U.S. Investment in Japan Is Key to Closing the Massive Trade Gap

Japan’s merchandise trade surplus in 1994 hit another record high: $145 billion, nearly $60 billion of which stemmed from trade with the United States. Yet there are signs that the relentless rise of the yen and economic recovery in Japan are beginning to have the expected effect. Japan’s surplus in its current account, the broadest measure of trade in goods and services, fell by $2 billion in 1994. Measured in yen, the current account surplus narrowed 9.5% in ‘94, its second consecutive year of decline.

Large increases in imports of consumer goods--textiles, electronics and automobiles--and a record outflow from tourism (nearly 14 million Japanese traveled abroad in 1994) and transportation services translated into a 14% increase in imports. It was the first double-digit rise in more than four years. Exports, on the other hand, rose only 2%, driven primarily by the continued strength of Japanese automotive components being shipped to expanding production facilities overseas.

More change is on the horizon. In January--fresh from success last year in a number of sector disputes and in the area of patent protection--the U.S. trade representative’s office concluded an agreement that opens the lucrative Japanese market for pension fund management to foreign financial houses. Autos and auto parts are next on the agenda.

Nonetheless, a number of academic studies have shown that full liberalization of Japan’s markets would trim the bilateral deficit by only a third, roughly $15 billion to $20 billion.

Instead, the key to further progress lies in liberalizing direct investment in Japan. Nearly 40% of world trade in manufactured goods consists of intra-corporate shipments of components and finished goods. Indeed, more than 73% of U.S. imports from Japan are channeled through the U.S. affiliates of Japanese corporations, according to a recent study by Dennis Encarnation of the Harvard Business School. On the other hand, only 17% of U.S. exports to Japan are due to intra-corporate imports by U.S. affiliates there.

Thus, argues Encarnation, the large trade gap between the two countries will not be reduced until U.S. investment in Japan begins to match the level of Japanese investment in the United States.

At a time when foreign direct investment (FDI) by multinational corporations has become a flood worldwide, Japan continues to be the odd man out.

Japanese companies have invested overseas at a rapid pace in the past decade. Their foreign corporate assets exceeded $325 billion in 1993, or 17% of the total world stock of FDI, which now approaches $2 trillion.

But the picture is very different if one considers inward FDI. The United States, for example, is home to about 25% of world FDI; the European Union accounts for another 38%. Japan, in contrast, is host to only 1.5%, or $31.2 billion, of which $12.7 billion represents U.S. corporate investment in Japan.

On a per-capita basis, the contrast is even more stark. Inward FDI for the period 1981-92 totaled $2,800 per capita in Britain, $1,500 in the United States, $1,200 in France and $850 in Canada--but less than $180 in Japan. Mexico, Brazil and China far exceed Japan in terms of inward investment.

From 1989 to 1994, Japanese corporations invested more than $159 billion overseas, whereas foreign companies invested less than $5 billion in Japan. During that same period, Japanese corporations made 1,467 acquisitions abroad, while foreign companies acquired only 123 Japanese firms.

The reasons for these discrepancies are many.

Starting a new venture in Japan is fraught with obstacles. Wages, office space and income taxes are all costly. Regulatory issues are often complex. Foreign companies have a difficult time attracting top-level executive talent from established Japanese firms. Furthermore, it is difficult to break into long-established supply and distribution arrangements in the face of strong domestic competitors.

Acquisitions are problematic as well, since cross-shareholdings--typical among Japanese firms--limit the availability of shares and may leave foreign investors in minority positions with little power or influence. (Just ask T. Boone Pickens about his failure to win a seat on the board of Koito Manufacturing Co., a leading Japanese auto parts maker, of which he owned 26.4%.) And management security may make it difficult for the new owner to make the necessary changes at the top.

Many major U.S. corporations have shunned entry into Japan in recent years, turning their attention instead to the attractive markets of China, Southeast Asia and Latin America.

Yet this indifference could be a fatal mistake.

First, Japan is the world’s second-largest market. Its consumers are among the most demanding. Coca-Cola and Procter & Gamble, among others, have recognized the value of this competitive environment for generating world-class capabilities in consumer products.

Second, a presence in Japan denies local competitors a free ride in their home market with which to finance worldwide expansion. IBM’s global competitive position has been strengthened by its constant pressure on Fujitsu and Hitachi’s home market.

Third, Japan is too important a center for technology to be ignored by U.S. firms with global ambitions. Five of the top 10 firms granted patents by the U.S. patent office in 1991-93 were Japanese, and their prowess in manufacturing processes is legendary. Thus, we see more U.S. firms--from Intel to Monsanto to Upjohn--establishing research and development facilities in Japan to tap into this wellhead of innovation for their global markets.

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Recent successes in automobiles and personal computers, semiconductors and distribution, franchising and business services prove that the Japanese market is not impossible to penetrate. In fact, a survey by the American Chamber of Commerce in Japan revealed that only 3% of its members claimed that bureaucratic impediments had affected their market access.

The net trade impact of U.S. affiliates in Japan was a positive $3.5 billion in 1992. If American investments in Japan matched their per-capita counterpart by Japanese companies in this country, a further $15-billion to $20-billion trade shift would result.

It is in the interests of both the companies and the U.S. government that the level of American investment in Japan continues to grow in the years ahead.