Direct Foreign Investment : A Japanese Model of Multi-National Business Operations [1 ed.] 9780203845660, 9780415585194

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ROUTLEDGE LIBRARY EDITIONS: JAPAN

DIRECT FOREIGN INVESTMENT

DIRECT FOREIGN INVESTMENT A Japanese Model of Multinational Business Operations

KIYOSHI KOJIMA

Volume 10

LONDON AND NEW YORK

First published in 1978 This edition first published in 2011 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon, OX14 4RN Simultaneously published in the USA and Canada by Routledge 270 Madison Avenue, New York, NY 10016 Routledge is an imprint of the Taylor & Francis Group, an informa business This edition published in the Taylor & Francis e-Library, 2010. To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk. © 1978 Kiyoshi Kojima All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library ISBN 0-203-84566-8 Master e-book ISBN

ISBN 13: 978-0-415-56498-4 (Set) eISBN 13: 978-0-203-84317-8 (Set) ISBN 13: 978-0-415-58519-4 (Volume 10) eISBN 13: 978-0-203-84566-0 (Volume 10) Publisher’s Note The publisher has gone to great lengths to ensure the quality of this reprint but points out that some imperfections in the original copies may be apparent. Disclaimer The publisher has made every effort to trace copyright holders and would welcome correspondence from those they have been unable to trace.

DIRECT FOREIGN INVESTMENT A JAPANESE MODEL OF MULTINATIONAL BUSINESS OPERATIONS

KIYOSHI KOJIMA

CROOM HELM LONDON

© 1978 Kiyoshi Kojima Croom Helm Ltd, 2/10 St John’s Road, London SW11 British Library Cataloguing in Publication Data Kojima, Kiyoshi Direct foreign investment. 1. Investments, Japanese 2. International business enterprises 3. Capital investments I. Title 332.6′7352     HG4538 ISBN 0-85664-592-3

CONTENTS

Preface 1. Issues of Direct Foreign Investment

9

2. International Division of Labour: Basic Theories for Trade and Investment

21

3. The Theories of Foreign Investment: An Overview

50

4. Direct Foreign Investment: Japanese Model versus American Model

83

5. A Macro-economic Theory of Direct Foreign Investment

103

6. International Trade and Foreign Investment: Substitutes or Complements?

119

7. Transfer of Technology to Developing Countries: Japanese Type versus American Type

134

8. Direct Foreign Investment to Developing Countries: The Issue of Over-Presence

152

9. Direct Foreign Investment between Advanced Industrialised Countries

172

10. Japan’s Resource Security and Foreign Investment in the Pacific

197

11. Giant Multinational Corporations: Merits and Defects

220

Index

243

PREFACE

Direct foreign investment and the activities of multinational corporations are new dynamic elements in the international economy. The emphasis on the growth of firms has resulted in the justification of oligopolistic direct foreign investment which may be called ‘American-type’ or ‘anti-trade-oriented’, and the justification for the domination of world production by giant multinationals of oils, copper and other primary products and sophisticated manufactured goods as well. The microeconomic, business administration approach which has been the most prominent method of analysis used in the study of multinationals has entirely neglected macro-economic theory, especially the theory of international division of labour. In many situations, host countries lack sufficient capital, technology or management resources to realise the potential comparative advantage in international trade. Thus, foreign direct investment is effective in supplementing these factors of production, thus making the industry internationally competitive. Therefore, if direct foreign investment is undertaken along the line of comparative advantage, it contributes harmoniously both to the steady industrialisation and economic development of the host country on the one hand, and, on the other, to a lower-cost foreign supply for the investing country. Thus direct foreign investment works to complement, instead of substituting for, international trade, and both will grow pari passu, bringing about prosperity of the international economy. This is what I want to call the ‘Japanese type’ or ‘trade-oriented’ direct foreign investment. In this volume an attempt is made to identify, theoretically and practically, those two types of direct foreign investment. This dichotomy will cast light on important policy implications and recommendations about: (1) direct foreign investments for developing countries; (2) investment by an advanced industrialised country in another advanced country; (3) investments in resource security; and (4) on the code of conduct of multinational corporations. The book, it is hoped, will add to our knowledge of the multinational corporation by, first, developing a macro-economic approach to direct foreign investment instead of the prevalent explanation from

8  Preface

the viewpoint of business administration and industrial organisation; secondly, by endeavouring to bridge the gap of separated treatments between international trade and foreign investment, searching for an integrated theory from the viewpoint of a dynamic reorganisation in the international division of labour; and thirdly, by developing a model of Japanese direct foreign investment which follows the integrated theory. We have added two introductory surveys on the theory of international division of labour and that of foreign investments with a hope that the book might be useful as a textbook of international economics. I am especially grateful to those eminent scholars who provided me with valuable comments and suggestions to earlier Japanese and English drafts; The late Kaname Akamatsu, H.W.Arndt, Jagdish Bhagwati, Ekkehard Bechler, Fred Bergsten, Richard Cooper, W.M.Corden, Sir John Crawford, William Diebold, Jr., Peter Drysdale, Shigeru Fujii, Koichi Hamada, G.C.Hufbauer, Kiyoshi Ikemoto, the late Harry G.Johnson, Nobuo Minabe, Lennart Ohlsson, Terutomo Ozawa, John E.Roemer, Ben Smith, Yoshi Tsurumi, Raymond Vernon and Taro Watanabe. All contributed to the clarification of my ideas. I am also deeply indebted, in this context, to Mr Chris Findlay of the Australian National University for devoting his time to going over my English text, and to Dr Makoto Ikema, Dr Kazutaka Kunimoto, Mr Tom Roehl, Dr Norihiko Suzuki, Mrs Hatsuho Kuwayama and Miss Mariko Ono for preparing the text at various stages. Hitotsubashi University, Tokyo January 1978

Kiyoshi Kojima

1

ISSUES OF DIRECT FOREIGN INVESTMENT

The importance of direct foreign investment and multinational corporations (MNC) has significantly increased since the Second World War but, at the same time, the corporations’ activities have created conflicts between international trade and investment and complaints and antagonism from host countries. While the conflicts and criticisms reflect the reality of MNC operations, it is not clear that the corporations must necessarily be condemned. Specifically, the criticisms levied against the institution are based on micro-economic, business administration conceptions which entirely neglect the macro-economic theory of the international division of labour. Through the use of both international trade theory and investment theory, can we not attempt to find types of MNC and direct foreign investment which minimise the host country complaints and which eliminate the conflict between trade and investment? A satisfactory answer is given by an enquiry into ‘Japanesetype’ direct foreign investments with which both trade and investment develop pari passu along the line of comparative advantage, the core of the theory of international trade. This is a central issue which I try to explore throughout the present volume. The plan of the book is presented in the last section of this chapter. 1. Importance of Direct Foreign Investment The following statistics emphasise the importance of the problem under study. The US cumulative foreign investment at the end of 1975 amounted to $133.2 billion, a figure equal to 8.8 per cent of the GNP in that year of the US. Investment per capita was $623. It was very remarkable that US cumulative foreign investment exceeded US exports by 1.2 times. This fact suggests that the US evaluates her direct foreign investment as more important than her foreign trade, letting the former substitute for the latter. Compared with the case of the US, the amount of Japanese direct foreign investment is still very limited: the cumulative total of Japanese foreign investment by the end of 1975 was $15.0 billion, which is about a ninth of US investment. It was only 3.1 per cent of the Japanese GNP.

9

10  Direct Foreign Investment

Investment per capita was $135. Exports are still much more important to Japan than direct foreign investment; foreign investment was only 27 per cent of exports. But the rate of increase of Japan’s direct foreign investment was remarkably high. The reason was that during the three years from 1970 to 1973, there was a rush of investment abroad because of Japan’s favourable balance of payments. Although such a rush might have been temporary, the rate of increase rose to 31.4 per cent for the period of 1967 to 1974. This rate was considerably higher than the increase of US investment, which has been around 10 per cent. In contrast, the rate of increase of Germany’s direct foreign investment rose to 26.1 per cent in the same period. According to the first forecast the Council for Industrial Structure1 presented, Japanese foreign investment would reach the level of $100 billion by 1985, that is, Japan’s investment abroad would become as high as the US investment at present. This would be a formidable amount. Among more recent forecasts, the Council for Industrial Structure, the Industrial Bank of Japan, Japan Economic Research Center and Nikko Research Center2 each forecast Japanese foreign investment in the future up to 1980 as $40.9, $42.5, $38.5 and $37.4 billion respectively. It must be questioned whether such an enormous amount of direct foreign investment could happen, and what kind of contribution it would make for both Japan and host countries. Stephen Hymer, a radical economist, presented a surprising forecast for the foreign investment activities of the world’s multinational corporations (most of which are American).3 The production by the multinational corporations has already occupied a quarter of world production. If this were to continue, Hymer states, a half of world production by 2005 and 80 per cent by 2040 would be performed by one or two hundred multinational corporations. This is an astonishing prediction, although I assume it would be unlikely, because many countervailing powers such as opposition from developing countries or resistance of labour unions would arise. Whatever one may think of Professor Hymer’s conclusions, his discussion indicates the importance of foreign investment in the post-war world. The future of the world economy, economic development and the welfare of all the developed, developing and socialist countries may well depend greatly or even critically upon how the direct foreign investments of a few multinationals are going to perform. As can be seen in the above prediction of Hymer, there is a view that several big multinationals’ oligopolistic activities over the world might dominate the world economy by establishing an ‘invisible empire’. I

Issues of Direct Foreign Investment  11

fear that while it is feasible for such an advanced nation as Japan to counter the activities of the multinationals, developing countries are in danger of not only being charged an exorbitant price for unnecessary beverages or expensive pharmaceuticals, but the countries are also in danger of surrendering all their important production activities to the multinationals. As the multinationals are efficient, they will be able to supply 80 per cent of the world production employing, say, 20 per cent of the total labour force. How can the remaining 80 per cent of the world labour force that are not employed by the multinationals find a job to survive? Hymer continues: ‘Multinational corporations, like pine trees, spread their cones on the ground, so that nothing else will grow.’4 It is also noteworthy that Hymer, in another paper,5 and other American economists as D.R.Sherk6 and J.E.Roemer,7 are interested in the competition between the USA and Japan in the Pacific and they consider foreign investment as a struggle for obtaining control of economic and political power. They assume that Japanese enterprises will also be multinationalised as predicted by Vernon’s ‘product cycle’ theory, creating its own product cycle with newly developed products. It is also the general opinion of Japanese economists8 that Japan ought to take this course. Japanese multinational enterprises will in due course either compete or collude, if necessary, with American multinationals in the Asian-Pacific area. It is the dominant opinion of American entrepreneurs, economists and policy-makers that the multinational corporation activities should be protected and supported as they admit, either explicitly or implicitly, that direct foreign investment gives the USA economic and political power.9 So the theory of direct foreign investment justifying this opinion has been energetically developed. This is the theory of what I call ‘American-type or anti-trade-oriented’ direct foreign investment. Unfortunately it has been widely believed in Japan that this is the only legitimate theory of direct foreign investment. The dominant theories of direct foreign investment and multinational corporations in the US seldom integrate the idea that direct foreign investment should complement and support the step-by-step and well balanced economic development of host countries, especially that of developing countries. This neglect cannot be condoned. Direct foreign investment should be of use to economic development of both the investing and host countries, promoting diversification and the upgrading of their industrial structure, aiming at mutual prosperity. In order to support this kind of foreign investment, another theory of direct foreign investment different from the dominant theory of ‘Americantype’ foreign investment is needed. It is this theory of the ‘Japanese-

12  Direct Foreign Investment

type or trade-oriented’ direct investment, based upon the principle of international division of labour, which I am trying to establish in this book. 2. International Trade versus Foreign Investment: A Theoretical Divergence In order to establish an appropriate economic policy for direct foreign investment and multinational corporation activities, we must have an adequate theory which is rigorously tested. I am convinced that this economic theory would eventually cast light upon, and help in finding answers to, the issues of direct foreign investment and multinational corporations. To my regret, conditions in foreign investment and MNCs have been changing so rapidly that reliable economic theory has not been able to keep pace, and an appropriate theory has not yet been fully developed. One issue which we consider central to the discussion is whether direct foreign investment complements trade, or substitutes for it. In other words, it is the question of what should be the role of direct foreign investment. We must examine the role of direct foreign investment and its relationships with trade, having in mind both investing and host countries. Another issue is the importance of the direct foreign investment to Japan. Is Japanese trade going to decrease relatively, to be replaced by foreign investment as in the case of the USA? Will Japan survive by depending upon the returns from investment abroad? Japan’s investment has already been criticised in Asia for its ‘over-presence’. In spite of that, is it possible for Japan to increase investment? If so, should she increase it? There is growing opinion that Japan should increase investment in such advanced countries as the US and Europe. Will investment in a country where the wage level is higher than in Japan be profitable? A controversial point in considering these problems is whether or not international trade and direct foreign investment each belong to a different theoretical framework. I think that an integrated theory of international trade and direct investment is missing, since each is separately treated. The following, are a few examples of disintegration of the theory of trade and investment or of inconsistencies between the two. First, such countries as the US consider direct foreign investment to be more important than trade. So they say their government should extensively support the activities of multinational corporations and the government and the multinationals maintain close ties. Thus the US government,

Issues of Direct Foreign Investment  13

for example, has urged Japan to liberalise the introduction of direct investment by foreign firms. In a more extreme example, it is well known that ITT caused trouble in Chile. This is one of the examples of putting great emphasis on direct foreign investment, so that direct investment policy takes precedence over trade policy. Secondly, the US labour unions, on the other hand, fear the continually increasing outflow of funds to foreign investment projects. Their protest derives from the fact that workers are not able to move freely between countries and, therefore, economic development and welfare have to be considered within the framework of a national economy and an international division of labour. Once investment and corporations are regarded without respect to national boundary, activity is undertaken wherever it can gain the greater profit. The more US investment flows abroad, the less the employment opportunity within the USA would be at fixed wage rates. This is why the labour unions object to direct foreign investment which eventually results in the ‘export of employment’, and I think it is very reasonable for them to be against it. Thirdly, the US urged liberalisation of capital inflow into Japan. On the other hand, the US has been intensifying her own protectionism to restrict imports, using balance of payments problems and increased unemployment as the justification. This argument is inconsistent. The reason for this contradiction is that a theoretical analysis dealing with trade and investment is lacking. Fourthly, when a certain country imposes tariffs on imports other countries attempt to get behind the tariff barriers through direct foreign investment rather than promote exports. Yet this only results in the shrinking of the scale of the home country operation, since without the barrier, the same goods would be exported. For these reasons, to overcome the tariff barriers is one of the biggest motivations to invest abroad. The most typical example was the investment rush by American enterprises to the EEC to get behind its common tariff wall. The US urged Japan to eliminate limitations on the inflow of direct investment and thus IBM invested in Japan. On the other hand, the US hoped to increase export of computers to Japan, and so requested that Japan abolish quota restrictions and tariffs on computers. This means that the US would like to increase direct investment as well as exports of the same products. These two requests are incompatible with each other. There is also the following contradiction: if Japan should eliminate tariffs, there would probably be no reason for the US to undertake direct investment to Japan. Nevertheless, many do not realise the seriousness of contradictions.

14  Direct Foreign Investment

This, too, we can attribute to a lack of an integrated theory of trade and investment. We consider the role of direct foreign investment as follows. A primary objective is to continue attempts to extend free trade all over the world. Free trade means that each country, on the premise that neither labour force nor capital is transferred internationally, promotes international divisions of labour along the line of comparative costs. That is to say, the principle of trade tells us how each country can develop in the international economy. Direct foreign investment should then complement the lack of capital or management skills of the host country. The cheap production which was not possible previously because of the lack of these elements is then possible. So, based on the new comparative costs, harmonious trade can grow. The role of direct investment, as it promotes the structural adjustment, is to establish this harmonious trade. In order to examine the role of direct investment in this scenario, we should first go back to the theory of international division of labour based on the principle of comparative costs and then use that theory to understand and analyse trade and investment comprehensively. Scholars of business administration have therefore been justifying and supporting multinational corporation activities from the point of view of the growth of an enterprise. The deficiencies of their view result from the complete disregard for policy implications inferred from international economics. The theory of international division of labour assures that while one country takes an advantage of specialised production and export of one commodity, it provides the opportunity for the partner country to produce and export another commodity for its own advantage, whatever difference in size, stage of development and tastes of demand may exist between the two economies. Therefore, the theory provides a sound basis for the interdependence and prosperity of trading countries. Thus, multinational corporation activities should also be reconsidered in the theory of international division of labour. Secondly, direct foreign investment is a prerequisite for expanding free trade, that is, to establish in the host country a new industry that produces at low cost. We should look at the relationship between direct foreign investment and comparative cost. Direct foreign investment that is released from a comparatively disadvantageous industry in the investing country and finds its way into the industry with overt or potential comparative advantage in the host country will harmoniously promote an upgrading of industrial structure on both sides and thus speed up the expansion of trade between the two countries. This is what I call ‘Japanese-type’ (in contrast to ‘American-type’) direct foreign

Issues of Direct Foreign Investment  15

investment. The detailed analysis of this ‘Japanese-type’ direct foreign investment is the core of this book. Thirdly, since a comparison of profit rates in the two countries is an appropriate yardstick in a foreign investment decision, I have tried to demonstrate that there is a one-to-one correspondence between comparative costs and comparative profit rates. As a precise explanation is needed to demonstrate the connection, I cannot summarise it here and the reader will have to wait until Chapter 5. Once the relationship is demonstrated, it is possible to find the right direction for international trade as well as for direct foreign investment, judging the situation either by comparative costs or comparative profit rates. 3. A Japanese Direct Foreign Investment Model What is the core of my analysis of ‘Japanese-type, trade-oriented’ direct foreign investment? The answer is simple. The comparative costs in Japan and the host country should be considered. Japan should undertake direct foreign investment in an industry becoming comparatively disadvantageous in Japan which at the same time has the potential of becoming comparatively advantageous in the host country. If an industry of the host country having potential comparative advantage, which has not been able to achieve its comparative advantage with cheap costs as it lacks technology, capital and management skill, were to become an industry of comparative advantage, it would develop as a new export industry in the host country. In response to this, Japan should enlarge another industry in which it has comparative advantage so that the capital and labour force of the industry which undertook direct investment abroad are transferred to this promising industry. This adjustment would upgrade the industrial structures of both Japan and the host country and could enlarge harmonious trade between them. Direct foreign investment of this type would create more complementary and more profitable trade than if no direct foreign investment took place, This is ‘Japanese-type, trade-oriented direct foreign investment’. Conversely, there is a tendency in some investing countries, as in the US, to invest abroad starting from the industry in which it has the largest comparative advantage (computers, for example). In this case, the consequence would be the reverse. I have named this kind of direct foreign investment ‘American-type, anti-trade-oriented’. In this case, where the country has the largest comparative advantage, the export of its product should be promoted. Direct foreign investment negates this export effort. ‘Japanese-type’ direct foreign investment, on the other

16  Direct Foreign Investment

hand, is complementary with trade. Consequently the two types of direct foreign investment will bring about very different results. Perhaps a few examples of ‘Japanese-type’ foreign investment will help the reader appreciate the differences between the two types presented above. The first example pertains to national resources. Japan possesses hardly any oil. It is said that there does exist a little oil on the Japan Sea coast, but to extract it would be prohibitively expensive. So Japan’s oil extraction is comparatively disadvantaged. On the other hand, Indonesian oil deposits are abundant, but they would not be an object of trade if left untouched. It is not until a country such as Japan or the US makes an investment that the extracting of oil becomes Indonesia’s comparatively advantageous industry. New trade is created. This tendency for Japan to invest in development and then import the products back to Japan is evident not only in oils, but also in other resources—fuel, agricultural raw materials and foods. Development followed by import is an investment to complement Japan’s comparative disadvantage and is a typical example of ‘Japanese-type’ direct foreign investment. The second one concerns labour-intensive manufactures such as textiles. As the economic growth in Japan accelerated, wages increased. This made it more costly to produce labour-intensive commodities. Therefore, since the wage rate in Korea, for instance, is one-third or even a quarter of that in Japan and labour efficiency is high, Japanese capital, superior technology and management skill entered Korea to create a textile industry, by establishing joint ventures. As Korea was originally abundant in cheap labour, it potentially possessed comparative advantage in the production of such labour-intensive manufactures. If there was no direct foreign investment, Korea could not have taken advantage of this potential comparative advantage. As a third example, there are cases that transfer a labour-intensive production process to a country where labour costs are less expensive. The most typical example can be seen in the assembly of cars and electric equipment and appliances. Only the assembly process is transferred to such countries as Korea and Taiwan. Furthermore, if the production of a certain part and component requires a highly labourintensive method, the process in question is undertaken in places where labour cost is saved. This is also a kind of ‘Japanese-type’ direct foreign investment, for it moves the production process with comparative disadvantage to a host country which has a comparative advantage in that process. ‘Japanese-type’ direct foreign investment plays the role of initiator

Issues of Direct Foreign Investment  17

and tutor in industrialisation of less developed countries. This should be the objective of direct foreign investment. To complement capital, technological and managerial knowledge, which are in short supply in the recipient economy, is a genuine function of direct foreign investment and a potent agent of economic transformation and development, not only in the more laggard developed countries but also in the developing countries of the world. The direct foreign investment, particularly in the case of labour-intensive manufacturing with simple technology, should play the role of ‘tutor’, teaching technology, management and marketing to local people, and encouraging the growth of local skilled labourers and managers, encouraging them to establish their own business. When the foreign firm successfully completes its job as tutor, it should be faded out. Then direct foreign investment must shift to more sophisticated intermediate goods. This is the logical result in the case of Japanese-type investment. According to the progress of industrialisation in neighbouring developing countries, Japanese direct foreign investment will step up to the second stage with the aim of establishing a network of intraindustry specialisation with those countries not only in consumer goods but also in intermediate goods production and machinery. In these more sophisticated industries, fading out should be considered much later. What would be the result if direct foreign investment, having transplanted industries one by one in the developing countries, faded out after completing its role as a tutor? After the fading out of direct investment, only free trade would remain and prosper, based upon production capability transplanted in every host country. The contribution of direct foreign investment would have been to enable each country to achieve its industrial potential, thus achieving an industrial structure in which an equilibrium is reached along the lines of comparative advantage. With all countries producing according to comparative advantages the stage is set for prosperous free trade among the nations. The resulting industrial structure will show horizontal division of labour within industries as industrial structures become more similar, and this tendency will generate still more potential for gains from trade. The future of the world economy or the economic outlook of AsianPacific region under ‘Japanese-type’ direct foreign investment is easily predicted. First of all, textile and other labour-intensive manufacturing industries would be transplanted from advanced countries to developing countries, resulting in a reorganisation of north-south trade. Next, the steel industry, other intermediate goods production, and then various

18  Direct Foreign Investment

machinery industries would establish a network of intra-industry specialisation between advanced and developing countries. If this were to succeed, a day would come when the national income per capita of the present developing countries became equal to that of the advanced countries. Thus the equalisation would be accomplished through trade, according to the principle of the international division of labour and ‘Japanese-type’ direct foreign investment. This kind of prospect for the future of the world economy is in contrast with, and much more desirable than, the result of pursuing ‘American-type’ investment. I have mentioned this in section 1. Therefore, we should be very careful in choosing either ‘Japanesetype’ or ‘American-type’ direct foreign investment and multinational corporation activity, for the difference between the two would definitely lead to very different prospects for the future of the world economy. In the US, those who are concerned are beginning to question whether the decline of US hegemony in the world economy is caused by overinvestment by the multinationals which prefer direct foreign investment to trade (export).10 Nevertheless, there is a strong argument in Japan that Japanese enterprises should adopt a world-wide strategy of ‘Americantype’ direct foreign investment in their recently developed oligopolistic products. Should Japanese firms be ‘too eager for growth’? They need not hurry at all. They should develop their own ‘Japanese-type’ direct foreign investment steadily and effectively. It cannot be said absolutely that the ‘American-type’ direct foreign investment is the right one to choose. 4. Scheme of the Book This book attempts to establish an integrated theory of international trade and foreign investment based upon the principle of international division of labour. In Chapter 2, the theory of international division of labour is introduced. The presentation uses two-commodities analysis and explores a principle of comparative (or relative) competition. Because of these characteristics of the theory, international division of labour can be the basis for international coexistence and mutual prosperity. Also, the Heckscher-Ohlin theory which considers factor proportions as determinants of comparative costs is introduced in some detail, because this theory is an essential tool for the theoretical analysis of the book. Chapter 3 surveys the development of the theories of direct foreign investment to date. There are two approaches to the activities of multinational corporations; one is the approach of those who are concerned with business administration and growth of a firm, and the

Issues of Direct Foreign Investment  19

other is that of economic theories, starting with MacDougall’s. Both are one-commodity analyses and are based on the principle of absolute competition. Thus, there is a great need to build a bridge between these approaches and the theory of international division of labour. Chapters 2 and 3 are, so to speak, preparatory exercises. My main observations will begin in Chapter 4, where ‘Japanese-type’ and ‘American-type’ direct foreign investment are discussed. The three chapters that follow Chapter 4 try to give theoretical foundation and reinforcement to the new approach, ‘Japanese-type’ direct foreign investment. The corresponding principles of comparative production costs and comparative profit rates are presented in Chapter 5. The propositions of Mundell and others of whether trade and investment are complementary or substitutive to each other are compared with analysis of ‘Japanese-type’ and ‘American-type’ direct foreign investments in Chapter 6. The question of whether the contrast between the ‘Japanese type’ and the ‘American type’ can also be found in technology transfer to developing countries is examined in Chapter 7. The last four chapters derive policy implications for direct foreign investment from the theoretical analyses in the preceding chapters. First, direct foreign investment in developing countries’ manufacturing industries, which has been severely criticised in recent years, is discussed in Chapter 8. People have often expressed a desire for more investment between advanced countries. Chapter 9 provides a warning against such investment. Then, a new policy for direct foreign investment concerning resource development and trade is examined (Chapter 10). Finally, merits and demerits of big multinationals are investigated and a code of conduct for them is suggested (Chapter 11). Notes 1. 2. 3. 4. 5. 6. 7.

Council for Industrial Structure, MITI, Japan’s Trade and Industry Policy for the 1970s (in Japanese) (Tokyo, May 1975). Sogo Kenkyu Kaihatsu Kikho and Nikko Research Center, Studies on Issues of Japan’s Direct Foreign Investments (in Japanese) (Tokyo, March 1976), pp. 75–6. Stephen Hymer, ‘United States Investment Abroad’ in Peter Drysdale (ed.), Direct Foreign Investment in Asia and the Pacific (Australian National University Press, Canberra, 1972), p. 29. Stephen Hymer, ‘The United States Multinational Corporations and Japanese Competition in the Pacific,’ a paper presented for Conferencia del Pacifica, Vina del Mar, Chile, 27 Sept.–3 Oct. 1970, p. 17. Ibid. Donald R.Sherk, Foreign Investment in Asia: Cooperation and Conflict between the United States and Japan (Federal Reserve Bank of San Francisco, October 1973). John E.Roemer, U.S.- Japanese Competition in International Markets: A Study of the

20  Direct Foreign Investment Trade-Investment Cycle in Modern Capitalism, Research Series, No. 21 (Institute of International Studies, University of California, Berkeley, 1975). 8. For example, Kioyoshi Yamazaki, Kokusai Kei-ei Nyumon (An Introduction to International Business Management) (in Japanese) (Nikkei, 1972). 9. See Robert Gilpin, U.S. Power and the Multinational Corporation, The Political Economy of Foreign Direct Investment (Basic Books, New York, 1975). 10. Ibid.

2

INTERNATIONAL DIVISION OF LABOUR: BASIC THEORIES FOR TRADE AND INVESTMENT

International trade in commodities is led by the international division of labour. Direct foreign investment contributes to a strengthening of this international division of labour and one of the basic aims of this book is to emphasise that both trade and investment should be carried out according to the same principle of comparative costs. This chapter therefore introduces the theory of international division of labour based on the principle of comparative costs. First it is shown that, following the principle of comparative costs, when one country takes an advantage of specialised production and export of one commodity, the partner country has an opportunity to produce and export another commodity for its own advantage, whatever difference in size, stage of development and tastes may exist between the two economies. Therefore, the principle provides a sound basis for coexistence, interdependence and co-prosperity between the countries (sections 1 and 2). Secondly, the principle of comparative costs à la David Ricardo has been further developed by the theory of factor proportions, or the Heckscher-Ohlin theorem so as to analyse issues on both the commodity level and factor-of-production level. The theorem is surveyed in detail in section 3 in order to give an understanding of the analytical tool used in the following parts of the book. Thirdly, the relationship of foreign investment to the international division of labour is briefly summarised in section 4, although this relationship will be developed in detail in the next chapter. 1. Characteristics of International Trade How and why does an international trade transaction differ from trade within a country? This question may be an appropriate starting-point for our discussion. In our highly civilised modern life, there are many economic transactions across national frontiers, by which we increase our standard of living. For example, Japan exports synthetic fibres and automobiles, 21

22  Direct Foreign Investment

while purchasing iron-ore, petroleum and computers from abroad. Tourism is also a transaction crossing national frontiers. International movements of capital are another important aspect. These international transactions can be classified into two classes. First are the transactions of commodities and services (services to tourists, and such services as shipping, warehousing, insurance, banking and so forth). Second is the movement of factors of production, namely labour and capital. Though land is also a productive factor, it is excluded because of its immobility. Both types of transactions are studied in international economics. The existence of ‘national frontiers’ makes international transactions different from domestic transactions. Then, what is a ‘national economy’ which is enclosed by each national frontier? In classical economics it was assumed that factors of production—labour and capital, if not land—were mobile within a country but immobile between countries. Practically, it is a matter of degree in mobility, but theoretically it has important implications. First, it is assumed that free competition prevails within a national economy not only in production, consumption and exchange of commodities (and services) but also in markets for factors of production. ‘One price for one commodity (or service)’ is established for prices of commodities and those of factors of production (rate of wage, interest, profit and rent). Productive resources are allocated optimally and national welfare is maximised. Thus the national economy has its own system of prices and values, under domestic free competition, which differs from other national economies. Secondly, each national economy has different endowments due to the size and the development stage of the community as an entity. Communications and the transportation network, gas, electricity and other public utilities are one aspect. Various business laws, the tax system, education, social insurance, the land system and labour unions are other aspects. More importantly, each nation has its own national currency, and the government can exert its own monetary and fiscal policy, industry policy, foreign trade policy, and foreign exchange rate policy. Thus, the national economy, especially in its external affairs, has a national policy organ besides individual business operators and consumers. Now it should be noted that, because of the reasons set out in the above two paragraphs, competition in international trade is subject to differences in wages, technologies, capital equipment and national policies between countries. In other words, international trade operates among nations under different conditions of factor markets. Thus direct

International Division of Labour: Basic Theories for Trade and Investment  23

foreign investment is required in order to make factor markets more competitive internationally and to improve production processes in the country which is less well endowed with the given resource. Consider the difference between individual transactions and the aggregate balance of trade. Individual exporting and importing transactions are undertaken in a manner similar to domestic trade under a given general price level and employment of the two countries and with a given exchange rate between them. That is, with a given exchange rate, domestic and foreign prices of a commodity are directly compared and suppliers sell goods in whichever—foreign or domestic—market they can sell at a higher price, while purchasers buy goods from whichever they can buy at a lower price. This is the principle of absolute competition that dominates individual transactions in international trade, and in domestic markets as well. The aggregated sum of individual transactions under the given exchange rate may not necessarily bring about an equal value between exports and imports. Then, an overall national economic policy, such as changes in exchange rate or in the general price level and aggregate demand, is used to attain equilibrium in the balance of trade. Individual transactions are affected by the overall measures and adjustments in the balance of trade. Since the system is backed up by this kind of overall adjustment, individual international trade transactions assure not absolute but comparative competition. Although the concept of ‘comparative’ is complicated and not easy to understand, it means here that the comparative competition provides every nation with the opportunity not only to import but also to export, bringing about the balance of trade. It seems to me, as I will explain further in the following section, that ‘comparative’ is the key concept in the theory of international trade which assures coexistence and co-prosperity of nations. 2. The Principle of Comparative Costs A question arises: will a country always be able to export some commodity in exchange for the import of another commodity even if the two countries are of different size, stage of development and tastes? A positive answer is provided by the principle of comparative costs (or comparative advantages). Ricardian Illustration

David Ricardo, a pioneer of the doctrine, used the following figures1 based on the labour (cost) theory of value:

24  Direct Foreign Investment

Here it is assumed that Portugal can produce both goods with a smaller expenditure of labour (cost) than England. It appears that Portugal can export to England both goods if one Portuguese labour-unit gets the same rewards as for one English labour-unit. Further, if immigration were allowed, all the English labour moved to Portugal in order to produce both goods at cheaper costs, leaving England vacant. These are the interpretations of Ricardo’s figures from the viewpoint of absolute advantage or absolute competitiveness, which is not effective in supporting the international division of labour. Ricardo’s figures can be interpreted differently in terms of comparative advantage (or comparative competitiveness). Portuguese superiority in production over England is greater in wine than in cloth: Portugal has a comparative advantage in the production of wine, for her cost-difference is relatively greater than in the case of cloth since is less than Alternatively, we may compare the ratio of the costs of production of the goods in Portugal with the ratio of the costs of two goods in England the former being less than the latter. That is to say, Portugal has a comparative advantage over England in wine relative to cloth. Conversely, the disadvantage of England is greater in wine than in cloth. Let us suppose that the terms of trade (that is, the quantitative exchange ratio of the two goods or, consequently, the reverse ratio of prices of the two goods) is established at 1 unit of wine in exchange for 1 unit of cloth. It is clearly advantageous to Portugal to export wine to England and to import cloth with the terms of trade 1:1, for in domestic exchange a unit of wine commanded only 80/90=0.9 units of cloth. Similarly, for every 100 labour-units which England sends to Portugal, embodied in the export of cloth, she receives 1 unit of wine which, in the absence of international division of labour, would have cost her 120 labour-units to produce for herself. The consequence is that each country specialises in that line of production in which it enjoys a comparative advantage, thereby obtaining a greater total product from its given factors of production (or obtaining the same total product with smaller factors of production). It should be remembered, however, that this trade does not ensure the provision of the equal rewards to labour-unit in both countries: instead, it results in the

International Division of Labour: Basic Theories for Trade and Investment  25

exchange of Portuguese 80 labour-units in wine for English 100 labourunits in cloth. Comparative Costs Formula

Since the labour (cost) theory of value is defective and unrealistic, let us reformulate the principle of comparative costs by using a money cost of production brought about from minimum cost combination of various factor inputs (say, labour, capital and land). Assume that comparative money costs in the two countries, I and II, before international division of labour and trade takes place, are as shown in Table 2.1. It should be mentioned that, using specific units, such as ton, yard and pound, to measure each commodity, a unit of each commodity is defined as the amount which can be produced at $1 in country II, and then the costs are expressed in the currency unit of each country. Now the cost ratio of the two commodities in country I (we denote this by a1/b1) is 1:4, and the cost ratio in country II (a2/b2) is 1/1 by definition. Subsequently, the ratio of the two cost ratios, that is, comparative costs, is as follows: a1/b1:a2/b2 is 1/4Ch′, it is not viable for the Japanese firm to invest in America and that since Japan has been exporting the product to America, she has comparative advantage in producing it and consequently Ch