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Foreign Direct Investment: Japan and China Case

Currently, Japan is the third-largest investor in China after the United States and Hong Kong. In 2006, the volume of foreign direct investment from Japan to China amounted to 6.2 billion dollars. Talking about Japan’s investment policy with respect to China, Japan Global economic strategy adopted in 2006 should be taken into account (Bebenroth, 2015). It reflects the main directions of the foreign policy of the state, including the cooperation with China. The document stresses that in recent years the relations with China have improved, the importance of which is huge in both bilateral trade and investment cooperation. For China, the strengthening of the long-term partnership with Japan provides foreign markets with increased access to Chinese goods, as well as an increase in capital inflows and technology from Japan. Consequently, the role of China as one of the main architects of regional economic cooperation develops. The joint businesses of Japanese and Chinese companies, as well as the activities of Japanese companies in China, are carried out in various forms. They include the creation of a joint venture on the basis of an existing company with the host country, the establishment of the company, completely proprietary companies – investors, and the establishment of the subsidiary. In China, currently, the most common form of activity of Japanese companies is the creation of joint ventures and enterprises with 100% Japanese capital (Bebenroth, 2015). This paper examines the case of FDI between Japan and China.

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Conceptual Framework and Mechanisms of Cooperation in the Investment Sphere of Japan and China

The basis of economic relations between Japan and China is an agreement on trade signed in January 1974 (Bebenroth, 2015). The agreement contributed to improving the climate of bilateral economic relations. In 1979, Japan began to provide economic assistance to China, most often within the framework of the Official Development Assistance program (ODA) (Bebenroth, 2015). Since that time, ODA has become an important part of bilateral friendly relations. Since the beginning of ODA in China, several credit programs have been implemented. ODA contributed to the expansion of the economic influence of Japanese companies abroad. Due to the ODA program, Japan produces the conditions for the formation of a market economy in the recipient countries, the most important of which is the presence of a mature infrastructure. At the same time, with the help of ODA, Japan “pulls” the recipient countries to the level at which they will be able to host Japanese investments and become effective foreign economic partners of Japan. The types of Japanese ODA include financial grants, technical assistance, low-interest yen loans, contributions to the budget, and participation in the work of international organizations dealing with development assistance.

The major incentive for the rapid development of trade and economic relations between the neighboring countries has been the economic reforms conducted in China since 1979, aimed at implementing the policy of open doors. This policy involved the development of comprehensive foreign economic relations, openness to foreign capital, and the intensification of China’s export products. When considering the characteristics of Japanese investment in China, it should be noted that most of it is direct. In this connection, official statistics tend to indicate only the volume of Japanese direct investment. This is due to China’s existing policy on foreign investment, which is aimed at encouraging foreign direct investment, while limitations are imposed on other forms of foreign investment (Bebenroth, 2015). In this case, the foreign direct investment determines the development of the real sector of the economy, finances economic growth to a large extent, and leads to production of new technology, know-how, and new market management.

Regulations of the FDI Relationships Between Japan and China

The main role in the regulation of world trade and economic relations belongs to the WTO. In November 2001, China became a full member of the WTO, which, of course, had a positive impact on bilateral economic relations (Horaguchi & Shimokawa, 2014, p. 90). China’s membership in the WTO involves the gradual liberalization of the import customs regime, the elimination of dual pricing practices, quotas and import licensing, and other obligations necessary for the liberalization of the foreign trade regime. This, in turn, leads to the expansion of bilateral trade investment in China from Japan. Annually, there are consultations between Japan and China on China’s compliance with the WTO requirements of the economic policy (Horaguchi & Shimokawa, 2014, p. 90). In 1990, with the aim of encouraging the mutual protection of investments, the Sino-Japanese organization development investment and the Sino-Japanese Committee of testing were officially established (Horaguchi & Shimokawa, 2014, p. 91). These organizations provide assistance to companies by solving problems associated with investing in China or Japan. Joint conferences and seminars dedicated to improving the investment climate in both countries are held annually to encourage research in the field of investments.

Overview of the Issue under Consideration

Since the beginning of the 1990s, the volume of Japanese direct investment in China grew rapidly. In 1991, the US $ 579 million were invested (Pekkanen & Tsai, 2009). An increase accounted for 57% as compared to the previous year. However, at the same time, the number of enterprises with the participation of Japanese capital was less than 5% of the total joint ventures in China (2800 from 64 thousand) (Pekkanen & Tsai, 2009). Direct Japanese investment in China sharply increased in 1992 by 167.9% amounting to 1.9 billion dollars (Pekkanen & Tsai, 2009). Therefore, in 1992, China became Japan’s second-largest market after the US. The high level of investment activity remained in the coming years. By the beginning of 1994, the total volume of Japanese business investment in China has exceeded a billion dollars. 3000 investment contracts totaling $ 4.5 billion dollars were concluded in that year. The share of Japanese companies in the foreign investment market reached 6.2% (Pekkanen & Tsai, 2009). For this indicator, Japan came in fourth place after Hong Kong, Taiwan, and the United States. The peak value of the inflow of direct investment from Japan reached in 1995, when it amounted to 3.2 billion dollars. Together, counting from 1979 till 1995, 11 588 investment contracts worth a total of 17.25 billion USD were signed between the parties according to Chinese data (Pekkanen & Tsai, 2009). According to the assessment of the Export-Import Bank of Japan, China has become the most attractive destination for Japanese investment companies, primarily due to the cheapness of production.

As a result of the investment activity of Japanese companies, the total volume of their investment in China exceeded 20 billion dollars, essentially approaching the scale of the Japanese loan capital. However, in 1996, the inflow of business investment fell sharply and the number of investment contracts concluded fell by 4.09% compared with the previous year (Pekkanen & Tsai, 2009). The economic stagnation in Japan and the sharp fall of yen began to show itself more clearly. There was a deterioration of the investment situation in China. Beijing has made adjustments in its policy on foreign investment by increasing taxes, the purpose of which was to contain the influx of investments in leading manufacturing industries, where excess foreign capital concentrated. Decisions of the Chinese authorities, according to the Japanese business community, threatened the interests of the companies planning to invest in the development of China’s industrial infrastructure, transport, communications, and high technology. Folding in the Chinese capital market situation gave another rise to fears of the formerly relatively high-risk Japanese business in China.

The emerging trend continued in the following years. In terms of investments in the companies, Japan took fifth place, behind Hong Kong, the United States Virgin Islands, and Singapore. However, in 2000, there have been positive changes in the direction of growth of investment in China. In 2002, the amount of Japanese direct investment amounted to 2.7 billion dollars, and –to 6.2 billion in 2006 (Pekkanen & Tsai, 2009). The increase in the volume of Japanese investment in China’s economy was accompanied by a decline in investment growth since 2003. First, the government of Japan believes that there are certain risks for Japanese companies in the Chinese market, such as the widening gap between the development of urban areas and rural areas, shortage of water and energy resources, pollution, etc. Government’s view, in turn, has had a definite impact on the decision-making process of some Japanese companies. Second, Japanese companies began to invest in other emerging markets, such as Brazil, India, Russia, and South Africa (Pekkanen & Tsai, 2009). Third, due to the improved economic situation in Japan, some Japanese companies have moved their investment projects with high benefits back to Japan (Pekkanen & Tsai, 2009).

However, despite the reduction in the rate of growth of Japanese investment, China continues to be a major recipient of the Japanese capital in the Asian region. The volume of direct investment by Japanese companies in China’s economy grew by 19.8% in 2015 and reached 6.53 billion USD, which was the maximum value in the history of trade relations between the two countries (Bebenroth, 2015). In 2015, the previous record was beaten by Japanese investment of 5.45 billion USD as was reported by the Japanese Organization for the Promotion of Foreign Trade (Bebenroth, 2015). Thus, in 2015, China was still the main market for Japanese investment in Asia, mainly due to the fact that the major Japanese automakers have invested in the construction of factories in China. The volume of investments in China by the United States and South Korea, Japan’s main competitors in the struggle for the Chinese market, has declined by 22.3% and 17.3%, respectively (Bebenroth, 2015).

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Factors Contribution to Acquisition Foreign Direct Investment from Japan

The main reasons for Japanese companies directing their funds to China can be explained by a number of factors. First, it is potential internal growth and high rates of economic growth. China is currently experiencing strong economic growth. The positive trend has delineated from the beginning of the reforms. The second factor is the formation of the middle class. The presence of the middle-class in the social structure is a guarantee of sustainable development. This class has a sufficiently high income, which creates the main purchasing power in the domestic market, stimulating economic growth. Third, geographical proximity is a contributing factor as well. Human resources and the cheapness of labor are among the most attractive factors for Japanese investors in China too, just as the low cost of raw materials is. In addition, membership in the WTO should be noted. Since China’s accession to the WTO, there have been significant changes in China’s economy, which were conducive to attracting foreign investment (Thorbecke & Salike, 2013). The presence of zones of preferential economic regime contributed to Japan’s decision to provide FDI in China. In China, there is a considerable experience in this field, as the process of creation of investment zones began in the late 70s (Thorbecke & Salike, 2013). At present, China established more than 200 preferential economic regime zones, which are among the engines of the inflow of foreign investments into the economy. Social and political stability and access to information about the country are additional factors making China attractive for direct investments from Japan (Thorbecke & Salike, 2013).

The Problems Preventing Foreign Direct Investment from Japan

The problems hindering foreign direct investment of Japan in China can also be expressed in the form of a list of factors. First, the legal system which is still undeveloped, and its vague execution are the main problems. Large market development is also a factor affecting the inflow of FDI from Japan negatively. China is one of the world leaders in attracting foreign investments, and it is actively involved in world trade. In this connection, the Chinese market experiences a fierce competition among foreign companies (Thorbecke & Salike, 2013). Moreover, there is a problem with the scope of protection of intellectual property rights. In addition, there are two trends that are related to the risk factors of doing business in China by Japanese companies. These are increasing taxes and increasing labor costs (Thorbecke & Salike, 2013). Thus, the main advantages of the Chinese market such as cheap labor and tax preferences might soon not be the determining factors.

Regional Distribution of FDI from Japan to China

The main characteristics of the Japanese investment in China include regional location, orientation, the structure of investments, forms of business activities of Japanese companies in the host country, and other indicators. In terms of regional distribution of Japanese foreign investment in China, the preferential orientation of Japanese investors in the most economically developed eastern China areas such as Jiangsu, Shandong, and Shanghai should be noted (Noh, 2011). In these regions, there exists the most advanced and extensive infrastructure that enables the import of raw materials and other components of production at the lowest cost, as well as the export of products. In this area, where the bulk of China’s large and medium industrial enterprises is concentrated, there are qualified technical personnel and cheap labor (Noh, 2011).

With regards to areas located at a considerable distance from the main industrial centers and lagging behind in terms of economic development in the western regions of China, it can be said that, despite the presence of the richest reserves of industrial raw materials and energy needed for developing Chinese economy further, they have clearly fallen outside of the regional priorities of foreign investors for many years (Noh, 2011). A program of large-scale development of the western areas adopted in China includes the existence of significant privileges and preferences for foreign capital investors among other things. Unfortunately, it has not improved the situation. The intention to expand foreign operations in the eastern region of China dominated in all industries. In addition, the geographical proximity of Japan to China contributes to the development of international industrial relations between the producers of the two countries.

Industries Receiving the Investments

China’s accession to the WTO and the growth of the purchasing power of the population have also become important factors in the change of the approach to business in China. Japanese companies have begun to explore the domestic market. During the accelerated movement of the Japanese venture capital, the picture of its distribution by industry has significantly changed in China. If before the start of the 90s the ventures with Japanese capital were established mainly in industries with intensive use of labor and assembly for the production of products with low added value, ever since the 90s Japan’s attention has shifted to the creation of innovative enterprises of high technology, high value-added products (Noh, 2011). More investment was needed to act in such branches of production as electrical, chemical, and automotive.

In general, the largest part of the capital invested by Japanese companies accounts for manufacturing industries. In 2014, Japan’s investment in the manufacturing industry amounted to nearly 500 billion yen, while reaching only 80 billion yen in untreated (trade, services), which is 84% less (Bebenroth, 2015). If we look at the structure of investment in the manufacturing sector of the economy, the largest share of investments is directed to the manufacture of transport equipment (180 billion yen), which is associated with an active movement of the Japanese automotive companies with branches on the territory of China (Horaguchi & Shimokawa, 2014). Thus, the volume of investments of the Japanese automobile company Toyota in the economy of China was 52.99 million dollars, while the company Honda has invested 98 million dollars (Horaguchi & Shimokawa, 2014).

The second place in this sector is taken by the electrical industry. However, since 2001, there has been a decline in interest of Japanese investors in the industry. In 2014, the industry has received a total of about 50 billion yen in investment, which is 28% less than in 2011 (Horaguchi & Shimokawa, 2014). This is primarily due to the unjustified expectations of foreign entrepreneurs in relation to the Chinese power industry reform. The lack of real change in tariff liberalization on the background of more than two-fold increase in market coal prices in 2012-2014 led to a sharp decline in profitability in the Chinese power industry (Horaguchi & Shimokawa, 2014). In addition, there is a slight tendency to increase investment in sectors such as metal processing and production of machinery. Moreover, a hallmark of Japanese investment in China is increasing investments in R & D (Bebenroth, 2015). In China, there is a tendency to expand the scope of development of new products and increase the number of R & D centers in the field of retail and wholesale chemical products, transport equipment, and other industries.

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Conclusion

Summarizing all the above-mentioned, one can draw the following conclusions. In terms of regional distribution of Japanese foreign direct investment in China, preferential orientation of Japanese investors in the most economically developed and resource-rich areas should be noted. In China, Japanese companies are most active in the eastern parts of the country, where investments are made in all branches of industry. A distinctive feature of Japanese investment in China is its focus on exports to third countries, as well as a high proportion of re-exports to Japan. At the same time, there is a gradual reorientation of Japanese investors to increase investment an expand sales in the domestic market. In the 90s, there was a reorientation of Japanese direct investment in the manufacturing industries in China. According to the 2015 data, most of the direct investment was directed to the automotive sector. The most common forms of business activities of Japanese companies in China are joint ventures and the establishment of branches of Japanese companies with one hundred percent Japanese capital.

The particular investment policy of Japan does not exist separately in relation to China, but its general direction is reflected in policy documents of Japanese economics. Enterprises with 100% foreign capital will remain the predominant form of foreign direct investment. Thus, one can say that China’s and Japan’s cooperation in the field of attracting foreign direct investment generally expands. The legal framework is developed through bilateral meetings and summits. Shifting production to China, Japanese business is able to focus on the most promising areas of development. For China, the strengthening of a long-term partnership with Japan provides Chinese goods with increased access to foreign markets, as well as an increase in capital inflows and technology from Japan and an increased role for China.

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