Discussion Paper No. 236
Is Japanese FDI a Substitute foror a Complement to Trade in Asia?
Jin Inhwan

August 2008, revised in October 2008

TOHOKU ECONOMICS RESEARCH GROUPGRADUATE SCHOOL OF ECONOMICS AND

MANAGEMENT TOHOKU UNIVERSITY

KAWAUCHI, AOBA-KU, SENDAI,
980-8576 JAPANIs Japanese FDI a Substitute for or a Complement to Tradein Asia?

Inhwan Jin†
Graduate School of Economics and Management, Tohoku University.

Abstract
This paper analyzes the effects of Japanese FDI on international trade in
manufacturing industries during the period 1989-2004. The panel regressions are
conducted for the net export of the six selected Asian countries at a sectoral level. The
econometric analysis reveals some FDI tends to simulate bilateral trade, while other FDI
has a tendency to reduce the volume of bilateral trade. The analysis also reveals that
FDI into non-manufacturing sectors and all other manufacturing sectors has spillover
effects on trade of manufactured goods in some countries and manufacturing industries.
The relationship between capital movement and bilateral trade is not one consistentpattern of substitutability or complementarity but differs across manufacturing sectors
and countries in Asia.

Keywords: FDI, bilateral trade, substitutability, complementarity, spillover effects
JEL Classification: F14, F21†

The Doctoral Program, Graduate School of Economics and Management, Tohoku University
The author thanks Hideo Sato for helpful and valuable comments on an earlier draft.
The author, of course, takes responsibility for any remaining errors.

1. Introduction
Growing international linkages through foreign direct investment (FDI) is one ofprominent features of contemporary globalization. During the past 10 years, world
foreign direct investment has more than tripled. Amidst a global boom in FDI, world
FDI, outward flows, amounted to US$ 877 billion, which is 2.1% of world GDP in 2004
(UNCTAD). Not only trade in products but also trade in capital performs a vital role inincreased economic integration. In contemporary world economy characterized by vast
flows of both capital and products across countries, it is important to understand therelationship between trade in goods and capital so as to obtain a complete picture ofinternational linkages.
The well-known trade theories of Ricardo and Hecksher-Ohlin explain how producttrade could arise among countries given that international labor and capital mobility
were absent. In the Ricardian theory, autarky relative prices are determined based ontechnology and a difference in technology between two countries is the basis for trade,
whereas in the Heckscher-Ohlin theory trade occurs because of international differencesin relative factor endowments (e.g., the number of units of capital for each unit of laborin the economy). Mundell (1957), in the context of the Heckscher-Ohlin-Samuelsonmodel, studied the substitutability between factor movements and trade. Relaxing thestandard H-O-S assumptions such as identical production functions, later theoreticalstudies show that capital movement and product trade are complements rather thansubstitutes (Schmitz and Helmberger 1970; Parvis 1972; Svensson 1984; Markusen
1983; Markusen and Svensson 1985). Markusen (1997, 2002) argued that whether
direct investment complements or substitutes for trade depends on the type of direct
investment. According to the study, if multinationals produce final goods in multiple
locations, direct investment tends to substitute for trade, whereas, if multinationals
geographically fragment production by stages, FDI tends to promote trade.
Most empirical researches of the relationship between FDI and trade employ data ona single home-country’s investment and exports into other countries using a gravity
specification. Many of the early empirical studies showed that FDI stimulated exports at
a country level or industry level (Swedenborg 1979; Lipsey and Weiss 1981, 1984;
Pfaffermayr 1996; Wei and Frankel 1997; Goldberg and Klein 1998; Clausing 2000).
However, Blomstrom et al. (1988) found negative coefficients on exports implying
some substitution of FDI for exports in some industries. Blederbos and Sleuwagen(1998) found evidence that direct investment subsitutes for exports in electronics firms.
Considering exports of intermediate goods to a host country from a home county,

1empirical evidence is somewhat mixed. Svensson (1996) found a positive relationshipbetween bilateral exports and FDI for finished goods but a negative effect forintermediate goods using data on Swedish multinationals. Head and Ries (2001) also
found complementarity between Japanese FDI and exports with substitutability arising
for Japanese manufacturing firms that do not export intermediate inputs to hostcountries. Amiti and Wakelin (2003) introduced investment liberalization as a
explanatory variable instead of direct investment. They found that investment
liberalization stimulates exports when countries differ in relative factor endowments andtrade cost low, while investment liberalization reduces exports when countries are
similar in relative factor endowment and size and trade costs are moderately high. Using
industry-level data for Japanese FDI, Kawai and Urata (1998) found a complementary
effect between export and FDI in some manufacturing industries with substitutability
between import and FDI in all manufacturing industries.
Many of empirical studies on FDI and trade have focused on whether FDI
complements or substitutes for home country’s exports of final goods and therefore, do
not point to exports of intermediates as a potential explanation for the frequent findingof complementarity. FDI is also very likely to affect home country’s import of final
goods as discussed in Markusen (1997, 2002), which is rarely discussed in most of
empirical studies. In addition, many of previous empirical studies could not capture thespillover effects of FDI in manufacturing industries. Therefore, empirical analysis byusing more disaggregated data is desirable to examine the effect of FDI on levels ofboth export and import. Goldberg and Klein (1999) provided the first empirical study ofthis relationship using detailed sectoral data on FDI and trade between the United Statesand eight Latin American countries. They incorporated the net exports in their analysis
as the independent variable to investigate the effects of direct investment flows onexports as well as imports.
This study is the first attempt to analyze the effects of Japanese FDI on trade of both
host and source countries at a sectoral level including spillover effects on trade in
manufacturing industries. This study investigates the relationship between Japanese FDI
and trade based on the framework of Goldberg and Klein (1999) with somemodifications during the period 1989-2004. In specific, this paper explores how direct
investment from Japan into specific manufacturing sectors as well as into othermanufacturing sectors and non-manufacturing sectors of six Asian countries (China,
India, Indonesia, Malaysia, the Philippines, Thailand) affects the net exports of those
sectors of their economy.

22. FDI and Trade Flows
GDP, FDI and Trade of World
Figure 1 shows growth rates of world FDI (outward) and GDP during the period
1989-2004. As shown in Figure 1, after the sharp slowdown in 2001, world economic
growth recovered gradually in 2002 and 2003. In 2004, world economic growth reached4.94%, the strongest growth rate since 1989. Similarly, world FDI edged up for three
consecutive years, 2002, 2003 and 2004 after the sharp slowdown in 2000 and 2001. In
2004, world FDI growth reached 57%, the second strongest growth rate since 1989.
World trade, similar to world GDP and world FDI, increased for three years from 2002
to 2004 in a row after the slowdown in 2001. In 2004, world trade growth reached 22%,the strongest growth rate since 1989.
[Figure 1]
Japanese FDI and Exports
Now, we examine Japanese FDI and exports and compare with those of US
representing one of the major sources of direct investment in the world. Figure 2
shows the total amount of Japanese and US FDI as well as US and Japanese exports
during 1989-2004. As shown in Figure 2, US export recovered gradually in 2003 and2004 after the slowdown for two consecutive years, 2001 and 2002. Japanese exports
increased for three consecutive years, 2002, 2003 and 2004 after the slowdown in 2001.
In 2004, both US and Japanese exports climbed up to $819 billion and $ 566 billion,
the largest amount since 1989, respectively. It is observed that both US and Japanese
exports show the upward trend overall during the period 1989-2004. Regarding foreign
direct investment, US FDI reached $209 billion in 1999 and gradually decreased to$129 billion in 2003. In 2004, US FDI increased again to $258 billion, the largest
amount since 1989. In 1989 and 1990, the amounts of Japanese FDI are greater than
US FDI. In 1990, Japanese FDI amounted to $ 48 billion greater than US FDI, $ 31
billion. Japanese FDI decreased to $14 billion in 1993 and increased again to $31
billion in 2004. It is also observed that Japanese FDI remains relatively stable, while
US FDI indicates upward trend overall during the period 1989-2004.
[Figure 2]

3

Japanese FDI by Region
In this subsection, we explore regional breakdowns of Japanese FDI. Figure 3 shows
annual amount of Japanese FDI to three major recipient regions (North America, Asia
and Europe). As shown in Figure 3, North America was the largest recipient region ofJapanese FDI until 1997. From 1998, Europe became the largest recipient region ofJapanese FDI. It is clarified that Japanese FDI to the three major recipient regions has
decreased overall during the period 1989-2004. In general, FDI flows to Asia accountfor 21% of Japanese FDI to the three major recipient regions. Specifically, the mainrecipient countries are China, Thailand and Korea, respectively accounting for
approximately 49%, 13% and 9% of the region’s inflows from Japan1 in 2004.
[Figure 3]
Net Export Position
For the purposes of this study, it is informative to explore the net export position ofeach manufacturing industry by country. Table 1 provides a general overview of the net
export position of the selected Asian countries at a sectoral level. As shown in Table 1,
Japan is the net importer in the sector of Food & Kindred Products. Regarding the fiveother sectors except for Other Manufacturing sectors, the selected Asian countries are
net importers. In the four countries besides Malaysia and the Philippines, Machinery
Except Electrical sector is the largest import sector, while Electric & Electronic
Equipment sector is the largest import sector in Malaysia and the Philippines.
[Table 1]
Sectoral Composition of Japanese FDI
For the purposes of this study, it is also informative to explore sectoral compositionof Japanese FDI. Table 2 indicates annual average of Japanese FDI to the selected
countries in Asia. As shown in Table 2, China has received the largest amount ofJapanese FDI. Electric & Electronic Equipment sector is the most important recipient ofJapanese FDI across the selected Asian countries. In India, Transportation Equipment
1

This study assumes that a host country is poorly endowed with capital. Thus, Korea is excluded fromthe study.

4sector is the most favored sector of Japanese FDI, while Chemical & Allied Products
sector is the most favored one in Indonesia among the manufacturing sectors during thesample period. In Malaysia, the Philippines and Thailand, Electric & Electronic
Equipment is the most important sector of capital investment from Japan among the
manufacturing sectors during the sample period. With respect to non-manufacturingsectors, China’s Service sector of is the largest recipient of Japanese FDI andIndonesia’s Finance sector is the second largest recipient of Japanese FDI across theselected Asian countries.
[Table 2]

3. Theoretical ModelIn this section, we develop a mathematical basic model based on the work of Goldberg
and Klein (1999) with a few modifications in order to explain the relationship between
product trade and capital movements. This model provides a context for our empiricalanalysis in which FDI to a particular sector affects the volume of exports and imports ofthat sector as well as other sectors.
Suppose we have one country producing two goods, A and B. The goods areproduced with capital, K which consists of domestic and foreign capital i.e. FDI, Kd andKf and the labor, L. Domestic capital is assumed to be completely sector specific and aperfect substitute for foreign capital. Unlike capital, labor shifts without any cost fromone sector to the other sector in response to an incipient wage differential. Foreign
direct investment is assumed to be exogenous and the quantity of product trade is
endogenously determined with the level of FDI. The greater the mobility of capital is,
the higher the volume of trade is for any given level of production efficiency. Capitaland labor used in the production of goods, A and B are denoted as KA, LA, KB, and LB
respectively. The production functions of goods, A and B can be expressed as         A: f(KA, LA)

B: g(KB, LB).           (1)where the partial derivatives with respect to labor, (fL, gL) and capital, (fK, gK) arepositive. The cross-partial derivatives with respect to labor and capital, (fLK, gLK), also arepositive. All of the second partial derivatives, (fLL, fKK, gLL, gKK), are negative.
With labor perfectly mobile across sectors and the labor market competitive, thewage paid to labor in the Sector A, w, is the same as the wage paid to labor in the Sector

5B. The first-order conditions for profit maximization require that firms in each sector
hire labor to the point where the product wage equals the marginal product of labor,        w/pA=fL

w/pB=gL                    (2)Totally differentiating each of these relationships and dividing through by themarginal product of labor, we can obtain as follows      (dw / w) – (dpA / pA) = (fLL / fL) dLA (fLK / fL) dKA         (3)(dw / w) – (dpB / pB) = (gLL / gL) dLB (gLK /gL) dkB
Full employment and a fixed amount of labor ensure       L = L A + LB

dLA  dLB                 (4)Solving out the sets of equations for the change in labor in each sector, we get

f g
dP
dP
g f
f g
   dLA = ( LK L Z )dK A୉( LK L Z )dK B + ( L L Z )[( A P )୉( B P )]
A

B



(5)

f g
f g
f g
dP
dP
dLB = ( L LK Z )dKB୉( LK L Z )dK A + ( L L Z )[( B P )୉( A P )]B

A

where Z = -(fLLgL + gLLfL)>0.
These equations imply that capital increase in one sector such as foreign direct
investment to that sector (dK  >0) pulls labor into that sector reducing the labor
employment in the other sector. It suggests that the marginal products of labor and thedegree of complementarities between labor and capital in production determine themagnitudes of worker reallocation.
From the production functions, we know            dA = fKdKA +fLdLA 

dB = gKdKB + gLdLB
Substituting for dLA and dLB in the above equations, we obtain6       

(6)

dA =

f L2 g L

dPA
dPB
f LK g L f L
f L2 g LK
[(
)
(
)]
+
[
+
(
)]
(
f
dK
୉
୉
K
A
Z
P
P
Z
Z )dK BAdB =g L2 f L

Z [(

dPB

(7)

B

P )୉(
B

dPA

g LK g L f L
g L2 f LK
)]
+
[
+
(
)]
(
g
dK
୉
K
B
P
Z
Z )dK AA

From the above equations, we can know that an increase in its relative price or capitalsuch as FDI into one sector stimulates output of the sector, whereas a decrease in capitalsuch as FDI into the other sector decreases its output. An inflow of foreign capital into a
sector increases sectoral output directly by providing more capital and indirectly byraising the marginal product of its labor and drawing workers away from the othersector. Overall, it can be said that investment to one sector increases production in that
sector and decreases production in the other sector.
These results imply that the effects of FDI on trade volumes depend upon whether asector was initially a net exporter or a net importer. An increase in production in Sector
A causes international trade by that sector to increase if that sector was initially a net
exporter, or to decrease if that sector was initially a net importer2. The converse also
holds. In all these cases, direct investment into a sector causes an increase in the net
exports of that sector and a decrease in the net exports of other sectors.

4. Empirical Analysis
The Empirical Model and Methodology
In previous section, the model demonstrates the relation between direct investment
and trade. Now, taking the theoretical model discussed in the previous section into
consideration, we develop regression model in order to estimate the effects of direct
investment on trade. We classify the manufacturing industry into seven sectors and add
direct investment into non-manufacturing sectors in order to test effects of this type of
FDI on the output and trade of manufacturing sectors.
The basic panel regression model used for parameter estimation of Japanese FDI
takes the form2

It is assumed that no demand effects exist and relative price effects are second order.

7

NX it =  i + 1RGDPit +  2 ORGDPt +  3EXCt +  4OFDIit䋭1,t䋭2 +  5OTFDIit䋭1,t䋭2+ uit +  t

(8)

where the subscripts refer to sector i and time t; NX denotes the change in net
exports;RGDP denotes the change in real GDP of Japan; 'ORGDP denotes thechange in the real GDP of the local countries; 'EXC denotes the change in the realexchange rate3 of that country; OFDI denotes the direct investment flow from Japan
into sector i;OTFDI denotes the direct investment flow to all manufacturing sectors
other than sector i;  is a fixed-effects dummy variable on levels of net exports for
manufacturing sector i; u is the error term specific to the particular industry for theparticular year; v is the error term common to all industries in the country for that year.
After adding the explanatory variables of FDI into non-manufacturing sectors, thepanel regression model becomesNX it =  i + 1RGDPit +  2 ORGDPt +  3EXCt +  4OFDIit䋭1,t䋭2 +  5OTFDIit䋭1,t䋭2+ 1TRDt + 2 FINt + 3 SERt + uit +  t(9)where TRD denotes the direct investment flow to Wholesale Trade sector; FIN
denotes the direct investment flow to Finance sector4; SER denotes the direct investment
flow to Service sector5.
Panel regressions by country and industry are conducted based on the above tworegression models. With respect to panel regressions by country, there exists a
possibility of contemporaneous correlation since there are common explanatory
variables to all industries in any particular year such as the change of the real exchange
rate, domestic income and income of Japan6. In order to deal with this problem, theseemingly unrelated regression (SUR) method, which provides robust estimators to thecontemporaneous correlation, is used. The regression specifications by country andindustry are all the same except for some different methods. When panel regressions by
3

In this paper, the real exchange rate (EXC) is defined as the nominal exchange rate(E) that is adjusted
by the ratio of the GDP deflators of a local country (P*) to the GDP deflators of Japan (P), which can bemathematically shown as
EXC = EP*/P
4 The Finance sector consists of Finance and Insurance sectors
5 Data sources and definitions are reported in Appendix.
6 See Kloek (1981) and Riddell(1981) for the problem of contemporaneous correlation.

8

industry are conducted, industry dummies are discarded because the left-hand-side
variable is the net export data for one industry of several countries. Instead of industry
dummies, country dummies  are used for panel regressions by industry. Panel
regressions by industry do not require the SUR method since the real exchange rate anddomestic income of each year are not common to all cross-sectional units7.
The sings of four coefficients, E1, E2 and E4 are expected to be positive, whereas thesign of the coefficient E3 andE5 are expected to be negative8.

5. Results and Discussion
Summary results for panel regressions by country using equation (8) and (9) arepresented in Table 3 and 4 respectively9.
[Table 3][Table 4]
The results in Table 3 and Table 4 suggest that own-sector direct investment plays asignificant role in promoting net exports in the Philippines. Similarly, the results inTable 4 show that own-sector direct investment plays a significant role in promoting net
exports in Indonesia. By summing across rows for each country in Table 1, it isobserved that the Philippines and Indonesia have a bilateral trade deficit with Japan withrespect to manufactured goods during the sample period. Thus, the results imply that
own-sector direct investment reduces imports from Japan for these two countries. This
result of own-sector FDI is consistent with the Mundell’s analysis explaining that own
sector direct investment has the marginal effect of reducing the volume of bilateral trade7

The statistics of the Breusch-Pagan test for income of Japan do not reject the hypothesis of no
heteroscedasticity.
8 A positive sign of the coefficient, E suggests that direct investment promotes trade if the country’s
4bilateral trade balance with Japan is negative. Corresponding to Mundell’s analysis, in this case, direct
investment decreases overall trade by reducing exports from Japan to the particular country (Supposingthat the negative overall trade statistic does not shift from a long-standing negative position to a larger
positive position because the sample period of this study is not long enough to do). Conversely, a positive
value of E4 with a positive trade balance for a country indicates that direct investment to that country
promotes trade by expanding an already-existing trade surplus. This corresponds to the situation in the
Ricardian model. A negative sign of the coefficient on other-sector direct investment, E, combined with anational bilateral trade deficit with Japan suggests that direct investment promotes the volume of trade byincreasing trade flows from Japan. Conversely, when a country has a bilateral trade surplus with Japan,
direct investment to one sector reducing net exports of other sectors serves to reduce the overall volumeof trade.
9 Appendix Table A1 and Table A2 provide estimates of the individual regression coefficients of theequation (8) and (9).

9in some ways. The results in Table 4 show that other-sector direct investment tends toincrease imports from Japan in Indonesia, while the results in Table 3 and Table 4 showthat the same type of direct investment tends to decrease imports from Japan in thePhilippines given a bilateral trade deficit. As shown in the complete results of Appendix
TableA2, other-sector direct investment stifles net exports with a one-year lag but
other-sector direct investment promotes net exports with a two-year lag in Indonesia andthe Philippines. This result may arise from following reasons. At first, other-sector
investment causes to decrease the output of own sectors by labor allocation acrosssectors after one year as discussed in the theoretical model and then, after two year,
other-sector investment leads to increase the output of own sectors through positive
spillover effects. In Indonesia, as shown in Table 4, the negative effect of other-sector
investment mitigates, but does not reverse, the positive effects of own-sector direct
investment because the sum of the coefficients on other-sector direct investment, -0.280,
although statistically insignificant, does not exceed the sum of the coefficients on
own-sector direct investment, 15.840 in absolute value. Therefore, it is clarified that
overall effects of FDI to the Philippines and Indonesia are to reduce the volume ofbilateral trade. The estimation results in Table 3 also suggest that other-sector direct
investment tends to reduce net exports in India. India has a bilateral trade surplus withJapan with respect to manufactured goods during the sample period. This negative
effect of other-sector direct investment mitigates the positive effect of own-sector direct
investment since the sum of the coefficient on other-sector direct investment, -1.051
does not exceed the sum of the coefficient on own-sector direct investment, 42.874,
although statistically insignificant, in absolute value. Therefore, the marginal effect of
direct investment is to increase the volume of bilateral trade in manufacturing goods in
India. The results in Table 3 and 4 suggest that other-sector direct investment tends topromote net exports in Malaysia and Thailand, respectively. For Malaysia, the marginal
effect of direct investment is to reduce net exports and thus, increase the volume ofbilateral trade in manufacturing goods because the coefficient on own-sector direct
investment, -0.030 is greater in absolute value than the coefficient on other-sector direct
investment, 0.026. For Thailand, the marginal effect of direct investment is to promote
net exports and thus, reduce the volume of bilateral trade in manufacturing goods due toa trade deficit with Japan.
Now, the effects of direct investment into non-manufacturing sectors on the trade incommodities are considered. This type of direct investment affects output of
manufacturing sectors directly and indirectly in some ways. Labor allocation, as
described in the theoretical model, across sectors affects output of manufacturing

10

sectors. Some output of manufacturing sectors possibly serves as input of
non-manufacturing sectors. FDI into non-manufacturing sectors has also influence on
output of manufacturing sectors through spillover effects10. Similar to the effects ofdirect investment to manufacturing sectors on the volume of bilateral trade, the effect of
direct investment to non-manufacturing sectors depends on whether a host country has a
trade surplus or a trade deficit in manufactured goods with a home country. If a hostcountry has a trade surplus in manufactured goods with a home country, a positive andsignificant coefficient implies that this kind of direct investment causes an increase in
the volume of bilateral trade, while a negative and significant coefficient implies that
this type of direct investment serves to decrease the volume of bilateral trade.
Conversely, in case of a trade deficit country in manufactured goods with a homecountry, the positive and significant coefficient implies that direct investment tonon-manufacturing sectors serves to decrease the volume of bilateral trade and thenegative and significant coefficient implies that direct investment causes an increase in
the volume of bilateral trade.
Direct investment to the Wholesale trade sector has a positive and significant effecton trade by manufacturing sectors in India and Indonesia. In India, direct investment tothis sector tends to increase the volume of bilateral trade due to a trade surplus, while
direct investment to this sector tends to decrease the volume of bilateral trade due to a
trade deficit. However, direct investment to this sector has a negative and significant
effect on trade by manufacturing sectors in Malaysia, the Philippines and Thailand. In
these three countries, direct investment to the sector increases the volume of bilateral
trade due to trade deficits in manufactured goods with Japan. Direct investment to the
Finance sector has a positive and significant effect on trade in manufactured goods in
India and Malaysia, while direct investment to this sector has a negative and significant
effect on trade by manufacturing sectors in China. Direct investment to the Financesector tends to increase the volume of bilateral trade in India having a trade surplus in
manufactured goods with Japan, while FDI to this sector tends to decrease the volume
of bilateral trade in Malaysia, a trade deficit country with Japan. FDI to this sector tends
to decrease the volume of bilateral trade in China. In the Philippines, the coefficient of
direct investment to the Service sector shows a negative and significant sign, which
implies that FDI to this sector tends to raise the volume of bilateral trade in
manufactured goods.

10 Not only the transfer of technology and management skills but also the transfer of knowledge of world
markets and ways of fitting into worldwide production networks, not visible in standard productivity
measurements, also increases efficiency in production.

11

The second group of regressions is conducted on data grouped by industry11. Table 5
and 6 present panel regression results for the cumulative effects of lagged independent
variables.

[Table 5][Table 6]
In Table 5, for the Chemical & Kindred Products, the Primary & Fabricated Metals
and the Electric Equipment sectors, the coefficients on own-sector direct investment
show negative and significant signs, while the coefficients on other-sector direct
investment show positive and significant signs. Given trade deficits in these threesectors with Japan, the positive coefficients on own-sector investment suggest that
direct investment into own sector increases Japanese export to the six Asian countries.
This trade-creating effect may arise from increase Japanese exports of intermediate
inputs in order to produce final products of these sectors. Whereas, the negative
coefficients on other-sector investment imply that direct investment into other sector
decreases Japanese exports. This trade-diminishing effect of other-manufacturing-sector
direct investment may occur because the output of these three sectors increases throughspillover effects. For the Chemical & Kindred Products sector, this positive spillover
effects are mitigated after two years because FDI to industries other than this industry
had negative effects on trade in this industry after two year as shown in the complete
estimation results presented in Appendix Table A3 and A4. The overall effects of direct
investment in all of these three sectors are to increase the volume of trade because thecoefficients on own-sector direct investment, -8.773, -17.881 and -6.749 exceed thecoefficients on other-sector investment, 0.303, 2.459 and 3.287 in absolute value,
respectively. Conversely, for the Other Manufacturing sectors in Table 5, theown-sector

directinvestment

stimulates

netexports

while,

theother-manufacturing-sector direct investment stifles net exports. The overall effect of
direct investment is to promote net exports because the coefficient on own-sector direct
investment, 3.812, exceeds the coefficient on other-sector investment, -0.473 in absolutevalue. Given a trade surplus in the Other Manufacturing sectors with Japan, it suggeststhat direct investment increases the volume of bilateral trade. In Table 6, for theTransportation Equipment sector, the overall effect of direct investment is to promote

11

Appendix Table A3 and Table A4 provide the complete estimation results.

12net exports. Given a trade deficit in this sector with Japan, it suggests that direct
investment to this sector reduces imports from Japan and, thus, decreases the volume ofbilateral trade.
Finally, effects of direct investment into non-other manufacturing by industry are
considered. As shown in Table 6, direct investment to the Wholesale Trade sector tends
to stimulate net exports in the Primary & Fabricated Metals sector and theTransportation Equipment sector, while this type of FDI tends to reduce net exports in
the Other Manufacturing sector. Direct investment to the Finance sector stifles net
exports in the Chemical & Allied Products sector and Transportation Equipment sector.
Direct investment to the Service sector stifles net exports in the Machinery Except
Electrical sector and the Transportation Equipment sector, while this type of FDI
increase net exports in the Primary & Fabricated Metals sector.

13

6. Concluding Remarks
The effects of capital movements on international trade have been open tocontroversy in both theoretical and empirical studies. The early theoretical study
showed FDI and trade may serve as substitutes, whereas the later theoretical researchdemonstrated that FDI and trade are complements other than substitutes. However,many of empirical studies show somewhat mixed results on the relationship between
FDI and trade.
This study aims to examine empirically the linkages between trade in manufactured
goods and Japanese FDI together with spillover effects of FDI in Asia. The empiricalfindings offer important aspects of the linkages between Japanese FDI and trade. The
empirical analysis reveals that some FDI tends to raise the volume of manufacturing
trade but other FDI has a tendency to diminish the volume of bilateral trade. That is,foreign direct investment and product trade can be both substitutes and complements in
manufacturing industries. For instance, FDI tends to diminish the volume of bilateral
trade in the Philippines, Indonesia and Thailand whereas FDI increases the volume ofbilateral trade in India and Malaysia. Similarly, some FDI has a tendency to promote net
exports in some sectors such as the Transportation Equipment sector and the Other
Manufacturing sectors, while other FDI stifles the net exports in some sectors such as
the Chemical & Allied Products, the Primary & Fabricated Metals sector and theElectric & Electronic Equipment sector. Furthermore, the empirical analysis also reveals
that some FDI into other-manufacturing sectors and non-manufacturing sectors has the
positive spillover effects on bilateral trade and some FDI has trade-creating effects ofintermediate goods
Consequently, it can be concluded that Japanese FDI can lead to significant andvarious effects on bilateral trade across manufacturing industries in Asian countries
rather than homogeneity of either substitutability or complementarity.

14

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17

Figure 1: Growth Rates of World FDI (outward), Trade and GDP, 1989-2004
Growth Rates of World FDI, Trade and GDP, 1989-2004
80
60
40

㩼

20
0
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
-20
-40
-60
Real GDPFDI Outward

World Trade

Note: World trade is calculated by adding total imports and total exports of world.
Sources: UNCTAD (www.unctad.org) for FDI, WTO (www.wto.org) for Trade and
IMF, World Economic Outlook Database, April 2006 for GDP
Figure 2: Outward FDI and Total Exports of US and Japan

USD billion

Outward FDI and Total Exports of US and Japan
900
800
700
600
500
400
300
200
100
0
1989

1990

1991

1992

US FDI

1993

1994

1995

1996

US Exports

1997

1998

Japanese FDI

1999

2000

2001

2002

2003

2004

Japanese Exports

Note: These amounts are based on current prices.
Sources: UNCTAD (www.unctad.org) for FDI and WTO (www.wto.org) for Export

18

Figure 3: Japanese FDI by Primary Region
Japanese FDI by Primary Region

JPY 100million

60,00050,00040,000

North America
Asia
Europe30,00020,00010,000

19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04

0

Year

Source: Ministry of Finance Japan (http://www.mof.go.jp)

19

Table 1: Net Export Position of Asian Countries (1989-2004)
100 Millions of 2000 JPY㩷Food &

ChemicalPrimary &Machinery

Electric &Transportation

Other

Kindred& Allied

FabricatedExceptElectronic

Equipment

Manufacturing

Products

Products

MetalsElectrical

Equipment

China

82750

-27840-26177-48820-17224-20556

60929

India

10467

-3273

-3659

-12222

-6317

-3383

23840

Indonesia

20442

-9768

-3271

-36899-11763-16964

190024

Malaysia

2434

-8312

-20615-20047-33497-2267784025

Philippines

13394

-6018

-6256

-9013

-20340-140144848

Thailand

39902-15631-30210-43004-31292-31831

10016

Source: Ministry of Finance Japan (http://www.mof.go.jp)2012.39615.20355.62435.482Indonesia

Malaysia

Philippines

Thailand

87.22824.67262.46

263.588

20.931131.47331.47

61.50876.575

3.53

73.28922.86635.92314.712

7.597

196.625

Source: Ministry of Finance Japan (http://www.mof.go.jp)

1.1711

India

136.11821200.07135.008178.35477.64316.316377.77166.24949.78914.135130.738

65.345294.199

136.84335.968130.50255.82822.668380.904

Equipment

Electrical

Metals

Products

Products

121.848

Manufacturing

Equipment

Electronic

ExceptFabricated& Allied

Kindred81.654

Other

Transportation

Electric &MachineryPrimary &ChemicalFood &

China

㩷

81.0077.003

32.17111.6475.424

106.142

Trade

Table 2: Sectoral Composition of Annual Average of Japanese FDI in Asia (1989-2004)
100Millions of 2000 JPY

53.03626.41039.713167.4566.509

39.188Finance49.95028.53143.58190.1837.797

171.959

ServicesTable 3: Estimation Results for Japanese FDI: Summed Two-Period Effects
Panel A

China

India

Indonesia

Malaysia

Philippine

Own Industry-3.25542.8741.780-0.0300.180

FDI(-0.372)(1.110)(0.250)(-0.249)**

Thailand

**

1.381

(2.003)(0.575)-0.001

0.026

*

0.199

0.164

FDI to all other

0.460-1.051

Industries(0.646)(-2.011)(-0.004)(1.809)(1.559)(0.448)

Obs

98

98

98

98

98

98

Notes: The dependant variable is the net exports of a local country. Parentheses ( ) shows
t-statistics with levels of significance*** (1%) ** (5%) * (10%)

Table 4: Estimation Results for Japanese FDI: Summed Two-Period Effects
Panel B

China

India

Indonesia*

Malaysia

Philippine

Thailand-0.012

0.321

***

1.248

Own Industry-5.18525.45415.840FDI(-0.515)(0.790)(1.662)(-0.078)(7.259)(0.584)

FDI to all other

0.649-0.147-0.280

0.037

0.005

0.466*

Industries(0.942)(-0.293)(-1.263)(1.097)(0.123)(1.917)

FDI to-4.24429.020***13.785***-0.105**-1.201*-2.390**Wholesale Trade(-1.012)(2.997)(3.909)(-2.309)(-1.825)(-2.364)

FDI to Finance-7.421*

13.318***-0.0350.149*-0.113-1.419(1.626)(3.982)(-0.214)(1.940)(-1.036)(-0.564)

2.297

0.914

-0.473-0.374-3.990***4.949(0.778)(0.305)(-0.853)(-1.094)(-13.091)(1.575)

98

98

98

98

98

98

FDI to Services
Obs

Notes: The dependant variable is the net exports of a local country. Parentheses ( ) shows
t-statistics with levels of significance*** (1%) ** (5%) * (10%)

22Table 5: Estimation Results for Japanese FDI: Summed Two-Period Effects
㩷 Panel A

Food &

ChemicalPrimary &Machinery

Electric &Transportation

Other

Kindred& Allied

FabricatedExceptElectronic

Equipment

Manufacturing

Products

Products

MetalsElectrical

Equipment

Own Industry-3.265-8.773***-17.881*-1.231-6.749***-2.9723.812***

FDI(-0.358)(-10.791)(-1.778)(-0.197)(-3.467)*****

FDI to all other 

2.459(-0.837)(3.224)

0.438

3.287

***

0.619

-1.473**

0.461

0.303

Industries(0.629)(8.116)(2.203)(0.431.)(5.259)(1.315)(-2.619)

Obs

84

84

84

84

84

84

84

Notes: The dependant variable is the net exports of a local country. Parentheses ( ) shows
t-statistics with levels of significance*** (1%) ** (5%) * (10%)

Table 6: Estimation Results by for Japanese FDI: Summed Two-Period Effects
㩷 Panel B

Food &

ChemicalPrimary &Machinery

Electric &Transportation

Other

Kindred& Allied

FabricatedExceptElectronic

Equipment

Manufacturing

Products

Products

MetalsElectrical

Equipment

Own Industry-5.185-4.914***-9.5397.317-6.757***4.708**

5.532

FDI

(-0.510)(-8.173)(-0.793)(1.015)(-3.505)(2.256)(1.121)0.649

0.308***

0.808-0.5833.405***-0.730**-1.801(0.932)(8.349)(0.569)(-0.523)(4.774)(-2.373)(-0.874)**-1.136

0.724

8.359

***

-5.488*

FDI to all other Industries

FDI to-4.244-0.392

6.695

Wholesale Trade(-1.001)(-1.108)(2.030)(-0.291)(0.216)(5.321)(-1.728)

FDI to Finance-7.421-2.003***

1.429-7.187-5.412-5.238**-2.007(-1.609)(-3.188)(0.266)(-1.035)(-0.831)(-2.086)(0.161)2.297-0.0758.377**-8.610**-5.499-2.729*-0.861(0.770)(-0.224)(2.573)(-2.075)(-1.567)(-1.790)(-0..383)

84

84

84

84

84

84

84

FDI to Services

Obs

Notes: The dependant variable is the net exports of a local country. Parentheses ( ) shows
t-statistics with levels of significance *** (1%) ** (5%) * (10%)

23Appendix
The Data for Japanese FDI Analysis
The panel data set for Japanese FDI consists of the six Asian countries such as China,
India, Indonesia, Malaysia, the Philippines and Thailand) and sixteen years of data
(1989-2004). Manufacturing industry is broken down into seven sectors such as Foodand Kindred Products, Chemicals and Allied Products, Primary and Fabricated Metals,
Industrial Machinery and Equipment, Electronic and Other Electric Machinery,Transportation and Other Manufacturing (residual category) to make the sector
definitions consistent across the trade and FDI series. Data for FDI into
non-manufacturing sectors are comprised of Wholesale Trade, Finance and Service.
The data of FDI into the six Asian countries from Japan are outward capital flows
showing positive value. The data of FDI are from the homepage of Ministry of FinanceJapan (http://www.mof.go.jp)
The data of net exports are calculated by subtracting the value of Japanese export to agiven country from the value of Japanese import from the country. The data of the valueof both Japanese export and import are from the homepage of Ministry of Finance Japan(http://www.mof.go.jp)
The GDP data for an individual Asian country together with Japanese GDP are usedas millions of real local currency units. The GDP data for an individual Asian country
including Japan are from the database of International Financial Statistics.
The data of the exchange rate for each currency are converted into Japanese yens.
The data of the exchange rate for all currencies are from the database of International
Financial Statistics.
Trade, investment and Japanese income series are converted into real dollar values
using producer price index. The incomes of the selected countries are also converted
into real values using producer price index of each country.

24

Estimation Results
Table A1: Estimation Results by Country for Japanese FDI
China

India

Indonesia

Malaysia*

Philippine

Thailand

**

2.662

Own Industry-3.67418.7723.486-0.134FDI(-0.406)(0.819)(1.062)(-1.859)(2.011.)(1.250)Own Industry

0.419

24.102-1.7060.104-0.001-1.281

FDI(0.105)(1.060)(-0.229)(1.233)(-0.006)(-0.655)

FDI to all other0.304**-0.559*-0.061

0.053**

0.025

0.452

Industries(1.977)(-1.793)(-0.276)(2.047)(0.177)(1.133)

FDI to all other

0.156-0.4820.060-0.0270.174-0.288Industries(0.240)(-1.181)(0.614)(-1.056)(1.149)(-1.343)

Real Exchange-5217.328

41.509-355868.0

0.174

626.735

8005.670

Rate(-0.681)(0.016)(-1.180)(0.002)(0.285)(-0.762)

Real GDP of

0.165-0.008

0.001

0.006

0.017

-0.121Japan(0.818)(-0.191)(0.021)(1.240)(0.959)(-1.439)

**

0.420

-2.685

6.119

0.181

(one period lag)(two period lag)(one period lag)(two period lag)Local Real-2.558

0.558

0.014

GDP

(-0.407)(0.592)(2.077)(0.114)(-1.067)(1.101)

Adj R

0.233

0.236

0.610

0.468

0.358

0.248

Obs

98

98

98

98

98

98

2

Notes: The dependant variable is the net exports of a local country. Parentheses ( ) shows
t-statistics with levels of significance*** (1%) ** (5%) * (10%)

25Table A2: Estimation Results by Country for Japanese FDI
China

India

Indonesia

Malaysia**

Philippine

Thailand*2.996**

Own Industry-2.568-21.050

3.832-0.143

FDI(-0.229)(-0.706)(1.363)(-2.523)(1.834)(2.017)

Own Industry-2.61746.504***12.0080.131

0.270***-1.748FDI(-0.633)(2.704)(1.464)(1.006)(7.729)(-1.022)

FDI to all other

0.450*-0.524*-0.557*0.052-0.119***0.578*

Industries(1.632)(-1.911)(-1.732)(0.928)(-2.759)(1.978)

FDI to all other

0.199

0.377

0.277**-0.0150.124**-0.112

Industries(0.310)(0.999)(2.081)(-0.548)(2.634)(-0.665)

Real Exchange-4055.618-2825.004-1202397.0**-102.968-1478.438**-1642.209

Rate(-0.762)(-1.218)(-2.502)(-0.932)(-2.086)(-0.123)

Real GDP of

0.088-0.0400.079*

0.016**

0.012**-0.205**Japan(0.347)0.051(one period lag)(two period lag)(one period lag)(two period lag)

(0.802)(1.672)(2.248)(1.998)(-2.597)

Local Real24.357*-0.993

0.022***-10.320-7.056***-1.787GDP(1.832)(-1.380)(4.634)(-1.552)(-7.217)(0.436)

FDI to-4.24429.020******-0.105**-1.201*-2.390**Wholesale Trade(-1.012)(2.997)(3.909)(-2.309)(-1.825)(-2.364)

FDI to Finance-7.421*

13.318***-0.0350.149*-0.113-1.419(1.626)(3.982)(-0.214)(1.940)(-1.036)(-0.564)

2.297

0.914

-0.473-0.374-3.990***4.949(0.778)(0.305)(-0.853)(-1.094)(-13.091)(1.575)

Adj R2

0.397

0.840

0.844

0.700

0.957

0.711

Obs

98

98

98

98

98

98

FDI to Services

13.785

Notes: The dependant variable is the net exports of a local country. Parentheses ( ) shows
t-statistics with levels of significance*** (1%) ** (5%) * (10%)

26Table A3: Estimation Results by Sector for Japanese FDI㩷Food &

ChemicalPrimary &Machinery

Electric &Transportation

Other

Kindred& Allied

FabricatedExceptElectronic

Equipment

Manufacturing

Products

Products

MetalsElectrical

Equipment

Own Industry FDI-3.674-9.113***-5.535

2.500

1.835

1.909

1.355**(one period lag)(-0.440)(-13.964)(-0.736)(0.701)(0.792)(1.597)(2.107)****2.457*****-12.346-3.731-8.584

Own Industry FDI

0.419

4.340

(two period lag)

(0.110)(5.035)(-1.399)(-0.979)(-4.659)(-1.620)(2.596)

FDI to all other 

0.304

0.461***

0.362-0.846

0.013

0.083

-0.661**(1.081)(10.730)(0.375)(-1.541)(0.017)(0.324)(-1.922)0.156-0.158***2.097*

1.284

3.274**

0.536-0.812**(0.263)(-3.256)(1.749)(1.591)(2.579)(1.299)(-2.189)

Real Exchange-5217.318-545.766-3111.763

6650.435-7164.228

5960.928

5356.240Rate(-0.910)(-0.736)(-0.479)(1.116)(-0.640)(1.279)(1.525)

Real GDP of

0.165-0.259***0.061-0.369*0.265-0.223

0.165

Japan

(0.788)(-8.761)(0.282)(-1.654)(0.688)(-1.103)(1.209)Local Real GDP-2.558-5.799***-1.5271.495-4.280-15.273

26.354***(-0.334)(-3.902)(-0.148)(0.195)(-0.356)(-1.538)(3.717)

Adj R2

0.296

0.978

0.314

0.507

0.756

0.477

0.667

Obs

84

84

84

84

84

84

84

Industries-4.881(one period lag)
FDI to all other Industries(two period lag)Notes: The dependant variable is the net exports of a local country. Parentheses ( ) shows
t-statistics with levels of significance*** (1%) ** (5%) * (10%)

27Table A4: Estimation Results by Sector for Japanese FDI㩷Food &

ChemicalPrimary &Machinery

Electric &Transportation

Other

Kindred& Allied

FabricatedExceptElectronic

Equipment

Manufacturing

Products

Products

MetalsElectrical

Equipment

Own Industry FDI-2.568-8.388

***

5.064

7.349

*

1.800

3.080***

2.215(one period lag)(-0.277)(14.425)(0.727)(1.772)(0.889)(5.074)(1.503)

***

1.628

3.317

Own Industry FDI-2.6173.474***-14.603-0.032-8.557(two period lag)(-0.626)(4.372)(-1.578)(-0.007)(-4.717)(0.925)(0.931)0.450

0.453***-1.515*-0.9200.351-0.262*-0.792*(1.615)(10.421)(-1.711)(-1.498)(0.330)(-1.649)(-0.727)

0.199-1.046***

2.323

0.337

3.054**-0.468**-1.009(0.307)(-4.159)(1.774)(0.370)(2.575)(-1.860)(-1.005)

Real Exchange-4055.618-609.014

4374.207-230.159-11597.00

4700.186

2083.014

Rate(-0.753)(0.943)(0.703)(-0.031)(-1.075)(1.525)(0.364)

***

**

0.191

0.580

-0.311*0.356*

FDI to all other Industries(one period lag)
FDI to all other Industries(two period lag)

-0.220Real GDP of

0.088

Japan

(0.343)(-6.634)(-2.176)(0.530)(1.404)(-2.127)(1.776)*-0.95012.5571.753-7.125-39.719***41.514***(1.813)(-0.531)(0.731)(0.091)(-0.373)(-4.325)(4.463)

FDI to-4.244-0.392

6.695**-1.1360.724

8.359***-5.488*Wholesale Trade(-1.001)(-1.108)(2.030)(-0.291)(0.216)(5.321)(-1.728)

FDI to Finance-7.421-2.003***

1.429-7.187-5.412-5.238**-2.007(-1.609)(-3.188)(0.266)(-1.035)(-0.831)(-2.086)(0.161)2.297-0.0758.377**-8.610**-5.499-2.729*-0.861(0.770)(-0.224)(2.573)(-2.075)(-1.567)(-1.790)(-0..383)

Adj R2

0.385

0.989

0.674

0.621

0.814

0.882

0.769

Obs

84

84

84

84

84

84

84

Local Real GDP

FDI to Services

24.357-0.590Notes: The dependant variable is the net exports of a local country. Parentheses ( ) shows
t-statistics with levels of significance *** (1%) ** (5%) * (10%)

28