RESTRICTED
WORLD TRADE WT/WGTI/W/11
3November 1997
ORGANIZATION(97-4801)
Original: English Working Group ontheRelationship
between Trade andInvestment
COMMUNICATION FROM JAPAN
Thefollowing communication, dated 6October 1997, wasreceived fromthePermanent Mission
ofJapan withtherequest thatitbecirculated toMembers.
_______________
I. INTRODUCTION
Inthelastfewdecades, trade liberalization hassteadily progressed under theWTO/GATT
system. Ontheother hand, although thegrowth rateofforeign direct investment (FDI) hasgreatly
outpaced thatoftrade1,acomprehensive multilateral legalframework forinvestment hasyettobe
established.
Asnoted below, mostoftheresearch carried outsofarconcludes thatthere isanextremely
strong andsystematic relationship between trade andinvestment.2Moreover, amidst theongoing
globalization ofeconomic activity, theimportance ofFDIinvitalizing theworld economy islikely
tofurther increase inthefuture. Under suchcircumstances, inorder torealize theefficient resource
allocation across borders (asnoted inthepreamble oftheMarrakesh Agreement), itisessential for
theWTO topayclose attention, notonlytotrade, butalsotoinvestment. Thus, thisWorking Group
should playasignificant rolebyusing thepastresults oftrade liberalization tothoroughly analyse the
relationship between trade andinvestment andtoexamine thepossibility ofestablishing amultilateral
framework fortrade andinvestment.
Inorder tocontribute totheefforts oftheWorking Group tobuildabasisforfruitful discussions
inthefuture, thispaper, mainly fromtheempirical standpoint, examines issues raised intheagenda,
i.e.,(1)therelationship between trade andinvestment, and(2)therelationship between investment
anddevelopment. Thus, toavoid anyduplication ofexisting work carried outbytheUNCTAD, the
OECDorotherinternationalorganizations,includingtheWTOSecretariat,thispapermainlyconcentrates
onJapanese data.
1During 1973-1995, theamount oftrade grew 8.5times andtheamount ofFDIgrew 12times.
2UNCTAD estimates thatonethird ofworld trade takes place within multinational corporations (MNCs).
Moreover, trade between MNCs andnon-affiliates occupies another thirdofworld trade, cf.theSecretariat note
fordetails.WT/WGTI/W/11
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II. THE RELATIONSHIP BETWEEN TRADE AND INVESTMENT
TheSecretariat note, which concisely overviews pasttheoretical andempirical research, is
extremely helpful inbuilding thebasisforourfuture discussion. Asdescribed inthenote,themajority
ofempirical research supports theideathatthereisastrong andsystematic relationship between trade
andinvestment. Asfortherelationship between FDIandthetradebalance ofhome andhostcountries,
although littleconsensus hasbeenreached indetermining whether FDIincreases ordecreases thetrade
surplus inhome and/or hostcountries, fewmembers denytheexistence ofasystematic relationship
between FDIandtrade balance.
Through providing Japan'sstatistics concerning therelationship between tradeandinvestment,
weshallattempt tosupplement pastempirical research conducted mainly byeconomists, andultimately,
attempt tohelptheMember countries oftheWTO toobtain abetter understanding ofthisrelationship.
A. Impact ofFDIonTrade
1. Effect ofinvestment onhome country trade
AsisportrayedinthesurveyoftheSecretariatnote,thepastempiricalresearchhasnotproduced
consistent results astowhether FDIhaspositive ornegative effects onahome country 'stradebalance.
InthecaseofJapan, according totheannual survey conducted bytheGovernment, wehave
beenabletoobtain rather more accurate figures oftheeffects ofJapanese firms'FDIonJapan'strade
flows. According tothissurvey, although theneteffect ofFDIontrade flows hasbeenconsistently
positive fromFY1991 toFY1995, themargin isdiminishing. More detailed figures show, inFY1995,
thattheexport inducement effect ofFDIwasUS$103.1 billion, approximately onefourth ofJapan's
totalexports. Additionally, theexport substitution effect wasUS$54.2 billion, imports fromoverseas
affiliates were US$46.8 billion (15percentofJapan'stotalimports) andthenetimport conversion
effect wasUS$1.1 billion. Consequently, calculations based ontheabove figures showthat,inFY1995,
thenettradefloweffect ofFDIamounts toUS$1.1 billion [which isequivalent to"export inducement
effect" less"export substitution effect" less"import fromoverseas affiliates" less"netimport conversion
effect"] (seeAppendix).
2. Effect ofinvestment onhostcountry trade
Asdescribed intheSecretariat note, atheoretical consensus onwhether theneteffect ofFDI
onahostcountry 'strade flowispositive ornegative hasnotyetbeenreached.3Theoverall trend
ofempirical research, however, suggests thatFDIhasapositive effect onthetrade flowofhost
countries.4
Byusing input-output tables, research hasbeencarried outtoexamine theeffects ofJapan's
FDIonhostcountries '/regions 'trade. According totheresearch, Japan'sFDIhasconsistently exerted
apositive influence ontrade flows inthesample regions (ASEAN andNIEs) andinonecountry
(i.e.China). Forexample, during FY1994, theimport substitution effect ofJapanese FDIonASEAN
3Itisworthwhile noting thatthesumofthenettrade balance ofahome country andahostcountry isnot
necessarily zero. Forexample, inthecasewhere exports from theforeign subsidiary drastically increase, since
theexport inducement effect willalsodrastically increase inboththehome andthehostcountries, theneteffect
oftheFDIonbothcountries islikely tobepositive.
4See,forexample,Hummel sD.I.,andR.M.Stern1994-"EvolvingPatternsofNorthAmericanMerchandise
Trade andForeign Direct Investment" -World Economy 17(1): 5-29 JanuaryWT/WGTI/W/11
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wasUS$30.3 billion, theexport inducement effect wasUS$19.9 billion, andtheimport inducement
effect wasUS$26.4 billion. Thus, theneteffect ofJapanese FDIonthetradeflowofASEAN inFY1994
wasestimated tobeUS$23.8 billion [which isequivalent to"import substitution effect" plus"export
inducementeffect"less"importinducementeffect"](seeAppendix).Inthisregard,ithasbeensuggested
that,intheinitial stage, FDIincreases imports. Research carried outbytheJapanese Government
supports thishypothesis.
B. Impact ofTrade Measures onInvestment
Asmentioned intheSecretariat note,pastresearch hasexplicitly demonstrated boththeoretically
andempirically thattrademeasures canseverely effect FDI. Forexample, hightariffratesandrampant
ADmeasures (non-tariff barriers) caninduce so-called "tariff-jumping FDI". Ontheother hand, it
hasbeenpointed outthattrade measures, suchasanti-circumvention measures, arelikely tohinder
efficient investment activities byprivate firms. Since trade measures clearly affect suchinvestment
activities byprivate firms, anabrupt and/or significant change oftrade policy byahostcountry can
cause severe damage onFDI(or,more specifically, foreign subsidiaries within thecountry). Thus,
inorder topromote FDI,itisbothnecessary torestrict trademeasures thatmight restrain theefficient
investment activities byprivate firms andtoenhance thepredictability ofthetrade policy ofthehost
country.
C. Summary (Implication fortheFuture Work oftheWorking Group)
Asoutlined above, empirical research anddatamore orlessdemonstrate theexistence ofa
symbiotic relationship between trade andinvestment. Furthermore, inrecent years, private firms are
making parallel choice between tradeandinvestment inorder toattain theultimate goal: tosellgoods
inthetargeted market.5
Thus, considering theabove evidence, there isenough rationale fortheWTO totreattrade
andinvestment inanintegrated manner.
III. DETERMINANTS OFTHE RELATIONSHIP BETWEEN TRADE AND INVESTMENT
(ANALYSIS OFCORPORATE BEHAVIOUR)6
Duetotherecent globalization oftheworld economy, when planning corporate strategies to
sellgoods inatargeted market, private firms choose simultaneously where toinvest and/or fromwhere
toexport, atthesametime.7Insuchabusiness environment, therefore, thedeterminants forinvestment
byprivate firms areclosely related tothedeterminants oftrade. Based onthisunderstanding, wewill
focus onthedeterminants forinvestment byprivate firms. Asabove, inorder toavoid unnecessary
duplication ofthose contained intheSecretariat note, dataaretaken mainly fromtheresearch survey
onJapanese corporate behaviour.
5UNCTAD 1996 -"World Investment Report 1996: Trade andInternational Policy Arrangements"
6Since thegeneral relationship between trade andinvestment hasbeen analysed intheabove survey, this
paper willexamine corporate behaviour formaking astrategic choice between trade andinvestment.
7SeeUNCTAD 1996WT/WGTI/W/11
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A. Determinants forInvestment
According totheresearch survey conducted bytheJapan External Trade Organization (JETRO),
of1,170 Japanese firms having invested inAsian countries, 51percentquoted "political andsocial
stability" asthemost important factor when making theirinvestment decisions. Thesecond factor
was"lowlabour cost" (44percent), andthethird"thefuture potential ofthedomestic market" (42per
cent). Inaddition, based ondatagathered through asurvey onJapanese companies, theJapanese
Government hasmade acomprehensive statistical analysis. According tothisanalysis, thedeterminants
ofinvestment thatseemed tobesignificant were a"nominal GDP oftheregion/country (positive)"
(aproxy forthemarket size), a"real wage (negative)", a"cumulative number ofexisting projects
(positive)" (aproxy forinfrastructure), and"safety (consistency ofgovernmental policy, national
economy, etc.)(positive)" (seeAppendix).
B. Barriers andProblems Affecting Corporate Activities inDeveloping Countries
According totheresearch survey conducted bytheJapanese Government, among theJapanese
firms thathaveinvested indeveloping countries, themain barriers orproblems faced inoperating
inthese countries arethe"rising labour cost" (54percent), a"lack oftransparency inapplication
oflawandregulations" (34percent), the"quality oflabour force" (29percent) andothers (see
Appendix).
C. Summary (Implication fortheFuture Work oftheWTO)
From theresearch survey described above, theprincipal determinants forprivate firms'
investment activities canbesorted intofourcategories: "labour-related factors (labour costetc.)",
"scale andfuture potential ofthedomestic market", "infrastructure conditions" and"predictability".
These findings areconsistent withtheresults ofpastempirical studies conducted bymanagerial
economists. Among these fourdeterminants, "predictability" canbesignificantly improved through
thecreation ofamultilateral legalframework. Infact,itseems thatoneofthemajor objectives of
establishing abilateral framework forinvestment istoenhance the"predictability" ofprivate firms.
Theongoing work within theOECD forestablishing theMultilateral Agreement onInvestment
(MAI) hasthepotential todrastically improve the"predictability" ofinvestment. Considering the
corporate behaviour apparent intheresearch survey above, iftheMAIisproperly formulated, those
countries having ratified theMAI arelikely togainanadvantage overother countries interms of
"predictability", which, inturn,willincrease theinflow ofFDI. Insuchcases, considering thefierce
competition among nations forinviting FDI,countries thatdonotratify theMAIarelikely tobeforced
tomake efforts toincrease "predictability".
IV. IMPACT OFINVESTMENT ONDEVELOPMENT AND GROWTH
A. Relationship between Investment andDevelopment andGrowth
According toeconomists 'research, there islittledoubt thatinvestment andeconomic growth
arehighly correlated.8Since sources forinvestment areeither domestic savings orcapital inflows
from abroad, especially forlow-income countries thatpermanently lacksufficient domestic savings,
FDIcanprovide anexcellent financial source foreconomic development. Infact,economists point
outthatastrong correlation exists between theamount ofFDIinvited andtheeconomic growth in
agiven country.
8Yujiro H.1996 -Development Economics -SobunsyaWT/WGTI/W/11
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Moreover, developing countries canreceive thetransfer ofvarious "positive externalities",
including technology andmanagerial expertise. Forexample, anempirical research shows that
technology transfer through thesubsidiaries ofmultinational corporations surpasses thatthrough other
routes.9
Ontheotherhand, previous experience tellsusthattheremight alsobeadownside ofinvestment
flows across borders (including FDI). Forexample, large amounts ofFDImight induce anexcessive
intervention offoreign subsidiaries inahostcountry 'spolitical economy. Also, asalready mentioned,
attheinitial stageofFDI,imports fromahostcountry arelikely toincrease andFDImight havenegative
effects onthetrade balance ofahostcountry. Even inthemid-andlongterm, there could besome
indication thatrepatriation ofprofits from foreign subsidiaries toahome country willhaveserious
effects onthebalance ofpayments (BOP) ofahostcountry.
Many scholars havealsoattempted toexamine therelationship between FDIandemployment.
There isawidely accepted viewthatFDIleads tothelossofwork forlow-skilled labour inahome
country. However, empirical research conducted byeconomists doesnotalways support suchaview.
Asforemployment inthehostcountry, theresults ofempirical research havenotyetreached awidely
shared consensus. Also, some adherents ofthedependency theory have claimed thatFDIallows
developed countries toexploit therelatively cheap labour force from developing countries, andthat
workers indeveloping countries aredeprived oftheopportunity toacquire advanced skills. However,
theeconomists 'empirical research shows thatFDIrather tends totransfer sophisticated technologies
andskills from developed countries todeveloping countries.
B. Summary (Implication fortheFuture Work oftheWorking Group)
While FDIandother forms ofinvestment flows generally havepositive effects ongrowth and
technological innovation, theymayproduce negative effects aswell. Thus, inorder toutilize FDI
asaforce toaccelerate thegrowth ofdeveloping countries, itisimportant forthisWorking Group
toexamine whatcanbedonebytheWTO andotherinternational organizations toavoid suchpotentially
negative effects from FDI(andpossibly, from other forms ofinvestment) ongrowth. Forexample,
since thescope oftheMAIoftheOECD includes portfolio investment, thecurrent consolidated text
oftheMAIcontains aBOPprovision, allowing thehostcountry totemporarily suspend therapid flow
ofcapital across borders. Inaddition, since there arepolitical economic concerns foractivities of
multinational firms within thehostcountry, thisWorking Group should examine whatcanbedone
toreduce suchconcerns, byalsotaking intoaccount thebenefit ofthehome country.
V. STOCKTAKING AND ANALYSIS OFEXISTING INTERNATIONAL INSTRUMENTS
AND ACTIVITIES REGARDING TRADE AND INVESTMENT
A. Increase oftheBilateral Investment Treaties (BITs)
Theexpansion ofFDIhasaccelerated theimportance ofinvestment ontheworld economy
andhasincreased itseconomic andsocial impacts onthehostcountries. Against thisbackground,
acommon framework needs tobeestablished topromote thepredictability ofenterprises andtofurther
increase FDI, thereby contributing totherealization ofastable andsustainable growth oftheworld
economy inthemedium andlongterm.
9Bloomstra M.,A.Kokko, andM.Zejan 1992 -"Host Country Competition andTechnology Transfer by
Multinationals" -NBER Working Paper No.4131WT/WGTI/W/11
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Atpresent there existapproximately 1,160 BITs, twothirds ofwhich wereconcluded inthe
1990s. Thisdemonstrates theincreased interest intheimpact ofFDIonahostcountry 'seconomy,
suchasthepromotion ofcompetition andtechnology transfer, andinthecreation ofastable environment
forinvestment.
Despite theirmerit ofbeing flexible innature, BITshavesome limitations. Forexample, they
tendtobefocused oninvestment protection, rather thanoninvestment promotion. Inaddition, BITs
areapplied onlytocountries 'concerns, fromwhich arises theproblem ofdifferences, notonlyintheir
geographical scope, butalsointheirsubstantive coverage, specific content, approach andlegalnature,
whenmakinginvestmentextensively.Furthermore,BITsimprovepredictabilityandincreaseinvestment
between thecountries involved, thereby influencing theoptimum allocation ofresources between them
andthecountries which lacksuchagreements. Unlike trade, investment tends towards thecountries
involvedandthusaccommodatesonlyspecificbi-polarizationforhomeandhostcountries(i.e.imbalances
intradeflows),whichmayundulyaffectdisputesettlementproceduresthroughthepoliticalandeconomic
relations ofthetwoparties.
B. TheImportance ofMultilateral Investment Framework
Since trade andinvestment proved tobecorrelated strongly witheachother, itisimportant
toconduct athorough examination oninvestment under theframework oftheWTO. Asrightly pointed
outintheSecretariat note,however, mostpertinent multilateral agreements, suchasthose intheWTO,
relate onlytosectorial ortospecific issues anddonotaddress investment inacomprehensive and
complete manner. Infact,astheglobalization oftheeconomy andtheinternationalization ofcorporate
activities progress, wehavewitnessed theemergence ofvarious issues:
- Oneexample istherestriction onFDIitself, including thecontrol overtheratioof
localfinancing andthevolume offoreign capital. Some countries andregions impose
oninvestors exchange restriction measures, suchasthecontrol ofafunds transfer and
aceiling ofroyalty ratio against sales. Other restrictive factors include local
employment requirements orlocal employment incentives, andthelackofsystems
toprotect investment, suchastheprotection ofpatent rights andtrademarks fromwhich
localfirms should benefit. Allofthesefactors make investors cautious toextend their
activities overseas. According tothequestionnaire, theJapanese machine industry
regards thefollowing factors asproblems formaking investment intheAsia-Pacific
region: namely, thetaxsystem (e.g.taxapplication, fairness), restriction against the
entry offoreign capital (e.g. restriction oflocal financing ratio), employment (e.g.
localemployment requirement), inefficient administrative measures, andtheprotection
ofintellectual property (e.g.lackofsystems toprotect patent rights andtrademarks)
(seeAppendix).
Other international fora,suchastheAPEC andtheOECD havealready launched discussions
forpossible instruments orframeworks inthefieldofinvestment. Toestablish aninternational rule
oninvestment would provide asolidfoundation tostably expand FDIthrough improved predictability.
Asdiscussed above, expansion ofinvestment, together withitsclosecorrelation withtrade, contributes
toeconomic growth anddevelopment ofbothhome andhostcountries. Furthermore, optimum resource
allocation among different regions anddifferent points oftimeisexpected topromote thegrowth of
theeconomy oftheworld asawhole, including thatofdeveloping countries. Inthisrespect, itis
important toexamine bothaspects ofinvestment facilitation through liberalization andinvestment
protection, taking intoaccount theinterests ofbothhome andhostcountries. Bearing these factors
inmind, thediscussions inthisWorking Group willleadustoa"win-win" solution.WT/WGTI/W/11
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APPENDIX
TABLE 1
Japan'sRecent Trend ofTotal Export/Import, Export Inducement, Export Substitution, Imports
from Foreign Affiliates, Import Conversion, andImpacts onTrade Balance
[Unit: US$billion]
FY1991 FY1992 FY1993 FY1994 FY1995
Total Export (a) 309.6 331.6 347.1 386.5 434.8
Total Import (b) 204.9 205.3 209.5 248.5 312.6
Export
Inducement (c)
(c/a)57.9
(18.7%)63.2
(19.0%)89.0
(25.6%)89.0
(23.0%)103.1
(23.7%)
Export
Substitution (d)25.2 27.6 40.5 45.0 54.2
Imports from
Foreign Affiliates (e)
(e/b)14.1
(6.9%)11.8
(5.8%)27.9
(13.3%)33.3
(13.4%)46.8
(15.0%)
Import
Conversion (f)2.2 2.4 1.8 2.0 1.1
NetImpacts on
Trade Balance
(c-(d+e+f))+16.3 +21.3 +18.9 +8.8 +1.1
Source: Export andImport: Bank ofJapan, Balance ofPayments
Others:MITI,The6thBasicSurveyofOverseasBusinessActivities(PreliminaryReport)WT/WGTI/W/11
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TABLE 2
Impacts ofJapanese Manufacturers 'Investment onHostCountries 'Trade
[Unit: US$billion]
1991 1992 1993 1994
ASEAN* +10.2 +13.5 +18.5 +23.8
Import
Substitution+13.7 +17.4 +19.2 +30.3
Export
Inducement+9.3 +8.7 +17.0 +19.9
Import
Inducement-12.7 -12.6 -17.8 -26.4
NIEs** +17.4 +19.9 +19.3 +25.4
Import
Substitution+17.6 +17.2 +20.1 +28.2
Export
Inducement+12.8 +13.5 +18.3 +22.3
Import
Inducement-13.0 -10.8 -19.0 -25.1
Source: Takugin Research Institute, Gaishi-kei Kigyo
Enkatsu-ka Chosa [Research onForeign Affiliates]
Note: *ASEAN =Indonesia, Malaysia, Philippines andThailand
**NIEs =Republic ofKorea, Singapore andChinese TaipeiWT/WGTI/W/11
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TABLE 3
Reasons forSelecting Investment SitebyJapanese Manufacturing Affiliates inAsia
1. Stable political/social climate 51.4%
2. Low-cost locallabour 44.8%
3. Future potential oflocalmarket 41.2%
Source: JETRO, Survey ofJapanese-Affiliated Manufacturers inAsia
TABLE 4
Estimate ofDeterminants ofJapanese Firms 'Foreign Investment (Conditional Logit Model)
Results ofEstimate
(Coefficients forEach Variable)
General
MachineryElectrical
MachineryAutomobile
RealGDP
Growth Rate0.0597 0.1104 0.0903
Nominal GDP 0.3228 0.2230 0.3913
RealWages -0.4661 -0.7159 -0.4341
Cumulative Number
ofExisting Projects0.4921 0.5609 0.6313
Safety 2.7978 3.3632 2.4724
Distance from Japan -0.0261 -0.2869 -0.0292
Source: MITI, White Paper onInternational Trade 1996
Note: Underlined coefficients aresignificant at1%level.WT/WGTI/W/11
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TABLE 5
Problems andBarriers toBusiness Activities intheDeveloping Countries
Rising personnel expenses 53.9%
Untransparent laws/regulations 34.4%
Quality ofworkforce 29.1%
Availability ofworkforce 29.1%
Complex taxsystem 26.2%
Complex localregulatory procedures 23.4%
Frequent changes ingovernment policy 23.0%
Restrictions onJapanese entering thecountry 19.5%
Source: MITI, White Paper onInternational Trade 1997
TABLE 6
Problems Concerning Investment inAsiaandOceania
Taxation 55points
Restrictions forforeign participation 42points
Employment 40points
Systems, practices, inefficient procedure 31points
Infringement ofintellectual property 28points
Source: Japan Machinery Exporters 'Association etc.,
Asianokeizai Hatten toBoueki Tousi noMondai-ten
[Economic Development inAsiaandProblems Concerning Trade and
Investment]