China in Transition
Shift of the Automobile Industry to China and Japan's Hollowing-Out Problem
Chi Hung KWAN
Consulting Fellow, RIETI
(Published in the August 9, 2011 edition of the Allatanys Newspaper Guide)
According to its medium-term plan for Chinese business announced on July 26, Nissan Motor will invest a total of 50 billion yuan (approximately 610 billion yen) in China over the next five years, from 2011 to 2015, and raise the target for local production for local sales by approximately one million units from the 2011 level to more than 2.3 million units in 2015 (morning editions of the Nihon Keizai Shimbun, the Asahi Shimbun, and the Yomiuri Shimbun on July 27, 2011). Toyota Motor also plans to produce strategic compact cars costing less than one million yen for emerging nations by investing 40 billion yen in China (page 9 of the Nihon Keizai Shimbun on July 29, 2011). Although the strategy of Japanese automakers to penetrate the fast-growing Chinese market can be appreciated, the fact that even the automobile industry, Japan's key industry, is shifting its production base to China could further accelerate the hollowing out of industry. Taking advantage of the vigor of the Chinese economy while avoiding the hollowing out of industry will be a major challenge for the Japanese economy that seeks to recover from the long-term downturn into which it has fallen.
Good direct investment vs. bad direct investment
In recent years, the expansion of foreign direct investment (FDI) by Japanese companies has been considered one cause of the hollowing out of domestic industry, and investment in China, in particular, has borne much of the blame. Essentially, if the market economy functions well, the overseas advancement of companies should facilitate the efficient allocation of resources. And yet, if hollowing out occurs, its cause can be attributed to market interventions by a trading partner, such as the building of trade barriers, as well as in the high cost structure in Japan due to excessive regulations.
Japanese FDI can be divided into two main types: one that emphasizes production costs and exports and another that aims to avoid trade barriers or friction with trading partners. The latter is more likely to result in the hollowing out of industry than the former. Direct investment that focuses on production costs and exports is intended to strengthen export competitiveness by reducing production costs via the acquisition of more advantageous production factors overseas. For example, many Japanese companies establish production bases in China in search of cheap labor and export their products to Japan and third countries, rather than selling them locally. This type of FDI improves the efficiency of resource allocation, and it is a win-win game for both the investing country and the recipient country.
On the other hand, direct investment that aims to avoid trade barriers or friction is conducted in a situation where there is no other option but to manufacture products locally, because exports from Japan are hindered by the import restrictions of the trading partner. This type of FDI distorts the allocation of resources, as the resulting division of labor works against the comparative advantages of both the investing country and the recipient country. While FDI that emphasizes production costs and exports is a good direct investment that encourages the efficient allocation of resources, FDI that aims to avoid trade barriers or friction is a bad direct investment that can result in lower efficiency and, in turn, the hollowing out of industry.
Advancement of automakers into China as a bad direct investment
The advancement of Japanese automakers into China is a typical example of FDI that aims to avoid trade barriers or friction. Both auto production and auto sales in China reached more than 18 million units in 2010, each exceeding the sum of the numbers in the United States and Japan. Although the automobile market in China is expected to grow further in the future, Japanese automakers should have the choice of producing cars in Japan and exporting them to China, rather than engaging in local production, to access the market. However, the tariff rate on automobiles in China, at 25%, is still high, although it was lowered after China became a member of the World Trade Organization (WTO) in 2001. To overcome the barrier of the high tariff, Japanese automakers are forced to undertake local production, although they are capable of producing high quality automobiles at low cost in Japan. As a result, high-value-added jobs which would have been created if automobiles were manufactured in Japan and exported to China have been lost, resulting in a hollowing out of the domestic industry.
Unfortunately, such a perspective is entirely absent in discussions on the hollowing out in Japan. Rather, if Japan closes down old factories in an industry that no longer has a comparative advantage and shifts them to China, this will result in major write-ups in the media as a serious hollowing-out problem because factory employees are being laid off. In contrast, there is virtually no objection when companies in sectors where Japan still has a competitive edge, such as automobiles, opt to establish factories in China, because it is perceived as being the result of efforts to open up a new market. Such a mistaken perception of the nature of direct investment not only results in the protection of domestic industries that are on the decline through import restrictions, but also delays the advancement of industry as a whole.
Free trade agreement with China as a countermeasure against hollowing out
Japan needs to promote good direct investments to facilitate industrial upgrading without hollowing out and, at the same time, stem bad direct investments. To that end, a free trade environment is essential. If a free trade agreement (FTA) is entered into between Japan and China, the foundation for using the advantages of both countries will be established without being hampered by tariffs. If Japan is able to export the products it manufactures in Japan to China freely by concluding an FTA with China, the key industries of Japan, such as the automobile industry, will no longer need to invest heavily in China and bear the associated risks. Consequently, numerous employment opportunities, particularly for good jobs with high wages, will be created in areas in which Japan excels. This will prevent the hollowing out of industry from occurring.
In addition, some estimate that the effect of creating trade and, in turn, boosting GDP will be greater for Japan upon concluding an FTA with China than upon entering into one with the United States, reflecting the following facts: 1) China has become Japan's largest trading partner, replacing the United States, 2) the trade structure between Japan and China is more complementary than that between Japan and the United States, and 3) there is greater scope to reduce tariffs in China than in the United States, as the import duties of China are higher than those of the United States ("Now is the time to open up the country (1) Becoming a trading nation will be a drive toward reconstruction," page 5 of the Nihon Keizai Shimbun on July 28, 2011). Thus, an FTA between Japan and China is also an effective growth strategy for Japan, which goes beyond a simple countermeasure against hollowing out.
- Related article
- "Local Production and Local Sales" is not the Only "China Business Model" posted in China in Transition on July 25, 2003
August 10, 2011
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