Comment on “Has Abenomics Succeeded in Raising Japan's Inward Foreign Direct Investment?”
Cross-country evidence indicates that Japan hosts little inward foreign direct investment (FDI), even after taking into account its size and geographical or cultural distance from potential investors. Hoshi (2018) is a judicious empirical assessment of the impact of Abenomics on Japan's ability to attract inward FDI, and, by extension, increase the nation's rate of economic growth. Hoshi reaches a skeptical conclusion as to whether Abenomics has contributed to increasing inward FDI. The Abenomics target goal for FDI may be attained, but according to Hoshi's analysis, the goal has been set too low and its achievement does not require any positive impact of Abenomics policies. That skepticism may well be justified. However, before accepting this conclusion it may be worth making the simple observation that insufficient time may have elapsed for the effects of Abenomics to manifest. The policy initiative was first announced in 2013, but some of the measures discussed in the present paper were introduced as recently as May 2016. It is possible that Abenomics will eventually work as intended, but it is just too early to tell. Hoshi correctly observes that from a theoretical perspective the impact of inward FDI flows on growth is ambiguous and the empirical literature generally concludes that inward FDI flows are only growth-enhancing conditional on financial sector development and outward orientation. The latter is particularly important, insofar as a plausible theoretical example of immiserizing capital inflows is FDI induced into a protected capital-intensive import-competing sector (Bhagwati & Srinivasan, 1983). The samples used by much of the empirical literature cited by Hoshi include developing countries where capital inflows into a protected sector of comparative disadvantage is a real problem, or are restricted to FDI into the manufacturing sector. Therefore, it is not evident that this cross-country evidence is entirely applicable to Japan. While exchange in differentiated products is pervasive in modern economies, one would not necessarily expect Japan to gain a lot from foreign investment in its dominant sector either directly or via interfirm externalities and spillovers. Yet even in this relatively inauspicious setting, analysis of firm-level Japanese data indicates that there are significant benefits to foreign investment in the manufacturing sector. The positive result for manufacturing suggests that the gains for Japan from investment in its lagging service sector, which has traditionally been sheltered via regulation from entry by either new domestic or foreign service providers, could be even more profound (Fukao, 2013). It is partly due to this lack of local presence by foreign service providers that historically Japan has been a dramatic outlier relative to other major industrial countries in the share of domestic sales accounted for by foreign firms (Bergsten & Noland, 1993). Given the relatively scant presence in Japan of foreign service providers, and Japan's evident competitive challenges in the service sector, increased inward FDI in the service sector could have a significant impact on domestic productivity, and, at least during a transitional period, the economic growth rate, thus fulfilling the promise of Abenomics. So, how could Abenomics increase FDI into Japan? Discouragingly, many of the robust correlates with inward FDI identified in Hoshi's paper such as physical and cultural remoteness, and parent gross domestic product (GDP) and per capita GDP, are exogenous and not susceptible to policy intervention. And even more discouragingly, there appears to be a disconnect between the conditions amenable to policy intervention that might promote FDI and what the government is doing. One approach could be a sharper, if not targeted, approach to inward FDI which would emphasize the removal of barriers to entry in the service sector. A government survey summarized in Hoshi (2018, Table 1) found that the "high cost of doing business" was the single most frequent complaint, with three-quarters of the respondents identifying it as a barrier to FDI. Apart from regulation, capital and labor market imperfections could be important. Addressing labor market policies that discourage interfirm labor mobility appear to be particularly salient. It is striking that among the factors inhibiting FDI into Japan listed in Hoshi's Table 1, "difficulty in securing personnel" is the only one that increased significantly between the 2012 and 2016 surveys, rising more than 10% points to 46%, indicating that the problem is both important and worsening. Such an approach of addressing basic factor market and regulatory inhibitions on business, would not only benefit potential foreign entrants, but could also contribute to revitalizing domestic entrepreneurship by making it easier to establish – and expand – vibrant new businesses (Noland, 2007), precisely the sort of structural change that the third arrow of Abenomics is supposed to promote.
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