and imports are carried out by trading houses.

In the financial sector, initial investment was undertaken in order to serve Japanese companies abroad, engage in foreign exchange business and participate in Eurocurrency markets. It is not surprising that Luxembourg and the U.K. have attracted large amounts and a disproportionate share of financial services, given that their financial markets are well developed. As Japanese banks and securities houses gained experience and knowledge of the European markets, they began to provide more diversified services and even offer European financial instruments (e.g., corporate bonds) to their Japan-based clients. Their growing familiarization with and involvement in European markets is manifest in the fact that in the past few years they have been active in establishing new offices in other regions of the EC. This movement out of the main financial centers is also the result of their strategic repositioning in advance of the creation of a single market within the EC.

Choice of Location

It may be thought that, once a Japanese firm is inside the tariff walls of the EC, the choice of location for investment is insignificant. Yet, some EC countries attract more overall investment and also more investment in particular industries. Moreover, with the exception of Spain, investment has not flowed to southern countries with cheap labor.

Table 3 shows the share of each industry relative to total investment in each country and relative to total investment in that industry in the whole of Europe (including non-EC countries; the EC accounts for 93 percent of all Japanese investment in Europe). That most of investment goes to the U.K., Germany and the Netherlands is easy to understand. These are the traditionally liberal members of the EC. Yet, the proportion of investment that goes to these countries varies quite substantially across industries. This difference implies that, when Japanese firms invest, the;, do not only consider the openness or receptiveness of potential host countries but also whether they are suitable locations for the particular needs of each industry.

When a firm considers investing abroad, its choice of location is determined by the general attitude and policies of host countries towards foreign investors and by specific factors that influence individual industries (e.g., competitors' strategies, location of maJor suppliers, location of major customers, etc.). Different industries would have a natural tendency to agglomerate in different countries if all governments followed neutral or similar policies on foreign investment. Because policies are not neutral, investment decisions are distorted by political or cultural factors.

In order to disentangle the industry-specific from the more general political influences, Table 4 presents an index of Revealed Locational Attraction (RLA). The index shows how attractive EC countries are to different industries after the more general influences are removed. The derived index removes the more general influences by normalizing each country's share of investment in each industry. A neutral location corresponds to an RLA value of one. Values of less than one show locations that are not attractive, while values greater than one reveal attractive locations. The greater the RLA number, the stronger the perceived advantage of a location.

The results for the U. K. are somewhat surprising. In spite of its large shares in almost all manufacturing sectors, it is not revealed to have any particular advantage in these sectors. The only sector in which the U. K. seems to do relatively better than other EC countries is in real estate. These results, however, are likely to be biased by the fact that the U.K. is the major recipient of Japanese FDI and that most of it is in services.

Finally, Table 5 shows another index of locational attraction based on the availability of incentives for investment. In an otherwise integrated market, firms would establish their operations in the country that offers the largest subsidy. The subsidies that would normally be available to Japanese firms are those for regional development purposes (apart from illegal subventions). The attractive countries for investment would be those in which regional aid per capita is higher than in other countries. The index allows us not only to rank countries but also to determine how much more or less attractive each country is relative to others. For example, the amount of regional aid available in France is 45 percent more than that in Germany. But, considering that France has a smaller economy, available aid makes it twice as attractive as a location for investment.

In summary, the two indices show that, once general political influences are removed, Japanese investment in different industries tends to agglomerate at different locations and its destination is not systematically affected either by low wages or subsidies. In consistence with the globalization hypothesis, Japanese firms tend to invest in their main markets, which are also the markets that have been relatively more open to their exports.


As demonstrated elsewhere, Japanese investment fits the pattern of investment by American multinationals that came to Europe in the 1950s and 1960s.(13) The latter expanded outside the U.S. at the time of America's technological leadership. If indeed the American Example can be a basis for predicting the growth of Japanese investment in Europe, over the next decade it should more than triple. Perhaps the major consequence of "1992" for American firms will not be more European protectionism, but tougher competition by Japanese firms located in Europe.


1 Both of these implications have been extensively analyzed in Michael Porter's Competitive Advantage, (Cambridge, MA: Harvard University Press, 1981).

2 See B. Heitger and J. Stehn, Japanese Direct Investment in the EC, Journal of Common Market Studies, 1990, vol. 29 (1), 1-15.

3 See K. Ishigawa, EC Sees Japan as a Challenge, Japan Times, 22 October, 1990, and Blatant EC Protectionism, Japan Tinws, 23 October, 1990.

4 IMF, Issues and Developments in International Trade Policy, Occasional Paper no. 63, Dec. 1988, p. 93.

5 See IMF (1988), op. cit.

6 Frankfurter Allgenwine Zeitung, 8 April 1989.

7 See Anna Murphy, The European Community and the International Trading System, vol. II, CEPS Paper no. 48, 1990, p. 57.

8 See Anneliese Herrmann, The European Market in 1992, Tokyo Club Papers, 1990, no. 3, 243-296, p. 266.

9 A more extensive analysis and further references can be found in P. Nicolaides, EC Antidumping Policy, Tokyo Club Papers, 1990.

10 For a more detailed review of the EC rules of origin see Brian Hindley, Foreign Direct Investment: The Effect of Rules of Origin, Roval Institute of International Affaris, Oct. 1990.

11 The nature and effects of Japanese investment in the EC are analyzed in depth in Stephen Thomsen and Phedon Nicolaides, The Evolution of Japanese Investment in Europe, Harvester-Wheatsheaf, forthcoming 1991). The data in this section are drawn from that book.

12 For references see Herrmann (1990), op. cit.

13 Thomsen and Nicolaides (1991), op. cit., examine at length the similarities between American and Japanese FDI in Europe.
 Table 1
Geographic Distribution of Japanese Investment in the EC
 (stock 1951-88, $ billion)
 Amount Share of EC
Europe 30.16 --
EC 27.81 100
U. K. 10.55 38
Netherlands 5.53 20
Luxembourg 4.73 17
Germany 2.36 8.5
France 1.76 6.3
Spain 1.04 3.7
Belgium 1.03 3.7
ireland 0.43 1.5
Italy 0.37 1.3
 Source: Japanese Ministry of Finance
 Table 2
 Industrial Distribution of Japanese Investment in the EC
 (stock 1951-88, $ billion)
 Amount Shares
Manufacturing 4.52 16.3(1)
 chemical 0.57 2.0(1) 12.6(2)
 machinery 0.60 2.2(1) 13.3(2)
 electric/electronic 1.20 4.3(1) 26.5(2)
 transport equipment 0.90 3.2(1)
Services 21.17 76.1(1)
 finance 13.61 48.9(1) 64.3(3)
 distribution 3.68 13.2(1) 17.4(3)
 real estate 1.28 4.6(1) 6.0(3)
TOTAL 27.81 100
(1)share of total FDI
(2)share of manufacturing FDI
(3)share of services FDI

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Author:Nicolaides, Phedon
Publication:Business Economics
Date:Jul 1, 1991
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