Japan has achieved economic growth by accelerating “external” globalization through expansion of trade and outward foreign direct investment (FDI). On the other hand, “internal” globalization through inward FDI falls behind and cannot gain benefit from the opportunities for further growth. The globalization of Japanese economy is characterized by close relationship through production networks with rapidly growing Asian countries.

For further globalization, which is important to realize further economic growth, it is essential for Japan to cope with three risks: COVID-19 and other future infectious diseases, the trade war and battle for supremacy between the U.S. and China, and protectionism. To counter these risks, there are individual measures as well as common ones. Among the common measures, the important ones for the Japanese government and companies are the establishment and implementation of international rules and human resource development.

Introduction

Globalization, which is cross-border movements of goods, money, people, and information, has brought major impacts on our economy and society, and governments and corporations as well as people are becoming increasingly interested in globalization. During the period of steady economic growth from the 1980s, when globalization accelerated, to around 2007, when the global financial crisis occurred, there were many positive views that globalization would play an important role to accelerate economic growth.

However, after the global financial crisis, as economic growth slowed down, unemployment increased, and income gaps widened, the view that globalization is the cause of these problems spreads, and the anti-globalization movement has grown. In addition, COVID-19 that broke out in Wuhan, China, at the end of 2019 spread quickly around the world through the active movement of people in a globalized world, causing many infections and deaths and bringing a significant impact on the world economy and society. As a result, people have become more concerned about advantages and disadvantages of globalization.

In this article, I would like to examine the actual situation and the impact of globalization in the Japanese economy, in the light of the progress and impact of globalization in the world as described above, and consider the future responses.

I 　Globalization of the Japanese Economy

When we look at the globalization of the Japanese economy through GDP ratios of trade and FDI, trade has increased from the early 1990s and FDI has expanded since the 1980s (Figure 1). However, compared to trade and outward FDI, the growth of inward FDI has been extremely slow. The low level of Japan’s inward FDI becomes distinct by comparing it with the situation in other countries.

Table 1 shows exports and imports as well as outward and inward FDI as a percentage of GDP for the world’s major economies as of 2018 and 2019.^*1 As for exports/imports-GDP ratios, Japan’s percentages are lower than those of the European countries and South Korea, but almost the same as that of China, and higher than that of the U.S. As a general trend, countries with large economies are less dependent on foreign countries, so Japan’s situation is not particularly different.

On the other hand, Japan’s FDI is quite different compared to other countries in terms of the large difference between outward and inward FDI, and the low level of inward FDI. The actual situation of FDI shows that the globalization of the Japanese economy has made considerable progress externally but is limited internally.

In this section, we will first examine the globalization of Japanese firms, that is, the globalization of the Japanese economy on the external front, and then examine the globalization on the internal front, focusing on the entry of foreign firms into Japan.

1. Expansion of overseas economic activities by Japanese companies

Globalization of the Japanese economy since the 1980s has been characterized by close relations with Asian countries, particularly with East Asian countries such as China and the members of the Association of Southeast Asian Nations (ASEAN). The expansion of the Japanese economy’s relationship with East Asian countries may be a natural consequence of the high economic growth rates that East Asian countries have recorded compared to other countries.

However, given Japan’s significant contribution to the economic growth of East Asian countries and the fact that Japanese companies have built production networks^*2 with East Asian countries, closer economic relations between Japan and East Asian countries are noteworthy developments.

Trade

Let’s start by looking at statistics of trade by region and commodity to clarify the characteristics of globalization in the Japanese economy (Table 2). Between 1990 and 2018, Japan’s exports to and imports from the world increased 2.7 times and 3.1 times, respectively. The regional composition shows East Asia’s share in Japan’s exports increased from 32.2% to 48.8% and in imports from 27.5% to 42.3% during the period as Japan increased trade significantly with the region.

Among East Asian countries, China has particularly extended its share. China’s share was 3% in exports and 5.1% in imports in 1990, but respectively rose significantly to 21.1% and 21.8%. During this period, ASEAN’s share of exports and imports has remained constant at 12-13%, and shares of other East Asian countries (not included in Table 2) have not changed significantly. This indicates that the major change in the East Asian share in Japan’s trade is largely the result of expanded trade with China.

In terms of commodity composition, Japan’s exports are mostly composed of intermediate and final goods. However, exports of agricultural, forestry, and fishery products, on which the Japanese government has been focusing in recent years, have shown significant growth, although their scale is small. While intermediate goods account for a large share of exports to East Asia, final goods account for a large share of imports from the region.

Behind this trade structure is the existence of a production network between Japan and East Asia where intermediate goods are exported from Japan to East Asia and assembled into final goods there, and then exported to Japan.^*3 FDI from Japan has made a significant contribution to building the production network, which will be discussed later. In contrast to Japan’s boosting trade with East Asia, Japan’s trade with the EU-28 and the U.S. did not expand as much. As a result, their shares in Japan’s trade declined.

Outward FDI

Outward FDI by Japanese companies has expanded significantly since the mid-1980s.^*4 The outstanding amount of foreign investment increased from USD 58 billion at the end of 1985 to USD 278 billion, about sixfold by the end of 2000, and to USD 1.818 trillion, 41 times by the end of 2019.^*5 In 2019, the shares of Asia, the U.S., and the EU-28 in the total outstanding foreign investment were about the same at 27% each.

By industry, manufacturing accounted for 41% and the non-manufacturing for 59%. Those with large shares were finance (21%) and wholesale/retail (15%) in non-manufacturing, and chemicals (10%) and transport machinery (8%) in manufacturing.

The most important factor behind the increase in outward FDI by Japanese firms since the mid-1980s was the sharp appreciation of the yen triggered by the Plaza Accord in September 1985. The rapid strengthening of the yen made it easier to purchase foreign assets, and Japanese firms actively made outward FDIs. In terms of value, investments in Europe and the U.S. by the service sector, such as finance and real estate, accounted for a large part.^*6

On the other hand, due to the sharp appreciation of the yen, Japanese export production enterprises that lost their competitiveness in domestic production used outward FDI to establish production sites overseas, mainly in Asia, and started exporting from their overseas locations. The reasons why Japanese companies chose Asia as a base for export production include the fact that they had established close economic relations with Asian countries through trade and other means, that there were many low-wage workers, and that infrastructure such as ports and roads was better than in other developing countries.^*7

Many Asian countries have implemented inward FDI liberalization policies and various investment incentives to invite FDIs with the aim of acquiring benefits, such as increased employment opportunities and technology transfers. These efforts also attracted FDI from Japanese firms.

Among the Japanese companies that entered Asia, those producing electric and electronic equipment and transportation machineries with many parts fragmented their production systems into processes and tasks, and established plants in countries where they could perform these tasks most efficiently through FDI. This is the development of what Richard Baldwin called the second unbundling.^*8 Firms produce parts at these plants, trade them between locations, and gather them at the assembly plant to complete the product.

The production networks established in this way were initially closed organizations involving the Japanese headquarters, overseas subsidiaries, and affiliates, but over time many of them have become more open, involving both local and foreign firms.

Even in the 21st century, outward FDI by Japanese firms has continued to grow.^*9 This was due in part to the expansion of investment opportunities created by the steady growth of the global economy prior to the global financial crisis of 2007. In its aftermath, many countries adopted monetary easing policies to recover their economies, and the abundance of investment funds also led to an increase in FDI.

In this context, a unique circumstance for Japanese companies is the stagnation of the Japanese economy. The bursting of the bubble in the early 1990s triggered low economic growth in Japan, and despite various recovery measures, slow growth persisted. This was partly from the lack of effective economic policies. But fundamentally, the rapidly aging population from declining birthrate and a pessimistic future view on the Japanese economy discouraged consumer spending and businesses investment, which led to the continued low growth.

In such a situation, Japanese companies turned their abundant investment funds to overseas rather than domestic investment.

2. Extremely Low Level of FDI in Japan

Outstanding FDI in Japan in US dollars has increased almost continuously since 2000, and reaching USD 310 billion at the end of 2019, about 6 times the amount at the end of 2000.^*10 However, as seen in Table 1, the outstanding amount of FDI in Japan is extremely low compared to the rest of the world as a percentage of GDP.

The Japanese government has focused on the contribution of inward FDI to economic revitalization and productivity improvement. It has been considering measures to expand inward FDI since the 1990s, reducing or eliminating obstacles to expansion into Japan, and adopting measures to promote investment in Japan through organizations such as Japan External Trade Organization (JETRO), but the gap between Japan and other countries remains large.

As for the countries/regions investing in Japan, developed regions accounted for a large share. European countries accounted for 39% of the total (as of end of 2018), while the U.S. had 26%, and Asia had 23%.^*11

By industry, manufacturing accounted for 41% and non-manufacturing 59%, with finance and insurance among non-manufacturing industries accounting for the largest share at 39%. In the manufacturing sector, electric machinery and transportation machinery accounted for a relatively large share of 11% and 15%, respectively.

Compared to inward investment in other developed countries, FDI in Japan is dominated by new investment (greenfield investment) as opposed to mergers and acquisitions (M&A). While M&A accounted for 69%, 65%, 63%, and 55% of total FDI in the U.S., France, the U.K., and Germany, respectively, it accounted for 47% in Japan.^*12

A number of surveys have been conducted on disincentives for FDI in Japan.^*13

In the “Survey Report on the Degree of Interest of Overseas Companies in Europe, the United States and Asia in Making an Investment in Japan” conducted by Nomura Research Institute in FY 2019^*14 , 116 global companies with headquarters in Europe, North America, or Asia/Oceania gave valid responses. According to the 106 companies that responded to the question “What do you think are the weaknesses of Japan compared to other countries and regions in Asia?” regarding the business environment and living environment, many companies pointed out the following as weaknesses in the business environment: smooth communication in English (52 companies), business activity costs (44 companies), tax rates (14 companies), and market growth potential (13 companies).

Regarding business activity costs, the companies mentioned high initial capital investment and labor costs. Weaknesses in the living environment include having to live using a foreign language (36 companies), a culture that accepts foreigners (31 companies), disaster preparedness (22 companies), and weather and climate conditions (18 companies).

According to the World Bank’s September 2019 survey on the business environment in 190 countries, Japan ranks 29th.^*15 By item, Japan’s rankings were particularly low for starting a business (106th) and obtaining financing (94th). The details of business start-up include the procedures, time, and capital investment required to start a business, which is consistent with the results of the Nomura Research Institute survey mentioned above.

Regulations are sometimes pointed out as an impediment to FDI, but according to the OECD survey, regulations in Japan are not as strict as those in other OECD countries. In terms of the FDI Regulatory Restrictiveness Index, which quantifies the severity of regulations (the lower the index, the less restrictive the regulations), Japan scored 0.052 points, which is less restrictive than the OECD average (0.064) or the U.S. (0.089).^*16 The indices for China and Korea are 0.135 and 0.244, and they are much more restrictive than Japan.

While the above survey results provide useful information for promoting investment in Japan, it is necessary to distinguish between issues that can be addressed through policy and those that are difficult to do so.

Tax rates and procedures for starting business can be addressed, but smooth communication in English and the culture of accepting foreigners are difficult to deal with. It is also important to recognize that some issues apply not only to foreign companies but also to Japanese companies. Tax rates, market growth potential, and disaster preparedness are issues that Japanese companies also face.

Ⅱ　Impacts of Globalization on the Japanese Economy

Regarding the impacts of globalization on the Japanese economy, there are possible advantages and disadvantages.

Advantages include growth in consumption of a variety of low-priced goods and services made possible by increased imports and inward FDI, as well as the realization of economic growth through increased trade and FDI.

On the other hand, disadvantages include wider income inequality and reduced employment opportunities due to increased imports and outward FDI. In the following discussions, I will first examine the merits, focusing on the impacts on improving the productivity of Japanese companies, which play an important role in promoting economic growth, and then examine the demerits.

The most significant benefit to the Japanese economy that can be gained from the globalization of Japanese firms is the increase in productivity realized through various channels. By engaging in overseas activities through exports and outward FDI, Japanese firms realize more efficient use of production factors, such as labor and capital they own.

In fact, empirical analyses of Japanese firms have confirmed that firms engaged in export and outward FDI are not only more productive than firms engaged only in domestic economic activities (selection effect), but also that they acquire superior technologies and management know-how overseas through competition and exchange with foreign firms, thereby increasing their productivity (learning effects, spillover).^*17

Some of the benefits of corporate globalization are related to production networks. In many cases, spillovers of technology and management know-how are realized through production networks in which continuous transactions are conducted between companies and plants.^*18

In the event of a shock, such as a natural disaster or a financial crisis, transactions conducted within the production network recover more quickly and are more resilient than those conducted outside, and production networks have the function of stabilizing the economic activities.^*19

The benefits of globalization have been discussed through its effect on the productivity of firms, but it is difficult to capture these in numerical terms. Assuming that high productivity is reflected in corporate profits, I will measure the benefits and contributions of globalization by Japanese firms to the Japanese economy using profits from overseas operations by Japanese firms.^*20

During the 19 years between 2000 and 2019, Japan’s FDI income, income transferred from Japanese firms’ overseas operations to Japan, expanded significantly from JPY 1.8 trillion to JPY 14.4 trillion, and the ratio of FDI income in the current account balance rose significantly from 12.8% to 70.2%.^*21 In 2019, the ratio of FDI income in the gross national income was about 2.5%, but this is expected to rise as Asia and other countries are expected to achieve higher economic growth than Japan in the future. The ratio of FDI income from Asia in 2019 was 43%.

In the previous section, we confirmed that inward FDI in Japan is at an extremely low level. The Japanese economy is lagging behind in globalization when it comes to inward FDI. We must recognize that Japan’s economy is missing out on growth opportunities due to the low level of inward FDI. The benefits of accepting inward FDI include productivity enhancement by acquiring superior technology and management know-how, economic revitalization through enhanced competitive pressure, and employment expansion.^*22

Disadvantages that may occur from economic globalization include hollowing out of domestic industries and regions and loss of employment opportunities from increased imports and expansion of FDI. Hollowing out creates a serious problem of industrial and social decline, but it is difficult to capture and analyze the actual situation quantitatively. Therefore, let us grasp hollowing out by the loss of employment opportunities, and see how increased imports and the overseas expansion of Japanese companies impact domestic employment.

The number of people employed across Japan increased from 67.8 million to 69.3 million between 1994 and 2018. On the other hand, the number of people employed in the manufacturing sector declined significantly from 15.2 million to 10.7 million.^*23 Imports and FDI continued to increase during this period, but it is unreasonable to conclude that they reduced employment opportunities in the manufacturing sector.

The reason is that there were a variety of developments that affected employment during that period. Technological progress and changes in demand are the most important factors affecting employment. The development of technologies that reduce the labor force and the shift in demand from industrial products to services will reduce employment in the manufacturing sector.

To capture accurately the impact of imports and outward FDI on employment, detailed analyses have been conducted using firm-level or plant-level data.^*24 The results of these analyses indicate that the impact of imports and FDI on employment is negligible. Studies that have analyzed the impact of imports from China on employment in Japan have shown that, contrary to expectations, imports of intermediate goods create jobs.^*25

Although the results of this analysis may seem contradictory, it is highly likely that with the increase in production and exports of industrial products, intermediate goods import and labor for manufacturing industrial products have increased. In other words, a complementary relationship has been established between imported intermediate goods and employment. One important point of this analysis is that, when examining the impact of corporate globalization on employment, it is necessary to consider not only imports but also exports.

A study of the impact of FDI by Japanese firms on domestic employment found that firms that increased employment at their overseas subsidiaries also increased employment at their Japanese headquarters, especially in the service divisions.^*26 In short, there is a complementary relationship between employment in overseas subsidiaries and the head office.

Regarding the impact of imports and outward FDI on employment, studies on the effects on workers with different abilities point out an important issue. Since Japan’s imports consist of a high percentage of unskilled labor-intensive goods, and since operations in Asian countries, where many Japanese firms have established operations, often employ large numbers of unskilled labor, the expansion of imports and outward FDI will reduce the demand for unskilled labor in Japan.

In contrast, activities requiring many highly skilled personnel are expanding in Japan. While the demand for unskilled labor is declining, the demand for highly skilled workers is increasing, leading to wider wage and income inequality gap.^*27 According to the OECD, the GINI coefficients for Japan were 0.336 in 2009 and 0.339 in 2015, with hardly any change. This means that income inequality has not increased in Japan in recent years,^*28 but many Japanese people feel that income inequality has been increasing.

By the way, not only globalization but also the development and application of technologies that require highly skilled personnel have been pointed out as causes of income inequality.

Ⅲ　Japanese Economic Growth Through Further Globalization

The Japanese economy has achieved growth by enjoying the benefits brought about by globalization. The expansion of activities by Japanese firms in foreign countries has contributed to the growth of the Japanese economy through the improvement of corporate productivity.

On the other hand, globalization of the domestic economy by accepting foreign companies has been slow, and the Japanese economy has not been able to take advantage of growth opportunities. To achieve economic growth in Japan, where the declining birthrate and aging population make it difficult to expand the domestic market, it is necessary to promote both external and internal globalization. I would like to consider the measures to realize this goal.

In promoting economic globalization, countries around the world are faced with three major risks. These are COVID-19 and other new infectious diseases that are likely to occur in the future, the U.S.-China trade war and battle for supremacy, and protectionism. How should the Japanese government and Japanese firms deal with these risks?

COVID-19 has claimed the lives and damaged the health of many people. Restrictions on the movement of people implemented to combat COVID-19 have had a major impact on the economy. By learning from this experience, we must be prepared to act against future infectious diseases.

One example is the importance of diversification of production networks. Production networks that played a major role in realizing the benefits of globalization were damaged, but companies that diversified their production networks were able to mitigate the damage. Diversification increases the resilience of production networks. Against the limitation of human mobility, we also found that it is effective to respond with data mobility, because the rapid development of digital technology has led to a situation where human mobility can be substituted by information (data) mobility, or what Baldwin calls the third unbundling, which is in progress.

In fact, many universities are switching online from face-to-face classes, and many companies are implementing remote work.

As national security problems become serious from the intensifying competition between the U.S. and China for hegemony, the response has led to restrictions on the movement of goods, people, money, and information. While there are limited measures that countries other than the U.S. and China can do to deal with the hegemonic competition itself, the Japanese government and companies must consider how to deal with issues related to the hegemonic competition. For example, China could be excluded from production networks for goods that pose a national security problem.

As a response to protectionism, it is necessary to reduce or eliminate economic disparities in income and other factors that are important causes of protectionism, and to achieve inclusive growth so that all people can benefit. Specifically, government support for education and trainings to improve the human capacity of people and workers who cannot share the benefits of globalization will be effective.

I have considered the individual responses to each of the three risks, but there are some common responses. These are the establishment, maintenance, and implementation of international rules that guarantee the free movement of goods, people, money, and information.

There is no one-to-one correspondence between the three risks and the movement of goods, people, money, and information. Yet, rules that enable the free movement of information to deal with the risk of infectious diseases that limit the movement of people, and rules on trade and data movement to deal with restrictions on the movement of goods and information due to the U.S.-China trade war and the rise of protectionism need to be developed and strictly applied. To address the issue of international rules, Japan needs to cooperate with like-minded countries and play a leading role in solving the problem.

One of the major issues in promoting the globalization of the Japanese economy is the development of human resources.

Human resources that need to be developed vary depending on the organization such as companies or government, department, industry, and occupation, but what is commonly required is the ability to utilize new technologies emerging from the digital revolution. They must also be able to communicate smoothly with people from other countries, tolerate diverse cultures and societies, and be ambitious, flexible, and educated. To develop human resources, international exchange in various forms, including Japanese students studying abroad and accepting foreign students in Japan, is important.

Shujiro Urata
Professor Emeritus at Waseda University. Earned BA in economics at Keio University, and PhD in economics at Stanford University. Careers include Research Associate at the Brookings Institution, Economist at the World Bank, and Professor of Economics at the Graduate School of Waseda University. Author of numerous articles and books. Recent books include Enhancing SME Participation in Global Value Chains (2021, ed, Asian Development Bank Institute), and Globalisation and its Economic Consequences: Looking at APEC Economies (2021, co-ed, Routledge)

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[Notes]

^*1 See Urata (2009) for Globalization of Japanese economy until the beginning of 2000s.The Ministry of Economy, Industry and Trade (METI, 2020) conducted an interesting study concerning globalization in 2020.

^*2 As will be discussed later, production networks are the actions of companies that fragment production processes and place them internationally. Similar concepts include global value chains (GVC) and supply chains (SC). There does not seem to be a strict definition, but broadly speaking, GVC covers all processes (or more precisely, value added) related to a product, including development, production, sales, and after-sales service, whereas SC covers production and sales, and production networks cover production. However, these terms are often used without distinction; for GVC, see Word Bank (2000), WTO (2019) and others.

^*3 This kind of trade relationship between Japan and East Asian countries is observed in the Value Added Trade Database developed in recent years. Specifically, the share of value added by foreign countries (FVA) in Japan’s exports is low, while the share of Japanese value added used for foreign exports (DVX) is high. Statistics on value-added trade, such as FVA and DVX, are available from UNCTAD.
https://worldmrio.com/unctadgvc/

^*4 Kiyota (2015) provides a comprehensive survey of empirical studies and a thought-provoking analysis of outward FDI by Japanese firms and inward FDI to Japan by foreign firms. The results of many interesting empirical studies on the globalization of Japanese firms are included in Wakasugi et al. (2008). See also Hoshi (2018) and Hoshi and Kiyota (2019) for analyses of inward FDI in Japan.

^*5 UNCTAD. FDI database,
https://unctadstat.unctad.org/wds/TableViewer/tableVies.asps?ReportId=96740

^*6 Bank of Japan, FDI statistics,
https://www.mof.go.jp/policy/international_policy/reference/iip/data/index.htm

^*7 Kimura and Todo (2010) found that development aids from Japan for infrastructure construction attract FDI from Japan. From this point, Japanese aid is sometimes called the trinity of aid, investment, and trade.

^*8 Baldwin (2016) sees that globalization can be thought to take three steps using a concept of unbundling. The first unbundling, seen roughly from 1820s to 1990s, is defined as the unbundling of production and consumption where production areas and consumption areas are linked by trade. The second unbundling, observed since around 1990 to around 2015, is defined as the unbundling of production processes and tasks, where they are internationally located. The third unbundling, observed since around 2015, is defined as a global division of labor at the level of individuals.

^*9 Japan has continuously expanded outward FDI since the 21st century and became the largest investor in the world in 2018 and 2019.

^*10 Japan External Trade Organization (JETRO), FDI statistics,
https://www.jetro.go.jp/world/Japan/stats/fdi.html

^*11 Bank of Japan, FDI statistics

^*12 Yoshinaka and Ishimoto (2019)

^*13 Concerning disincentive factor of FDI, Kiyota (2015) reviews that a clear analytical result cannot be obtained by academic studies using econometric method. One reason is that some disincentives are difficult to quantify.

^*14 NRI (2020)

^*15 While it is not possible to rigorously verify changes in the rankings over time due to the difference of number of countries included in the survey, Japan’s ranking was 20th in 2010, but it has dropped to 39th in the 2018 survey. See World Bank, Ease of Doing Business ranking.
https://www.doingbusiness.org/en/rankings

^*16 These are statistics in 2019. See OECD FDI Regulatory Restrictiveness Index for details on the index.
https://oecd.org/investment/fdiindex.htm

^*17 See Kiyota (2015) and Ito (2021)

^*18 See Todo and Inoue (2021)

^*19 See Kiyota (2015)

^*20 If Japanese firms gain profit from the established subsidiaries by outward FDI and transfer it to Japanese account, it is included in the National Gross Income.

^*21 Bank of Japan, International Balance of Payments, FDI income. https://www.boj.or.jp/statistics/br/bop_06/index.htm

^*22 See Paprzycki and Fukao (2008), and , Kiyota (2015) for the effects of inward FDI to Japan.

^*23 RIETI, JIP database 2021, Number of employees by industry. https://www.rieti.go.jp/jp/database/JIP2021/index.html

^*24 Ito (2021) introduces a study about the effects of globalization on labor.

^*25 Taniguchi (2019). This result contrasts with the finding that imports from China in the U.S. caused a decline in U.S. employment. For the results of the analysis in the U.S., see the literature discussed in Taniguchi (2019) Hayakawa et al. (2021) in their study of Japan found negative impacts of the Chinese import penetration on total employment, especially in industries producing competing products to Chinese imports, and a positive impact of the import penetration in the industries from which firms purchase their inputs (upstream import penetration).

^*26 Ando and Kimura (2017).

^*27 See Ito (2021).

^*28 OECD https://www.oecd.org/social/income-distribution-database.htm
On the other hand, World Bank statistics shows Japan’s GINI coefficient declined from 0.348 in 2008 to 0.329 in 2013．
https://databank.worldbank.org/reports.aspx?source=world-development-indicators

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