Priorities for the Japanese Economy in 2021 (January 2021): Using the COVID-19 Crisis as a Chance to Revive the Japanese Economy

Is Japan the least attractive country?

Research Associate, RIETI

A surprising result

A college student communicating with her friends via LINE while commuting to school; a businessperson looking at an iPhone at Starbucks; a couple looking for a wedding ring at Tiffany; a mom shopping at SEIYU... Even though we have less occasions to go out these days due to the spread of the new coronavirus, these are scenes that we have seen before. What they have in common is that all these service providers are foreign-owned firms. Indeed, it is now common to see the services provided by foreign-owned firms in daily life.

According to the United Nations Conference on Trade and Development (UNCTAD), in 2019, the stock of inward foreign direct investment (FDI) relative to GDP in Japan was 4.4%, the lowest among 201 countries in the world ranking (UNCTAD, 2020). Inward FDI stock means the stock of the investment by foreign-owned firms. This lowest ratio means that the presence of foreign-owned firms in Japan is the lowest in the world. This suggests that Japan is the most closed and/or the least attractive country in the world for foreign-owned firms, controlling for the size of the economy. Of course, a higher ratio does not necessarily mean a better economy. Also, it can be said that Japanese firms are able to provide sufficient volume and quality of products and services and reasonable prices. Nevertheless, the lowest rank sounds unusual for an advanced country like Japan. Note that the 200th place is North Korea. This is a surprising result (Note 1).

"Mystery Factor"

Inward FDI has many benefits such as the expansion of employment, the transfer of new technology and know-how, and the introduction of new products and services. Although increasing inward FDI leads to concerns such as intensifying competition, it is generally considered that the benefits outweigh the costs. Therefore, countries usually attempt to attract FDI. Japan is no exception. The expansion of inward FDI in Japan was regarded as one of the most important policy issues in the previous administration and continues to be so in the current administration. Accordingly, various efforts have been made, such as deregulation, reductions to corporate tax, and so on. Inward FDI in Japan has almost doubled from 17.8 trillion yen at the end of 2012 to 33.9 trillion yen at the end of 2019. Such efforts themselves should be appreciated, but Japan still records the lowest success rate.

Why is inward FDI in Japan so small? Despite that numerous studies have been conducted to answer this question, the reason has yet to be identified. The low level of inward FDI in Japan cannot be explained by the size of the economy, income level, geographical factors, language differences, or historical relationships between countries. There should be some Japan-specific factors, but the previous studies could not pin them down explicitly. The factors remain unknown, or what we will refer to as "Mystery Factor."

However, there are some possible explanations. For example, Hoshi and Kiyota (2019) found that countries with higher rank in "starting a business" in the World Bank Doing Business publication tend to attract FDI. Japan's "starting a business" score is ranked below average globally. Currently, the Japanese government is working to simplify the procedures for establishing a firm. In February 2021, all procedures for establishing a firm can be done online and at one-stop consultation counters. If such systems actually work and their benefits are recognized by foreign firms, we expect that inward FDI in Japan will increase. Moreover, Jayet and Marchal (2016) confirmed a positive correlation between the international movement of skilled labor and that of capital. If Japan can attract high-skilled foreign professionals, inward FDI may also increase. Of course, other countries are also hard at work attempting to attract FDI. It is thus unlikely that inward FDI in Japan will increase explosively with these efforts alone. Still, it is an important step towards increasing the attractiveness of investment in Japan.

The post corona world

Global FDI is expected to decline by more than 30% year-on-year in the second half of 2020 (OECD, 2020). However, once the pandemic of the new coronavirus subsides, global FDI will also resurge. Because Japan faces an aging and declining population, it will be essential to utilize the foreign supply and demand to maintain her economic growth. Creating an attractive environment for foreign-owned firms will be an important aspect when considering future growth of the Japanese economy. In terms of policy, it will be important to steadily advance current efforts while deepening the cooperation between the central government and local governments in anticipation of the post-corona era. It is also essential to make these efforts widely known to the world. If Japan hopes to become a major global financial center, we need to set an ambitious target. In the meantime, it is a major issue for researchers to discover the "Mystery Factor" so that we can present a policy prescription for expanding inward FDI in Japan.

There may still be excellent technologies and services that Japanese businesses and customers do not know about out there in the world. If they enter Japan through inward FDI, we will have a better life. Prior to the spread of the new coronavirus infection, the number of foreign visitors demonstrated an upward trend. Although some problems arose due to this rapid increase, the foreign visitors helped the growth of the Japanese economy as a whole and helped convey the positive aspects of Japan to people around the world. In the post-corona era, I hope that we expand our focus not only to foreign visitors but also to foreign companies, which will create another source of attractiveness for Japan.

December 24, 2020
  1. ^ According to the Japanese Cabinet Office, the ratio of inward FDI stock to GDP is 6.1% as of the end of the year 2019. Although this lifts Japan out of the bottom position, Japan still ranks near the bottom (198th of 201 countries).
  • Cabinet Office Foreign Direct Investment Promotion Office (2020a) "Current Status of Foreign Direct Investment in Japan and Future Procedures," October 26, 2nd year of Reiwa, Materials for the 1st Meeting of the Working Group on Medium- to Long-Term Strategies for Promotion of Foreign Direct Investment in Japan (Document 3).
  • Hoshi, Takeo and Kozo Kiyota (2019) "Potential for Inward Foreign Direct Investment in Japan," Journal of the Japanese and International Economies, 52: 32-52.
  • Jayet, Hubert and Lea Marcel (2016) "Migration and FDI: Reconciling the Standard Trade Theory with Empirical Evidence," Economic Modeling, 59: 46-66.
  • Organization for Economic Co-operation and Development (OECD) (2020) "Foreign Direct Investment Flows in the Time of COVID-19," OECD Policy Responses to Coronavirus (COVID-19), OECD: Paris.
  • United Nations Conference on Trade and Development (UNCTAD) (2020) UNCTAD Stat, Geneva: UNCTAD.
  • World Bank (2020) Doing Business Data, Washington, D.C.: World Bank.

January 18, 2021

Article(s) by this author