Insights into a Recent Increase in Foreign Direct

Abstract
1. Foreign direct investment (FDI) into Japan, which were extremely low in
comparison to other advanced nations traditionally, has showed a dramatic increase
over the past few years (Chart 1), largely owing to growth in Out-In M&A (foreign
company's acquisitions of Japanese companies). In terms of the industrial distribution,
Out-In M&A implemented in the finance, machinery and telecommunications
industries as well as greenfield investments (establishment of brand-new subsidiaries or
affiliates by foreign parents) in the retail, service and software industries accounted for
a large share of the FDI inflows in Japan (Chart 3-2).
2. The growth in FDI inflows is not a typical phenomenon of Japan, having occurred in
many advanced countries in recent years. Global consolidation that is proceeding in
various industries and multinational companies' strategic emphasis on worldwide
reallocation of resources are the two major factors behind the growth in global flows of
FDI (Chart 2,5).
3. FDI has two distinctive features: one as a function of capital transfer from a country
with abundant capital to a country facing lack of capital, the other as a international
movement of a package of resources from an investors' home economy to the host
economy. Such resources include tangible and intangible assets, such as management
skill, technology, operating franchise (brand loyalty), funding ability, etc. As for the
former, even if the nation has ample capital as does Japan, any impediment to the
nation's ability to supply risk capital could promote inflows of FDI as an alternative
supply of risk capital.
4. FDI to Japan can be classified into the following five groups, i) rescue-type M&A, ii)
restructuring-purpose M&A, iii) deregulation-driven M&A, iv) industry
consolidation/market integration seeking M&A and v) IT-led greenfield investments.
The first four groups, which are carried out through Out-In M&A, have rapidly
increased over the past few years, while the last group, "IT-led greenfield investments"
started to increase earlier, at the beginning of the 1990s (Chart9).
5. Given the increasing globalization of the economy, the spiral of "FDI to Japan" and
"the ongoing structural changes in the Japanese economy" are the major factors
influencing the recent growth in FDI to Japan. That is, structural changes in Japanese
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industry stimulate FDI to Japan, while FDI to Japan accelerates the speed of structural
changes. Concretely, such structural changes include 1) changing the safety-net
mechanism in the financial system, 2) changes in corporate governance of Japanese
companies triggered by changes in the financial system (increasing share of foreign
equity holders à a rise of required rate of return for the Japanese firms à a shift to the
globally accepted "level playing field"), 3) Japanese companies' recent focus on
business restructuring for the purpose of improving profitability (e.g., Japanese
companies' increasing interest in introducing new management know-how developed
by foreign firms and restructuring business portfolios through M&A), 4) increasing
transparency of Japanese companies as a result of reinforced disclosure requirements,
5) a series of deregulation initiatives lowering or eliminating barriers to new entrants
(Chart 8, 10).
In addition to these Japanese specific factors, ongoing global consolidation
accelerated by increasing integration toward a single global market and intensifying
international competition have been stimulating FDI to Japan (Chart 6).
6. Given the structural changes in the Japanese economy as well as worldwide
consolidation in various industries, FDI to Japan is expected to increase over the long
term. "External pressure", which occurs as a result of foreign companies' entry, is
expected to accelerate the speed of structural change in Japan, and will accelerate
drastic restructuring that would not be accomplished through the efforts of existing
stakeholders. The expected increase in FDI inflows may create deflationary pressure
over the short-term; however, from a long-term perspective, growing inflows of FDI
are likely to lead to a strengthening of the growth potential of Japan's economy by
improving productivity of various industries, especially regulated industries, and
helping develop globally competitive business practices as well as corporate
governance.

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