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FDI in East Asia from 1985-2011
Before 1985 Japan led East Asia in outward FDI, although its annual outflows were small. Japan's overseas investments were aimed at exploiting natural resources in resource-rich countries or at manufacturing labor-intensive products such as textiles and clothing in labor-abundant developing countries. Most outputs from the first type of FDI were shipped back to Japan, while the manufactures from the second type were either exported back to Japan or to third-country markets.
As Figure 2 [ PDF 15.9KB | 1 page ] shows, Japanese FDI began in earnest after the Plaza Accord in September 1985. The yen appreciated 60% against the dollar between September 1985 and September 1988. Japanese firms lost their price competitiveness and responded by shifting labor-intensive assembly operations to other Asian countries.
Figure 3 shows that as Japanese FDI to Asian countries increased, its exports of intermediate goods to these countries increased in tandem. As Kojima (1973) posited, Japanese FDI and exports to Asia thus functioned as complements rather than substitutes.
Panel A of Figure 3 [ PDF 20KB | 1 page ] shows that immediately after the Plaza Accord there was a surge of Japanese FDI to Republic of Korea and Taipei,China. However, in the late 1980s the United States (US) Treasury named these countries as currency manipulators and they let their exchange rates appreciate. These countries also exhausted their supply of surplus labor in the agricultural sectors in the 1980s, causing their wage rates to increase (see Yoshitomi, 2003). Minggao (2011) noted that manufacturing labor costs in Republic of Korea and Taipei,China remained stable between 1980 and 1987 and then skyrocketed.
As the locational advantages of assembling labor-intensive goods in the NIEs declined, Japanese firms transferred production to the ASEAN countries.2 This is clear in Panel B of Figure 3 [ PDF 20KB | 1 page ]. Japanese FDI and intermediate goods exports to ASEAN countries trended steadily upwards until 1997. Surplus labor in ASEAN held wages down, and exchange rates in these countries were pegged at competitive levels relative to the US dollar.
Japanese FDI in Southeast Asia often began with a joint-venture system with more limited technology spillovers, before allowing stand-alone operations of greenfield subsidiaries of foreign multinationals.3 FDI also produced a surge of capital goods imports in which new technologies were typically embodied. The MNEs initially provided ASEAN firms with detailed engineering and managerial instructions and specifications, facilitating assimilation of the new technologies.
Exporting was thus an important learning vehicle for ASEAN firms and a mechanism for achieving technology transfer. The ability of countries in the region to assimilate new technologies depended on their technological capabilites (see Wignaraja, 2008). Especially important in this regard was the quality of local engineers. Engineers were sent abroad to identify the state-of-the-art technology required to compete in world markets. Adoption of technology then led to a process of learning-by-doing for engineers and skilled workers, generating spillover effects within and among industries. Engineers and workers migrated among firms and sectors, bringing their accumulated human capital with them and dispersing it across the expanding economy. These positive externalities then contributed to a virtuous cycle of growth.
Researchers referred to this period as the East Asian Miracle, and it continued until the Asian Crisis of 1997–1998. Panel B of Figure 3 [ PDF 20KB | 1 page ] shows that flows of Japanese FDI to ASEAN countries collapsed during and after the crisis. Interestingly, though, Panel B shows that flows of parts and components from Japan to ASEAN continued unabated.
Thorbecke (2008) reported that, once a Japanese firm establishes a cross border production network in another country, it is reluctant to withdraw from that country. As Kimura and Obashi (2010) noted, firms pay high costs in identifying locational advantages and reliable business partners. Hence transactions within these networks tend to be stable. Obashi (2010a, 2010b) found that trade in parts and components between East Asian countries tends to be more resilient than trade in finished goods or trade with extra-regional partners. Thus, while the Asian Crisis reduced the locational advantages of channeling FDI to ASEAN, it did not cause the MNEs to break off existing relationships with Southeast Asian firms.
Panel C of Figure 3 [ PDF 19.6KB | 1 page ] shows that FDI and parts and components then began flowing to the PRC, especially after the PRC joined the WTO in 2001. Many have argued that the PRC's WTO accession gave foreign investors confidence that the PRC would sustain an FDI-friendly environment through fair and coherent enforcement of the relevant laws and regulations (see, e.g., Chen, 2008).
While Japanese firms were the first to shift labor-intensive assembly operations to lower-wage locations in Asia, other Asian firms soon followed. Producers in Taipei,China and Republic of Korea, confronted with higher wages and stronger exchange rates in the late 1980s and 1990s, also shifted production to less costly regions in Asia.
Figure 4 presents data not only for Japan but also for other East Asian countries. It shows the flow of electronic parts and components within East Asia and the flow of final assembled computers from East Asia to the world. The category 'electronic parts and components' is the largest category traded within the region and the category "computers and office equipment" is the largest category exported from East Asia to the rest of the world. Electronic parts and components are also key inputs into computers.
Figure 4a [ PDF 19KB | 1 page ] shows that during the 1980s electronic parts and components from East Asia flowed in equal quantities to the NIEs and to ASEAN countries. Then in the 1990s, as the NIEs lost their locational advantages in assembly operations, flows to ASEAN far surpassed flows to the NIEs. Starting in 2001 there was a surge in electronic parts and components going to the PRC, and the PRC's imports of these imported inputs soon surpassed ASEAN's imports.
Figure 4b [ PDF 18.9KB | 1 page ] shows exports of final assembled computers from East Asian counties and regions to the world. While Japan was the leading exporter in the 1980s, ASEAN became the leading exporter in the 1990s. This reflects the large increase in electronic parts and components flowing into ASEAN in the 1990s. Then starting in 2001 computer exports from the PRC exploded, again reflecting the surge in parts and components imports into the PRC that began in 2001.
Intricate production and distribution networks developed in the region, involving complicated combinations of intra-firm trade, arms-length transactions, and outsourcing. FDI firms broke up the production processes for a good (e.g., a computer) into fragmented blocks, and allocated these blocks across countries in Asia based on differences in factor endowments and other locational advantages. In the case of ASEAN's imports from East Asia, for instance, 33% in 2009 were electronics goods. In the case of ASEAN's exports to the PRC, almost 60% were electronics goods.
An example of this intra-regional trade in electronics goods comes from the hard disk drive (HDD) industry. As Hiratsuka (2010) documents, affiliates of Japanese MNCs in the Philippines make parts and components and ship them to Thailand to produce HDDs. These HDDs are then shipped to the PRC to assemble computers, and the final computers are exported throughout the world. Value chains such as these have mushroomed in East Asia. The next section analyzes these production networks in more detail.
Up until recently the lion's share of goods produced within East Asian production networks have been exported outside of the region. However, as Gaulier et al. (2011) discussed, firms in Japan and the Asian NIEs have increasingly established enterprises within the PRC to cater to local demand. They then export parts and components and capital goods from the home countries to their affiliates in the PRC. These exports that are directed to the local PRC's market are classified as ordinary exports by the PRC's Customs Agency. These exported inputs from the home countries to foreign-invested enterprises in the PRC caused Japan and the NIEs to run ordinary trade surpluses in 2010 of $70 billion with the PRC.
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