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ON JAPAN: Chilly Welcome

Author: Edward J. Lincoln, Director, Center for Japan-U.S. Business and Economic Studies, New York University
February 16, 2005
Newsweek Japan

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Since the late 1990s, a number of dramatic foreign purchases of Japanese companies have occurred, including Shinsei Bank and Nissan. Overall the flow of foreign direct investment— including both purchases of existing Japanese firms and establishment of new wholly owned firms— has exploded in Japan. This followed over 60 years of very low levels of foreign investment in Japan. As recently as 1997, the annual amount of direct investment in Japan was less than 700 billion yen. In 2003, the inflow was over 2 trillion yen. Foreigners used to complain that Japan was relatively closed to foreign investment. Surely that era is over, right?

The best way to evaluate the relative size or importance of these investments is to look at the inflow of foreign direct investment as a share of the total fixed investment occurring in a country. For the world as a whole, the United Nations reports that this ratio began rising about 20 years ago. At that point, global international direct investment flows were 3 percent of total capital investment. Since 1998 this ratio has been over 10 percent.

The global trend is reflected in the experience of the United States and the EU. In the United States, the inflow of direct capital had been between 3 and 5 percent of domestic capital investment in the first half of the 1980s, but has averaged 12 percent since 1998 (despite a temporary drop in amount in 2002). Similarly, in the EU the ratio rose from 3 percent in the first half of the 1980s to an average of 26 percent since 1998. Today, direct investment into both the United States and Europe appears to be continuing at levels above 10 percent of total capital formation.

So how does Japan compare? While it is true that foreign direct investment entering Japan has increased quite dramatically, the increase was from a very low starting point. Using the same ratio of incoming direct investment to total capital fixed capital formation, the level in Japan was less than 0.5 percent back in the 1980s, but has jumped to an averaged of 1.7 percent since 1998. What can one say? The ratio has tripled, but remains miniscule relative to the experience of the United States, Europe, or the rest of the world.

I am worried by these numbers. The world is changing much faster than Japan is. Foreign direct investment is a means to tap into expertise and competition from abroad to improve to benefit consumers and improve the performance of the economy. It would be to Japan's advantage if there were a much larger flow of foreign direct investment, bringing management expertise or new technology to a variety of lagging industries.

Prime Minister Junichiro Koizumi has announced a goal of doubling the inflow of foreign direct investment by 2008, a good starting point. But will the authorities focus seriously on the obstacles to investment? In the past year, the government has paid for advertisements in the American media about what a great place Japan is to invest. That is not what is needed. The government should focus on changes in regulations governing acquisitions of existing domestic firms. Acquisition is a common form for firms to invest elsewhere around the world, including Japanese firms investing in the United States.

Sadly, official actions are doing more to discourage than encourage acquisitions. In January, the government's Industrial Revitalization Corporation of Japan (IRCJ) weeded out all the foreign firms bidding to rehabilitate Daiei, narrowing the competition to only Japanese bidders. Worse, at the end of January the Ministry of Finance announced plans to dramatically increase the capital gains taxes imposed on foreigners profiting from resale of firms they have acquired. This proposal was apparently motivated by the high profit earned by Ripplewood on the partial sale of shares of Shinsei Bank.

These actions send a chilling signal to foreign investors and are detrimental to Japan's economic future. The essence of capitalism is risk and reward. Ripplewood took a huge risk in acquiring the bankrupt Long-Term Credit Bank and deserves the reward from success. At the same time, the Japanese economy benefits from having a healthy bank. Take away the rewards, and the foreigners will not invest— and Japan will not benefit. Rather than decrying them as "vulture funds," Japan ought to extend a warm welcome to foreign firms with expertise in turning around distressed firms.

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