Second draft for The World Bank-IPS
Research Project on the Rise of China and India
The Coming Age of China-plus-One:
The Japanese Perspective on East Asian Production Networks
February 18, 2006
Masahisa FUJITA
IDE-JETRO and KIER-Kyoto University
Nobuaki HAMAGUCHI*
RIEB-Kobe University
________________________________
* Corresponding author: E-mail address hamaguchi@rieb.kobe-u.ac.jp
1. Introduction
In this paper, which focuses on China, we examine the factors affecting the recent
reorganization of industrial production networks in East Asia, paying specific attention
to the role of foreign direct investment (FDI) and Japanese multinational firms (MNFs).
We also present some policy suggestions for the continued development of affected
countries.
Over the last two decades, FDI has been rapidly growing in East Asia. Most
notably, China alone received about US$ 60 billion in 2004, representing nearly 10% of
the total world FDI flow. China attracts global attention as a production platform by
offering a huge pool of low cost labor as well as a growing number of skilled laborers. It
also offers a huge consumer market with a rapidly growing number of middle class.
Undoubtedly, economic linkages with China have been playing an important role in the
recent economic growth of many countries around the world. We will explore in detail
what factors are likely to contribute to the continuing migration of industries to China.
However, following the old adage, there is an emerging concern for “putting all
the eggs in one basket”.
In particular, Japanese MNFs have started to pursue a
strategy of diversification of risk concerning the concentration of their production
activities in China. We discuss what could be the countervailing factors mitigating the
concentration of industrial activities in China, leading to a more even distribution of
industries across Asia and elsewhere.
This paper is structured as follows. First, in Section 2, we present a rough
picture of current production networks in East Asia, showing the pattern of
specialization across countries. Then, in Section 3, we suggest that the concentration
of manufacturing industries in China can be characterized as a cumulative process of
FDI, exports, and income growth.
It is also pointed out that this phenomenon is
geographically concentrated, leading to the self-organization of industrial clusters in
China. In Section 4, from the perspective of Japanese MNFs, we discuss emerging risk
factors in China which are gaining in relevance to the future development of the
regional production network in Asia. The final section concludes the paper with the
discussion of policy implications in the long-run.
2. Integrated Production Networks in East Asia
For the past two decades, East Asia has deepened intra-regional trade1. An
1
See Fujita (2005)
1
appropriate measure for examining this issue is the intra-regional trade share, which
represents the share of international trade (exports and imports) within the region in
terms of the total trade by all countries in that region with all countries in the world.
It is apparent from Figure 1 that the intra-regional trade share is the highest for the
EU15, hovering at around the 60% mark. This is not surprising, as the situation of
many rich neighboring countries with small lands cooperating in unison over the past
half-century has made regional integration considerably deeper and wider. On the
other hand, the intra-regional trade of both East Asia and North America has shown
steady growth in the past couple of decades. In particular, except during the period of
the Asian financial crisis in 1997-98, the intra-regional trade share of East Asia has
been progressively increasing and approaching that of EU15, while becoming
significantly higher than that of NAFTA.
Figure 1. The intra-regional trade share (export + import) of each region, 1980-2003
70 ％
60
64.4
EU15
58.7
56.4
52.4
East Asia
50
44.6
40
30
34.9
NAFTA
33.2
25.8
ASEAN10
20
10
15.9
22.2
China-JapanKorea
13.9
0
1980
1985
1990
1995
2000
2003
Note: East Asia consists of ASEAN10, China, Japan, Hong Kong, South Korea, and Taiwan.
Source: United Nation, Comtrade Database for EU15 and NAFTA, IMF Directions of Trade,
2004, CD-ROM, and Council for Economic Planning and Development, Republic of
China, Taiwan Statistical Data Book, 2004 for Taiwan.
Moreover, one of two lines in the bottom part of Figure 1 shows the change in the
intra-regional trade share of ASEAN-10, whereas the other line shows that of
China-Japan-Korea region (North East Asia). We can see from the figure that the
intra-regional trade share of each sub-region of East Asia is much lower than that of the
whole of East Asia (which consists of ASEAN 10 and China-Japan-Korea plus Taiwan
2
and Hong Kong). For example, in 2003, the intra-trade share of ASEAN 10 was 22.2 %
and that of China-Japan-Korea was 25.8%, whereas that of East Asia was 52.4%. This
indicates that although neither ASEAN alone, nor China-Japan-Korea alone represents
a sufficiently integrated region, the two sub-regions together constitute an integrated
region with a strong interdependency. We can also see from Figure 1 that over the last
several years, the intra-trade share of China-Japan-Korea is increasing faster than that
of ASEAN 10. This is due to the rapid growth of China in recent years.
Next, Table 1 shows the recent trend in the relative changes of economic powers
among East Asian countries in terms of GDP and world trade shares. The top block of
the table indicates that East Asia as a whole increased its world GDP share from 20.5%
in 1990 to 23.4% in 2000, which then returned to 20.1%, coinciding with the rise of
China and the decline of Japan. In contrast, the share of NIES3 and ASEAN remains
the same over the same period. As a consequence, Japan’ s GDP share in East Asia
declined from 71.2% in 1990 to 56.7% in 2004 whereas that of China increased from
9.3% to 19.9%, implying that Japan remains in the dominant position despite of the
rapid catch-up of the latter over the two decades.
Table 1. World share in GDP and trade
GDP*
Exports**
Imports**
Japan
NIES3
ASEAN
China
East Asia
1990
14.6%
2.4%
1.6%
1.9%
20.5%
2000
15.1%
3.1%
1.8%
3.4%
23.4%
2004
11.4%
2.8%
1.8%
4.0%
20.1%
1990
8.3%
6.2%
4.0%
1.8%
20.4%
2000
7.5%
8.2%
6.7%
3.9%
26.3%
2004
6.3%
7.6%
6.0%
6.6%
26.4%
1990
6.6%
5.8%
4.5%
1.5%
18.4%
2000
5.8%
7.8%
5.8%
3.4%
22.8%
2004
4.9%
7.1%
5.3%
6.0%
23.3%
Note: NIES3 includes Hong Kong, South Korea, and Taiwan.
Singapore is included in ASEAN.
（Source）*IMF, World Economic Outlook Database （http://www.imf.org） and **IMF, International
Financial Statistics (CD-ROM) 70..D and 71..D
In contrast with GDP share, trade shares provide a significantly different picture
of East Asia. As the second and third blocks of Table 1 shows, the world export share of
East Asia grew from 20.4% in 1990 to 26.4% in 2004. However, its composition has
changed dramatically over the same period. World share of both exports and imports of
NIES3, ASEAN, and China grew much faster than that of GDP. As a consequence, they
occupy about the same world share as Japan. All four countries/regions of East Asia
3
have significantly smaller import shares than export shares. This means that East Asia
as a whole has built up an export-platform to the rest of the world over the past
quarter-century.
Figure 2. Composition of Exports and Imports of Asian Countries by Types of Goods
(2003)
Unit: million US$
(Source) Author’s own calculation based on METI (2005) Figure 2-3-1 and IMF Direction of Trade
Statistics (CD-ROM).
The trade pattern is characterized by an intra-regional division of labor. We can
observe from Figure 2 that China is by far the biggest net exporter of consumer goods
while importing parts, processed materials and primary goods. On the other hand,
Japan is the major supplier of capital goods and parts in a complementary relationship
with China. Korea and Taiwan have similar characteristics to Japan, although they
are still net exporters of consumer goods. Singapore is specialized in capital goods
4
related to information technology and processed materials derived from petrochemicals.
Other ASEAN countries are net exporters of consumer goods while also showing
comparative advantages in exports of capital goods (computers in the Philippines and
Malaysia and automobiles in Thailand) or processed and unprocessed primary
commodities in Indonesia.
Figure 3. The triangular trade pattern in Asia-Pacific.
(Source) Fujita (2005)
Figure 3 represents a rough picture of the trade pattern in the Asia-Pacific region
with the focus on East Asia and the US. Japan, Asian NIEs, China and ASEAN
together have developed a highly integrated production system. Intermediate goods
move back and forth, while consumer goods assembled in China and ASEAN (as well as
in Japan and NIES) are exported to the US (as well as to the rest of the world (ROW))2.
In particular, China has become the largest export-platform to the ROW.
Here, it must be pointed out that a large share of China’s trade activity is
conducted by affiliates of multinational firms (MNFs). For example, according to the
Chinese official data3, 57% of both exports and imports were mediated by MNFs in 2004.
Although it is obvious that the US and the rest of the world also export their products
to East Asia, this aspect is omitted in Figure XX in order to emphasize that East Asia as
a whole has developed an integrated export-platform to the world.
3
China Statistical Yearbook 2005, National Bureau of Statistics of China,
2
5
We examine the evolution of this production system, with a focus on the role of
Japanese MNFs, in the next section.
3. Agglomeration to China
The formation of the regional production network in East Asia was influenced by
active foreign direct investment (FDI) by Japanese firms. Japanese FDI intensified in
the late 1980s due to the appreciation of the yen which followed the Plaza Accord of
1985. Such investment was first hosted by ASEAN countries with low cost unskilled
labor, enabling cost reduction in the final assembly for export. In the 1990s, China
started to gain more attention with its economic liberalization and rapid growth. In
Table 2, we can observe that the share of FDI in developing economies in the world
increased from 17.2% in 1990 to 36.0% in 2004. The FDI in developing economies was
slightly diversified as the share of Asia declined from 63.3% to 54.7%. Within Asia,
there was clear tendency towards concentration in China, which represented only 15.4%
in 1990 (illustrating concentration in Southeast Asia) but sharply increasing to 47.5% in
2004. Thus we can roughly depict a picture of fractal concentration where a half of
FDI for developing economies was invested in Asia which is, in turn, redirected toward
China. Then, as we can see below, FDI in China is concentrated in the costal regions.
Table 2. FDI inflow to Developing Asia
(Unit: Million US$)
1990
2004
207,878
648,146
- Developing Economies <D>
35,736
233,227
- Developing Asia <A>
22,614
127,545
- China <C>
3,487
60,630
D/W (%)
17.2%
36.0%
A/D (%)
63.3%
54.7%
C/A (%)
15.4%
47.5%
World <W>
(Source) UNCTAD, World Investment Report FDI Database, http://www.unctad.org/wir/.
Table 3 shows that Japanese FDI in Asia at the beginning of the 1990s was
concentrated in ASEAN, and in particular in Singapore, Malaysia, and Thailand. Since
then the focus of interest has shifted to mainland China. Japanese FDI in China is
mostly concentrated in three areas, which are, in terms of relative importance, Bohai
Rim （Beijing, Tianjin, Hebei, Shandong, Liaoning）, Yangzi River Delta (Jiangsu,
6
Zhejiang, Shanghai), and Hong Kong – Guangdong (Pearl River Delta).
Recently,
Vietnam is being increasingly considered as an alternative location for investment to
Guangdong because the wages of unskilled labor have started to rise. In terms of the
rest of ASEAN, the growth of the number of affiliates of Japanese firms has been
moderate in Indonesia and the Philippines and has even declined in Malaysia and
Singapore. However, Thailand stands out as an exceptional case, as it has kept
attracting Japanese FDI, stimulated by the recent development of the automobile
industry there. Finally, the growth of Japanese FDI in India is still modest, although
financial investment in the Indian capital market is already heated4.
Table 3. Number of Japanese Firms’ Foreign Affiliates in Asia
Location
China
Bohai Bay
1994
2000
2004
1061
2432
4041
404
815
1039
Yanzi River Delta
77
384
1060
2187
Pearl River Delta
47
152
310
525
Others
50
121
247
290
793
727
399
743
509
766
292
171
1
71
1022
1112
1121
812
404
961
709
983
439
234
21
891
496
1129
881
1342
676
426
174
909
640
1067
805
1512
698
453
220
81
168
193
Hong Kong
Taiwan
Korea
Singapore
Malaysia
Thailand
Indonesia
Philippines
Vietnam
India
1990
315
141
(Source) Toyo Keizai Inc., Overseas Japanese Companies Data.
Due to time lags between the investment boom in ASEAN and that in China,
Japanese firms tended to consider the strategies for the two economies separately. With
stronger regional integration, however, there is a growing concern now that operations
in East Asia should be reorganized, especially when a company has duplicate functions
within the region. For example, Asaka (2005) claims that with the highly developed
international logistic chain and expanding web of the free trade agreements, Japanese
The net asset value of Japanese India investment funds was boosted to 755.7 billion
yen, or US$ 7 billion, as of end-January 2006.
4
7
firms are facing the need to establish a more unified “Greater Asia Strategy”. At the
same time, Japanese firms are revaluating their investment within Japan, while their
interest in India is rapidly growing. Thus, a substantial reorganization of the supply
chain of Japanese MNFs is expected to occur on a wider regional scale in Asia.
In this regard, the FY2005-result of the Survey on Overseas Business Operations
by Japanese Manufacturing Companies5, conducted annually by the Japan Bank for
International Cooperation (JBIC), brought more detailed insights about the future
outlook. According to the survey, 85 firms out of the sample-set of 590 firms expressed
their intention to reduce some foreign operations in the next 3 years because of the
following motivations: to transfer business units back to Japan (10 firms); to withdraw
from the present business there (38 firms); and to transfer business units to other
foreign countries (37 firms). Among the 37 firms that intend to change one foreign
location to another, there are 21 production units and 16 sales/administrative units.
The largest part of rearrangement strategies are considered within the East Asian
production network. For eleven production units and seven sales/administrative units,
their next location will be China. As far as production units are concerned, the
distribution of locations where the reduction/withdrawal might occur is: 5 from
Malaysia; 3 each from Taiwan and Indonesia; 2 each from Hong Kong, Singapore, China,
and EU15; and 1 each from North America and Mexico. Most firms moving from
Taiwan and Hong Kong may go to mainland China, while firms in Singapore will move
to Malaysia. Four out of eight firms intending to relocate from either Malaysia or
Indonesia declare China as an alternative location, although they also cite Thailand,
Vietnam and Indonesia (if the origin is Malaysia) as possible options. At the same time,
there are two cases which are considering moving out of China to Myanmar and India in
search of cheaper labor costs. These figures suggest that while the East Asian strategy
of Japanese MNFs will continue to be focused on China, the redefinition of operations in
ASEAN will be another key issue. The latter point will depend on the deepening of
intra-ASEAN integration and the progress of specialization there.
It should be noted that the continuing migration of firms into China exhibits a
circular causation phenomenon. In other words, the attractiveness of China as the
destination of FDI has been enhanced by growth and agglomeration itself, making the
growth trend even stronger. One force in the self-organizing agglomeration of
economies is the rapidly growing consumer market. Panel (a) of Figure 4 plots the
Chinese provinces evaluated by their growth rate of exports during 2004-2005 on the
vertical axis and the share of the multinational firms (MNFs) in exports in 2005. A
http://www.jbic.go.jp/autocontents/english/news/2005/000077/pdf/attach.pdf. For
previous years’ survey results, see http://www.jbic.go.jp/english/research/report/review
5
8
cluster analysis (in Ward’s method) identified four groups with respect to the growth of
exports and the presence of MNFs. As shown by Panel (b), the provinces with high
export growth and more than 50% share of MNFs in exports (Group I) constitute three
economic cores in the costal area. Then, provinces of Group II with 20-40% MNF share
are located the adjacent regions which can be seen as a sprawl of Group I. Inland
provinces of Group III still demonstrate high export growth but the contribution of
MNFs is less than 20%. Finally, for the provinces of the periphery regions (Group IV),
both export growth and presence of MNFs are quite low.
Figure 4. Mapping of the MNF-led Export Growth
(a)
(b)
(Source) Author’s own calculation based on Tables 18-10 & 18-12 of China Statistical Yearbook 2005
Next, a comparison between the Panel (b) and Figure 5 suggests that the
population of higher income households that lead consumption in domestic markets is
concentrated in the area occupied by provinces from Group I. It is possible to interpret
this phenomenon in the following way. In general, productivity is higher in export
oriented MNFs than local firms allowing the workers in MNFs to obtain higher wages.
With the population earning higher wages, the MNFs are able to expand sales in the
local market. Then, the scale economy from increased production size enables the
MNFs to achieve even higher productivity. Thus, the circular causality through the
interaction of the market size and the scale economy may have been playing a key role
in the formation of industrial clusters.
As we observed in Table 1, it is in these regions that Japanese FDI has
concentrated since the 1990s. With this data analysis, we can roughly confirm that the
9
MNF-led export growth performed as a catalyst for uneven regional development in
China. Here, the case of Chongqing may be seen as an exceptional case. Chongqing
belongs to Group III in Figure 4 and has less than 20% of MNF share in exports,
however, the government has designated the city as a gateway to the West and invested
heavily to establish an inland growth pole.
Figure 5. Regional distribution of the higher income households*
＊Number of households earning greater than 6,000 yuan in large metropolitan areas or 4,000 yuan in
medium size cities, which in total correspond to about 10% of total urban households.
(Source) METI (2005) Figure 2-1-87.
Next, the second cause of the spatial agglomeration of Japanese FDI in China is
the backward and forward linkages between final goods manufactures and their
suppliers.
Essentially, the establishment of final assembly plants has attracted
specialized suppliers of parts and components, whose diversity and accumulation, in
turn, has enhanced the productivity of final production. Table 4 shows that final good
producers and parts suppliers are mutually reinforcing the concentration of Japanese
FDI in the electric and electronics equipment industry in three regions. In this table,
each number represents the number, by year of establishment, of the producers of
intermediate products classified as “electric and electronics equipment”, while each
company name shows a final good manufacturer. In particular, localization in Yangzi
Delta region has been intensified recently. In the automobile sector, reported in Table
5, a large number of auto-parts suppliers have also been located in Yangzi Delta region,
although there is no Japanese automobile plants there, for export-oriented production
10
as well as to attend to the market created by other multinational firms6. More recently,
Japanese FDI in the automobile sector is rapidly increasing on the Bohai Rim and
Southern coastal area, where big Japanese automakers have established passenger car
assembly plants since entry deregulation in the late 1990s. As these new comers are
gaining market share against the incumbent producers, supported by the clustering of
parts suppliers nearby, the geography of automobile production in China is changing.
Table 4. Number of Japanese MNF affiliates in China by year of establishment and
region: electric and electronic equipment industry
South Costal
Yangzi Delta
1980ｓ
1
4
199094
30
Matsushita
JVC
48
199599
46
Casio
Sony
Pioneer
Sanyo
Matsushita
Fuji-Xerox
79
200004
46
Sony
Pioneer
Matsushita
Hitachi
140
Sanyo
East
Interior
0
Sharp
Sony
Matsushita
Toshiba
Pioneer
JVC
Hitachi
Fujitsu
Kenwood
Sharp
Sony
Pioneer
Oki
Mitsubishi
Sanyo
Matsushita
Fujitsu
Onkyo
Cannon
Pioneer
Matsushita
Toshiba
Bohai Rim
North
East
0
North
West
1
0
0
6
Matsushita
1 NEC
KonicaMinolta
39
NEC
Matsushita
JVC
1
1
4
34
Sony
Sanyo
Matsushita
Toshiba
1
3
4 Hitachi
27
Sotech
Matsushita
1
1
South
West
NEC
3
2
(Source) Toyo Keizai Inc., Overseas Japanese Companies Data.
(Note) Numbers represent producers of intermediate products classified as “electric and electronics
equipment” sector. South coastal region includes Guandong and Fujiang provinces.
Table 5. Number of Japanese MNF affiliates in China by year of establishment and
region: automobile industry
Chinese automobile industrial policy initially set out the “three big, three small, two
micro” regime which restricted entry and production sites. Production in Shanghai led
by Volkswagen stood out due to access to the wealthiest local market, while the other
two main production sites, Jilin and Hubei Provinces, did not enjoy such conditions.
6
11
NEC
South Costal
1985-89
Yangtzi
Delta
East Interior
1
Bohai Rim
North
East
North
West
South West
1
Isuzu
1990-94
3
7
1
Suzuki
5
1
1995-99
10
Honda
23
7
Nissan,
MMC
35
3
2000-04
61
Honda,
Toyota,
Isuzu
71
7
Honda,
Nissan
32
Total
number
74
112
15
Hino,
Toyota
73
12
Suzuki
Toyota
3
1
2
7
1
14
(Source) Toyo Keizai Inc., Overseas Japanese Companies Data.
(Note) Numbers of suppliers include parts producers classified as “automobile industry” plus
producers of materials (such as plastic, metal, rubber, and fabrics) which are explicitly prescribed for
use in automobile manufacturing.
Additional comments should be made concerning the recent trend in Japan’s
connections to China in service outsourcing. The annual questionnaire survey on
international transaction in the computer software industry, conducted by Japan
Information Technology Services Industry Association (JISA)7, uncovered that about
one-fourth of respondent software firms (77 out of 318 firms) utilized overseas
outsourcing worth 52.7 billion yen (about US$488 million) in 2004, in which contracts
with China represented 63% of Japanese software outsourcing, thus growing as rapidly
as 3.4 times in the last two years. The preference for China also owes to the ability of
Chinese workers to read Japanese characters, which are derivative of Chinese. One of
main software export hubs, Liaoning Province, had exports worth US$ 143 million in
2005, up by 20% from the previous year, of which 93.5% is sold to Japan8. Also in the
service sector, call center services for Japanese customers is increasing in Dalian, a
port-city in Liaoning, where a sizable population speaks Japanese. Actually, not only
Japanese firms but also global companies such as Hewlett Packard, Dell and IBM
utilized the same services there (or multi-lingual services in Chinese, Japanese, and
Korean to cover Northeast Asia).
4. China Risk and the Emerging China-plus-One Strategy
4.1 Business risks in China
We have seen above that China offers a wide variety of locational advantages for
MNFs, including strong agglomeration economies created through market size effects
7
8
http://www.jisa.or.jp/pressrelease/2005-1019.html (In Japanese)
Information given by China Customs (http://www.customs.gov.cn/) January 25, 2006.
12
and backward and forward linkages. In this regard, one may not have much doubt
that the concentration of investment in China will continue in the foreseeable future.
However, several factors that might hinder the current development model are already
apparent. MNFs are already re-examining their future strategy taking into account
the following problems.
(1) Labor shortage
Guangdong province has been known as the “world’s factory,” owing to the
availability of sufficient cheap labor and the concentration of foreign direct investment
from all over the world. The supply of labor which used to be taken for granted or seen
as unlimited in light of the huge inland rural population is now in question. According
to a document9 of the Ministry of Labor and Social Security (2004), the labor shortage
problem can be observed in labor-intensive processing industries such as footwear, toy,
electronic parts, garment, and plastic products in southern Chinese cities such as
Shenzhen and Donggan. In particular, it is getting harder to find young (18-25 years
old) female workers. There is strong dissatisfaction among workers about poor
conditions and lengthy work hours, often extended to as much as 10-12 hours per day.
The reward for such painstaking work is just a meager salary.
International
competition has kept wages as low as 600-700 RMB (  80 dollars monthly) which has
been almost unchanged for nearly a decade, despite of the growth of the region.
Workers can expect almost the same level of income in the inland area where living
costs are much cheaper, or they can choose to go to the Yangzi River Delta region which
offers higher wages. Firms will not have to face this problem if they are willing to pay
more than 1,000 RMB. But some firms already seek to expand business in other
locations where the pool of cheap labor is still abundant. Taiwanese firms, which are
reported in the Chinese official document cited above and have been most seriously
affected by labor shortages, top the list of foreign direct investment in Vietnam which
increased foreign direct investment
(2) Revaluation of RMB
People’s Bank of China (PBC) has introduced gradual flexiblization of the
exchange rate regime since late July 2005 when the RMB was pegged to the
multi-currency basket allowing up to 2 percent appreciation. Six months later, in the
beginning of January 2006, over-the-counter transactions in the inter-bank foreign
exchange market were introduced.
9
The exchange rate can be determined through
http://www.molss.gov.cn/news/2004/0908a.htm
13
bilateral settlements, without intermediation of the central bank, taking the central
parity announced daily by the China Foreign Exchange Trading System (CFETS). The
margin of flexiblization is controlled by the PBC to limit fluctuations within the band to
0.3% of the parity of the previous day. Yet, the RMB is expected to be revaluated due
to both political and economic pressure. The political pressure comes from the trade
imbalance with the United States. The economic reason is the violation of Mundell’s
“impossible trinity” by pursuing integration with the international capital market,
exchange rate stabilization and independent monetary policy at the same time10. To
sustain the current level of economic growth, China should have autonomous monetary
policy and more liberal foreign capital inflow. This requires giving up the exchange
rate control which should lead to the appreciation of the RMB due to the strong
performance of exports and the current account surplus.
Revaluation of the RMB will make Chinese exports less competitive. This may
have a significant impact on some industries, especially unskilled labor intensive ones.
Investment in such industries may move to other countries. But such an effect can be
offset by cost reduction from cheaper imported intermediate goods. The latter effect is
especially beneficial for domestic market oriented industries. Over all, the revaluation
of the RMB may induce effects of promoting specialization in the Chinese industrial
sector, but will not drastically affect the foreign direct investment flow.
(3) Security Risk: SARS and Anti-Japan Protests
The wide-spread of SARS in 2003 highlighted the existence of unexpected risks
from contagious diseases in China.
Matsushita’s factories had to be closed
temporarily.
Another incident in 2005 that frightened Japanese firms was the rise of massive,
violent anti-Japan protests in various cities in response to the diplomatic conflict
regarding Prime Minister Koizumi’s visit to the Yasukuni Shinto Shrine.
More
recently, Sony, which has achieved a high reputation in the Chinese market, suspended
the sales of its digital cameras following Zhejiang province authority’s judgment that
they had fallen short of quality criteria.
(4) Bottleneck of Energy Supply
The problem of infrastructure is most seriously felt in electric power supply.
Power shortages have occasionally paralyzed many factories. The problem is expected
According to Fukao (2005), the PBC maintains a low interest rate while curtailing
investment through credit rationing and restrictions on investment permits. Such
intervention has promoted corruption and illegal operations.
10
14
to be gradually eased by the completion of the ongoing investment projects in power
plants. However, the electric power system in China should be further restructured in
order to guarantee a high quality service. First, the system should reconsider its high
dependence on coal as its primary energy source.
The demand for coal has been
strained along with industrial production such as steel mills.
It is reported that
uncontrolled exploration of coal mines has caused several serious accidents which killed
a large number of mining workers. Second, the quality of the electricity transmission
and distribution system should be re-addressed.
(5) Institutional Uncertainty: Democracy and the Rule of Law
The strong discretionary power held by central and local governments is a source
of occasional and unpredictable changes in rules which perplex company management.
The authority may give tax incentives to attract investment but such benefits can be
renounced suddenly depending on the fiscal situation. The influence of power and
political practices may also support conditions which enhance corruption.
The problem of a lack of a solid basis for the rule of law is also problematic for the
protection of intellectual property rights. The difficulty of controlling the emergence of
copy products and leakage of technological information is quite notorious in China.
With these risk factors examined, firms naturally consider diversification of
productive assets. A new phase of East Asian business appears to be developing in the
following direction.
4.2 China-plus-One
The above list of potential business risks in China have become a matter of
concern for business leaders. It does not necessarily mean, however, that firms will
withdraw investment assets from China and transfer them elsewhere. To the contrary,
there is a growing consensus that firms facing global competition must establish links
with China. Consumer goods manufactures see China as an essential “profit center”
for generating cash flow through cost reduction and through the growing consumer
market, which may support the cost of administration and R&D in headquarter offices.
Parts supplies and subcontractors, in turn, feel the need to make a physical presence in
China because most of their customers are already there. Service firms will be able to
enjoy a higher rate of profit by offering their sophisticated services and know-how to
rapidly increasing numbers of higher income class consumers. This means that the
risk of “not being in China” is as big as any risk of “being in China”. Hence, the
migration of investment into China by firms which have not yet established a platform
15
in China will continue.
However, the increasing salience of the above mentioned business risks urges
MNFs to prepare for any potential mal-functioning of the system or disturbances in
logistic links which may disrupt the supply chain. Such concerns have prompted firms
to seek “the China-plus-One strategy”, or risk diversification. In this vein, investment
in China and investment either in Japan or in other Asian countries (or both) are
expected to grow concurrently.
(1) Reorientation of investment to Japan
Capital investment within Japan had shrunk since the financial bubble burst in
the beginning of the 1990s.
On the other hand, as the investment in overseas
productive assets continued, the proportion of outward investment kept rising, as
Figure 6 shows. Recently, domestic investment has increased, for three consecutive
years, for the first time in the past decade.
Figure 6. Japanese firms’ capital investment
25
20.0%
Trillion yen
20
15.0%
15
10.0%
10
5.0%
5
Outward Investment
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
0.0%
1988
0
Domestic Investment
Owtward propotion(right scale)
(Source) Outward Investment – METI, Kaigai Jigyo Katsudo Kihon Chosa; Domestic Investment –
MOF, Hojin Kigyo Tokei Chosa and BOJ, Nichigin Tankan (for 2005). Outward investment data for
2004-05 are not available yet.
Following this trend, Cannon has announced that it will invest about 80 percent
of the 800 billion yen of its investment plan for 2004-06 in Japan. The new investment
includes even low value added production that other companies are eager to transfer
abroad, such as printer toner cartridge production.
Cannon’s position is shared by many Japanese firms who intend to increase
16
productive capacity in Japan, but this should not be understood as “repatriation”.
According to the survey conducted by the Japan International Cooperation Agency, in
2002 and 2004 firms which set expanded overseas production as their highest priority
constitute the largest group (54.6% in 2002 and 57.9% in 2004). Moreover, in 2002,
32.5% of companies mentioned “sliming the business group” and 25.4% referred to
“revision of domestic production systems”, indicating that FDI was accompanied by
internal restructuring. In 2004, 40.2% of companies affirmed “strengthening R&D”
and 22.4% “active entry in new business”, while firms mainly concerned with
enlargement of domestic production increased from 8.6% in 2002 to 17.8% and those
which focused on “revision of domestic production system” declined to 7.0%.
The
recent survey result showed that having settled the domestic restructuring and the
installation of overseas production networks, FDI and new domestic investment are
likely to make progress concurrently.
In fact, Cannon was one of the first optical precision equipment manufacturers to
shift production to China and its factories in Dalian, the Peal River Delta and the
Yangzi River Delta accounts for about 70% of the total overseas production, which now
reaches 42% of the total production. According to the remarks11 by Mr. Mitarai, the
COE of Cannon, “Our production base in China is almost complete. Next target is
Japan. Overseas production will be less than 40%.” “Factories in Japan will be able to
compete with cheap labor economies depending on appropriate tactics.”
Such tactics should be based on the so-called “closed black box” approach:
utilizing high degrees of automation, equipping with self- made factory machinery and
tightening the linkage of value chains from R&D to vertically-integrated production
process. This business strategy aims at reducing the risk of leakage of technology and
piracy by making technological contents more invisible, as well as taking advantage of
agglomeration economies by locating near the industrial clusters within Japan to
reduce logistics cost and to enhance innovation through intense interaction between
R&D – intermediate input – final production. The same strategy is taken by Sharp’s
Thin-Film Transistor Liquid Crystal Display (TFT-LCD) production and Matsushita’s
ambitious plan for the world’s biggest Plasma Display Panel (PDP) factory.
Mass production of standardized products has already shifted abroad and this
trend should be irreversible with China still being a central part of this strategy.
However, higher quality customized-type production （of many kinds and of small
quantities） can be expanded in Japan. Such industries include:

11
Chemical materials: functional resin.
Nikkei Business, 2005/08/02..
17

Steel: high quality steel panels used for automobile production.

General machinery: office and factory machinery and equipment for domestic
investment and exports.

Electronics: electronic devices and digital home appliances.

Optical and precision: digital cameras and medical equipment,
semiconductor equipment.

Automobile: new models for high-end users.
(2) Alternative foreign investment destinations
-
ASEAN
In the previous section we have seen that Japanese FDI growth in ASEAN has
been slow in contrast to rapid expansion in China. The information gathered in Table
6 highlights several aspects of development within ASEAN for the electric and
electronic equipment industry. In a rough synthesis, Japanese FDI has shifted from
the upper left corner to the lower right corner, creating the co-agglomeration of final
product makers and parts suppliers. .
Vietnam is the latest comer to this group, surging as an alternative option for
those facing difficulty in finding low cost labor in the Pearl River Delta.
The
advantages of Vietnam include: an unexplored labor force, which is 30-50% cheaper,
and has much less turnover than the Chinese industrial clusters; its location as a
mid-point between China and other ASEAN countries allowing access to intermediate
goods there; high potential as a consumer durable goods market.
Yet, physical
infrastructure still is underdeveloped and ad-hoc government intervention, rather than
regulation by law, remains in many aspects. Firms from Korea and Taiwan are more
aggressively investing in Vietnam. In the first seven months of 200512, the Vietnamese
government approved 99 investment projects from Korea and 86 from Taiwan, along
with only 45 from Japan.
In terms of the size of capital, investment from Japan
(US$ 176 million) is second to Taiwan (209 million), but surpasses Korea (138 million).
It should be emphasized that Table 6 demonstrates that while Malaysia and
Singapore are attracting much fewer numbers of companies recently, Thailand remains
a favored Japanese FDI location. This is related to positive economic prospects based
on recent remarkable developments in the automobile sector. Automobile production
increased from 412 thousand units in 2000 to 1,125 thousand units in 2005, while
exports also grew from 153 thousand to 441 thousand units, or US$ 83 million to
12
Data from the Ministry of Planning and Investment (http://www.mpi.gov.vn)
18
US$ 294 million including parts, during the same period13. The Thai automobile sector
has the peculiar characteristic of strong specialization in pickup trucks, which occupied
nearly 65% of domestic market sales and 73% of exports in 2005. As one of the major
automobile producer countries (ranked 14th in production, 7th in exports, and 2nd in
pickup truck production), Thailand has already developed diversified suppliers of parts
and materials. Japanese auto-parts suppliers have been established since the late
1990s as reported in Table 7.
Table 6. Number of Japanese MNF affiliates in ASEAN by year of establishment and
region: electric and electronic equipment industry
Singapore
1960s
0
1970s
28
198084
5
198589
12
199094
10
199599
7
200004
5
Malaysia
Thailand
2
Matsushita
4
16
NEC
Sharp
Matsushita
5
7
4
Sharp
Hitachi
3
2
Sony
Sanyo
Toshiba
45
Onkyo
Sony
Mitsubishi
Sanyo
Matsushita
JVC
Hitachi
44
NEC
Casio
Sharp
Matsushita
Toshiba
JVC
4
Epson
54
Kenwood
Sharp
Pioneer
Sanyo
Matsushita
Toshiba
JVC
Fujitsu
20
Pioneer
Mitsubishi
JVC
Fujitsu
23
41
5
16
Matsushita
Toshiba
JVC
Mitsubishi
Sanyo
Toshiba
Indonesia
0
Philippines
1
Sanyo
Matsushita
Matsushita
1
Vietnam
0
0
3
Sharp
0
Sanyo
7
Matsushita
0
31
Sharp
Epson
Matsushita
Toshiba
9
Epson
1
Sony
Sony
Matsushita
42
Sanyo
Toshiba
JVC
38
Matsushita
18
NEC
Sanyo
Matsushita
Toshiba
JVC
Fujitsu
Matsushita
4
8
Matsushita
Toshiba
11
(Source) Toyo Keizai Inc., Overseas Japanese Companies Data.
(Note) Numbers represent producers of intermediate products classified as “electric and electronics
equipment” sector.
13
Data from Thailand Automotive Institute (http://www.thaiauto.or.th/)
19
Table 7. Number of Japanese MNF affiliates in Thailand by year of establishment and
region: automobile industry
1960-69
1970-79
1980-89
1990-94
1995-99
2000-04
Total number
Assemblers
Hino, Toyota, Isuzu
Nissan
MMC
Honda
Mazda (Auto Alliance)
7
Suppliers
3
14
23
26
90
62
218
(Source) Toyo Keizai Inc., Overseas Japanese Companies Data.
(Note) Numbers of suppliers include parts producers classified as “automobile industry” plus
producers of materials (such as plastic, metal, rubber, and fabrics) which are explicitly prescribed for
use in automobile manufacturing
- India
In contrast to China’s status as “the world’s factory”, India came to be known as
“the world’s back office” assuming the operations of business process outsourcing of
global companies including call centers and software design. Such activities require
English-speaking qualified labor, of which India has an abundant low cost resource.
Since back offices and subcontractors can be connected with their customers around the
world without the barrier of distance using advanced information and communication
technology, the presence of US-based global companies such as IBM, Microsoft, and
Cisco Systems is bigger than that of geographically closer Asian counterparts. Still,
the offshore software development contracts from Japan are expected to grow.
For the manufacturing FDI of Japan, India is simply considered too far to
incorporate in the East Asian production network14. Compared to the rich human
capital in the service sector, the manufacturing agglomeration in India is still
considered weak as a production platform. This might change in near future if the
growth of the domestic market will continue to grow and the “home market effect”
becomes significant, just like it has become relevant in the Thai automobile sector. In
this vein, the compact car manufacturer Suzuki, which is highly acknowledged for its
long-standing success in India, announced investment in a diesel engine plant for
enhanced production for export to Europe, China, and Southeast Asia.
It should be also noted that the Japanese government shows a keen interest in
In fact, the flight distance between New York and Los Angels is about the same as
that between Tokyo and Bangkok. This means that, given today’s transportation and
information technologies, the geographical area of NAFTA or of East Asia represents a
natural unit of economic activity. In contrast, the flight distance between Tokyo and
Delhi is roughly the same as that between Tokyo and Los Angeles.
14
20
counter-balancing the growing presence of China by involving India in diplomatic
relations in East Asia. Japan welcomed India to the East Asian Summit in Kuala
Lumpur and launched a feasibility study into an Economic Partnership Agreement
between the two countries.
5. Concluding Remarks
Over the past decade, China has attracted a large volume of foreign direct
investment and became markedly integrated in the production network of East Asia.
The MNFs are responsible for more than a half of the total exports and imports of China
today. FDI inflow and generation of higher incomes are mutually reinforcing each
other, leading to better conditions for further economic growth. China will remain in a
pivotal position in the East Asian production network because of agglomeration
economies achieved through the industrial clustering of intermediate goods and services
already established there, together with the gravity of the rapidly growing consumer
market.
However, to make the recent development more sustainable, it is necessary for
China to mitigate some risk factors identified in this paper.
To understand the
situation clearly, we must understand that China as a nation is too large a unit of
analysis because the said development is highly concentrated geographically. First,
the myth of an unlimited flow of unskilled labor from rural areas might be near an end.
Indeed, there are already signs that the labor market is tightening, especially in
Guangdong province. Experiences elsewhere suggest that it will not be possible to hold
on to footloose industries producing undifferentiated goods much longer, because they
are quite sensitive to production cost differentials. Rather, policies should be directed
to the further cultivation of skilled labor and to the sophistication of input-output
linkages at the local level. Secondly, the rapid concentration of industries revealed the
lack of infrastructure, especially electricity supply, which can be solved by focused
planning of investment. Thirdly, the lack of transparency in the exchange rate regime,
macroeconomic policy, market regulation, and intellectual property rights might
discourage further investment into China. They will need to be more open to the
disciplines of the market mechanism and the rule of law, while reducing the sphere of
discretionary decision making by the government.
While firms competing in the global market cannot be indifferent to China, they
have started seeking the diversification of their production activities globally. In this
vein, Japanese MNFs consider investment within Japan strategically important for
enhancing their innovative capability and for the prevention of leakage of their core
21
technologies. The emerging new “Greater Asia” strategy tends to integrate and unify
Japan, China and Southeast Asia operations, which used to be subordinate to different
systems of command. Recently, for example, Vietnam surged as a suitable location for
unskilled labor-intensive production, as an alternative to Southern China. Although
Southeast Asia has been seen to be under the shadow of rapidly growing China for the
past years, their strategic geographical position between China and India may present
new opportunities.
In that case, it will be necessary for ASEAN to make further
progress toward economic integration and to promote specialization in each country.
Thailand is already successfully established as a sub-regional center of automobile
production. Furthermore, the Japanese government will be able to contribute to the
deepening of East Asian integration by supporting intra-ASEAN and ASEAN-India
integration.
References
Asaka, Toshimasa, “Kakudai Ajia Senryaku Koso Ikinokori no Seimeisen,” Nihonn
Keizai Kenkyu Senta Kaiho, 2005: pp.4-11
Fujita, Masahisa, Development of East Asian Regional Economies, Mimeo, Institute of
Developing Economies – JETRO, 2005
Fukao, Mitsuhiro, “Chugoku Keizai to Jinmin Gen no Yukue,” Boeki to Kanzei,
December 2005: pp. 4-15.
METI, White Paper on International Economy and Trade 2005, Tokyo, Ministry of
Economy, Trade and Industry, 2005.
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