Japan's Inward FDI is Extremely Low Among Developed Nations

February 24, 2015Japanby East Asia Forum

Abe is working hard to boost Japan's inward FDI.

Japan’s inward foreign direct investment (FDI) is extremely low in comparison with that of other developed countries and even its Asian neighbours.

In 2013, the ratio of Japan’s inward FDI stock to its GDP was 3.5 percent, the lowest among developed countries and far below the global average of 34.1 percent. The US and Germany for instance have ratios seven to eight times higher than Japan, while China and South Korea have ratios three to four times that of Japan’s. Inward FDI in developed countries is characterised more by mergers and acquisitions (M&A) — involving buyouts of existing companies — than by greenfield investments entailing the establishment of new companies. In this context, M&A by foreign companies in Japan is sluggish.

Receiving direct investment from foreign companies promotes economic growth by increasing investment, production, and employment. But the benefits of receiving direct investment are not limited to these quantitative expansions. They also include qualitative improvements through transfers of advanced technology and management know how to Japanese companies. Higher productivity also stems from intensified competitive pressure on Japanese companies. Similarly, consumers benefit from the availability of new products and services.

Aware of the contributions inward FDI could make to Japan’s economic recovery and medium- to long-term growth, the Abe administration — in a revised version of its Japan Revitalization Strategy released in June 2014 — advocated expanding inward FDI. The strategy aims to double the 2012 year-end inward FDI stock by 2020. This expansion is a key part of the third arrow of Abenomics’ approach to growth.

What factors hinder inward direct investment in Japan?

In opinion surveys of foreign companies conducted by the Japan External Trade Organization (JETRO), the Ministry of Economy, Trade and Industry and others, the problem most commonly cited by foreign companies seeking to operate in Japan is the high cost of doing business. Specifically, the high corporate and other tax rates applicable to businesses and high office rents. Among the other obstacles noted were the closed and peculiar nature of the market and administrative procedures; the complexity of approval and licensing systems; the difficulty of securing needed personnel; and, in particular, the scarcity of personnel capable of communicating in English.

Surveyed companies pointed out that M&A in Japan is sluggish. They claimed that this is due in part to tax regimes and procedures that make it harder to pursue M&A than in other developed countries and in part to the significant barrier of closed corporate governance in Japanese companies, that inhibits M&A.

Recognising the need to expand inward FDI, since the 1980s the Japanese government has been pursuing a variety of polices to encourage such investment — offering foreign companies low-interest loans, tax breaks, debt guarantees and useful information. The second Abe administration, inaugurated in 2012, sought to reduce or eliminate factors inhibiting investment in Japan by setting targets to double inward investment, creating a council for foreign direct investment promotion to help achieve these targets, and implementing regulatory reforms.

These latest measures to promote direct investment in Japan feature several characteristic elements. One is the connection with Japan’s National Strategic Special Zones (NSSZs), which are actively introducing regulatory reforms in designated areas. The Abe administration regards NSSZs as an extremely important policy measure. The establishment of such zones expects to produce an expansion of inward FDI. Another is the reforms to corporate governance undertaken to encourage M&A. Ensuring that corporate governance is open and transparent will lead to greater inward direct investment via M&A.

The obstacles impeding greater FDI in Japan that would assist in Japan’s economic recovery and increase the benefits for consumers are apparent. The problem lies in developing and implementing the policies needed to reduce or eliminate these obstacles. Previous administrations have devised policies needed to expand direct investment in Japan, but these policies could not be implemented due to strong resistance from vested interests.

The Abe administration scored a major victory in the House of Representatives elections in December 2014. It now holds an overwhelming majority of seats in both houses of the Diet. Now the Abe administration must overcome the resistance put up by vested interests that prioritises short-term gains. It needs to implement the regulatory reforms needed to make Japan’s economy and society prosperous and dynamic.

If regulatory reforms can establish a business environment that facilitates the participation of foreign companies in the Japanese economy, foreign companies will expand their direct investment in Japan. Greater direct investment in Japan will speed up Japan’s economic recovery and boost its future economic potential, resulting in further direct investment in Japan. It will create a virtuous cycle in which expanded direct investment in Japan leads to economic recovery and growth that in turn attracts more investment.

But whether this virtuous cycle can be set in motion will depend on the Abe administration’s determination and ability to get things done.

Revitalising sluggish FDI in Japan is republished with permission from East Asia Forum

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