ON JAPAN: “”Hollowing Out”” in Perspective

Over the past couple of years, the Japanese media have focused extensively
on Japanese companies’ rush to invest in China. This shift of production
from Japan to China is alleged to be “hollowing out” Japanese domestic
manufacturing. Recent stories have emphasized that Chinese engineering
capabilities are now so sophisticated that firms are shifting production of
higher-end products or even R&D to China.

All of this sounds quite worrisome. But is the picture accurate?

Recently, I was analyzing data on investments abroad by Japanese firms
and was struck by the disparity between the story that comes through in the
media and the reality of the number. In 2001, Japanese firms invested $180
billion in China. True, that was up a lot from the $84 billion of two years
earlier. But let’s put these numbers into perspective:

— In 2001, Japanese direct investment in China was still lower than it had
been in the mid-1990s, when it exceeded $200 billion. So why all the
attention now? Perhaps one should ask why investment was so low in 1999,
producing the image of a surge when none really exists.

— China is not even getting the majority of Japanese investments in Asia.
In 2001, Japanese firms put almost $800 billion into Asia, of which China
was less than a quarter. Back in 1995, 37 percent of such investment went to
China. Surveys indicate a possible shift away from Southeast Asia to China
in the future, but so far at least, the numbers on actual investment haven’t

— Japanese firms are not even rushing to Asia more broadly. Japanese
investment in all of Asia was lower in 2001 than in the late 1980s—over a
decade earlier. The extreme strength of the yen appeared to spark a boom in
Asian investment in the mid-1990s, but that has abated.

All of this is confirmed by data from other Asian countries. Japanese
firms are indeed important investors in the region, but they hardly stand
out. Back in the late 1980s, for example, 16 percent of new inward
investment by foreign firms in China was Japanese. A decade later, that
share was only 7 percent. The idea that somehow Japanese firms are unique in
knitting together an Asian economic zone through their heavy investments in
China and elsewhere is false. In China, American and European firms are now
investing more than their Japanese counterparts. Much the same is true in
other Asian countries. The reality is that all major global firms—Japanese,
American, European and others—are building production networks across Asia
(and the rest of the world).

The big story about Japanese investment, in fact, is that the majority
of it flows to the developed countries—the United States and the EU.
Between them, these two regions have absorbed 60 to 75 percent of all
Japanese new overseas investment in every year since the late 1980s. While
Japanese firms were investing their $180 billion in China in 2001, they
poured $800 billion into the United States and $1.3 trillion into Europe.

It turns out that this pattern is true for other industrial nations as
well. Taking advantage of low wages is only one of many reasons firms invest
abroad, and not the most important one. Japanese firms invest in the United
States to escape protectionism, as was the case of the Japanese automobile
manufacturers in the early 1980s when the U.S. government (wrongly) imposed
restrictions on auto imports from Japan. But protectionism is not the major
motive these days, since the United States has few protectionist barriers
that affect Japanese exports (other than the unfortunate case of steel).

Other more important reasons include a desire to be close to customers to
provide better interaction from product design through after-sales service,
a desire to tap the skills of local engineers or scientists, or high
transportation costs.

If you’re anxious about hollowing out, the story here is to stop
worrying about the loss of low-productivity jobs to China and start worrying
about the loss of high-productivity (and higher-wage) jobs to the United
States and Europe. As an economist, I’m not concerned about hollowing out,
but I am amazed that the media in Japan focus so much on China when the real
story is about the United States and Europe.