Globalization and Challenges Facing Japanese Firms: Promoting profit repatriation from abroad

KIYOTA Kozo
Research Associate, RIETI

The expansion of foreign direct investment (FDI) by Japanese firms has reached a historically high level. According to the International Investment Position released by the Ministry of Finance in May 2015, the net stock of Japan's FDI was 143 trillion yen, as of the end of 2014, which is 20% higher than that in 2013 and 3.7 times more than that in 2005 (39 trillion yen).

Japanese domestic demand has grown stagnant, partly due to the aging society. It thus is natural for Japanese firms to go abroad to seek business opportunities. At the same time, the general public is concerned about the expansion of foreign activities by Japanese firms. In this article, I focus on the FDI by Japanese firms and discuss the current situation and its policy implications.

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With the expansion of Japanese FDI, one of the major concerns for the general public may be the hollowing out of Japanese industries. When firms shift their production activities abroad, there is a possibility of closing their plants in Japan, which could lead to diesemployment. However, the previous studies did not find significant differences in the decline of domestic employment between firms with FDI and those without it.

It is true that domestic plants are consolidated or closed with FDI. However, at the same time, workers are reallocated from production to other activities within a firm through business restructuring. Moreover, the expansion of FDI could increase exports, which, in turn, also helps the firms maintain their domestic employment.

In spite of the limited impacts of FDI on employment, there are some concerns. A study by Kneller, McGowan, Inui, and Matsuura (2012) pointed out that, with the expansion of FDI, productive plants could be shut down, which leads to lower productivity of the Japanese manufacturing sector as a whole.

Why are productive plants shut down? One may argue that less productive plants, rather than the productive ones, are the first to be shut down in order to increase the profits of firms and to improve the productivity of the manufacturing sector as a whole.

To understand the fact, as a thought experiment, let us consider two firms (A and B) each with two plants, as shown in the Table. The figures in the Table show the productivity of each plant. The greater the figure is, the more efficient it is.

Table: Relationship between Domestic Factory Closure and Productivity
Firm A's FDI
Before After
Firm A Productivity of Factory 1 30 30
Productivity of Factory 2 24 Closure
Firm A's average productivity 27 30
Firm B Productivity of Factory 3 18 18
Productivity of Factory 4 12 12
Firm B's average productivity 15 15
All factories' average productivity 21
(=84/4)
20
(=60/3)
(Note) Assuming that all of the factories are in the same scale

Now let's suppose that firm A has shifted the activities of factory 2, which is the less productive of the two, to a foreign country. Closing factory 2 improves the productivity of firm A from 27 to 30. In contrast, the productivity of firm B remains the same at 15. However, surprisingly, the average productivity of all of the plants declined from 21 to 20.

Although factory 2 was the least productive among the plants owned by firm A, it was the second most productive among all of the plants. In other words, firm A's best choice was not necessarily the best choice as a whole.

On average, firms that conduct FDI are more productive than those which do not. Even if less productive plants among such firms are closed, those plants are relatively productive at the nationwide level, thus, bringing down overall productivity.

Preventing productivity slowdown depends upon whether the productivity of plants remaining in Japan grows or not. In the case shown in the Table, if the productivity of factory 1, which is owned by firm A that conducted FDI, increases by three points, overall productivity will remain unchanged.

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In spite of these concerns, the expansion of Japanese FDI could bring positive effects on the overall economy because those successful Japanese firms have earned substantial profits from abroad, which could not have been happened if the firms had stayed in the domestic market.

According to the White Paper on International Economy and Trade 2015, the ordinary profits of Japanese overseas subsidiaries were as high as 7.6 trillion yen, which accounts for 32% of the ordinary profits of firms in Japan (24.1 trillion yen). Furthermore, retained earnings accumulated in Japanese overseas subsidiaries have reached 28.7 trillion yen. Even if Japanese firms expand FDI, as long as the profits of overseas subsidiaries are repatriated to Japan, it will have positive effects for the economy as a whole.

However, if the profits obtained by the overseas subsidiaries are not sufficiently repatriated to Japan, Japanese FDI will have limited effects on the Japanese economy. Therefore, a policy challenge will be how the large stock of retained earnings by overseas subsidiaries can be repatriated to Japan.

Against this backdrop, the Japanese government revised its taxation system in 2009 to stimulate dividend repatriations from Japanese-owned foreign subsidiaries. Hasegawa and Kiyota (2015) confirmed that the changes in the tax system had some positive effects on the profit repatriations. The study also found that it would be an effective way to stimulate dividend repatriation than lowering withholding tax rates through the revision of existing tax treaties or concluding new tax treaties to lower withholding tax rates on dividends.

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Finally, let us discuss about the possible effects of the Trans-Pacific Partnership (TPP) on Japanese FDI. Would signing the TPP trade pact further accelerate the FDI by Japanese firms? Or would it direct their investment back to Japan? The answer to these questions is "not so sure" for now, as the TPP has both promoting and curbing effects on FDI.

On the one hand, the removal of the restrictions on the entry of foreign firms among TPP member countries will accelerate FDI by Japanese firms. On the other hand, FDI for the purpose of averting tariffs will decrease as the elimination of tariffs could make exports easier. Immediately after the Great East Japan Earthquake, delayed response to free trade agreements (FTAs) was listed as one of the "six handicaps" for firms which were located in Japan. If firms consider tariffs imposed by host countries as a burden, they will scale back FDI once tariffs were lowered with the conclusion of the TPP because exports will be easier.

Questions still remain as to what extent an FTA is actually utilized by firms. For example, Hayakawa, Hiratsuka, Shiino, and Sukegawa (2013) revealed that FTAs were actually utilized by just 1/3 of all of the firms involved in trade between Japan and the Association of Southeast Asian Nations (ASEAN) member countries. They pointed out the procedural burden for firms, including obtaining a certificate of origin, as one of the reasons.

Even if the TPP is concluded, unless it is actually utilized by firms, investment, which is supposed to direct to domestic market under natural circumstances, would go abroad.

As mentioned above, the TPP has the effects of both promoting and curbing FDI. Which effects work greater depends on individual firms, and it is not possible to predict which will appear more prominently for the economy as a whole. For these reasons, it is unclear whether or not Japanese FDI will be further accelerated.

Japanese firms will continue to increase their FDI in order to accept foreign demand. In order to maximize the benefits from FDI and FTAs, it is hoped that Japanese government will design policies that accelerate the profit repatriations from Japanese overseas subsidiaries and productivity growth. Even if FTAs including the TPP are concluded, sufficiently positive effects cannot be expected unless they are utilized. Improving a business environment whereby firms could make maximum use of FTAs is another key policy challenge.

>> Original text in Japanese

* Translated by RIETI.

December 30, 2015 Nihon Keizai Shimbun

Reference(s)
  • Hasegawa, Makoto and Kozo Kiyota (2015), "The Effect of Moving to a Territorial Tax System on Profit Repatriations: Evidence from Japan" Keio-IES Discussion Paper Series 2015-008, Keio University.
  • Hayakawa, Kazunobu, Daisuke Hiratsuka, Kohei Shiino, and Seiya Sukegawa (2013), "Who Uses Free Trade Agreements" Asian Economic Journal, 27: 245-264.
  • Kneller, Richard, Danny McGowan, Tomohiko Inui, and Toshiyuki Matsuura (2012) "Globalisation, Multinationals and Productivity in Japan's Lost Decade," Journal of the Japanese and International Economies, 26: 110-128.

February 22, 2016