BUSINESSREVIEiW
42nd

ANNUAL VOLUME,,ectsV3TEl.Ol:3:

RESEARCH INSTITUTE FOR ECONOMICSAND BUSINESS ADMINISTRATIONKOBE UNIVERSITY
1997

KOBE ECONOMIC & BUSINESS REVIEW
Editor in Chief
Seiichi Katayama

Co-Editors
Hideki Izawa; Kenji Kojima; Kazuo Shimomura

KOBE& BUSINESSECONOMIC
REVIEW
42nd

ANNUAL VOLUME

ectS"lg'El.o...,,kN

RESEARCH INSTITUTE FOR ECONOMICSAND BUSINESS ADMINISTRATIONKOBE UNIVERSITY
1997

CONTENTS

Page
A Simple Model of Technology Transfers in the North and South Economies;

Technology as Intermediary Goods '••••""•••'"••"'•••' Kazuhiro IGAwA 1

Trade and Investment Relations of Japan and ASEAN
in a Changing Global Economic Environment •••••••••••• Shigeyuki ABE 11

Japanese Financial Relationships in Transition •••••••••••••••'•• Kenji KoJiMA 55

Organizational Coordination for Project Interdependency

in New Product Development ••••••••••••••••••"••••••• Kentaro NoBEoKA 97

A Regime Shift in Long-Run Money Demand in the United States''""'"""""""""'"''"""'"''"'"'"'""''"""''"""'•''' RyuzoMiyAo 117

The Competition between Regional Standards and the Success and Failure ofFirms in the World-Wide Mobile Communication Market'''''''"'"'"'"'"'''''"'"""""''"'""""'"""'''•'"'"''' JeffreyL. FuNK 137

KOBE ECONOMIC & BUSINESS REVIEVV, 42 (1997), 1-9

A SIMPLE MODEL OF TECHNOLOGY TRANSFERS
IN THE NORTH AND SOUTH ECONOMIES;TECHNOLOGY AS INTERMEDIARY GOODS

KAZUHIROIGAWA KobeUniversity

Abstract
Using a simple model of H-O-S with an intermediary product, technology transfers bylicensing, FDI, and R&D, are investigates. It is shown that the three altematives can betreated in a model, but with specific interpretations respectively. This model is usefulwhen a service of technology is contained in the intermediary goods.
JEL classification: 033

Keywords: Technology transfer; Licensing; FDI; R & D; Intermediary product1. Introduction
It is interesting to investigate changes of international trade patterns, when in-

ternational transfers of production technology are taking into account. In thispaper, international trade patterns are investigated for different types of produc-tion technology transfer and innovation. A production technology becomes avail-able for a country where domestic R & D activities develop it or transfers oftechnology from abroad through licenses or FDI are accepted. Depending on thethree types of technology acquirement, the country might show different tradepatterns in the case of an introduction of new production processes, using thetechnology.

In this paper I will show a way to explain the difference of trade patterns,

when technologies services are intermediary products and the technologies arenecessary for production of goods or services. There are many roles of technologies in production; one of them is a role as intermediary inputs, that is, servicesof technologies are combined with other fundamental factors for production. CalCorresponding Address:
Kazuhire Igawa
Research Institute for Economics and Business Administration, Kobe University
2-1 Rokkodai-cho, Nada-ku, Kobe 657-8501, Japan
E-mail: igawa@rieb.kobe-u.ac.jp
Fax: (81)-78-803-0391

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 1-92

culating factors inputs to reproduce the services of the technologies, it will bepossible to treat the services of a technology to be an intermediary product,
which is produced using the fundamental factors for production. I will construct avery simple model, which explains important features of technology transfers or
technology developments, treating a technology as an intermediary product.

In the following section, a simple model is introduced to show how production
and consumption, and thus international trade export and import, are determinedwhen technology is contained in intermediary goods. In section 3, a technology
transfer through licenses will be introduced. Using a similar model as in the caseof intermediary goods, properties of technology transfers through licenses are investigated. Properties in the case of FDI are investigated in section 4. Differencesin the case of technology acquirement through R&D innovation will be investigated in section 5 and dynamic aspects of R&D technology innovation will be discussed.

2. Technology as Intermediary Goods
A typical North and South economies, developed and developing countries, aremodeled as follows. Starting from production of a labor intensive product X, thedeveloping country (country B) plans to produce more capital intensive productY, which requires a specific technology service M at a fixed proportion to aquantity of Y. It is assumed that fundamental production factors are a labor anda capital. The product M (services of technology M) is produced using the laborand the capital. It is also assumed that M is more capital intensive than Y (excluding the inputs of M), and Y is more capital intensive (excluding inputs of M)
than X. For simplicity the capital labor ratios are assumed to be fixed.

Without international transaction, developed country (country A) produces
both products X and Y, using intermediate goods M (and thus technology M).
This implies that unit value iso-quants of outputs X, Y (excluding the input valueof M), and M, on the diagram of labor and capital, tangent to a common unit
cost line. See the figure in Appendix. This is the case when all the tree markets
are perfectly competitive. The slope of the line shows relative price of two fac-

tors. Adding input vectors of Y (excluding intermediary inputs) and M, a factor
contents vector of Y (including intermediary inputs M) will be constructed, whichis called F. Combine the factor contents vectors of X and F, production quantities

of X and F (and thus Y and M) are determined to attain the full use of factors

endowment of the developed country.
Demands for X and Y (and thus also for M) are determined by relative prices
of X to Y, and GNP (factor income) of the country. If demands for X and Y are

3
IGAWA.- A SIMPLE MODEL OF TECHNOLOGY TRANSFERS

different from the products supply, relative prices will change, and thus unite
value iso-quants will shift away or toward the origin. These adjustment processes

will stop when markets for X and Y are cleared, demand is equal to supply ineach market.
Now let us introduce international trade between a developed country A and adeveloping country B. Country B is assumed to be producing only commodity X,

because of a luck of technology M. By opening trade, demand for Y from developing country will rise the relative price of Y, And this will reduce demand for

Y in developed country. Country A exports Y, exchanging imports X from country B.

Production of Y will become possible When the developing country accumulates

capital and if intermediary goods of technology M is importable. The cases of
production of Y through license contracts of M or through FDI or own development of technology of M, will be discussed in the following sections.

When a factor endowment ratio of country B is less capital intensive than thecapital intensity of X, country B will specialize in X and labor will be .unem-

ployed. The production of Y becomes possible when the ratio of endowment ismore than the capital intensity of X, and full employment will be attained. The

productions of X and Y are determined at the full employment of the both endowments of capital and lacor in country B. GNP of the country B is an aggregate of factor incomes and this is less than the value of products X and Y by thevalue of imported intermediary products M.
On the part of country A, factor inputs of intermediary exports of M are ad-justed from factor endowments for producing X and Y. The production of Y will
be reduced and production of X will be increased when an export of M increases,

and when M is most capital intensive (Rybczynski Theorem). This implies thatthe export of Y and import of X deereases and export of M increases in country
A, as a capital accumulation increases in country B and it produces more Y using

more imports of M. When a production of Y is small enough in country B, an export of X is large. However an increase in production of Y may change trade pat-tems. Country B may export Y and may import both X and M.
3. License for a Technology

Consider the case that a developing country B can make use of a license of
producing services of technology M and can produce Y. Inputs of factors for producing the services is assumed to be the same for M in the previous section. Now

production factors of the developing country are also used for production of M,
Then the situation is similar to the familiar H-O-S model of factor inputs vectors

4

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 1-9

F (for products Y) and X in both country A and country B. However the difference here is a license fee, and it will be the difference in a value of income be-

tween GDP with license and GNP without license.
When a capital endowment is scarce and capital endowment ratio is less than
the intencity ratio of X in country B, the country B will specialize in producing X

and will export X exchange for import of Y. Capital accumulation in country B
will make efficient to produce both X and Y, by paying a license fee. Determina-tion of production pattern is a familiar one explained by H-O-S theory, as mentioned above. Demand pattern will be different from the case of intermediary in-

put M is imported, by the effects of transfer of the license fee. The value of
license fee will be the difference of factor incomes with and without the license,

when the technology is monopolized by a firm in country A. The value of incomes are evaluated at the prices when the license is used. The prices will change to-ward better terms of trade for country B. Therefore gains from trade in this casecome from the improvement of terms of trade in country B. Gains are transfer oflicense fee plus negative effects of terms of trade change, in country A.

Comparing with the case of import of intermediary input in the previous section, it seems that the country B is worse in the case of licenses. However, it
must be aware that competitive conditions of the two cases are different. In thecase of licenses, it is assumed that the technology is monopolized and in the caseof import of intermediary input, it is assumed that the market of intermediary
goods is competitive, and thus profit of products M industry is zero. If the market

of intermediary goods of technology services is monopolized, price of M will exceeds marginal cost of factor inputs of producing M. That is, a positive profit will
exist. This profit will correspond to the license fee. If the license fee par one unitof production of M is the same as a mark up rate in pricing of intermediary goods

M, the two cases of the technology license and the import of intermediary inputof technology services will be same.

It is impossible to make license contracts when the technology is not divisible
as one entity. Even if it is divisible, costs of transaction should be low to makelicense contracts. An evaluation of technology is very difficult in many aspects,
and thus transaction costs will be very high, in general. The main difficulty comesfrom asymmetry of information about technologies. A technology is valuable inthe market when it is unknown or at least known incompletely. A supply side,which has advantage in knowledge about a technology, does not show all the information about the technology. A demand side always has uncertainty about thetechnology and also about effects of using it. Therefore price levels they offer
scarcely coincide. Another difficulty might be risks of reveal or spillover of thetechnology after the license contracts.

5
IGAWA: A SIMPLE MODEL OF TECHNOLOGY TRANSFERS

A license contract is possible when transaction costs is not prohibitively large
and if the cost to cheat the contract is very large. Furthermore, a licenser shouldhave merits to use the technological advantage in the form of license. This depends on situations of alternative use of the advantage. An own use for production may not efficient because of higher factor costs to manage the technology
and because of opportunities of more productive use of scarce factors in the firm.

To protect from the potential rivals to appear, increase of supply by licensing
might be a strategy of a firm. Licensing to the firm in developing country might
be better strategy for licenser firm in developed country. In this case, the possibil-

ity of a licensee become competitor of the licenser, in production technology developments in future, may be small.

4. Technology Transfer by FDI
Instead of licensing a technology, it might be more profitable to keep the technology inside the firm (organization) and use it in a form of FDI activities. In thecase of FDI from country A to country B, a profit of FDI belongs to country A.
An equilibrium in the case of IDI of the M industry, can be shown explicitly inthe same diagram of iso-quant as in the case of licensing. Producing both output

X and output Y competitively in country B, unit value iso-quant of X and unit
value iso-quant of Y (excluding inputs value of M) and also iso-quant of (1+m)
value of M should tangent the same unit cost line, where m is a mark up rate in
price of M. See the figure in Appendix. The price of M is a competitive market

price when technology services are produced and are traded as intermediary
goods.
In the case of IDI of jointly producing Y and M, the price of M is not a market price, but a price for internal trade in the organization, within the FDI firm.
It is important in this case that the FDI firm is a monopolist in the market of Y.
And thus the profit of M is reflected in the pricing of product Y.

An important aspect of FDI is an existence of headquarters in home country.

This case is extensively investigated in Helpman & Krugman (1985). The casethat services of technology M are produced in headquarters in country A and FDI
firm produces Y in country B will correspond to the case of import of intermedi-

ary input M, in section 2. Instead of jointly producing M in country B, the FDI
company produce Y using intra-firm trade of M. The firm producing Y in country
B is owned by the firm of the country where headquarters have located, here incountry A. The firm gets profits as a monopolist of M and can use transfer pricing in the intra-firm trade.

It is well known that OLI elements are important as determinants of FDI.

6

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 1-9

Ownership advantage in the above model is technology owned by a firm in country A. Locational advantage might be a low factor price in the developing country
B before FDI (it may disappear after FDI). Internalization is the choice of controls of production of M (when a separation of M is possible) and of Y.

The technology advantage of a firm, in developed country, might disappear
when rival firms, in developed country or in developing country, develop thesame or more advanced technology. Once some technology is developed in a
firm, risks and costs of R&D for similar technologies will be reduced. The possibility of those potential rival firms enter the market will be reduced by expanding

production of the products using the technology. The rival firrn in developing

country will have more competitiveness when FDI to developing country is more
profitable than production activities in developed country. In this case incentives
to make FDI will be large to get profits and to protect an entry of rival firms.

There are many disadvantages to make economic activities in foreign countries.

FDI should compensate those disadvantages with other advantages. The advantages might be lower factor prices, easier access to resources, and close to markets, and protection policies, and others. Advantages of FDI may be different de-pending on production processes and products. In the case that production processes of final goods and technology embodied intermediary goods can be separable, it will be a matter which production process should be transferred to a foreign country. If protections of technology spillover are difficult in the foreign coun-

try andlor a production of the technology embodied intermediary goods costs
more, only FDI of the final process will be taken, as in the headquarters case dis-cussed above. There is a case that only the process of technology embodied intermediary goods is put into a foreign country as FDI and local firm take the pro-

cess of final products. Some recent trends of FDI of R&D activities in developing
countries will be explained by locational advantages.

It is often true that technology advantages are sources of competitiveness of afirm. In this case use of the technology should be kept inside the firm and acces-

ses to the technology should be limited within members of the firm. Here is areason why a licensing (alternative way to FDI) is not used, as mentioned in theprevious section. The selection of ways for transaction, that is, transactions
through market (arms length transactions) or through organizations (intra-organization transaction) is extensively investigated by Williamson (1975) and the fol-lowers. The arguments for intra-organization transaction, compared to alternative
forms of activities in foreign countries, are applicable to the argument for FDI.

7
IGAWA: A SIMPLE MODEL OF TECHNOLOGY TRANSFERS

5. Development of Technology by R&D
In the case of developing a new technology in the developing country, produc-tion factors should be invested in R&D. The newly developed technology is put
into use for production of Y when all costs of R&D for developing technologies
and the cost to make use of the services of technology are expected to be covered

with sales of Y and M. The profit over time should be nonnegative, and will be
zero when competitions prevail in R&D activities. If the developing and managing costs of technology in country B are same as in the developed country A, previous model of intermediary input of M, in section 2, can be used to explain thesituation of R&D of the technology. If the factor inputs vector of M is the previous sections is interpreted as R&D costs per period, then the relation of factor

costs and price of M can be interpreted as profit condition, on average perperiod, for developing the technology. In the case of R&D, costs exceed in theearly stages and which are covered by positive profits in the later stages of a life-

time of technology. Therefore a dynamic treatment of R&D is more appropptate.
However, simple investigations of important aspects of R&D are still possible byusing average figures per period. The decision weather or not to develop thetechnology by own R&D activities depend on overtime net profits, and thus average net profits per period, if there are no liquidity constraints.

If processes of R&D and changes of production patterns (and also trade patterns) though life cycles of new products are issue, dynamic approaches should betaken. Using endogenous growth theory, Grossman & Helpman has shown ananalytical framework of the product cycle theory developed by Vernon (1966).
Decisions of R&D investments depend on the probability of success in getting
new technologies and on the profitable uses of the technologies. In which country
to use the technologies for production or for license, depends on the differencesin the time profiles of factor prices. Timing of IDI or of import substitution will

depend on abilities to imitate the technology in developing countries and abilityof innovation in developed countries.

Consider a case that developing country depend on its own R&D activities for

obtaining new technologies. Investments for R&D activities should be financedwith savings, income minus expenditure. This happens in a gestation period of
R&D, and the country will import the products until it succeeds in imitating of

the technology for the products. When the country has competitiveness of the
products using advantages of the country, import substitution will change to ex-

port to developed countries. In the mean time, R&D activities in the developed
countries will introduce new technologies or new products. Depending on the innovation speed in the developed countries and catching up (imitating) speed inKOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 1-98

the developing countries, different life cycles of products will be found and diffe-

rent movements of gaps of factor prices between developed and developing countries will be found. On the part of developed countries matters are a decision of

volume of investment to R&D and a decision of timing of technology transfer by
licenses or FDI, taking into account of in the speed of imitation in developing
countries and speed of innovation in developed countries.

6. Final Remarks
A technology is an important factor for firms to have competitiveness, and atransfer of technology is crucial for developments of South countries. It is shown
the effects of the behavior of the firms in North countries, depending on the pat-terns of technologies transfer. Depending on the behavior, production, consumption and trade patterns in South countries are investigated. However, an attention
is paid mostly on the aspects of technology as intermediary goods, and effects areinvestigated in the context of technology transfers. There are other types of tech-

nologies, one embodied in capital goods, and another embodied as human capital, and another one of know-how to improve production.
In the case of capital goods embodied technology, it is possible to investigate ina similar way as in the case of intermediary goods. The difference will be durability of the capital and analytical concepts of average per period, used in the pre-vious section will be effective. In the case of human embodied technology, an international mobility of labor determines the way of use of technology. To inter-nalize a human technology, the firm might pay more than the market price (wagerate), or the technology are changed specific to the firm. Education or training
will be the ways of technology transfer, when labor is immobile internationally.

Some know-how is difficult to put into a manual. Then a transfer of technology
is difficult, except totally imitating the way of production. However some knowhow can be put into a blue print. A blue print has specific properties for market
transactions. The copy can easily be made. The situation is similar to the case oflicense contracts with higher possibility of spill over. Furthermore, it is easy forthe firm with the blue print to increase the services of technology with very small
marginal costs. These make the firm profitable to use the blue print itself.

The limitation of static analyses of R & D here will be relaxed with costs ofcomplexity.

References
R. Vernon, "International Investment and International Trade in the
Product Cycle", euarterly Journal of Economics, 80, 1966

9
IGAWA: A SIMPLE MODEL OF TECHNOLOGY TRANSFERS

O. E. Williamson, Markets and Hierarchies: Analysis and Antitrust
Free Press, 1975
E. Helpman and P. R. Krugman, Market Structure and Foreign Trade,

G. M. Grossrnan and E. Helpman, Innovation and Growth in the
MIT press, 1993

Implications, theMIT Press, 1985

Global Economy,

Appendix: A presentation of equilibrium in production side
The following figure shows an equilibrium situation of production of X and Y and M,
in the country whose factor endowment point is point E. The horizontal line indicatesvolumes of labor and the vertical line indicates volumes of capital. A factor intensity of

X is shown in vector X from origin O and the one of M is shown in vector M from theorigin. A factor intensity of Y (excluding input of M) is shown in vector Y from point
O. The factor contents of Y, including the one of M, which is an addition of vectors M
and Y, is shown in the vector F from the origin. Unit value iso-quants of X, Y (excluding the costs of M), and M are shown in L shaped production level curves of 1/Px, 1/Py,
and 11Pm, respectively. The line tangent to those iso-quants is a unit cost curve, which
passes through 1/w (on horizontal line) and 1/r (on vertical line). Here w is a wage rate
for labor andris a rental rate for capital, Full employment of factors is attained by pro-ducing OA of X, and OB of Y, and OC of M. The factor contents in the products of Y
(including intermediary inputs M) is shown in OD. The line OD is parallel to the line
AE and the lengths of these lines are same. The iso-quant level in the case of monopolyof product M is shown as (1+m)IPm.

K

1/r

t
tl

E

11pm,(1+m)/pm.-e

'
tt

'

' '
' '

'

Di'-'

tt

'f'

ll
tt ttt Et

tt tt' 'Crti tt ftlttt l
ftlt

Y

-t
ll

tt

t
'

ltt tltl tt.. .. t
'

ttx
tt
stt

1/P y,"

,

t
'

tt lt
tt

t
'

tt

'

i.

'

'

B
.--'
'

..vt'-

"
' '

1/px

A

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o

11w

FigureL

KOBE ECONOMIC & BUSINESS REVIEVV, 42 (1997), 11-54

TRADE AND INVESTMENT RELATIONS OF
JAPAN AND ASEAN

IN A CHANGING GLOBAL ECONOMIC ENVIRONMENT"SHIGEYUKIABE KobeUniyersity

Abstract
This paper analyzes the patterns of trade and investment of Japan with ASEAN in the
1980's and early 1990's. The development of the region was brought by positive foreign

direct investment and trade activities of Japan in particular. Trade structures havechanged, reflecting the relative cost performances and the development of international

productionfdistribution networks. ASEAN now engages in intra industry trade withJapan but it is still one sided. Japan is expected to transfer technology, management
ski11s, and capital substantially to this region. With the emergence of economic powers
such as China and Indochina countries, which turn out to be very strong in labor inten-

sive products, ASEAN faces a challenge to upgrade their industries and to this end
Japan should play a positive role from the standpoint of harmonious growth of the region.

JEL CIassopication: F14; F21; O14; 053

Keywords: Intra-industry trade; Rying geese pattern; FDI; ASEAN

Corresponding Address:
Shigeyuki Abe
Research Institute for Economics and Business Administration, Kobe University
2-1 Rokkodai-cho, Nada-ku, Kobe 657-8501, Japan
E-mail: abe@rieb.kobe-u.ac.jp
Fax: (81)-78-803-0397* This paper was originally presented at the conference, "AFrA and Beyond: An ASEAN Perspective," Bangkok, Thailand, April 25-26, 1995. At the time of the conference, ASEAN had been enjoying high economic growth ted by export expansion. The world environment has changed substantially since then. Particularly in 1997 the Thai baht devaluation triggered the Asian foreign exchange crisis and that affected not only Asia but the world. The immediate cause of the crisis was
the burst of bubble and the withdrawal of foreign short term capital; but the real cause should beslow and lagged adjustments of their economies to advanced industrial structure and the continued

large gap between actual and real exchange rates. This paper is old but is suggestive enough towhat ASEAN and Japan should do in the future. In fact, this paper recommended upgrading theirindustrial structures in their high time of economic miracle. The author would like to thank Miss
Kaori Kiyohara and Mrs. Mika Yoshida for data collection and preparation.

12

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 11-54

1. Introduction

This paper addresses the role of Japan and East Asia in the world trading sys-

tem in light of the 1993 conclusion of the Uruguay Round, successive APEC
meetings and trends toward a more regional trading system centering around theWorld Trade Organization (WTO). To do so, we analyze the pattems of tradeand investment of Japan with the ASEAN countries for the past decade or so andproject the direction of future relations of Japan and ASEAN in the context ofthe global trading system.

Japan faced an acute yendaka or high yen situation after the Plaza Agreementin 1985; The yen rate rose from 240 to 150 yenldollar in nine months. By mid
1995 the yen appreciated again to 80 yen/dollari. Trade structures have beenchanging, reflecting the relative cost performances and the development of international productionldistribution networks. Neighboring Asian countries have been
pursuing export-oriented policy and encouraging foreign direct investments(FDI).

FDI contributes to the international transfer of technology, management skills,
and capital. Accordingly, such FDI enabled host developing countries to expand
production and exports of capital and technology intensive goods, which changed
comparative advantage structures. As a result, Japan became a significant impor-ter of manufactured goods from the world. To ASEAN, Japan, however, remained to be a big exporter; this is because ASEAN was still at an intermediatestage of development, which requires large imports of intermediate and capital
goods.

Structures of comparative advantage, thus, was transformed substantially in
Asia and the Pacific and intra-industry trade sharply increased in this region.

With the emergence of economic powers such as China and Indochina countries,

which turned out to be very strong in labor intensive products, ASEAN now
faces a challenge to upgrade their industries and to this end Japan is expected toplay a positive role.

Japan should support the ASEAN countries in their industry upgrading efforts
through financial and technical cooperation. It is important to have a viewpointthat this effort is part of Japan's process of establishing an internationally harmo-

nious industrial structure. Full Set Industrialism for Japan2 should be changed to
Full Set Industrialism in the region or in the world. AFTA, although its scale is

1 In terms of effective exchange rates this appreciation was no smaller than the former one. Currently the yen depreciated to 130 yenldollar. This paper analyses this situation upto 1995.

2 Full set industrialism means the production within Japan of virtually all consumer, intermediate,and capital goods used in Japan, as had been the case in the 1970's.

ABE: TRADEAND IIVVESTMENTRELATIONS OFJAPANAND ASEAN 13

quite limited, has and will have an impact which leads Japan to move in thisdirection.

In this paper the issue of structural change in ASEAN and Japan and their relation is analyzed in a focused manner by reorganizing and aggregating the extensive data available on trade flows. First, we will review the status of Japan and
ASEAN in world trade in terms of shares, growth rate, trade intensities, and re-vealed comparative advantage (RCA). Second, the Japanese trade pattern will beanalyzed in more detail. The main objective here is to show the development of
intra-industry trade (IIT). To see the real specialization, however, our aggregation is not satisfactory. We will go into more detailed classification, that is, to the

SITC 5 digit level to examine the division of labor between Japan and theASEAN countries. Thirdly, we will review the development of direct foreign investment in this region, which prompted the above changes in the trade relationship. Fourthly, the prospect of further cooperation in trade and investment will

be discussed in reference to the recent regionalism; i.e. APEC,- NAFTA, andAFTA. The last section gives a conclusion.

2. Importance of ASEAN as Trade Partner of JapanThe average real growth rates of East Asia were much higher than those ofOECD countries. Despite the slowdown in the world economy, East Asia in the
1990's has maintained relatively high growth rates. The real economic growth
rates of selected countries in the region for the years 1988 through 1990 were as
follows: Thailand, 11.79e; Malaysia, 9.29o; Indonesia, 6.79o; Philippines, 2.89e;

Korea, 8.09o; Taiwan, 6.79o; Hong Kong, 4.79o; Singapore, 8.89o; China, 6.89o;
and Japan, 4.29o3.
In addition, this region's importance is self evident if we take into account thesize factor, i.e., population and GDP. There is no doubt that East Asia had beena growth pole in the world economy during the 1980's and in the early 1990's.
The U.S. and Japan are beginning to regard the Asia Pacific strategically indis-

pensable. The economic performance of the Asian NIEs (ANIEs), ASEAN, andChina contributed to this recognition. China is now a strong rival of ASEAN in
attracting foreign capital and exports of labor intensive products.

Trade Shares and High Trade Intensities: 1001o vs. 2001o Trade Importance

Table 1 gives a world trade matrix for 1980 and 1991 with Japan and ASEAN
being a focus. According to this table, the share of ASEAN's trade expanded
3 World Bank, World Table, 1993.

14

42 (1997), 11-54
KOBE ECONOMIC & BUSINESS REVIEW,

from 3.59o in 1980 to over 4.59o of the world trade in 1991. This size was roughly

half of the Japanese world trade share. The same table shows the importance of
ASEAN as a Japanese trade partner; its relative importance increased in exports(from 109o to 129e) while it decreased in imports (from 179e to 149o). Although

the share was greater in Japanese imports, the main items were non-manufac-

tures. The trade of ASEAN and ANIEs combined expanded almost 5 percentage
point in the world trade share. To this development the United States contributed

mainly in expanding imports while Japan mainly in expanding exports; Asian
NIEs increased both exports and imports. China increased its trade share with theregion most of all, the growth rate of trade being 16.1 percent. Asian NIEs con-tributed far more than Japan to this development; in fact, Japan and ASEAN4
contributed less than the world average. China is by far the fast trade expanding
country in the Asia-Pacific region. China's exports to ASEAN4, in fact, increased
by 24 percentage point.

Table 1 VVorld Trade Matrix
Trabe Madx: 1980 (miIlion ef US$)rvorld usu

Japen "t Kmu reh,ren Cha

snj.

Nof nloi intlo. nv. etbv",' Rew AsEANs

ASEAN5

1,895,500 239,562 123,667 22,057 19,376

t9,73317,e30 25,7eT 10,761

8,644 11,039 8,t86

566 1,388,292

64,9S339,1964,673

O 3,e33 1,337

1,263 t,M5 1,999

70 178,698

9,247

6,2t4

Japen

220,781 O 20,7oo 2,6S8 4,6S5
130,435 31,9tO O 4,784 5,393

5,353

5,1ce 3,9re 2,07e

1,925 3,476 t,692

89 ec,7ou

13r181

9,252

Hong Kong

19,720 5,157 9oo O 227

1,249 e63 t76

2,207

1,3"

tT,439 4,624 3,039 823 O

868

19,Sll 6,760 2,t73 1,551 267

China

18,139 983 4,e32 4,353 O

O 7,609
4 7,491
O 7,576

1,134

Tetwan213 617 328
t65 366 t53
i76 4T8 195

tO 9,721

Koree

2se
ro9

Sngapore

19,377 2,424 1,5oo 1,496 289

4,303

12,seO 2,119 2,958 244 262

277 8,776
23 3,812

4,303

Mataysia

2,923

cu

thailand

6,50t 823 9S2 33e 49

ee

t,os4

21,oo9 4,303 tO,793 152 O
Philh' pm'nnes
5,787 1,594 1,540 192 203

4,589 395 3,253 1 O

sco
lt7
75

1,398,052 17e,47t 71,638 5,444 e,oo1

ASEAN6 Tl,123 tl,65T 21,085 2,414 803
ASEAN5 51,746 9,233 t9,525 918 5t4

wond
usu

tncionesia

Brvnei

ROW

o
e
222
425

O 267 tec
O S45 l70
O 421 184
so7 0 2,eo9
217 2,480 O
t24 503 re2
0 2,484 60

312 21 25S

8" O 273

t88 34 19S

e 237 23

1,023

1,1os

775

O 282

380
5e5

562
276
268
2S4

3,271 4,158 2,e35

801,091,505

24,43413,5e4t,3t9 378 727

313 20,987

12,O166,t36

475 378 454

36 t2,2M

7,713

1,833

O 30t 44

35 O 18I
63 107 O
189 O 51

7,780

tO,779 10,M9 3,240

t,468

693 5,879 3,4oo

1,2os

386 5,879 491

45 113 94

9 3,039
O 3,362
3 1,716

1,568

2,760

Tracte Matrix: tco1 (million of US$)

WOrld USA Jepan HK Kome rininten Chinewt"ld,4sc,4oo 4oo,74t 213,095 97,7i5 70,765 M,716

Ust

421,755 O 4S,147 8,141 15,548 12,612
3i4,e92 92,anC) O16,337 20,088 16,os9

sop. Met rhthi[ liNlo. pnv. etvtlei Raw

ASEANS ASEAN5

62,795 6i,975 32,sc3

33,636 t9,236 f2,S64

1,6co 2,302,Sre t6t,T"

99,769

O 8,BOS 3,oo2

3,758 1,8g2 2,269

11,9e38,oo5 42.228 7,M9

9,446 5,6ie 2,663

162 316,547 20,791
129 123,e61 37,732

98,579 22,391 5,308 O 2,111 1,"6
69,489 18,3tl a2,lgs 4,641 e 1,3"
67,214 21,746 e,346 e,556 1,213 O
71,986 6,192 10,265 32,lil 2,177 O

26,736 2,688 7tl

t,e73 705 916

3,427

so7 2,4su t,117

O 2,2ou 1,1ou

1,350 t,048 632
1,424 1,2ca 81t

O 2,O13 527

M7 481 253

21 34,473 6,115
2 26,tlO 5,583
2 20,563 6,7oo
lt t7,109 4,132

85e 0 8,800
63g e,o2o o3,706 O 681

553 20,724 t3,740
117 8,793 10,037

13,740

Mataysia

59,SS8 11,674 5,133 4,260 t,393 1,4os
34,405 5,808 5,458 t,152 1,514 1,oo3

lhaitend

27,824 6,O16 5,1ou 1,297 46S 448

419 2,1ou 6tO

30 lt,02S 3,044

lndonesia

29,142 3,509 10,767 703 O 922

1,19i 2,410 342

O 145 96261 O t6S

Phitlipinnes

8,B40 3,151 1,77t 392 22S 236

128 229 123

dnnei

2,597 26 1,365 6 256 90

ROW

2 168 1

880
T77
387
28e

2,248,489 299,717 99,236 20,120 25,800 19,140

Jopen
Hong Kong
Kotea
TaivanChina&'ngapcve

ASEAN6 161,996 30,184 29,599 7,810 3,S5B 4,t05
ASEAN5 102,808 18,slO 24,466 3,5sO 2,466 2,6gg
Source: Celculated based mpon jMF Direcbon ef Trade

1,098 503 301

221 42 O
a89 O 89

O 6i864 3,18T

1 2,317 617

O 405 448

25,504

4,t48
4,58T
2,119

2,elB

23,9M 18,609 7,457 le,259 7,557 3,985

661 1,712,035 48,529

29,9203,236 12,99t 9,e76

5,480 690 1,334

IS,0842,3T8 12,9gt 1,OT6

t,7T4 690 653

702 52,131 31,073
t48 3t,406 t7,333

4,342

ABE: TRADEAND INVESTMEIVTRELATIONS OFJAPANAND ASEAN 15

On the other hand, for ASEAN, Japan has been the largest trading partner. As
an ASEAN's export partner, Japan's share was 309o in 1980, dropping to 189o in
1991, which corresponds with the above observation. Japan increased its importance as ASEAN's import partner from 20 9o in 1980 to 239e in 1991.

Although these development occurred over the past decade, Japan regards
ASEAN as roughly a 109o trade partner while ASEAN regards Japan as a 20%
trade partner. Japan's importance to ASEAN is twice as large as that of ASEAN
to Japan in their trade relationship.

Another way to see the trade dependence is by trade intensity4. Table 2 gives
these figures. This intensity shows how different particular bilateral trade relationis compared with the world average. Japan-ASEAN trade intensity dropped from2.95 in 1980 to 2.56 in 1991. (ASEAN-Japan figure, i.e., ASEAN's exports toJapan, changed from 4.54 to 2.96.) The corresponding figure for the U.S.ASEAN changed from 1.22 to 1.05. Thus, although the intensity dropped, Japanwas more strongly tied with ASEAN in trade than the case of the United States.

Among ASEAN countries, Japan had the largest trade intensity with Indopesia(3.20), followed by Thailand (3.08), Malaysia (2.59), Philippines (2.27), and Sing-

apore (2.16). The intensity with Korea and Taiwan was at the similar level aswith Indonesia. Asian NIEs also dropped their intensities with Japan between
1980 to 1991.

One possible explanation of this result is the following. The two successive oilshocks and various trade frictions taught a lesson to this region about the import-

ance of diversification. Japan and Asian NIEs diversified trade of oil away fromIndonesia and Malaysia; Indonesia and Malaysia did not intend to diversify but
there was no other choice. Thus, the trade intensity indices of this region did not
rise during this period although the intensity levels were already high.

Another interesting finding is that although ASEAN6's intensity was 4.10,
ASEAN5's one is much lower, 1.46, in 19915. This is because Singapore andMalaysia showed very high trade intensities with Brunei, 19.11 and 6.96 respectively .

In sum, although the absolute trade volume of ASEAN grew rapidly, the rela4 The direction of trade for the Asia-Pacific countries is prepared from the IMF Direction of Tradestatistics and a direct source of Taiwan, Statistical Yearbook of the Republic of China. The compiled
table is an export based one for 1980 and 1991. For some countries 1991 figures are not available atpresent time. In such cases 1990 figures are used instead (Taiwan); for some countries figures are
not available at all(USSR). In such cases trade partners' import data are used without any modification. The difference between CIF afid FOB should be duely considered. However, this amendment has been done for less than 59o of the data and for minor countries only.

5 ASEAN6 consists of Indonesia, Malaysia, Singapore, Philippines, Thailand, and Brunei. ASEAN5

excludes Brunei from ASEAN6.

& B USINESSREVIEW, 42 (1997), 11-54
KOBE
ECONOMIC

16

tive

share and trade mtenslty with Japan dropped for the period

between 1980

and 1991.
Table 2 Trade Intensity

Index

1980

USA Japan HK Korea Taiwan China sing,

MaL Thai.

ASEAN6ASEAN5
ROW

lndo. Phil. Brunei

USA

o.oo

1,44

1,05

2,08

2,03

O.OO 1,Ol 1,07

1.25 1,20 2.10

1.06

1,11

t,22

1.36

Japan

1,94

o,oo

3.15

4.04

3,94

4,16 2,21

2.80

3,24 4,58 3,OO

2,28

O.68

2.95

3.43

Hong Kong 2,07

O.71 o.oo

1.13

1,22

6,73 3.22

ri.57

2,37 5,37 3,85

1.70

O,67

3,26

3.29

Korea

2,10

2,67

4.06

o.oo

1,15

O,OO 1,12 1.86

2,08 3.60 2.03

O.04

O.60

4,90

2.41

Taiwan

2,70

1,68

6,73

1,32

o,oo

O,OO 2,02 1.51

1,95 4.14 2.28

O.67

O.52

2,31

2,50

China

O.43

3,41 20.62

o,oo

o.oo

O,OO 1.7t 1,79

3.77 O,20 3,29

o.oo

O,57

1.92

2,07

Singapore

O,99

1.23

6.63

1,46

IAO

1,69 O,OO 26,44

9.55 O.OO 3,27

47.9f

O,62

6.48

10,74

Malaysia

1,29

3,50 1,61

1,98

3.15

1.78 14,06

o.oo

3.19 O.45 3.53

5,99

O.40

6,58

1.66

Thailand

1.00

2.31

4.36

O.74

1,33

2.02 5,68

7.92

O,OO 6,25 O.84

4,79

O.64

4,78

4,18

indonesia

1,55

7,55 O,60

o.oo

2,37

O,OO B,33 O,48

O,35 O.oo 1,92

o,oo

O.21

3.67

O.61

Philtipinnes

2,18

4,08

2,85

3,43

t,95

O,83 1,43 2.87

2,39 3.t8 O.OO

t,85

O,40

1.92

2,24

BrvneiO,68

10.86 O,02

o,oo

1.56

O.OO 4.81 1,70

9.01 O.OO 2,58

o,oo

O,08

3.72

2,99

ROW

1,Ol

O.79

O,33

O,56

O,53

O,82 O.57 O,41

O.51 O,51 O,47

O,19

1,07

O,51

O,47

ASEAN6ASEAN5

1,30

4,54

2,92

1,10

1,98

1,04 6,08

8.42

4,07 O.9t 2,37

14,73

O,40

493

4.17

t,4t

5,78

1,52

O,97

2,31

O,79 8,35 1,67

2,Ol 1.25 2,03

2,31

O,32

4.35

171

1991

USA Japan HK Korea Tatwan China Sing,

MaL Thai.

lndo. PhiL Brunei

ROWASEAN6ASEAN5

USA

o.oo

1,85

O,68

1,80

t.89

o,oo

1,t6

O,99

O.91 O.8t 1,44

O,79

1.t3

1,05

O,98

Japan

2,06

o,oo

1,es

3,11

3.22

1.50

2A6 2.59

3,08 3.20 2,27

O,84

O.59

2.56

2,80

Hong Kong 1,60

O,87

o.oo

1,05

O,93

l4,92

1.52

O,77

1,12 1,28 2,50

O,44

O,52

1,32

1,20

Korea

1,85

2,84

2.36

o.oo

1,22

O.24

1.95

1,72

tS9 2,71 2,44

O,05

O,56

2,02

2.07

Taiwan

2,28

2.01

4.50

O.88

o,oo

o.oo

t,83

1.75

2,18 3.33 3.24

O.07

O,46

2.t6

2,36

China

O.61

2.31 15.77

1.48

o,oo

o,oo

1,56

O,78

1,21 1,20 O.94

031

O.36

4.23

1,02

Singapore

1,39

1,41

IA5

1,50

O,80

o,oo t5,88

6.43 O,OO 3,09

19,11

O.53

4.96

8,04

Mataysia

IA9

2,57

IAB

2,15

1,84

1,02

12,99 o,oo

3,28 2,62 2,35

6,96

O.38

6.23

2,03

Thaitand

1,52

2,97

1.65

O,82

1.02

O,83

4,34

2,34

O,OO O.94 O.92

2.20

O,59

2.34

1.10

Jndonesia

O.85

5.99 O,85

OiOO

2,OO

2,25

4.61

t,25

O,94 O.OO 1,55

o.oo

OA6

2.34

O,92

Phillipinnes

2,51

3,25 1,57

1.26

1,69

O,80

1,45

t,49

2.57 O,85 O,OO

O,23

O,39

1.49

1,52

BruneiO,07

8,52 O,09

4,80

2,19

O,04

3.61

O,06

7,46 O.02 9,24

o,oo

O.23

3.68

3.73

ROStV

094

O,72 O,32

O,56

O,54

O,58

O,46 O.35

O,47 O.60 O.48

O,60

M4

O,46

O,46

ASEAN6ASEAN51,31

2,96 1,70

t,16

1,60

1,10

4,47

6.51

3,47 O.76 2.21

8.85

O.48

4,10

3,86

1,27

3,86 1.22

IA7

1.66

1,27

7,04

1,12

1.77 1,21 1,71

2.95

O.46

3.60

1,46

2.54

Source: Calcuiated based upon IMF Direction of Trade ,ABE: TRADEAND INVESTMENTRELATIONS OFJAPANAND ASEAN 17

Drastic Changes in Trade Structures

The above treated simply gross trade nelationships and we will now turn toproduct breakdowns. Asia's increasing trade shares accompanied rapid and drastic

structural changes. One way to examine these changes is to look at the revealed

comparative advantage (RCA) index6. In Table 3 the RCA indices were shownfor Japan, the United States, Singapore, Hong Kong, Thailand, and Indonesia.
This table only lists the highest 15 RCA industries both for 1980 and 1988.

In Japan, while iron related products and woven textiles lost RCA, electronics

related machines and various other machines gained RCA. The changes of the
RCA structure of the United States were not substantial except the coal and pet-roleum industry, which gained RCA drastically. For the developed countries likethe United States and Japan the RCA structures change at a slower pace. The
rankings of RCA for 1980 and 1988 are not much different, i.e., most of the top
15 industries in 1980 ranked within the top 15 in 1988. This is more true for theUnited States.

Singapore gained RCA in office machines, nickel, coin, and office supplies
while she lost RCA in special transactions, crude materials exciuding fuels, clo-

thing, watches and clocks. The RCA index for machinery increased in Singapore.

Hong Kong's RCA structure scemingly did not change much in terms of rankings
but when we closely look at the values of RCA, Hong Kong lost RCA in watches,clocks, toys, clothes, and cinema films, all the labor intensive products. Thailand

gained RCA in leather manufactures, gold, silverware, jewelry, clothing, travel
goods, footwear, toys, pottery, electric distributing machinery and domestic elec-

tric equipment. Most of the top listed industries in 1988 were new ones in Thailand. This shows how drastic the change of the trade structure was. Accordingly,
Thailand lost RCA in silver, platinum, crude rnaterials, zoo animals, pets, woven

textile, cutlery, and some of the parts industry. For Indonesia substantial RCA
rises were found in veneers, lace, ribbons, wood manufactures, woven cotton fabrics, aluminum, and iron in primary forms. Indonesia lost RCA in developed cine-

ma film, beverages and tobacco, and some electrical machinery. The pattem of
6 The revealed comparative advantage (RCA) is a useful concept to see directly in which products
one country has a relative strength in exporting. The RCA measures the relative strength as is revealed in the actual exports data. It is the ratio of the strength of that product of this country to theworld average strength of it. The formula of the RCA is:

X••/X. -RCA iJ == Xiw X• w)
where subscripts mean the following.
i: commodity i, .: all the commodities, j: country j, and w: the world.
The RCA is a good proxy of international competitiveness. To calculate RCA we used SITC 3 digit
data for 5 to 9 categories and one digit for O to 4 categories. This is because we weigh more on
manufactured products. The most recent data available is 1988, which is compared with 1980 fi-

gures.

18

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 11-54

Indonesia was similar to Thailand but the change of Thailand was more impressive.

With the limited observation as above we can see the rapid changes in the
rankings of RCA in ASEAN countries. For developed countries more technology
intensive products gained RCA, NIEs gained RCA in less sophisticated products,

and developing ASEAN gained in more labor intensive products. The speed of
the change, however, is remarkable. This is indicative of the existence of Flying
Geese Pattern of Development in Asia. Japanese strong RCA industries in the past

became the strong RCA industries of ANIEs, and ANIEs' strong RCA industries

became the strong RCA industries of ASEAN now.
Japan-ASEAN Trade Relationships
Let us, next, look specifically at the trade relationship between Japan and
ASEAN countries by regrouping detailed trade data into manageable size of industry categories. This is to project how ASEAN might develop in the future byreferring to the current Japan-ANIEs and Japan-U.S. trade relationships.

Regarding the exports to Asian NIEs, machinery, semiconductor, and industrial

machinery expanded drastically. In particular when Japanese FDI expanded to
Asian NIEs, machinery exports increased. Japanese export items consisted of
automobile parts, electronic parts, industrial machinery, steel, and non-ferrous
metal. As was true for the ANIEs, Japan proved to be a supplier of capital goods

as well as intermediate goods. In the area of machinery ASEAN increasingly
raised the dependence on Japan since the latter half of the 1980's. Japan still im-

ported petroleum and other raw materials from ASEAN. Since 1988, however,drastic increases were found in miscellaneous manufactures such as clothing, bags,

and footwear; since 1989 machinery such as parts of office machines, computer,audio-video equipment expanded to a large degree. The share of non-manufactur-

ing products in Japanese imports from ASEAN decreased to less than 70 percent
and the ratio of machines increased to almost 10 percent in the early 1990's,

Table 5 investigates 10 major traded items out of 47 commodity categories7. It
is surprising to find out that just 10 major commodities trade accounted for morethan 859e of exports and 759o of imports. Regarding the exports from Japan to
the U.S./Canada, Japan's exports of commodity categories 29, 40, 42, and 41,
totaled 749o in 1990. This pattern was true for any other sub-regions of the Asia-

Pacific. For imports, Japan's imports of non manufactures (NM) was the largest
category from all the regions. This was followed by categories 40, 42, 43, 41, and
29. As far as we can see, there exists a possibility of IIT in the four manufactured

goods which appeared twice above.
7 Table 4 gives the 47 categories. These categories are further aggregated to four manufacture groupings. This typology is similar to Krauss (1988).

INVES TMENT RELA TIONSABE: TRADE AND
OF JA PAN AND
ASEAN19

Table 3 RCA of Selected Countries
Japan
Order of t980 RCA

V980 f988

Order of 1988 RCA

RCA rank RCA rank

1980

t988

RCA rank RCA rank

891--Soundrecorders,produ

6,10

1

3,99

1

e91-Soundrecorders,produc

6.10

t

3,99

t

735--Ships and boats

4A1

2

2.01

9

724-Teiecommunicationseq

3.sc

4

2.45

2

678-lron,stltubes,pipes,etc

4.09

3

1,81

12

729--Electrical machinery ne

1.66

29

2.24

3

724--Telecommunicationseq

3,54

4

2,45

2

732-Road motor veticles

2,99

8

2,22

4

674--lrn,stluniv,plate,sheet

3,op

5

2,09

8

862-Photo,cinemasupplies

1,82

25

2,21

5

666-Pottety

3,06

6

t,47

18

861--instruments,apparatus

2.86

9

2,21

6

864--Watches and docks

2.99

7

1,63

17

715--Metalworkingmachinery

1.89

24

2,20

7

732-Road motor vehlcles

2,99

8

2.22

4

674--Irn,sti univ,plate,sheet

3,44

5

2.09

8

861-Instruments,apparatus

2.86

9

2.21

6

735--Ships and boats

4,11

2

2.01

9

696--Cutler)f

2.66

10

1,30

22

717-Textile,leathermachnry

1,68

27

t,86

10

673--lron and steel shapes

2,65

11

1,OO

31

895-Office suppiies nes

t,96

t9

1,85

11

672--lron,stt primary forms

2,51

12

O,87

36

678--lron,stl tubes,pipes,etC

4.09

3

1,Bl

12

653--Woven textjles noncotto

2.36

13

O,90

35

714-Officemachines

L19

40

1,81

13

694t-Stl,copprnails,nuts,etc

2,24

14

t.36

21

726--Electro-medcl,xrayequi

O,93

50

1.77

14

723--Electr distributing mach

2.21

15

1.07

27

722--EIec pwr mach,$witchge

1.72

26

1.75

t5

USA

V980 f988
RCA rank RCA rank

t980

V988

RCA rank

RCA rank '

4
3

3.50

f

3.36

2

t,33

24

3.3f

3

7,16

2

2,39

4

1.81

16

2,OB

5

56t--Fertilizers manufactured

2,03

12

2,04

6

9

S96-Works of art etc

3,88

5

1,96

7

1,77

10

521-Coal,petroleumetcche

O.17 105

1,89

B

9

1,67

12

726--Electro-medcl,xrayequi

2.32

1.82

9

2.12

10

O,99

32

689-Non-ter base metals ne

2.16

1.77

10

2.08

11

IA8 22714-Officemachlnes

2,63

t,76

lt

561-Fertilizersmanufacture

2.03

12

2.04

6

71 1-Power machinery non-el

2.15

7
s
6
9

1,67

12

729--Electricalmachineryne

2,OO

13

1,54

13

729--Electricalmachineryne

2,OO 13

1.54

13712-Agricultvralmachiner)r

1,97

14

1.29

19

2-Crude matls exci fueis

1,74

17

1,44

14

862--Photo,cinemasupplies

1,S9

15

1.14

25

514-Othrinorganicchemical

1.68

18

1.39

15

840--UN special code

7.18

1

o,oo

111

95t-Warfirearms,ammunitio

3,96688--Uranium,thorium,a"oys

7,16

2

2,39

4,

734--Aircraft

4,03

734--Aircraft

4,03

3

3.36

2

931-Specialtransactions

951--Warfirearms,ammunitio

3,96

4

3,50

1

6B8-Uranium,thorium,alloys

896--Works of art etc

3,88

5

1.96

7

51 5-Radioactive etc material

714--Oracemachines

2,63

6

1.76

ll

726--Electro-medcl,x;ayequi

2,32

7

1,82

689--Non-fer base meta)s ne

2,t6

8

71 1 -Power machinery non-e

2.t5

863--Deve[oped cinema film

71B--Machsforspclindustry

Singapore1980 I988

I9SO

t9e8

RCA rank RCA rank

RCA rank

RCA rank

521-Coal,petroleum etc che

21,M

1

6,60

2

687-Tin

6,73

3

9,99

t

931--Specialtransactions

7,42

2

O,49

55

521-Coal,petroieum etc che

21.54

1

6,60

2

687--Tin

6.73

3

9,99

1

7t4-Office machines

O,53

39

3.89

3

4-Animal,yegetableoil,fat

4,34

4

3,36

5

724-Telecommunicationseq

3,65

3,68

4

631--Veneefs,piywood,etc

3,73

5

1,81

10

4-Animal,vegetableoil,fat

4,34

6
4

3,36

5

724--TelecomrnunicatioRseq

3,65

6

3,68

4

3-Mineral tuels etc

a.29

t2

2,53

6

729--Electricalmachineryne

3,10

7

2.38

7

729-E[ectricai machinery ne

3.10

7

2.38

7

735-Ships and boats

2,56

B

1.34

14

891--Soundrecorders,produc

1,49

11

2,32

s

2-Crude matls excl fuels

1.85

9

O.84

29

683--Nickel

O.11

97

2,26

9

911--Mail not classed by kind

1.49

10

1.03

20

631-Veneers,plywood,etc

3.73

5

1.81

10

891-Soundrecorders,produ

i,49

11

2.32

8

961--Coinnongold,noncurren

O,05

103

t.69

11

3--Mineral fuels etc

t.29

12

2,53

6

B95-Orncesuppliesnes

O.54

37

1,64

12

725--Domesticelectricequip

1.21

13

t,16

t5

722-Elec pwr mach,switchge

t,05

16

1,64

13

864--Watches and ciocks

1.20

14

O,96

21

735-Ships and boats

2.56

8

t,34

14

B41-Clothingnotoffur

1.10

15

1,04

18

725--Domesticelectricequip

1.21

13

1,16

15

20

REVIEW, 42(1997), 11-54& BUSINESSKOBE ECONOMIC

Table 3 RCA of Selected

Countries (concluded)

Hong Kong

I980 1988
RCA rank RCA rank

1980

1988

RCA rank

RCA rank

961-Cojnnongo)d,noncurren

23,89

i

2.41

21

675--lron,steelhoop,strip

O.12

88

27.61

1

864--Watches and clocks

19.09

2

9,34

3

831-Travelgoods,handbags

le.78

6

9,57

2

894--Toys,sportinggoods,etc

13,03

3

8.B8

4

864--Watches and clocks

19,09

2

9,34

3

B41--Clothing not of fur

12.le

4

6,24

6

B94-Toys,sportinggoods,etc

13,03

3

8.88

4

842--Fur etc clothes,prod

lt,33

5

8.07

5

842--Furetcdothes,prod

11.33

5

8.07

5

83t--Travelgoods,handbags

10.78

6

9,57

2

841-Clothing not of fur

12,10

4

6,24

6

899--Othermenufacturedgo

B,96

7

5.33

7

8g9--Othermanufacturedgo

8,96

7

5,33

7

652-Cottonfabrics,woven

7.57

8

5,OB

8

652--Cotton fabrics woven

7.57

8

5,08

8

656--Textile etc products nes

6.50

9

2.38

22

696-Cutiery

2,74

18

3.74

9

863-Develeped cinema filrn

6.01

10

2,81

18

653--Woven textiles noncotto

2,3e

21

3.64

10

911-Mail not classed by kind

4.70

11

3,02

15

697--Base mtl household equ

4.63

12

3,38

11

697-Base mti househoid eq

4.63

12

3,38

lt

891--Gotd,si[verwefe,iewelry

4.32

14

3,27

T2

725--Domesticelectricequip

4.42

13

3.0B

14

613-Fur$kinstanned,dresse

O,68

50

3.17

13

897--Go(d,silverwafe,jewelfy

4.32

l4

3,27

12

725--Domesticelectricequip

4,42

13

3.0S

14

571--Explosives,pyrotech pro

3.72

15

2,36

23

9"-Mail not classed by kind

4,70

11

3.02

15

'

Thaitand

V980 1988

19BO

1988

RCA rank RCA rank
6B7-Tin

46,28

1

10.00

1

O--Food and live animals

RCA rank RCA rankt
46.28
10.00 t4,74
2
4.28 4612-Leather etc manufactur

021

43

8,46

2

6B7--Tjn

931-Specialtransactions

4.t4

3

O,42 50

B97--Gold,silverware,jewelry

1,54

14

6,05

3

632--Wood manufactures ne

3,82

4

2.80 9O-Food and live anirnals

4.74

2

4,28

4

656-Textile etc products nes

3.71

5

2,51 12841-Clothing not ef fur

2,04

12

4.11

5

722--Eiec pwr mach,switchge

3,39

6

O,40 52

831-Travelgoods,handbags

1.32

17

3.93

6

681-Silver,platinum,etc

2,65

7

e.ol IDo

667-Pearl,prec-,semi-pston

2.48

8

3,93

7

667-Pearl,prec-,semi-pston

2,48

8

3,93 7

851--Foetwear

O.38

33

3,10

8

652--Cottonfabrics,woven

2.48

9

1,48 17632--Wood manufactures ne

3.82

4

2.80

9

2--Crude matls excl fuels

2.33

10

1.40 18

899-Othet manufactufed go

1.32

18

2,54

10

94t-Zoo animals,pets

2.29

lt

1.10 29894--Toys,spodinggoods,etc

O.10

60

2,53

11

841-Clothing not of fur

2,04

12

4," 5

656--Text"e etc products nes

3.Tl

5

2.51

12

653--Woven textiles noncotto

1,93

13

1,36 20666--Pottery

O.22

42

1.99

13

89T--Gotd,silverware,iewe(ry

1.54

t4

6,05 3

T23-Eiectrdistributingmach

O,16

47

1.74

t4

696--Cutlery

1,49

15

O,51 43

725-Domesticelectricequip

O.05

74

1.65

15

lndoneisa

198e 1988
os7--Tln
3--Mineral fuels etc
2--Crvde mat)s excl fvels

4-Animal,vegetebleoil,fat

RCA rank RCA rank
10,49
1
23,44 2
3,66
2
6,75
3
2.65
3
2.49
8
2,13
4
6,Ol
4

1980

f988

RCA rank

RCA rank

531--Veneers,pSywood,etc

O.97

6

35.44

1

6B7-Tin

10,49

1

23.44

2

3-Mineral fuels etc

3,66

2

6.75

3

4-Animal,vegetableoij,tat

2,t3

4

6,Ol

4

551-Essentloil,perfume,etc

1,02

5

1.28

16

654--Lace,rbbons,tulle,etc

o.es

23

4.56

5

631--Veneers,plywood,etc

O.97

6

35.44

1

661-Cement etc bui[ding pro

O,48

9

2,9e

6

863--Developed cinema film

O.92

7

o,oo

ID7

632--Wood manufectures ne

O.11

21

2.50

7

O-Food and live animals

O,63

8

1,2e

18

2--CFude matls exÅëI fuels

2,65

3

2,49

8

661--Cementetcbuildingpro

O,48

9

2,90

6

561--Femilizersmanufactured

O,31

11

1,96

9

532--Dyes nes,tanning prods

O,39

10

D.98

22

B41-Clothingnotoffur

O,22

13

1,78

10

561--FertIIizefs manufacture

O,31

11

1.96

9

652--Cotton fabrics,woven

O,03

35

1.62

11

1--Beverages and tebacco

O,28

12

O.47

37

653--Woven textiies noncotto

O.t4

19

t.55

t2

S41-CIothing not of fur

O.22

13

1.78

to

684--Aluminium

O.Ol

48

1,54

13

67T-Pig iron etc

O,21

14

1,47

14

67t-Pig iron etc

O,21

14

1.47

t4

729--Electricalmachineryne

O.18

15

O,08

62

672--lron,stl primary fofms

o,oo

97

1.34

15

Source/ Calcvlated based upon OECD trade data,

INVES TMENT RELA TIONSOF IAPAN AND
ABE: TRADE AND
ASEAN21

Table 4 Classvacation ofTraded Goods
SiTC

SITC

SITC

Rev, 1

Rev, 2

Rev.3

1 teather61

2 Wood

63

61
63

6t
63

3 Mineral manufactures

661-3

661-3

661-3

4 Precious stones

667

667

5 Pig iron

67t

671

6 Nonferrous metals

68

68

667
67t
68

Natural Resource lntensive (NRJ

Unskilted Labor lntensive {UL)

7 Texitles

65

65

8 Glass and pottery

6646

664-6

9 Ships735793

10 Sanitary, plurnbing, heating and lighting fi

81Sl

11 Furniture

82

82

12 Travelgoods83

t3 Apparei

84

83
84

14 Feotwear85

15 Plasticanicles

893

65
6646
793
8t
82
83
84
85
893
894

16 Toys894

17 0Mce supplies

895

18 Manufactured articles, n,e,c.

899

85
893
894
895
899

53
55
62
ou

53
55
62

22 Paper

53
55
62
ou

23 Steel

672-9

672-9

672-9

24 Metel rnanufactures69

25 Television receivers

7241

69
76t

69
761

762
763
775
78
791

762
763
T75
78
791

895
899

Human Capital lntensive (HC)t9 Paints

20 Perfume
21 Rubber

26 Radios7242

27 Phonegraphss, recorders

S9111

28 Household-type electricai machinery

725

M

29 Road vehides

732-733

30 Rajlway vehicles

731

3t Watches

B64

32 Printed matter

892

885
892

S85
892

33 Antiques and jewelry

896-7

896-7

896-7

34 Musicalinstfuments

S98

89B

egs

rechnology lntensive (TC)35 chemical elements
36 other chemicals

51
52,57,59

51

51

52,57,59

52,57,59

sc
56
58

54
56
5S

40 nonelectficalmachineray

54
56
58
71

71-5

71-5

4ttelecommunication equipment

724

7ou

764

42 electfical raachinery otheT than 775

724,-725)

77(-775)

77(-775)

792
87
88t-4

37 medicine
3e fertilizer(chemical)

39 piastics

43 aircraft

7sa

44 scientificinstruments

861-3

45 photegraphicgoods

861-3

792
87
8814

Others (OD

9

9

9

Non-Manufactures (NM)

04

O-4

oq

22

(1997), 11-54
BUSINESSREVIEW, 42
KOBE ECONOMIC&

Table 5 Major Traded Goods: 45 Categories

GrowthShere ii

do"ers

nete

rtede

19e5 19su

S5sc

199a

Exports in m", US

Secterslmperts in m". US
Secters

USA end Canede

6rorvthShere indo"ers

Rete

Trede

19e5 r99V

8590

19su

USA end Cenede

29
ua
42

25,4M

32,581

5.05

33.47

strco-4

15,532

26,546

11.32

43.83

12,43924,68e

14.69

25.36

2,854

6,S41

19.11

11.30

4,452

S,773

14.53

9.01

40
42

1,4M

3,651

20,06

6.03

4t

3r497

5,197

8.24

5.34

slrcy

1,131

3,2M

23.55

5.37

sircg

3,461

4,629

5.99

4.]6

IA52

2.961

15.31

4.89

2Z
45
23
44
24

5,316

3,ss7

-8.78

3.45

1,442

2,545

12.03

4.20

1,669

2,413

7.66

2.48

43
36
6

2,O02

24.53

3.31

2,sc3

2,243

•5.29

2.30

u

668
919

1,9T3

T5.79

3.16

905

1,995

17.14

2.05

7,14

2,07

1,374

IAI

990

53.91

1.63

61.43987,250

120
727

886
114

1,251

1,295

35
29

89,ca

sub tetel

26,463

51,953

14.44

85.7S

887

5,557

an.35

31."

slrco-4

15,08618,205

4

78

1,059

3,855

29A7

21.81

2

1,077

2,379

33.71

13.46

1,802

15Je

1020

6
40

69
-2

5

557
869
216
83
11D
150
75
79
4,OM

79
596
50

61

2

682
472
353
325
314
256

25.S9

3.e6

SI TC9

102

2.67

25.28

zoo

16.75

1.84

33.32

1.78

1

1,45

57
45
5
D
o

"e

26.52

42
4
13
11
41

38
45
46
116

2

41.67

tS,995

31.40

9e.51

sztb tetet

le,O19ANIES

1-- --+-

4e
42

3,91S

12,19825

23

strce-4

3,935

3,3BO

9,871

24

19

13

slrcg

1,361

3,316

19

SITCS

23
29
4r

1,715

3,pa8

12

1,054

2,844

22

827
637

2,235

22

StTCO4

1,987

26

3fi

181

1,865

59

7
35

1,1sc

1,792

8

524

1,588

25

6
6
5
4
4
4
3
3

23
42
4a
7
16
14
4i

935
874
529
427
235
387
161
227
125

sub tetel

14,791

40,7"

22.46

77.46

sub tetal

42,122

M,298

28,43061,518

25
24
11

ua
fi

sub totel

ASEAN

to
29
42
23
4i

36
S/TC9

24
35
sirco-4
sub totst

ASEA"

ArvIESSt TC9

23
27
45
9
44
sub totel

296
250
220
158

2

2
1
1

1

na

6.72

95,S2

6,743

11

28

3,280

29

13

2A18

23

10

1,572

24

6

1,446

28

6

22,177

1,411

43

6

707

13

3

707

sc

3

7e3

25

3

638

38

3

7,836

19,625

20.16

80.14

slrco-4

87,589115,092

slrcg

3,D85
3,934
3,68D

12.705
12,209

6
33
25

9,381

21

1,4M
728

7,832

2,199

6,456

39
58
24

52
6
5
4
4

Wodd

Worid

29
40
42
41

547
543
514
368

12,78628,310

6.745
7,226

14,241

12,518

9
17
17
16
12

11,995

tO,868

•3

8,512
3,408

8,933

1

6,so2

5
5
4
3
2
2
2
83,26

5,820
2,D28

4,226

t3
•1
16

129r071

215,ou6

10.83

5,430

13
29
42
33
36
35
sub totai

3,579

75
16
t4

3
3
2
2
2

IS4,260

11.45

82,57

7,2"

312

5,141

2,245
1,883

4,621

107r139

ABE: TRADEAND INVESTMENTRELATIONS OFJAPANAND ASEAN 23

Out of 47 categories of goods, sector 29, automobiles, and sector 40, non-electrical machinery, shared roughly 259o each and sector 42, electric machinery ex-

cept home electronics shared 119o in Japanese exports to the world. The growth
rates of sectors 40 and 42 were more than 16.5%. Only a few selected items moreor less monopolize the export trade scene; this is a characteristic of the Japanesetrade.

As far as imports are concerned, the major portion of imports went to nonmanufactures, 36.19o in 1990. The rapidly growing items were SITC 9 (OT) and
sector 40, non-electric machinery, sector 6, non-ferrous metal, sector 13, apparel,and sector 29, road vehicles. The rate of growth was very rapid, more than 20 9o

per annum; in the case of sector 29, the growth rate recorded was 589o per

annum.
In the same table we showed Japan-ASEAN trade relationships for 47 categories of goods. As is observed for ASEAN as a region, the trade is a one-sided
game, i.e., Japan exported most of the technology intensive and capital intensive

goods in large amount while ASEAN exported to Japan natural resources. andlabor intensive goods constantly and high tech and capital intensive products only
recently. Indonesia and the Philippines began exporting even labor intensive products only in recent years.

This is roughly the picture of the Japan-ASEAN trade in the past.
We will analyze in more detail, i.e., at the SITC 5 digit level, to see if there
are differences between Japan's trade with selected Asia-Pacific countries, i.e.,the U.S., Korea, Taiwan, Hong Kong, Singapore, Malaysia, Thailand, Philip-

pines, Indonesia, and China. We included non-ASEAN countries to see if how
ASEAN will evolve in the future to follow the Flying Geese Pattern. As was ex-

amined in the former sections, intra-industry trade was found in sectors 28(household type electric machinery), 29 (road vehicles), 40 (non-electricalmachinery), 41 (tele-communication equipment), and 42 (electrical machinery
other than household type). We will investigate and verify the trend of intra-industry trade in these sectors for selected countries in 1990.

Table 6 reveals the following. For home type electric appliances, Japan engaged in exports solely with Malaysia, Singapore, Indonesia, and China. Japan

imported these goods from more than exported to Korea and Thailand. Quite adevelopment of intra-industry trade was observed with Taiwan, followed by the
U.S. and Hong Kong. Taiwan exported to Japan electric space heating units; refrigerators were more or less traded both ways in comparable value. Korea's caseis probably an exception where Japan exported only parts and imported refrigera-

tors and cooking utensils. In 1990 the data show that no imports from ASEAN
took place but in recent years we observe quite a development in ASEAN's ex-

24 KOBE ECONOMIC&BUSINESS REVIEW, 42 (1997), 11-54

ports to Japan in this category of goods.

Table 6 Intra-lndustry Trade of Selected Sectors and Countries
Heme Appfiances (Sector 28)

SITC

Explanabon

TradeSpecieltzabonindex mi1$

USA O,7S%

SITC Explanation

mi1S

%
51.70

77586 ovens and cookers, cooking plates, ete. 12i,248 ",op77571 vacuumcleaners

17351

77587 electr"therorric domestc oppliances, n.e.s, 73,262 26,83

775B8 electric heaing resistors

9609 28.63

77589 parts of the electro-theramic appliances of 7758 27,8as 10.21

77573 other electro-mechanicel, dc"nesbe eppliances

total 273,077 1oo.oo

Thailand -O,ss

nse9 parts of the elactr"thetarnic oppltaaceset 7758 8,ou3 1oo.oe

6598

19,66

33558 too,oo

T7521 retigeraters

99ss

56.02

77583

7801

43.98

tobl 8,043 1oo,ooMalavsia
1.00775" washing machines
6,693 tOO,OO
tota 6,693 100,oo

17736 loe.oo

Singapore
7752t reingeraters1.oo
13,os9 4s,41775" washingmachines 10,172 33,74
6,287 20,S5
30,14S 1oo,oo

77586 ovens and cookers, cooking plates, eic•
tota'

Inbonesia
77521 reingerators1,oo
fi,125 100,OO

tota 6,125 1oo,oo

China 1,oo

77586 ovens andcookers,ceoking plates, etc. It,090 ".78775it vacuumcleaners 7,676 30.99

77521 refigerators 6,oot 24.23

tota 24,T67 1oo.oo

Korea -O,45

T75S9 pas of the electro-therarnic appliances of 7758 13,056 1oooo

77521 refigerators
775S6 ovens and cookers, cooking piates, etc.

totel 13,056 tOO.oo

TaiwanO,6977511 washingmachines 23,196 21.0t
775e7 electTe-theramic domestic appliances, n,e.s. 39,597 35.87

77521 rethgerators 14,938 t3.53

teta 11o,3s7 1oo.oo
Hong Kong O,88
77587 electr}theranic domestic appliances, n,e.s, 22,175 2e.67

22404 65.50
lt802

su.50

34206 100.00

77582 elecbic space and soil heaing apparatus

8242

40.19

77521 rethgerators

67"

32.89

77587 electro-therarTSc domestc appliances, n,e,s.

5521

26.92

20507 100.00

77587 electro-theramic domestic appliences, n.e.s.

5118 100,OO

77521 retigerators 49,668 25.42

77586 evensandcookers,cookingplates.eic. 14,251 t8.4277511 washingmachines 12,839 1fi,60

totel 77,359 1ooOO

5118 100.00

INVES TMENT RELA TIONS
OF JAPAN AND
ABE: TRADEAND
ASEAN25

Sectors and Countries (continued)

Table 6 Intra-Industry Trade of Selected
Road Vehicles (Sector 19}

SITC

mi1 $

Trade Speciaization index

Explanation

USA

%

SITC

Explanafon

mil $

ek

O.93

781 20 rnotor vehicles for the transport of person$

2i,225,693 71,99

7el20 rnoter vehicles fer the tran$port of persons

602915 59.19

78219 motor vehicles fo rthe transport of goods, n,e,s.

2,060,1sc 6,9978439 other parts and accessories

94898 9.32

78439 other parts and accessories

lr712,6M 5•8178432 other ports and ecce$series of bodles

78432 ober parts anti accessories ef bodies

1,492,315 5.06

7821i dumpers designed lor ofi-higtrway use

73459 7.21
43613 4,28
1018620 100.00

29,486,044 1oo,oo

tota

Thailand t.OO
78219 rnotor vehicles to rthe transport of goods, n.e,s.

604,072 M.98

7841O chassls fitted with engines, fof 722, 781, 782 and

270,224 t5,6578439 othor ports and accessories

256,998 t4.88
214,723 12,43

78120 motor vehicles for the transport of persons

1,726,7oo 1oo.oo

tota

Melaysia 1,oo
78120 motor vehicles for the transport of persens

170,8oo 28,25

78439 other parts and accessohes

1ca687 17.31

78219 motor vehicles fo rthe transport ef goods, n.e.s.

96,603 t5.se
63,956 10,58

785t1 motorcvcles belovv 50 oe
tobl

6ou,701 too.oo

lndonesia 1.oo
7N39 other parts and accessories

237,t73 27.sc

T8t2e rnDtor vehldes tor the transport of persons

172,e24 no.26

7ou1O chassls fitted wfth engines, tbr 722, 7Sl, 782 and

7S,2os 9.21

76,602 9.02

7B432 ather ports and accessoties of bodies

848r964 1oo•ooPhilippines O.96

7B439 ether parts and accesso-es

le301

100.0078t20 rnotor vehicles for the transport of persons

187,202 41.48

78219 motor vehides fo rthe transpert of goods, n.e.s,

121,233 26.S6

o,oo78439 other ports and accessories

41,288 9.15

o.oo78513 rnetorcvcles over 50 cc but not 250 cc

23,412 5,19o,oo

45a,339 100.oo

10301 100.00

China O,95
782S9 motor vehicles fo rthe transport of goods, n.e.s,

78,O08 33.53

T81 20 rnotor vehicies for the transport ef persons

33,635 14.46

78439 other ports and eccessories

25,411 10,92

7853T perts and eccessories of other vehicles of 785

o.oo
o.oo
5B69 100,OO

232,631 1oo,OO

Kerea

5B69 loo.eo

O.73

7B439 other parts and accessodes

155,681 36.21

7e630 containefs specidlv designed for caniage24972 37.52

7S434 geor boxes

84,755 t9,7178439 othef parts and accessodes

12435

78432 other parts and accessories of bodies

45,608 10.61

781 20 motor vehicles for the transport of persons

8302

12.47

78227 cencrete-mixertonies

41,768 9,71

7S432 other parts and accessories of bodles

e289

t2.45

429,98t 1oo.OO

18.68

66562 100.00

B USINESSREVIEW, 42 (1997), 11-54
KOBE ECONOMIC&

26

Table 6 Intra-Industry Trade of

Taiwan O,79

Selected Sectors and Countries(continued)

78537 parts and eccessories ot other vehides ef 7e5

280,60S 25.22

78439 ether parts and accessodes

7ec32 ether pacts and eccessories of bodies

le4,385 16.57

7S52e bicvdes and other cvcles, rK)t motorized

42790 32,57

78219 motor vehicles fo rthe transport of goods, n.e.s.

179,670 16.15

78537 parts and accessories of other vehictes ef 785

32645 24,85

1ss,204 13,95

7B685 vehicles, not mechanicalv prope"ed, n,e.s.

7e439 other parts and eccesseries

78120 rnotor vehictes for the transport ofpersons

330,54e 4T,46

7821 9 rnotor vehicles io rthe transport of goods, n,e.s.

125,463 18,02

78513 rnotorcycles over 50 cc but not 250 cc

93,694 13.45

7715 5.B7
131369 100.00

1,112,617 1omOO

Hong Kong O.99

42849 32.62

Te5t7 motorcvctes over eoo cc

5079 too'oo

o.oo
o.oo
5e79 100.00

696,545 tOO.OO

Machinery (Sector 40)

SITC

Explanaion

USA

mi1$

Trade Speciaiiation ;ndex

oA

SITC

Explanation

mil $

%

O.55

75997 parts and accessories of the machines ot grovp 7

3,929,380 16,70

75997 parts and accesseries of catculating machines1402764 20.58

75260 input er output vnts

28os399 14,93

75230 digital processing unks

1286282 18.87

75270 storage units

1,9oo,3os 8.08

7149t parts of turbo-jets or turbo-propellers

512681

7.52

71322 reciproceting pjston engines not ever 1 OObec

1,133,135 4.82

75270 storage units

3989975.85-t6814920 leo,oo

23,522,939 1oo,OO

Thailand O.76
72322 mechatTicel shavels

2oo,sct

7.99

7ca10 bal beaings

116S43 33.94

71323 cotnpression-ignlo'on engines

162,24S

6,4575997 parts and accessodes of caiculafng machines

9T765

28,40

72S49 mechinety having indMdual functions, n,e,s,

ll8,osS

4.69

7527e storage unks

35898

10.43

1oo,as1

3.99

7t61O electric motors of an output not exceeding 37.5

25085

7.29

2,5t5,2tr

too'ou71391 pats for the internel combuston pisten engines

Malavsia O.85

344238 too'oo

72849 mechineny having indMdual functions, n.e.s,

139,"8 13.29

75997 perts and accessohes of caicuiating machines

38497 45.83

72842 machinery lor working rubber or plastics

65,355 6.23

75121 electroniccalculators

2"Ol

72322 rnechanical shovels

63,951 6.09

74t51 airconditioningmachines

1369e 16,30

fiS,451 5,57

72e49 machinery having individual funodons, n.e,s.

71391 ports for the internal combustion piston engines

8.82

S3995 1oo.OO

1,ou9,367 1oo.oe

Singapore O.71

7407

29,05

7t61O electic motors of an output not exceeding 37,5 w

2ou,551

9.05

75270 $torage units

75260 input or omput units

t78,5407.sc

759g7 parts and eccessories of caiculating machines

51M5 13,59

72e49 machinerv having indMdual functions, n,e,s.

149,220

6.60

7161O electhc moters ot an output not exceeding 37.5

37233

75997 ports and accessorie$ et the machines of greup 7

122,lt7

5.4e7461e ball beaings

33419 8,81

2260950 100,oo

lelndonesia

1,OO

72443 textiIe spinning, doubling or twisting machines

164,256 9,66

71323 compression-ignuion engines

t22,972 7,237245t weaving mechines (tooms}

t05,287 6.t9165175 43.55

9.82

379319 100.00

IIVVESTMENT RELA TIONSABE: TRADE AND
OFJAPANANDASEAN27

Table 6 Intra-industry Trade of Selected
71391 parts for the internal combustion p}ston engines

Sectors and Countries(continued)

97,708 5.75
1,70e,337 100.oo

Ph-ppines O.32
75997 parts and accessories of the machines of group 7

53,452 18.32

75270 storage units

65996 43.63

71323 compression-ignltion engines

28,265 9.69

75997 part$ and accessories of calculating machines

4B445 32.03

72S49 machinery having individud funcbons, n.e.s,

21,113 7.24

o.oe71392 perts fOr the internal combusbon piston engines

19,24S 6,60

o.oo

291,730 100.oo

151267 100.00

China e.7772849 machinery heving individuel funcbons, n.e.s.

Sl,950 10.83

71610 electhc rnotors of an output not excceding 37,574e95 76.12

72435 ether sewing machines

32,791 4,33

75121 electronic calculators

11931

12.13

72443 textiIe spinning, doubling or twisting machines

32,680 4.32

75122 other cdculaing machines

5e91

5.99

71391 parts fbr the intemel combusbon piston engines

31,909 4,21

747eO taps, cocks, valves and simitar opp)iances, n.e.s.

5676

5,77

Korea O.85
72849 machinerv having individual functions, n,e.s.

359,9767.18

75997 pas and accessories of calculaing machines

75997 parts and accessories of the machines of group 7

145,5722.oo

72344 other boring and $inking maehirbery, not sett-prop

4Mse 10.95

72451 weaving machines {k)oms}

129r2242.58

74918 injection or compression moulds for rubber or pla

36453 S.97

1os,3ou

2.127161O electric motors ef an outout not exceeding 37.5

72M3 textile spinning, doubiing or twisting machines

M743 8.55
406189 1oo.oo

5Ol4991 1oo.oo

Taiwan O,72

127536 31,40

Å}l75270 storape unks

198,1316A871610 electric Tnotors of an output not exceeding 37,589820 17,14

72ec9 machinery having indMduel functions, n.e.s,

te6,3225.8175997 parts and accessories ot celcotaing machines

67663 IZ92

75997 ports and ecÅëessorles ot the machines of group 7

177,3025.53

72433 sewing machines et the househ(Md type53237 tO.16

72322 mechanical shovels

124.6S2

3,8975230 digital processing units

HongKong O,89

47910 9,14523955 100.oo

3,2ou,scO 1oo.oo

75997 parts and accessories of the mechines of group 7

189,2S6 11.02

75997 ports and accessories of celculaing machines

6ASos 60.86

72435 other sewing machines143,537 e.36

75995 parts & accessohes ot calculating machines ef 7

19934 19,60

75270 storage units

12a,414 7,07

7591O parts and accessohes of the photo-copying appa

i136S

75260 input or output units

117,911 6,87

7161O electhc motors ot an output netexceeding 37,5

B505 8.36

11.18

101703 100,OO

1 717 246 ico.ooltTelecormunication Equipments CSectof 41)

SITC

Explanation

USA

Trade Specielizaion index

mil$

%

SITC Explanaion

mil$

ors

O.69

76482 televlsioncameras 1,920,32i 39,57

76493 parts & accessories of TV, radio, transmission et203629 22.82

7M19 othertelephonic or telegrephic opparatus 720,3M 14.or

7M9S parts & aceessories of telepheny er telegraph152792 17,12

7M32 transmission apperatus incorporafng reception 411,3ec 8.4S

76432 transptission apparatus incorporating receptien

1"730

76493 perts & accessories et .TV, radie, transmission etc 396,205 8.16764t5 telephonic or tefegraphic swtiching opparatus

t30438 14.62

4,853,044 iOo,oo

Thailend O.58

16.22

892321 too.oo

76415 telephonic or telegraphic $witehing apparatus

98,717 30.89

76499 perts & accessories of sound recorders or reprod

543el

7ou99 parts & accessories ofsound recerders or reprod

6S,8os 2T.T9

16411 tetephonesets

t2t32

t4.37

7M32 transmission appatatus incorporeting reception

27,458 8.59

7ou15 telephonic or telegraphic switehing apperatus

6169

7.31

26,9t5 8,4276423 Ioudspeakers, not mounted in their enclesures

5970

7,07

76493 parts & accessories ef TV, rexSio, transmission ete

319,550 100,OO

64,41

84430 100.00

BUSINESS
KOBE ECONOMIC&REVIEW,42 (1997), 11-54

28

Table 6 lntra-Industry Trade of

Malaysia O,72

Selected Sectors and Countries (continued)

76499 parts & accessories of sound recorders or reprod

120,957 43.27

76493 parts G eccessohes of TV, radio, transmission et25653 55.86

76493 parts & eccessories of rv, radio, transmission ete

6f,508 22Dl

76499 parts & accesseries ef seund recorders or reprod

20269 44.14

76417 other opparatus for cerrier-current line svstems

25,O08 S.95

76432 transmission apparatus incorporating recepbon

22,717 S.13

o.oo

279,5t7 100DO

45922 100.oo

Singapore O.84

o.oo

7M99 pans & accessories of sound recordefs or reprod

185,300 29,07

76499 parts & accessories of seund recorders or {eprod

37706 69,83

76493 parts & accessories of TV, radie, trensmission ete

97,192 15.25

76493 parts & accessehe$ ef TV, radio, transmission et

8299

15.37

76482 televisioncarneras

96,159 15.08

76432 transmission opparatus incorporating reception

7989

14.80

76419 other tekphonic or telegraphic apparatus

s3,e2e s,"e,oo

637,50t tO(?,oo53994 too.oo

lndonesia O,50
7ou11 telephone sets

15,236 a8.33

76499 parts & accessodes of sound recorders of reprod

22572 80.53

7M32 transmission apparatus incorporating reception

11,135 13.40

76491 parts & accessories of telephonv or telegraph

5459

76493 parts & eccessories of TV, redie, transmission etc

9,055 10,90
8,72e 10.50

76499 pans & accessodes of $ound recorders or reprod28031 100,OO

83,tou 100.oo

China O.49

19.47

o.oo
o.oo

76415 telephonic or teIegraphic swhehing appatatus

43,897 27.t4

76493 parts a accessories of TV, radio, transmission et19675 33.92

76499 perts G accessories of sound recorders or reprod

35,4" 21S9

76499 parts & accessches of sound recorders er reprod

10642 le.35

76432 transmission apparatus incorporaing recepfon

22,282 13.78

7ou11 telephorre $ets

9SS2 17,04

7ou93 parts & accessories ot TV, radio, transrission ete

le,399 11.38

76424 headpbones, earpbones

6276

10,82

76419 other telephonic or Wegraphio apporatus

IS,115 lt,20

7M23 loudspeakers, net mounted in their enclesures

6248

tO,77

161.745 1oo,oo

Korea O,1057996 100.00

76499 perts & accesseries of sound recordefs or reprod

t76,691 43,87

7ou99 ports & accessodes of sound recorders or reprod

142096 43,15

76493 pents & accessories of TV, fadio, transmission eic

131,672 32,69

7ou93 parts & eccessories of TV, radio, transmission et

68408

20.77

7649t pams & accessodes of teiepbony or lelegraph23,023 5.72

76423 loudspeakers, not mounted in their encIosures

40149

12.19

18,S29 4,6776424 headphones, earphane$

39612

12.03

76432 transmission apparatus incerporaing recepbon

oo2,779 1oo,OO

Tatwan O,35

329335 100.00

76499 parts & accessories of sound recorders or reprod

123,69e 28,82

76493 parts & accessohes of TV, radio, transmission et

55058

76493 pams 8 eccessories of TV, radio, transrTtission etc

55,e50 13,Ol

75411 telephone sets

37712 tS.09

764i9 other telephonic or telegraphic apparatus

50,332 11,73

76422 Ioudspeakers, mounted in their enclesures

30169 14.47

76491 parts & accessories of telephonv or telegraph

42,63e 9.93

76499 parts & accessories of sound recorders or reprod

429,258 10Qoo

Hong Kong O.90

26.4127299 13.10
208451 100.00

76482 teTevisioncameras

150,049 19.61

76432 transmission apparatus incorporating receptien

20556 50.55

76432 transmission apparatus incorporating reception

136,812 t7,8876411 teIephone sets

11882

76499 perts & accessories ot sound recorders or repred

136,3i6 17,82

76491 parts & accessories of telephonv or telegraph

8229

76419 other teiephonic or teiegraphic apparatus

65,03S 8.50

o.oo

765,034 100,oo

40667 too.oo

29.22
20.24

ABE: TRADEAND INVESTMENTRELATIONS OFJAPANAND ASEAN 29

Table 6 Intra-Industry Trade of Selected Sectors and Countries (continued)
Electhc Machinery (Sector 42)

SITCE)cplanabon

Trede Specializaion index miI S

USA

oA

SITC Explanabon

mil $

nk

O.40

77ou1 digital menolithic integrated unis

2,438,439 29.28

77641 digitel morrolimic integrated units

1479854 41.43

77878 other electricel machines and apparatus

475,993 5Jl

77878 other electrical rnechines and opparatus

4Sou76 13A5

77831 electical ignition or starting equiprnent

327,778 3.94

77ou3 nan-digitet monotithic integrated units

2S9569

8.ll

77812

266,165 3.20

77259 ether electcal switching circuits ever 1Ooo v

t2169e3.413572043o.oo

8,329,1oo tOO-ooo.e3

Thailand

63,P71 8.13

77641 digitat monolithic integrated units

77M3 non-digita rnonolithic integrated units

57,8S5 7,36

77314 other elecbic cenducters belovv SO v

12278

16.48

77261 boards, panels, conseles, ete. belew 1OOOv

51,955 6,61

77259 other elecheal swhehing circuits over 1OOO v

8789

11,79

77831 electricel ignhien or starting equipment

48r604 6•187712i staticconverters

7409 9,94

786,S97 too.oo

Melavsia

74518 1co,oo

O,717764t digital rnendthic integrated unks

280,7os

26.12

77Ml digild rnonottthic integrated unks

776S9 parts of ICs and rTicroassembllas

IM,"3

17.16

7768t piezeelectric cry$bls, rnounted

6so13 37.ec
29583 16.13

77611 tetevision picture tubes, cathode ravi cok}r74,5626,9477119 electTic transfbrmers

21ee6 tl,98

77M3 non"igita monolthic integrated unds

56,1245,2277121 staticconverters

1,074,7"

too.ooSingapore O,S7

20016 10,92
183358 1oo,oo

77Ml digital moroikhic integrated unds 733,722 32.75
77M3 non-digibl rnonolthicintegratedunks 155,287 6,93

77out digital monolmmic integrated units

40856 25,66

77259 other electcel suitehing circuts over 1OOO v

35148 22.os

77259 swhcbing orprotecting circuks over tOOO voks 73,922 3,so

77121 static converters, rectitiers and rectigying appora

20362 12.79

77689 parts of lCs and rnicroassemblies 68,602 3.os

776t1 television picture tubes, catho(le ray: cdw

2,2co,580 1oo.oo

15630 9.82
159218 tco.oo

tndonesia O.93
77831 electhcd ignition or staning equiprrient

cor923 25•8177261 boords, panels, consoles, eic. below 1OOO v

18,634 11,75

77esa electricel lighting equipment windscreen wipers,

17,382 10.ee

77886 carbon electrocles, brushes, 1ornp & batterv carbo

77Sl 1 primary cells and bateries, and ports thereof, ne

6170 1oo,oo

12,510 7,89

o.oo
o.oo
o.oo

15S,558 100.oo

fi170 100.oo

Ph"ippines O.59

77641 digitel monetithic integfated units t07,eou 3t.93

77313 insulated electric wire , cabels, bors, stip and th

51965 60.30

77689 ports of lCs and tricroassembies 47P67 13.937763t diedes, transistors and similar serTti-condvctor

14113 16.3e77259 switching or protecting circuks over lOOO volts 26,666 7,e977125 elecbic transforrners, staic cenverters

1314S 15.26

77328 insulating fidings forelacbical machines, etc. 25,OT3 7,4277119 elecbic transformers

337,Ml 100,oo
China6954 S,07
86180 1oo,oo

O.59776t1 television picture tubes, cathode rav: cdor

77,353 18,S5

77119 elecbic transformers

53156 50,57

77629 ports of tubes and valves of TV tubes ete.

70,529 17.19

77125 electric transformers, staic cenverters

1679S 15.98

77261 beerds, panels, censetes, etc, below 1OOOv

35,204 8.58

77255 appartatus for making and breaking electrical circ

16099 15.31

77421 apparatus based on the use ef x-rays

25J53 6.2e77315 insulated electric wire , cebels, bars, sbip and th

8394 7,99

440,348 100.00

105122 100.00

30

42 (1997), 11-54
KOBE ECONOMIC & BUSINESS REVIEVV,

Table 6 Intra-Industry Trade of Selected Sectors and Countries (concluded)
Korea

O.63

77641 digha1 rnonolithic integfated units

406,192 14,637764l digital rnonolithic integrated units

97t12

77M3 non-digital monolithic integrated units

259,260 9.34

77643 non-digital monolithic integrated units

93809 14.73

77623 othercathede rav tubes

178,anO 6.43

77119 eiectric transforTners

92267 14.497726t boards, panels, consoles, etc. below tOoo v

151,111 5.447761 1 television picture tubes, cathode ray44067 6,92636737 ioo.oo

2,775,759 1oo.OO

Taiwan

15.25

O.66

77641 digitel rnonolithic integrated unds

460,241 16.58

77627 othe electronic vdves and tubes

79970 13,8S

77623 oti}er cathode rav tubes

4ca,255 16.08

T7643 non-digital monolthic integrated units

5e79t

77629 parts ot tubes and vdves of rv tubes ete.

1oo,e19 5.79

77121 static converters, rectifiers and rectigying oppora

55M3 9.66

109,497 3.94

77641 digital monolithic integrated unks

77M3 non-digita1 monolithic integrated units

46103 e,oo
576153 100.00

2,775,995 too,OO

Hong Kong

10.20

O.99

77ou1 digital rnonolithic integrated units

467,967 25,33

77643 non-digital monolithic integrated units

77ou3 non-digital monolithic integrated units

155,239 8,40

77884 electicel capaciters, fixed or vaiable

1,an7,635 100.oo

8135 5S.42
5790 41.58
13925 100,OO

Regarding road vehicles, trade with selected countries was all one sided as was
exemplified by intra-industry trade index (IIT was larger than O.70, mostly larger
than O.90); i.e., Japan exported most of the part and imported none or only marginally, except the cases with the U.S. and Korea. Japan traded with the U.S. on

an equal basis, but with other countries, Japan imported only parts and low-end
vehicles such as bicycles and motor cycles. It is evident that Japan imported parts

from ANIEs and nothing from ASEAN in 1990.
For machinery, Japan engaged in fairly large intra-industry trade with the U.S.

in data processing parts and machinery. Parts which require advanced technology
were mutually traded. Intra-industry trade index for the U.S. was O.55, the lowest
among all, suggesting large intra-industry trade. Traded items were different in
the case of ASEAN from that of the U.S., while they were more or less similar in

the case of ANIEs. Japan's trade was in general one sided. Japan exported, forinstance, roughly 200 items while she imported only 100 items; In terms of value,

Japan exported to ASEAN and ANIES more than 10 times than she imported
from them. Japan imported ball bearings to an amazing degree from Thailand;
this, of course, is a reflection of Japanese FDI by Minebear.

Sector 40, non-electrical machinery, gives a good example. In 1990 Japan exported to Malaysia 101 billion US dollars while Malaysia imported from Japan by
the amount of 126 billion US dollars. Intra-industry trade index must be O.15.

For tele-communication equipment (Category 41), intensified intra-industry
trade was observed. Surprisingly order of intra-industry trade index was Korea,

ABE: TRADEAIVD INVESTMENTRELATIONS OFJAPANAND ASEAN 31

Taiwan, China, Indonesia, Thailand, the U.S., Malaysia, Singapore, and Hong

Kong.
Electric machinery (Category 42) shows a case where fairly extensive intra-in-

dustry trade took place with the U.S. while one sided trade took place in value

terms with ASEAN and ANIEs.
The value of the exports of Japan to these countries, in most cases, was morethan ten times larger than the value of the imports from these countries. Intra--in-

dustry trade in a number of products emerged but a great asymmetry existed be-

tween the level of Japanese exports and imports; this asymmetry will decrease
only gradually in the future. Japan exported many of and imported very little ofhigh-end products such as various machinery and key components of TV, video
recorders, central processing units, and electrical ignition equipment.

As far as Thailand is concerned, Japanese exports of machinery were overwhelming in value. Even when they have intra-industry trade in the SITC 5 digit
level such as parts and accessories suitable for use in televisions and so on, thevalue of exports of Japan to Thailand is 33 million dollars while the value of imports is 2 million dollars. The same is true for Indonesia. Japan's imports of mis-cellaneous parts are small compared with Japan's exports to Indonesia. Singapore

imported video recording apparatus in large volume. One interesting finding isthat Singapore exported black and white television receivers at the same time she

imported more than ten times as much. Singapore also exported digital automatic
data processing machines and digital processing units which are high end technol-

ogy products. The problem is that they were relatively small in amount. For
Hong Kong the same is true. Hong Kong started to export high end goods but insmall amount. Hong Kong imported video recording apparatus, black and whitetelevision receivers, television cameras and other essential parts of manufacturing

and exports electric motors, and calculators, which are more toward the low endof the technology spectrum.
Although intra-industry trade has been emphasized in the Asia-Pacific region,
the trade between Japan and these Asian countries remain mostly one sided, i.e.,

dominated by Japanese exports.
3. Development of Foreign Direct Investments

Japanese FDI expanded rapidly since the 1985 when acute yendaka started. By
1990 to 1992 the accumulated or single year Japanese investment reached 259o to359o of the total FDI in ASEAN countries; Japan had become the largest inves-

tor to ASEAN (Table 7).

32& BUSINESSREVIEW,42 (1997), 11-54
KOBEECONOMIC

to ASEAN

Table 7 Largest Investors
Indonesia (mil, of US$)
f992

f967-f992

o/o

%

Japan

1,so2

14,59

12,907

22.01

Hong Kong

1,O18

9.89

5,231

8,92

U.K.

978

9.50

2,397

4,09

U.S.A.

923

B.97

3,419

5,B3

South Korea

6t7

5.99

2,846

4,85

Taiwan

563

5,47

3,93B

6.72

Sjngapore

448

4,35

2,027

3.46

10,292100.005B,643100.00

tota1

Source: lnvestment Coordinating Board, lndonesia {BKPM)

Malaysia (mil, of M$)
t990

%

V991

%

Japan

1,777

28,53

1,t61

20,91

Tatwan

2,353

37,78

1,573

28,33

Singapore

32t

5.15

368

6,63

Hong Kong

136•

2,18

315

5,67

S. Korea

164

2.63

376

6.77

u.s.

187

3,OO

438

7,89

U.K.

315

5.06

184

3.31

totai

6,228

100,OO

5,553

100,OO

Source: Malaysian lndusthal DeveiopmentAuthority (MIDA)

Philippines(mil, peso)
t99f

f992

ora

olo

Japen

5,773

26,99

1,847

25.47

.U.SA

2,281

10,66

1,570

21,65

S.Korea

1,223

5.72

1,084

14.95

UK

7,809

36,51

741

10,22

Hong Kong

229

1,07

323

4.46

Netherland

489

2.29

293

4,04

Taiwan

330

1,54

232

3.20

Singapore

83

O.39

21389,3

100,OO118
7250,4

1,63
100,OO

toai

Source: Board of lnvestment (BOI>

ThaUand(mil, Baht)
I960-V986

f960-t99t

Japan

48883

20,48

277382

32,69

u.s,

45542

i9,08

105220

12,40

7,68

U.K.

12759

5.35

65129

Taiwan

14742

6,18

60460

7,13

Hong Kong

7652

3.21

47282

5.57•

Singapore

6646

2,78

40418

4.76

Othe{s10246942,93252540

29.77

total

23e693

100,OO

848431100.00SourÅëe: Board of lnvestment {BOI), Thailand

Singapore (mil, S$)
-t989

-f985
u.s.

4656

35.38

7143

33.24

Japan

2943

22.36

6600

30.71

EC

4172

3t,70

6172

28.72

others

1389

10,55

1575

7.33

total

13160

100,OO21490

too.ooSource: Economic Develonmpnt Board, Singapore

ABE: TRADEAND INVESTMENTRELATIONS OFJAPANAND ASEAN 33

ASEAN attracted around 109o of the total Japanese FDI (Table 8). That is,from ASEAN countries Japan was the biggest investment partner while from theJapanese point of view ASEAN has just one quarter importance compared with
North America. Another feature is that FDI to ASEAN on average is on a smaller scale than that to North America.
Table 8 Japan's Overseas Direct Investment by Region (fiscal year, mil. of US$)Re ion

I992

North America
Central and South Am

14,572Asia

ASEAN
Brunei Darussalamlndonesia
Malaysia

o/o

95f-f99

o/o

42.69

169,580

2,726

7.99

6,425
3,867

18.82

46,54759,88035,OOO 9.05

11.33

43.87
12.04
15.49

o

o.oo

t09

1,676

4.91

14,409

2.06
O.47
1.96
1.92
2.08

4,815

Middle East

704
160
670
657
709

4,231

O,03
3.73
1.25
O.50
2.03
1.52
1,09

Europe

7,061

20.68

75,697t9.58

Africa

238

O.70
7.05

6,813

1.76

Philippines

Singapore
Thailand

Oceania
Total

2,406
34,138 100.00

l,943

7,837
5,887

23,782 6.t5
386,530 100.00

Source: Ministry of Finance, Japan

What can we tell about the industrial composition of Japanese FDI? The FDI
to Asia is different from that to the world in the following aspects. Manufacturing

shares were almost twice as much as the world average and they showed an increasing trend, with a strong contribution being found in food and beverage, tex-tile, chemical, steel and non-ferrous metal, general machinery, and electricmachinery. In terms of regional FDI intensity figures (Table 9), textile recorded

2.96, followed by chemicals 1.9. This implies that Japanese FDI contributed tothe expansion of production and exports of Asian host countries more than othercountnes.

REVIEVV,42 (1997), 11-54& BUSINESSECOAIOMIC
KOBE

34

Table 9 Japanese FDI by Direction(as of 1992

and by Industry(a) Value in milhon yen
tetat

Asie

.
1955)
smce

(b) FDI lntensity

NAniorica

LArnehea

totalAsia

orhersNAmeheatAmetica

Others103,981

24,69150,367

6,913

22,OIO

1,OO

1,53

IA6

e.55

O,69

food&bevarages

5,2M

1,3os

2,587

268

983

1.oo

1.72

1.19

O.43

O.61

textile

5,043

2,3t2

1,058

484

1,189

t'oo

2,96

O,50

O.80

O.77

lumber&pulp

3,7tl

6tl

2,508

243

M9

t'oo

1,06

1,62

O,54

O,31

chemicals

t4,558

4,282

5,923

868

3,485

1.00

1.90

O,9B

O.50

O.78

steel&non-femousmetalproducts

i2,040

3,310

5,027

2,142

1,561

1,OO

1.77

1,OO

1.48

O,42

machinery

10,320

2,117

4,723

483

2,997

1.oo

1.32

t,10

O.39

o.ps

electricalmachinery,equipment&sup

24,473

5,ss7

12,707

7ou

5,415

1.oo

t,47

1.25

O,26

O,72

transportationequipment

14,os5

2,os1

6,312

1,479

4,213

1,oo

O.95

1.08

O.87

O.97

others

14,537

3,os1

9,524

181

1,771

t'oo

1.36

1,57

O.10

O.40

Non-manufacturing

243,294

22,839 110,631

35,86973s955

1.oo

O,61

1,09

1.22

O,99

comrnerce

40,2685,259

21,074

2,537

11,39B

1.co

o.er

1.26

O.52

O.92

finance&insurance

74,8695,711

22,66tt5,73530,762

1.00

O,49

O,73

1.75

t.33

services

46,6106,731

27,80t

2,688

9,3oo

1.00

O,93

1,43

O.48

O.65

transportation

21,652t,530

769

14,667

4,686

1,oo

O,46

o.co

5.63

O.70

realestates

59s8953,oo8

38,326242

17,719

1,oo

O.39

1.M

O.03

O,96

Others39,255

12,350

8,582

3,756

14s567

1,oo

2.03

O,52

O.79

1,20

Total

386,5oo

59,880 160,998

46,547lt9,105

1,oo

1,OO

1oo

t'oo

1,oo

Manufacturing(c) Share in tobl industry FDI to the wondtctalAsie{d} share in total ragional FDI

NArnehee LAmehee Others

totol

Asie

NAtnericetAtrietice

OthersManutactllring

1oo,oo

24

48

7

2t

26.so

41,23

34,28

14.85

18.48

food&bevarages

1oo,oo

27

49

5

19

1.35

2,33

t,61

O.58

O,83

textile100,OO

46

2t

ao

24

1.30

3,es

O.66

1,04

1.00

lumber&pulp

100,OO

16

68

7

9

O,96

t.02

1.56

O.52

O.29

chemicals

1oo.oo

29

41

6

24

3.77

7.l5

3.68

1.86

2,93

steel&non-ferrousmetalproducts

1oo.oo

27

42

t8

13

3.11

5.53

3,12

4,60

1,31

machinery

too'oo

21

46

5

29

2.67

3.M

2.93

1,04

2.52

electrioalmachinery,equipment&sup

100,oo

23

52

3

22

6.33

9.33

7,89

1,64

4.55

transportationequlprnent

100,oo

t5

45

M

30

3,or

3.44

3.92

3,18

3,54

others100.00

21

66

1

12

3,76

5M

5.92

O.39

1,49

Non-manufacturing

1co,oo

9

45

15

so

62,94

38.14

ce,72

77.os

62,09

commeToe

1oo.OO

13

52

6

28

10.42

8,78

13.09

5.45

9,57

finanoe&insurance

1oo.oo

8

so

21

41

19,37

9.M

14.08

33,80

25,83

'servrces

100,oe

44

60

6

20

12,os

14.24

17.27

5.77

7,88

transportabon

100.00

7

4

68

22

5.60

2,56

O,48

31.51

3,93

realestates

100.00

6

ec

o

30

15,so

6.03

23,81

O.52

14.88

Otherstoo'oo

31

22

10

37

10,16

20,62

5.33

8,07

12.23

Total

1oo.OO

t5

42

12

31

1oo,oo1oo.OO1oo,oo1oo.OO

IOO,ooABE: TRADEAND INVESTMENTRELATIONS OFJAPANAND ASEAN 35

More country specific data can be found in General Survey of Japanese Affili-

ates Abroad (Kaigai Shinshutsu Kigyo Soran) of Toyo Keizai. Based upon thisquestionnaire study, Table 10 summarizes these flows. For Thailand, Japanese investment was largest in industrial machinery, transportation, shipbuilding, electricmachinery in terms of capital invested. For Malaysia, electronic machinery andtransportation represented around 159o each of capital invested. With heavy electronics also having an 89o share, the concentration in electronics and transportation equipment is obvious. Indonesia still attracted IDI from Japan in agriculture

and forestry, unlike Malaysia and Thailand, and food had a large share, 129o incapital and 259o in employment. Other important sectors were metal products,
89o, and shipbuilding, 109o. In the case of the Philippines, leading sectors were

shipbuilding (179o), cement (129o), metal products (119o), home electronics andparts (109o), pharmaceuticals (109o), and food (79o).

As we discussed in the former sections, the RCA and IIT were closely linked

with the development of Japanese FDI activities. Although we cannot provide
rigorous statistical tests, we see apparent correspondence between the MI concentrated industries and industries of trade expansion.

We should look more closely how Japanese firms were motivated to perform
FDI. The objectives of these Japanese FDI are given in Table 11. The most common objective was to secure local market. Nothing surpassed this objective; infact, Japanese firms primalily consider ASEAN as a production base for a grow-ing domestic market, which can be shown by low percentage of objectives G and
H in Table 11. Rather, Japanese firms started to regard the production network
important, which can be verified by high percentage of objectives D. Of course,
all these were different from one country to another. Export base objective wasstronger in Thailand and Malaysia than the Philippines and Indonesia. The objectre of royalty and information gathering was also important.

The interest to construct production networks has an important implication for
the AFTA scheme. Let us discuss it further in detail next since AFI"A might sim-

plify the establishment of a production scheme which covers the whole ASEAN
area.

42 (1997),
KOBE ECONOMIC & BUSINESS REVIEW,

36

Table 10 '11-54

Japanese FDI in ASEAN
ThaHandShore(1}

agrkxitture,Fere$by,Fist)er

ss

Mining

as

Food

12

Textile15

abporel4

Wood,Fumiture3

Cherricds

1

Medkn'nevePainls4

OthorCherTical

5

Petrdlttmandboel

4

RubberMo[ftrclsoLeatherProducts

9

CeraTics

t5

GIass

4

Cement3

ChinaendPeroelain

o

Steel

o

Non-terousMetels

t2

Metals22

Machinery15

lndustridMachinery

22

EIectricMatttinery

5

HeavyElactricMachinery

21

Telecorrnwnioation

1

CensumerElectroniosand'2

Elactronkes

19

TransportationEquipments

14

tutomobileandPorts

9

shipbeimxng

ss

PrectisionInstruments

7

OtherManutacturing

17

Sorvbe

'200

T6td

577

C2)C3){1)e)
1553ee 9.19St7.eaX

Obpttwes

c
AB
210

C3)

3,72%

7os22 4.5tX3.41X 4,57% 104
58402 2.08SS2.44ts 5,eo%
172oo 2.60)CO,49$ 4,oo%
O1747 O.69XO.ooX 1,2t%

05
07
30
1co3 O.52XO.49X
Ol
O.17XO.oo$oeaoo927t2 3.47X4.39X
02
17as O.69SCO,49X O.M% 031579 o.e7%o.4g%
03
O310 O.69etO.coX
Olo,oogco.oc"too 1.scscO.98X oo
2ss11
1332206 2,ooX1.46X
03
1990 O,69XO.49SG
Ol
615a3 O,52%2.93Sa
oo
O.oo%O.OOSG
oooo o,oo%o.oox oooo
2.os%2.an%
51ss2
06
159773 3.81sc7.32Dt
1tO
421as 2.60eCt,95X
02
22ce10 3.SIX10.73X
O10

4

t

e

2

2

1

5

o

o

O,2t%

o

o

O,06sc

o

o

1.B7%

3

6

1

1

o.co%

1

3

O,2t%

2

1

o.oosc

o

o

2,ve%

2

2

1,52SC

2

3

o,ce%

o

1

1,ce%

o

o

o,oosc

o

o

o,oox

o

o

1.10%

2

1

6.75%

7

4

1,92%

1

3

4,70%

4

6

1

2

1373 O,87XO.49sc O.26% Ol

9es23 3,et%4.ooX

D

6

09

6,t6%

Ol
02
1913211 3,29)C9,27X 9,12X
otco O,17scO.ooX o.os%
OsoT o,sssco.oox o.ss%

05
O11
05
08
06
18
t15

2515554 2.43)tt2.ooX fO,74X
34054 1.56X1,caX 2.eo%
14162ro 5.721t6,esX tt.22%
74049 t,2tX3,41X 2.eoX
34tes 2,95X1,46X 2.eeX
as14359 M,66X12.ce% 9.92%
205144779 oo.ooxomoo%oaoo% 19142

5

8

o

o

G H
EF
IJK
132

17

03
05
oo
Ol
oo
18
02
03
Ol
oo
02
05
04
ot
oo
oo
16
O13
05
28
12

1

3

3

6

o

3

o

3

o

o

o

o

o

e

1

1

o

o

o

o

o

o

o

o

o

t

3

2

1

o

o

o

o

o

o

o

1

o

4

3

3

2

3

4

1

1

O13 4

3

o

o

1

o

4

5

6

1

3

2

12

to

2

2

4

1

6

8

Ol
oo
03
12
06
i13
02
04
2387

79

ew

1

o

1

2

2

4

1

2

1

1

o

o

3

2

17

9

32239

51

52

1Ot3

O03
O03
OOI
ooo
OOI
ooo
O02
OOI
OOI
oet
ooo
eoo
102
O02
ooo
ooe
ooo
OOI
114
Oll
112
ooo
200
ooo
ooo
100
leo
201
101
OIO
oeo
34ua

M o

L

o

1

o

1

2

1

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

1

o

e

o

o

o

o

o

e

o

o

o

o

o

o

o

o

1

1

o

o

o

o

o

o

o

o

o

o

o

o

o

1

o

o

o

o

o

o

o

1

o

o

o

1

o

o

o

o

o

o

o

o

1

o

o

o

o

o

o

o

o

o

o

o

1

o

o

o

o

o

o

10

5

1

14Seo 13

9

7

Pt
317
13
03
05
el
Ol
oo
13
Ol
02
13
oo
oo
06
02
oo
oo
oo
03
04
05
05
Ol
09
oo
oo
02
13
13
O16
02
03
1143

1

t

16

14

19t46

sa

42

2

3

2

3

2

6

o

2

2

3

1

1

1

o

o

o

1

o

2

e

t

o

t

1

1

o

o

o

o

1

o

o

o

o

o

o

o

o

o

o

1

1

t

o

t

o

2

3

o

o

o

3

o

o

o

2

o

o

2

1

o

o

2

3

o

o

Malaysia

Shore
ct)

C2)

t3)

Cl}

Objecfyes

C2)(3}

A

B

c

D

E

F

G

agticullure,Fore$try,Fisher

435253B 10,41X

2,54%2.15%

3

5

7

4

l

24

o

Mining

4

2

419

O,97X

1,o2eAo.op%

t

1

2

o

o

2

1

9

6174

2.osX

7

5

5

o

3

3

Textila

2

o

9M

O.4B%

1

1

o

o

1

o

Apparel

10

2

22es

2.42%

6

2

3

o

o

t

Wood,Furniture

1

o

to

O,24sc

t

o

o

o

1

t

o

o

o

o

o

o

5

9

6

t

7

2

o

o

o

o

o

o

o

o

2

o

2

t

1

t

o

Food

Chendcals

1

o

2t9

O.24%

Medkn'ne

2t

8

2105

5.ceX

Paints

o

o

o

o,oox

OtheFChernical

5

1

ro4

t,21X

4,57%5.22% oO.oo%O,81% o
1,02%1.93% s
O,oo%O.03% oO,oo%O.19% o
4.06%1.78% 6o,oo%o.oo% oO.51scO,M% oPetrdiumorxiCoal

1

o

1os

O.24%

O,ooOAO.14% o

o

o

1

Rubber-Products

o

o

e

o.oo%

o

o

o

o

o

7

1

1274

1,69%

5

4

o

1

o

o

CeforTics

7

4

1ue

1.69%

3

1

3

o

2

2

Gless

7

1

1232

1.69%

2

3

2

o

5

1

Cement

3

2

1221

O.73%

o,oo%o.oo% oO.51%1,08% 4
2.03%1.14% o
O.51%1,04% 1
t,02%1.03% 1oLeatherProducts

1

1

3

1

3

o

lt

HIJK
12115
1000
1000
oooo
2000
oooo
oooo
OO03
oeoo
OO02
oooo
oooo
3000
1201
OO02
OOOI
L

M o

P

1

3

o

1

3

13

4

5

o

o

o

o

1

o

o

o

o

o

o

8

o

o

o

o

o

o

o

1

o

o

o

o

o

o

2

1

o

o

o

o

o

o

o

o

o

o

o

'

o

o

1

o

1

1

2

o

3

o

o

o

o

o

o

o

o

o

o

o

2

o

2

o

o

o

o

1

o

o

o

o

o

o

o

o

o

o

o

o

o

o

2

1

o

o

o

o

2

o

o

o

o

o

1

2

o

1

o

o

o

o

1

o

o

ABE: TRADEAND INVESTMENTRELATIONS OFJAPANAND ASEAN 37

Table 10 Japanese FDI in ASEAN (continued)

Chinaa)dPorcelah

o

Steel

2

oo
t699

oo
Ol
1ra%
03
5os%
19
04
03
oo
O15

o.oo%

o.co%

o.oo%

o

o

o.ng%

O.51% O,59%o2

10t7ng 2,42%103eo2 5,08sc

5.oa%

15

41463

2.03%

lnduskielMacttinery

10

ElactricMachir,erv

2

HeavyElactricMachineryretsSon-ferousMetals

10

Metds

21

Macininety

Ttmnicati[m1ConatrrnetElactrooiosarrd

5

ElactroniosreTransportationEqdipments

31

botorTvbilaandParts

6

suilpbuihing

11

RecisionInstruments

8Ott)erManvfacturk}g

7

5

o

3.so%

5

3

1.24sc7716ee 2,42% O.51% o.ss%

2

3

a,o3%

a

t

6.oo%

7,61% 15,e7%

10

s

O.24X

o.cox

Ol
O.5tX o.oa%

o

o

2

3

3,63scO4t
15IB769
O45
1ac1
ret642427252oso,oo%

O.48SC

1.21X

03
O10

6,so% 14.72X 13,ea%
7.51% t3,71X

21so1 1.45sc
134240 2,osX

47705
11427

o.ou%

1.029t

1,IS%

6,oo%

3.se%

1,sc%

2,03et6.51%

1.69sc

O.51%

1.21%

Sorvioe

1094413294 26.ee% n.M% tl,24%

Totd

413

197"e299

co•co)tcooox

3

O19 lt21,37%

oo
t3
02
03

2
lt

1

o

4

4

2

3

2

1

21
28114 sc 79

oo•oo%

5

2

oo
Ol

06

o

o

o

o

o

o

o

o

o

o

o

o

2

t

A

o

o

o

o

o

o

2

o

o

o

o

o

o

o

o

o

o

o

3

e

o

O12 t

1

3

o

3

o

o

o

o

3

t

5

4

'

1

2

1

o

1

1

1

4

3

1

o

2

o

2

1

o

o

o

o

1

4

,

o

o

o

e

t

o

o

e

e

e

o

t

5

19
03
tl
2lt
oo
Ol

08
113
02
t2
ot
03
1145

6

3

3

o

o

o

t

1

2

6

2

o

1

1

o

o

o

o

o

o

o

1

o

t

t

o

o

o

o

o

o

o

o

1

o

2

1

1

o

1

o

1

1

o

4

1

4

7

4

1

o

e

o

o

o

o

7

o

2

o

o

o

o

o

o

o

o

o

o

o

o

1

1

3

o

o

2

o

o

o

2

t

2

1

o

1

o

o

o

o

o

o

1

o

1

t

1

o

o

o

o

1

o

o

1

o

1

4

4

,

o

22

2

1

t

s

20

12

2

22169 42

oo

oo

5

ss

8

5

6

16

87

ss

sa

L

M o

P

t

2

3

o

o

o

i

8

o

o

o

o

o

o

t

o

o

o

o

o

o

8

o

o

o

o

o

1

o

o

o

lrKSonesia

Shate
{2}

{li

{t){2)(3)

Obiectwes
C3}

A B

c

D

E

F

G

H

ngrkuIture,Forestry,Fisher

17

24

Mim' ng

t

o

TO

Food

9

6

9sc7

9,18pt11,76% 25,11%

o

7

3

Textile

2

o

16ea

o

o

o

Apporei

o

o

o

o

o

o

o

o

o

e

o

Wood,Fumiture

1

o

tes

2.ou%O.oo% 4.32%
o,ooxo.oo% ooo%
1.02XO.ooX O,49%

1

o

o

o

o

o

o

o

Charricdsoooo,ooxooex

o.cosc

o

o

o

o

o

o

o

o

Medkuhe3o281

3.osXO,oosc

O.74%

1

o

o

e

o

2

1

o

Ptints3e

12ss

3,os%O.co% 3,rsX

o

2

o

o

o

1

o

o

Otherim1oso

1,02"eO,ooX

O,13X

o

o

1

o

o

1

o

o

PetrotltttTlorKiCoal

1

o

13ss

1.02XO,ooX 3,ssX

o

o

1

o

o

1

o

o

RubberProduets

o

o

o

o,ooxo,o("t

o,cox

o

o

o

o

o

o

o

o

LeathetProducts

o

o

o

o.ooxo.oox o,co%
1,02%O,co% O,59X
3.osX3,92X 4,41X

o

o

o

o

o

o

o

o

o

o

1

o

o

1

o

o

1

o

o

o

1

1

o

o

o

o
o

o

o

o

CerorTScs

4214 17.sssc47,co% lt,13%

3

6

G

1

o

7

o

o

t.e2sco.oox

o

t

o

1

o

f

o

o

t

o

8

o

o

o

o

t

o

o

o,test

o

225

Glass

3

2

1670

Cementoooo,ooxooox

o,cox

o

o

Chhaor}dPoroelain

o

o

o

o.ooxo.ooec o.oo%
o.oo%o,cosc o,co%

o

o

o

e

o

o

o

o

o

o

o

o

o

o

o

o

1

Steot

o

o

o

Non-ferousMetels

5

1

746

Metels3

4

2S66

Machinery

3

o

sc4

lndustridMachinery

6

t

1622

ElactricMechinery

o

o

o

624

5.10%1,os% 1,97%
3.osX7,B4% 7.57sc
3.os%O.oo% O.91sc
6.12X1.96% 4.2esc
o,ooxo.oo% o.ooet

o

'

3

t

o

t

e

1

o

o

1

o

o

2

o

o

o

o

e

o

o

o

o

o

o

1

2

o

o

4

o

o

o

o

e

o

o

o

o

o

5,10%1,sesc

o

1

1

1

o

2

o

o

o

o

o

o

o

o

o

o

e

o

o

o

o

o

o

o.ooxo.co% o.oo% oo.oo%o.oo% o,oo% oo.oo%o.oo% omo% o

o

o

o

o

o

o

o

o

O.OOetO,ooM o.oox

o

o

o

o

o

o

o

o

o

1

1

1

o

3

o

o

1

2

5

4

o

6

o

1

o

o

o

o

o

o

o

o

o

o

o

o

o

D

o

D

1

4

2

3

o

7

3

2

e

26

21

13

o

49

5

4

HeavyElactricMachineFy

5

1

Telaoorrvnunicafon

o

o

o

ConsumerElectroniosand

o

o

o

EIectronicsooTrensportatienEquipmentsooAutomobiloandParts

5

1

Shipbuilding

115Precisionlnstruments

o

o

1.65%

OtherManufacturing2oService16

6

5.10Xi,96% 3,69%7624 lt.22X9.co% oo.14%oo.oo%o.oo% o,oo%
476 2.04XO.oo% 1.26%
17M 16.ss%11,76X 4.se%

Total

98

51

37e5B co,oo%oo,coeA ouco%

1397

IJK
O03
ooo
103
ooo
ooo
ooe
ooo
Oll
ooo
OOI
ooo
ooo
ooo
ooo
101
ooo
ooo
ooo
too
ooo
oeo
OOI
ooo
10t
ooo
ooo
ooo
ooo
O03
OOI
ooo
ooo
lel
5i16

o

o

o

o

o

o

o

o

o

o

o

1

o

o

o

o

o

o

o

o

o

o

o

o

o

t

1

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

1

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

e

o

o

o

o

o

2

o

o

o

o

o

o

1

o

o

o

o

o

o

o

o

o

o

o

o

1

2

o

o

o

o

o

o

o

o

o

o

o

o

o

2

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

2

o

1

o

o

o

o

o

t

5

1

o

o

o

o

o

o

o

o

o

o

o

1

o

o

o

o

1

o

1

2

1

o

o

1

2

6

st

3

t

(1997),
KOBE ECONOMIC & BUSINESS REVIEW,
4211-54

38

Table 10 Japanese FDI in ASEAN (concluded)
PhHipmnes
Objectives

Shore
{1)

ra)

{t}(2)

C3)

(3}

A

B

c

D

E

F

G

agfkujlture,Forestry,Fisher

26

1

ss28

2t.67%2.44X

e.M%

5

IO

1

5

1

9

o

Mining2

1

13?6

1.67%2,"%

3.05X

o

o

o

o

o

2

o

Food

3

3

1ss7

2.so%7,32% 3.ss%

o

3

2

o

o

t

o

Textile

1

o

1200

o.esxooo% 2.75sc

o

o

o

o

o

o

e

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

3

4

o

t

o

AppereloooWood,Furniture

o

o

o

Chemicelsoooo.oo%o.oosc ooo%o,ooxo,oosc ooo%
o.oo%o.oox ooo%

Medkine547sc

4.17%9.76% 1,73%

4

2

Paints2o102

1,67XO.OOSt O.23%

o

o

o

o

o

1

o

OtherCherrical

2

o

o

o

o

1

o

2

o

PetrdiurnorKiCod

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

1

1

o

o

1

t

o

e

RubberProductsooLeatherProducts

1oCorornics

o

e

GIass

1

o

1,67%O,oo% O,t9%oo.oo%o,co% o.ooacoo.oo%o,oo% o.oo%
am o,esxo,oo% O,61%oo.oo%o.oox o,oo%
1eo
o.s3xe,oox O,4t%

Cernent

15

ChinaandPoroelain

o

o

Stee1

1

N(m-torousMetats

1

et

o

o

o

o

o

o

o

o

o

1

o

o

o

o

o

o

o

o

o,ooxo,oosc

o,cost

o

o

o

e

o

o

o

o.eexo,co%O.esX4.eeX

t,07%

o

t

o

1

o

o

1

1.39%

1

o

o

o

o

o

o

am O.83X12,nosc

t.95X

o

o

nc

2

oo5

o

Metels5445e6

4,17sc9,76X

10,MX

2

3

1

3

o

2

1

Machinery

2

o

143

o.sax

o

o

o

o

1

,

o

IndustrialMachinery

3

o

92

t.67WO.ooX
2,seXO,ooX

O.2tX

o

2

t

1

o

2

1

1

o

co

o,ee%ooox O,21sc

e

o

o

o

o

o

o

3.ssXO,OO"C

1,19sc

o

,

1

2

o

1

o

o

o

o

o

o

o

o

o

1

o

o

o

o

1

o

1

o

o

o

o

o

o

3

t

1

o

1

o

ElectricMachinerv
HeavyEloctricMa(ttinorv

4

o

517

Teleoonnxinication

o

o

o

ConsumerEloetroniosand

2

4

3223

Electronics

1

o

31se

TrorT$portdnEquipments

4

2

oo22

AutomobilesTKIPorts

1

o

ea

o,ooxo,oox o,oo%
1,67X9,76% 7,401"
o.asxo.oox 7.20)t
3,ss%4.eeX 6,ouX
O.83%O.OOXo.mox

o

o

o

o

o

1

o

Shipbeikling

to

7

6407

e.33sc17.07X 14,72X

o

6

6

3

o

3

2

Precisionlnstrurnenls

1

o

2so

O,S3"6O.oo% O.57%

o

t

o

o

o

o

o

OtharManutacturing

mo o.es%o.oo% o.sox

t

o

o

o

1

o

o

1

o

Servioesoe1084S sa,50ts19.51%

24,92X

o

B

2

2

2

22

1

Telel

1ro

41

43525

oo.ooxoaoox

oo,cox

12

43

ee

23

4

52

8

Source/ Compiled based upon Tcyo Keizai, Kagal Shinshulsu Kbyo Soren (Generel Directorv ot Japanese Firrns Abroad}, 1ee3.

Note/ {t) Number of firms (2)Cdytd invest (3) NuvTx)bor of ornplcryment

HIJK
3003
oooo
OOOI
oooo
oooo
oooo
oooo
1000
oooo
oooo
oooo
oooo
oooo
oeeo
OOOI
oooo
oeoo
oooo
oooo
OIOt
2000
1000
oooo
OIOO
oooe
1000
ooeo
2000
oooo
2000
eooe
oooe
1019
132115
L

1

o

M o

P

1

2

o

o

1

6

2

1

o

o

o

1

o

o

3

o

o

o

o

o

1

1

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

2

o

o
o

o

o

o

o

o

1

o

o

o

o

1

o

1

o

o

o

o

e

o

o

e

o

o

o

o

o

o

o

o

1

o

o

o

e

o

o

o

o

o

o

o

t

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

e

o

o

o

o

o

o

o

o

o

o

o

1

o

o

o

o

o

o

2

1

o

o

o

o

o

o

o

o

o

o

o

o

2

o

o

o

o

o

o

o

o

o
o

`

o

o

o

o

3

o

o

o

o

o

o

o

o

o

o

o

o

1

o

o

o

o

o

o

1

o

o

o

o

o

o

o

o

o

o

o

o

o

1

o

o

o

o

o

o

5

o

1

o

o

o

o

o

o

o

o

o

o

o

o

o

o

1

1

o

2

10

3

4

3

1

1

3

ss

8

9

INVES TMENT RELA TIONSABE: TRADE AND
OFJAPANANDASEAN 39

Table 11 Objectives of Japanese Firms in ASEAN
Capital Employment

No, ofFirms
Thailand

577

205

144779

Malaysia

413

197

118299lndonesia

98

5t

37858

Philippines

120

41

43525

Number of responses

FGHt JKLMOP12
BC D89 E32 239
7 19 146 38
51 52 148 80 13A
ThaUand

19 142

79

Malaysia

28 11494

79 22 169 42 30 20

lndonesia

8

26

27

13 O 49 5 4 5Philippines

12

43

20

A

LMOPV2
BC D37 E13 FIOOG21H22l 6 J3 t<
33
3 8 61 16

9

23 4 52 8 13 2

5 53 8
1 16 O
1 15 351
1

6 16 87 35

3

42
38

2634 31336 81

9

Ratio to F (Olo)Thailand8

Malaysia

17

59

33

67

56

47 13 100 25 18 12

27 O1oo 10 8 1044 8100 15 25 4lndonesia

16

53

55

Philippines

23

83

38

5

4

3 31

5

3

2 33
2 29

o

2

6

2

4 9 54 21
4 12 69 6
2 6 69 t5

3
18

22

2
17

Objectives

A

to secure materialslto aocompany group firms or araliated firms

B

to use cheap laborJto finance and to avoid exchange rate riskc
D

DFI promotion policy of local govemK

to aquire royalty and information gathering

intemational predudion networkL

devetopment and planning of goods intemationally soldE

intematienal disthbution netwrokF

to seoure k)cal matkets

M new businesso trade inchonsG

to export third counbes

PothersH

to export to Japan1

profit2

in baiance

3

loss

Source: Same as Table 1O,

40

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 11-54

Development of an International Network of Japanese Private Enterprises

The Twenty Second Survey on Japanese Business Activities Abroad gives somehints regarding the recent development of international networks. This survey
covers all the firms, where Japanese capital involvement is more than 109o, ex-

cept finance, insurance, and real estate. Based upon Table 12, Japanese firms
abroad generally marketed their products more than three quarters in local markets. There is no distinct trend for the entire period but for the past few years it

seems that exports and networking became more important than before.
This is more evident in terms of purchases of Japanese firms. More than half ofpurchases was from other markets and amazingly large proportion was fromJapan (42.4%) in 1991. The local content in all regions remained around 489osince 1989. The Japanese imports content dropped, particularly, it dropped in
North America, from 62.39e in 1986 to 47.19o in 1991, while the local content increased steadily from 32.39o to 47.19o during the same period. Imports from third
countries to total input recovered in all the regions from 5.39o in 1988 to 9.59o in
1991, cornparable to 9.39o in 1983.

In the case of Asia, the proportion of exports in total sales was twice as large(45.59o), with this share increasing. The export to sales ratio of Japanese affili-

ated companies in Asia was four times higher than that of the U.S. Japaneseaffiliated companies. This simply shows the fact that Japanese affiliated companies in Asia were more export-oriented.
What is noteworthy is that imports by Asian affiliates from countries other thanJapan recovered from 11.59o in 1988 to 16.79o. The local content in Asia, however, showed a decline from 53.79e in 1987 to 44.59o in 1991.

Thus, FDI towards Asia was motivated not only by the yen appreciation but
also by export-oriented policies of the host countries. Thus, we see these policies

enhanced and expanded international network activities.

ABE: TRADE AND IIVVESTMENT RELATIONSOFJAPANANDASEAN 41

Table 12 Trade of Japanese Firms Abroad(Manufacturing)

Sales
f983

f986

f987

f988

1989

f990

199f

Werid Tota1
Loca1 Sales

75.2

81A

79,3

8t,7

76,2

24.8

189

20,7

18,3

84
t6

81,4

Expons

18,6

23.8

Japan

11,6

7.8

9,1

7,1

7,9

5,8

8.4

othercountries

13.2

11A

11,6

11,2

8,1

12,8

15,4

Loca1 Sales

87,2

92,8

92,B

93.8

93,1

90,1

89.4

Expons

12,8

7,2

7,2

6,2

6.9

9,9

10,6

Japan

7,7

3,3

4,8

4

4,5

3.3

4,1

other countries

5,1

3,9

2,4

2,2

2,4

6.6

6,5

North America

Asia

'

Local Sales

66,9

547

59

59.8

63,9

59,6

54,5

Expons

33,1

45,3

4t

40.2

36.1

40,4

45.5

Japan

10,8

15,8

16,7

13,7

15,8

11,8

15.5

North America

B,2

10,2

8

8.7

6

7,6

8,5

Asia

8,2

12,8

11,1

11,4

9.7

12,6

15,6

Europe

3,t

4,6

3,5

4,5

3.3

6,e

4,3

other countries

2,8

1,9

1,7

1.9

1.3

2.3

1,6

V983

V986

f988

f989

f990

Local Purchases

40,3

40,1

48,5

41.8

48,t

47,9

lmpons

59.7

599

51,5

58.2

51.9

52,1

51,9

Japan

50,4

53

44,5

52.9

45,7

44,8

42,4

other countries

9,3

6,9

7

5,3

6,2

7,3

9,5

Loca1 Purchases

28.5

32.3

44,3

36,9

47,1

42,8

47.1

lmports

71.5

67,7

55,7

63,1

52,9

57.2

52.9

Japan

68,7

62,3

52,9

60,8

49,2

52,6

47.1

other countries

2,8

5.4

2,8

2.3

37

4,6

5.8

LocaiPurchases

44,7

42,2

53,7

47,2

49,8

48,5

44,5

lmpons

55,3

57.8

46,3

52,8

50,2

51,5

55.5

Japan

38,4

45,3

33,6

41,3

38,9

38.8

38,8

other counines

16.9

12,5

12,7

11,5

11,3

12,7

16.7

Purchases

f987

t99f

Worid Total
48.1

North America

Asia

Source: MiTl, 22nd Survey of Japanese AMiates Activities Abroad (Dai 22 Kai

WagakuniKigyo no Kaigai jigyo Katsudo)

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 11-54

42

4. Prospects of Trade and Investment Relationship between Japan and ASEAN
In former sections we made it clear that trade shares of ASEAN, ANIEs, andJapan expanded in the past and this area became a growth pole. Although thetrade intensity somewhat decreased, it still remained at very high level. We havealso seen a development of diversification of trade by direction and by products.
Japanese FDI has a special characteristic in ASEAN; the share of manufactures is
far greater than the world average. This implies that Japanese FDI to this region
helps expand production more than other cases. It is also pointed out that there

seems to be a positive correspondence between Japanese FDI and changing comparative advantage structures of ASEAN countries.
To visualize future prospects we should consider the following aspects. All thequestions are not mutually exclusive.
1.

Can ASEAN have a higher trade intensity? Can ASEAN have higher tradeshares?

2.

Can ASEAN upgrade its production in the face of the emergence of China
and South Asia as a supplier of labor intensive goods?

3.

Can ASEAN create new Japanese markets for their products at a time when
U.S. demand is growing less rapidly and countries like Mexico are granted apreferential access?

4.

What are the prospects of increased intra-industry trade?

5.

Can ASEAN invite more FDI from Japan? Or might FDI intensity rise?

Higher Trade Share and Intensity?
For the first question of trade share, it might grow a little further but the tradeintensity might drop because of the emergence of new markets. Recent Japanese
investment in China and South Asia is indicative that the trade share of China
and South Asia will grow, which has a negative impact to ASEAN's trade share.
AFTA might speed up in lowering tariffs, and more importantly non-tariff barriers, and this might increase regional as well as non-regional trade. It is indeed

important how their import competing industries are protected by tariffs andother barriers. Economic theory suggests that the more countries are protecting
their import competing industries, the greater the trade creation effect of theformation of a free trade will be. Since the tariff levels of the U.S. and Japan are

already low, the problem is with ASEAN and Asian NIEs. Except for Singapore,
where the trade weighted-average tariffs are low (i.e., about one percent), tariffs

in East Asian countries are substantially higher than those of Japan and the U.S.
In particular those in Indonesia and in the Philippines are high at around twenty
percent, while those in Japan and the U.S. are less than four percent. Thus, as isABE: TRADEAIVD INVESTMENTRELATIONS OFJAPANAND ASEAN 43

often the case in most developing countries, the degree of tariff protection in East

Asia is also fairly high9. AFTA was created to reduce tariffs within ASEAN but

member countries are encouraged to continue unilateral trade liberalization.
Thus, the prospect of trade creation is rosy. The tariff rate increases according to

the degree of processing, thus consumer goods have the highest tariff rate, andprimary goods the lowest. It should be noted that in Indonesia and Malaysia thetariff rates for consumer goods are as high as sixty percent. In addition to tariffs,

imports by East Asian countries heavily protected by non-tariff barriers (N'IBs),
such as quotas, restrictive licensing and import prohibition. These are also thetarget of reduction of the recent AFTA endeavor. Considering this, if AFTA succeeds in lifting tariffs and non-tariff barriers and in coordinating trade and invest-

ment policies, we can expect a rosy scenario for further trade expansion.

Another important aspect related to trade expansion is that the current
Japanese DI expansion is still at an early stage and the real trade of products ofmultinational companies is expected to expand in the near future. This will enhance the trade volume and intra-industry trade.
Upgrading Possibility?

For the second question, the emergence of China and South Asia implies that
low-end products, mostly labor intensive products will be supplied by these coun-tries and ASEAN should move toward upgrading production. If ASEAN succeed
in upgrading, ASEAN can still expand trade intensities in some products andtrade shares overall. The more upgrading possibilities exist, the larger the benefitof regional integration will be. This direction seems to be the best for ASEAN.

Still a gap exists among developing ASEAN countries, and Japan. Sharp wage
hikes, labor shortages, and insufficient infrastructure put ASEAN a difficult situa-tion. China and Vietnam, on the other hand, can be expected to start competingwith the ASEAN countries in attracting FDI from developed countries. In fact,
the U.S. normalized the relationship with Vietnam and China recently. China andVietnum can provide abundant low cost labor as well as large domestic markets,
although they lack in infrastructure and various institutional systems. In the labor

intensive industries such as food processing, apparel and relatively simple
machine assembly, these two countries might increase their competitiveness evenfurther. ASEAN countries should reinforce their international competitiveness by
upgrading their industrial structure as a whole. Developments of regional integra-

tion such as NAFTA and the EU, might negatively affect these countries due tothe formation of trade blocs and protectionism, In addition, the U.S., which has

9 Goto and Hamada(1993) and Naya and Plummer.

44

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 11-54

consistently been providing Asia with its largest export market in the post war
yeas, seems to be losing its absorption capacity. To keep and to level up interna-

tional competitiveness ASEAN should convert domestic industries from labor-intensive to increasingly capital and technology intensive industries by enhancing

R&D and better machinery including robots. In which industry can ASEAN upgrade?

Automobile demand in the ASEAN countries expanded substantially after
1985, reaching 800,OOO units in 1990. Although the local content of the ASEAN
automobile industry has been gradually increasing, the industry is not yet internationally competitive. This is attributable to small scale of production, high priceand low quantity of locally procurred parts, and high import tariffs on essential

parts and raw materials. Japanese automobile companies in the region should
strive to develop top-grade parts manufactures in ASEAN in cooperation withlocal firms, to cooperate in the development of local human resources and topromote the further division of labor within the region. Japanese automobile
companies will boldly increase their investment in attractive countries and sectors
with a plan to increase their exports.

Consumer electronics went through the import substitution stage in the 1960's,
export oriented stage in the 1970's and grew into 309(o of the total Japanese FDI

in Asia in the latter half of the 1980's. The ASEAN region has grown to becomea productionlexport base for consumer electronics as a result of the rapid increaseof the Japanese FDI. Japanese FDI peaked in 1987 to Asian NIEs and it increased drastically to ASEAN since then; accordingly Japanese imports of consumer electronics from ASEAN increased rapidly while imports from the Asian
NIEs decreased between 1989 and 1991. This reflects the change of Japanese FDI

policy from local production to import back to Japan. The Electric Industries
Association of Japan released the demand projection of electric appliances for

ASEAN. Reflecting the changes of life-style, the local demand is unlikely toreach levels that would replace external demand. The consumer electronics indus-

try in ASEAN is expected to remain highly dependent on exports for some time.
The traditional advantage that ASEAN countries have so far enjoyed are being
lost as a result of increasing wage costs. Thus, the industry should be upgraded byshifting production to high value-added products.
The textile and apparel sector is a typical Wild Flying Geese Hypothesis sector.

The ASEAN textile and apparel industry has emerged as a production base with
abundant, high quality labor force in contrast to Japan, South Korea, and Taiwan
whose international competitiveness is falling. In the past five years, textile andapparel exports of ASEAN have quadrupled, while imports expanded three fold.

Japanese exports have decreased due to competition from ASEAN and China

ABE: TRADEAND INVESTMENTRELATIONS OFJAPANAND ASEAN 45

and imports rapidly increased from these countries, creating a deficit in 1987 forthe first time. Vietnam, in addition to China, is expected to become increasingly

important as a destination of FDI. China, Vietnam, and ASEAN will become
ever more interdependent. Again, as Japan did first, and as Taiwan and Korea
did next, ASEAN should upgrade this industry by investing in capital and by introducing technology from advanced nations.

The machine parts industry includes machine parts assembly, machine partsforming, and die technology. In recent book by Seki (1993), Ohtaku of Tokyo,
where all these supporting industry small firms are located, is said to be sufferingfrom labor shortages and plan to abandon the operation. Young labor dislike thistype of profession because of the three Ks-Kitsui, Kitanai and Kiken (or hard,
dirty and dangerous). Many firms have already gone to China or elsewhere. Thisactually breaks the past one-set industrialism because Japan itself cannot support

these machine parts domestically; thus, Japan has to be dependent upon Asianneighbor countries and, like it or not, should consider to promote international
division of labor in the true sense of the word. The casting industry is a typicalmachine parts forming industry and has been developing steadily as a supporting

industry for agricultural and mining machines as well as general machines andautomobile industry. This industry in ASEAN has much room for improvement
and, therefore, for cooperation because of the high defect rate and other problems.

Larger Japan Market?
Given that the above two prospects apply, ASEAN needs markets for their upgraded products since the U.S. started to be less positive in providing markets to

ASEAN; the only possible alternative markets will be Japan and Asian NIEs. Aslong as Japan is concerned, Japan necessarily can provide sufficient market to
ASEAN if Japan expands its production network as a process of de-industrialization in domestic economy. Japan, like it or not, must transform from full set indttstrialism of domestic economy to that of regional or global economy. It seems
that the trend is already in this direction.

Japanese FDI development necessarily results in de-industrialization of domes-

tic economy. Since FDI is an international transfer of production base from investing country to host country, which certainly affects the economic activities in
the former, there is a worry about the domestic "de-industrialization" or the "hollowing out" effect of IDI. De-industrialization can broadly be defined as a situa-tion where there is a continued and large decline in employment, in private
equipment (or research and development) investment, in high value-added manufacturing output, and in the balance of trade (an indicator of revealed internation-

46

KOBE ECO,NOMIC & BUSINESS REVIEW, 42 (1997), 11-54

al competitiveness in manufacturing) in the investing country.

What is the outcome of de-industrialization? At the specific industry level, weobserve a de-industrialization effect of FDI in Japan. For example, the textile industry, a labor intensive industry, left Japan in the late 1960's mostly to the Asian

NIEs and ASEAN, when textile production became too expensive in Japan (theshare of textile exports in total merchandise exports in Japan declined from 7.39oin 1974 to 2.59o in 1991). However, while Japan was moving out its comparatively disadvantageous textile industry overseas, it shifted the production factors re-leased from the declining textile industry to a further development of the machinery industry, a capital and technology intensive industry, in which Japan has comparative advantage (the share of machinery exports in total merchandises exports
in Japan increased from 50.29o in 1974 to 75.29o in 1991). Thus, as a whole, theindustrial structure of the Japanese economy has been upgraded and has become
more internationally competitive (the total merchandise exports increased 5.7
times from 1974 to 1991, compared with an increase of 4.2 times in the U.S. forthe same period). This example suggests that FDI has an important role in res-tructuring the economy. The higher the international dependence becomes, theeasier the de facto regional integration results.

Necessarily the de-industrialized sector's products should be imported to Japan,
thus, this process is trade expanding. In the spirit of flying geese development pat-tern, ASEAN should behave the same as Japan to give way to emerging China insome areas, while upgrading its own industry to create further demand in new industries.

FDI has impacts on trade in stages. FDI affects trade in a different manner inaccordance with each development stage. First, in the period from the start ofconstruction on an overseas production base to the start of production, exports ofcapital goods, such as equipment, from the home country to the host country increase (Stage 1). After production begins, exports of intermediate products, suchas parts and raw materials from the home country to the host country, increase

because local procurement of these products does not progress immediately(Stage 2). Exports of final products from the home country decrease as these pro-ducts are replaced increasingly through local production, and/or homeward exports of final products from the host country may increase, depending on the divi-

sion of labor between home and host countries and the corporate strategy (Stage3). Finally, as local procurement of parts and raw materials progresses, exports ofsuch intermediate products from the home country to the host country decrease(Stage 4).

Thus, we can expect alarger absorber role of Japan. Japan will lose some sectors and require imports and, thus, FDI trade stages will evolve.

ABE: TRADEAND INVESTMENTRELATIONS OFJAPANAND ASEAN 47

Stronger Intra-Industry Trade?
The fourth question can be easily realized. As long as Japanese FDI promotesinternational networks in the future and as long as ASEAN endeavors to upgrade
its industries, the natural result is ever stronger Intra-Industry Trade Index (IIT).

This in fact should be placed as immediate goal or objective of industrial policy of

ASEAN.
According to Lincoln (1990), the Japanese IIT dropped from 26 to 23 during
the 1970-1985 period while the U.S. IITrose from 53 to 54. The drop of Japanese
IIT is due to two consecutive oil crises, which raised the share of oil in total

trade; but the IIT of manufactures alone fell from 32 to 26. Table 13 shows the

combined IIT development of the U.S. and Japan. For the 1985 to 1990 period
IIT expandediO. Particularly Japan experienced quite a gain. Japan performed IIT
widely and intensively in the sector 46 (other manufacturing), sector 15 (plastics),
sector 7 (textile), sector35/36 (chemical products), sector 24 (metal products), sector 44 (scientific tools). Country wise, llT is greater than 90 in with Korea textiles

and steel, other manufactures, and telecommunication equipment. On the other
hand, the U.S. performed llT in the following sectors and countries. The U.S.
performed intensively and widely in the sectors 42 (electronic machinery) and 40(non-electric machinery). Trade with Hong Kong, Singapore, EC, Thailand,
Malaysia, and ASEAN in sector 42 all recorded more than 90 in IIT.

Differences in FDI between labor-intensive industries and capital- andtechnology-intensive industries seem to be most pronounced in local procurementof parts and raw materials. In the case of FDI in labor-intensive industries, which
requires little high-level technology, local procurement of parts and raw materials

makes relatively good progress. In the case of similar investment in capital- andtechnology-intensive industries, however, parts and raw materials of higher quality are required. Thus, in order to promote local procurement in these industries,

spadework must be done in such basic areas as development of local industries
and human resource development. For this reason, where FDI is made in capital-

and technology-intensive industries, local procurement progresses more slowly
than is the case with labor-intensive industries. Thus, exports of intermediate pro-ducts from the home country do not decrease in a short period of time. It is prob-

ably for this reason that the positive intra-industry trade indexes of Japanesemachinery for the NIEs and ASEAN countries have so far shown relatively small
negative changes.

10 Abe (1994).

ECONOMICB&USINESSREVIEVV, 42(1997), 11-54
KOBE

48

Table 13 DevelOpmentof Intra-Industry

Trade
USA

Japan
Country

Wortd

t985

Industry

1990

Tfade
Value(1990)

Country

46

O,60

O,99

186,736 Worid

USA

44

O,99

O,99

39,789

Korea

7

O,88

O.98

t8,575

Korea

23

O,69

O,96

94,474 Worid

USA

19

O,95

O,96

11,683

Worid

35

O,89

O.96

1985

lndustry

1990

Trade
Value(1990)

19

O,54

O.99

18,483

42

O,47

O,99

22,125

45

O.66

O,98

45,897

1

O.71

O,98

28,493

21

O,80

O,96

78,320

293,180 Singapore

42

O.68

O.96

102,310

28

o,to

O.96

11,026

O,45

O.96

26,310

HongKong
EC

ROW

Korea

46

O,81

O,95

ss,756 Taiwan

Worid

15

O,62

O,95

48,491

EC

16

EC

15

O,56

O.94

5,541

Slngapore

47

O,79

O,96

27,983

China

36

O,58

O,94

34,058 Korea

40

O,80

O,96

164,321

ROW

46

O,46

O,92

231,778

EC

40

O,98

O,96

1,659,779

EC

46

O,90

O.92

31,482

ROW

8

O.90

O,95

65,565

NIES

3

O.85

O,92

70,111

EC

42

O,99

O,95

413,426

World

36

O,48

O,91

772s693 Japan

44

O,90

O,95

158,179

Korea

41

O,52

O.9t

67,84

40

O,98

O.94

7,460,203

Taiwan

7

O,88

O,90

52,965 NIES

3

o,eo

O,94

6,859

USA

15

O.68

O,89

37,781 Worid

20

O,85

O,94

128,026

Worid

ROW

7

O,42

O,89

136,933 Thaiiand

42

O,85

O,94

65,356

Worid

7

O,60

O.89

7es,461

EC

37

O,95

O,94

i79,844

EC

28

O,11

O,89

26,685

ROW

46

O,86

O.92

1,998,246

World

3

O,48

O,88

217,378 Maiaysia

42

O,81

O.92

251,623

Malaysia

6

O,08

O.87

18,109 Japan

4

O,36

O,92

8,035

Korea

24

o,oo

O,87

52r642 ASEAN

42

O.83

O.92

461,639

Singapore

31

079

O,86

7,159 Taiwan

29

O,08

O.92

140,677

ROW

36

O,75

O,85

400,739 Japan

32

O.45

O,91

36,640

NIES

18

O,83

O,85

68,086

32

O,68

O.91

99,444

EC

ROW

44

O.33

O,84

52,295 lndonesia

World

16

O,57

O,84

437s981 NIES

NIES

46

O,78

O.84

EC
USA
USA

35

O,65

O,84

32

O,83

O,84

46

O,51

O,83

Worid

1

O,45

O,83

62,701 Philippines

USA

11

o,oo

O,83

World

19

O,81

O,82

Worid

20

O.95

Philippines

46

o,oo

Thailand

15

o,oo

O.82

6,547

ASEAN
USA

46

O,96

O,81

160,855

35

O,77

O.81

China

15

o,oo

7

o,oo

O.91

6,942

34

O,32

O,91

106,120

898,403 ROW

7

O,89

O,91

291,384

305,474 China

29

o.oo

O.90

9,471

65,795 Malaysia

40

O,48

O,90

52,397

47

O,58

O,90

276,178

42

O.84

O,89

140,872

58,075 Malaysia

36

o,oo

O,89

11,731

217,396

ROW

42

O,94

O,B9

2,236,633

O,82

155,262

ASEAN

23

o.oo

O,89

6,452

O.82

13,226 World

35

O,98

O,88

1,704,886

EC

35

O.75

O.88

661,714

ROW

37

O.84

O.88

t80,927

340,652 Singapore

15

O,91

O.87

5,045

O,81

6,774 World

39

O.66

O,87

461,317458,254 Singapore

46

O,76

O,87

168,939

22

O,53

O,87

t59,079

Worid

22

O,82

O,80

ROW

43

o,oo

O,80

1•273s898 China

18,759EC

AND 49
ABE: TRADE AND INVES TMENT RELA TIONS OF JA PAN
ASEANTable 13 Development of Intra-Industry Trade (concluded)
USA

Japan
Country

1985

lndustry

1990

Trade
Value(1990)

Countrylndustry

t985

1990

Trade
Value(1990)

ASEAN

26

o,oo

O.79

9,071

ROW

35

O,94

O.87

Korea

31

O.75

O,79

25,079

ASEAN

1

o,oo

O,86

12,f32

Korea

27

o,oo

O.79

23,480 Worid

42

O.76

O,86

7,996,t63

Thailand

7

O.84

O.78

15,604

ROW

24

O,88

O,86

737,936

World

44

O.71

O,78

1,535,4t6

Japan

35

O,89

O,85

269,795

Korea

18

O,71

O,78

4f

O,94

O,85

817,639

Taiwan

46

O.56

O,75

ROW
413,493 ROW

10

098

O,85

86,504

Philippines

35

o,oo

O,75

5,450 Wortd

34

O.57

O.84

886,496

21,047

EC
EC

China

24

o.oo

O,74

23,985

EC

44

O,65

O,74

388,886

Taiwan

24

o,oo

O.74

79,OOO ROWThailand

46

O,93

95,110EC

618,374

18

O,84

O,84

62,162

46

O,50

O,84

2,699,996

17

o,oo

O,84

29,499

47

O,98

O,84

4,190,345

ASEAN

15

o,oo

074
074

15,271

ROW

29

O.85

O,84

9,171,719

Malaysia

25

o.oo

O,73

5,724

EC

36

O,98

O.83

857,765

Singapore

46

O.69

O.73

182,144

ROW

30

O,49

O.83

158,788

Korea

21

o,oo

O,73

24,696

HongKong

8

o,oo

O.83

6,423

NIES

t5

O,67

O,73

16

O,62

O,82

220,430

28

O.86

O.82

226,071

38

O,83

O.82

429,765

37

O,83

O.82

952,340

O.71

O,82

7,851

O.82

345,530

Korea

15

o,oo

O,73

World

32

O.79

O.72

ROW
32,679 ROW
206,086 ROW

Korea

34

O,87

O,72

30,597 Worid

Philippines

36

O,46

O,72

8,962

EC

25

USA
USA
EC

22

O,65

O,72

238,07t

ROW

33

026

16

O.23

O.71

305,516

39

O,68

O,82

168,620

46

O,55

071

2,122,067

EC
EC

1

O,57

O.81

58,700

Malaysia

46

O,49

071

92,801 Taiwan

20

O,61

O,81

10,862

World

8

O,24

O,71

481,567 Tatwan

44

O,83

O,80

69,288Singapore

26

O,16

O,7f

65,725 Worid

46

O,71

O,80

13•992r031

Malaysia

35

o.oo

O.70

17118'

World

30

O,93

O,79

210,928

EC

7

O,95

O,70

386,338

ROW

15

O,99

O,79

395,153

Korea

3

O.68

O.68

157,148 NIES

42

O,56

O,78

2,476,188

Malaysia

21

o.oo

O,68

47

O.35

O,78

192,114

USA

39

O,98

O.68

47

O,62

O.77

40,738,600

NIES

23

O,47

O,68

1,476,044

HongKong

15

o.oo

O,68

16,272

World

18

O,97

O,67

ROW

31

O,44

O,67

92,804

B,376 Philippines

165,765 World

ROW
ROW

18

1,OO

O,77

103,688

36

O,99

O,76

1,898,030

390,674 China

22

o,oo

O.75

28s863342,781 Chlna

40

o,oo

O,75

271s899
4,626,734

USA

7

O,28

O.67

241,625 Worid

41

O,56

O,75

World

31

O,25

O.67

990,687 Korea

22

O,89

O,75

42,828Thailand

6

O,15

O,67

45,183

EC

17

O,44

O,74

54,285

N]ES

24

O,03

O,66

328,730

ROW

23

O.38

O,74

1,142,733

NIES

26

O.30

O.66

174s767 ROW

19

O.67

O,74

207,597

50

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 11-54

As the stages of FDI development suggest, Japan will increase IIT with
ASEAN as the current and future FDI projects mature.

More Japanese FDI to ASEAN?
Whether or not the last statement is realized is a key for the future success of

ASEAN economy. As long as AFTA succeeds in uniting and opening theASEAN market, Japanese firms might have stronger interests in the market. Any
single country is not sufficient to provide good incentives, compared with thehuge possible markets of China and India, so that ASEAN should benefit greatly
by being considered as a single entity. For trade and investment, if Japanese firms

can regard ASEAN as a single country in so far as regulations, benefits and tax-

es, and etc. are concerned, Japanese FDI will incrase or at least maintain its
share. It all depends upon the efforts of ASEAN to build up infrastructure, toease bottlenecks, to liberalize trade and investment, and so on.

5. Conclusions: Challenges and Directions for Cooperation
The more Asian countries engage in upgraded wild geese flying pattern of intraindustry trade, the more tightly their economies become inter-linked. Japan, used
to be known as full set industrialism country, has started to engage increasingly in
the international division of labor, whether she likes it or not. the pattern of DI

flows are such that this change will become more visible in the near future. Once
the Japanese industrial structure changes in this direction, the integration of theJapanese economy in the region will inevitably be strong. The way Japanese industries have been integrated is as follows. The development of Japan's FDI to
Asian countries varies by industry. Japanese FDI to Asian countries has particu-

lar characteristics when compared with its FDI to the world. In case of Asian
countries FDI was more concentrated in manufacturing industry such as food andbeverage, textile, chemical, and machinery industries. Since 1986 steel, non-fer-rous metal products, and electrical industries became FDI concentrated indus-

tries. Although the share of Japanese FDI stock in Asia was much lower thanthat to North America, industry wise, the textile share of Japanese FDI stock in
Asia was higher than that in other regions. The share of chemical, steel and non-ferrous metal products, machinery and electric machinery in Asia was greaterthan 20 percent. Since the flow figures are relatively large in recent years andyears to come, the stock figures are expected to rise in the future, and thus, moreregional integration should be realized in the true sense of the word if Japan im-

ports more of these products. There is ample room for Japan to enhance intra-industry trade in these areas. Such a rapid development of the business activities ofABE: TRADEAND INVESTMENTRELATIONS OFJAPANAND ASEAN 51

Japanese firms necessarily expands networks in production, distribution, and intermediate products. The so-called globalization of Japanese firms has progressed
and is going to develop tremendously in the near future.
Regional Cooperation from the Industrial Re}ocation Viewpoint
Although the total outflow of FDI in 1993 might result in a slight decrease like
1992, it is stil1 at a high level by historical standards. The Asia Pacific region is

one of the most dynamic growth areas in the world. The driving force behind thisgrowth, as was already pointed out, has been the increasingly active trade and in-vestment under an open policy environment, resulting in deepened interdependence within the region. Following Asian NIEs, ASEAN countries have succeededin attaining rapid industrialization helped by a massive inflow of foreign capital,

but now bottlenecks have emerged in infrastructure, manpower, and particularly
supporting industries which mainly supply parts. If the ASEAN countries are to

maintain medium-to-long term growth with such countries as China and Vietnam,
who are rapidly catching up in the industrialization process, they must eliminate
these bottlenecks and upgrade their industries.

It is indeed important for Japan to help these countries solve their problems as
part of a process of establishing an internationally harmonious industrial structure. In other words, Japan should engage in strengthening the ongoing wild geese

flying developmentpattern, leaving light manufacturing and some of more technol-

ogy intensive products to Asian NIEs and ASEAN.
This region seems, whether or not the regional integration scheme is formalized, developing rapidly since the natural trading and investment linkages can be
developed by Japan's initiation of de-industrialization and active relocation of in-

dustries in the region. Both AFTA and APEC will surely help this development;
Regional integration will be enhanced in this region simply because of the potential attached to the region as is explained in the former section. This dynamism ismore important than simple policy slogans. Asia has a tough mentality to supersede practical merits over political skepticism. From this viewpoint, we will touchupon somewhat more on what Japan and Asia can do to enhance the growth of
the region and the world.

Improvement of the Industrial Cooperation Scheme
The industrial sector involved with technological transfer plays an extremely
important role in supporting the upgrading of industries in developing countries.
Upgrading is such a complex agenda that it is of great importance for both Asian

counterparts and Japan to form a common understanding of goals to be attaified,including clarifying the priorities. This is necessary for both private and public

52

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 11-54

sectors. Efforts by the entire region are necessary as exemplified by initiatives

such as AFI'A and other ASEAN regional cooperation schemes. As we discussed, we should now endeavor to construct one efficient full-set industrialism com-plex within broader region, i.e., APEC or the world, and continued cooperationis required by all the countries in the region. Countries alone or in small groups,

cannot achieve the goal. If we should strive for this goal, we end up naturallywith trade and investment liberalization and harmonization of systems and standards. In turn, all of these measures are expected to lower transaction costs in theentire Asia and the Pacific region.

With this understanding we may feel easier with the recent development of regionalism.

APEC, AFTA, NAFTA, and etc.
Intra ASEAN trade is not that significant and, in particular, if we exclude

ASEAN's trade with Singapore, it becomes quite small. AFI"A, therefore,
although it might expand regional trade, will work to harmonize trade and invest-

ment with non-ASEAN countries. Since AFTA is not only a free trade agreement
but also takes steps forward to standardize products and coordinate investment,

Japan, should welcome such moves. Thus, in the future, Japan will consider
ASEAN as another center in spite of the big move toward China and Vietnam inrecent years as a host of Japanese FDI. Probably the effect of AFTA is not to en-

hance trade within ASEAN but to enhance international networks of the region
and to attract more investrnent from Japan. This region should upgrade their industrial structure, leaving less technical products production to China and IndoChina countries.

AFTA still does not appear to address the problem of non-tariff barriers.
Although the tariffs are considered squarely in the CEPT scheme, tariffs are not
the real issue. ASEAN must agree to remove all quantitative restrictions, such asimport quotas, and all other forms of non-tariff barriers. Nevertheless, ASEAN's
potential to evolve from a political grouping into an economic one is attracting
attention from outside the region.

The Japanese governrnent is trying to make APEC successful as a model foropen regional cooperation. As to whether it feels APEC should become more institutionalized, and at the end of the day become a free-trading area, this is not
the direction or the objective the Japansese government believes would be desirable or that one should seek. Needless to say Asia-Pacific is a region where countries are at different stages of economic development. It is unrealistic to pursue afree-trading area in which economic transactions would take place with all theparticipating countries adhering to the same terms and conditions. This

ABE: TRADEAND INVESTMENTRELATIONS OFJAPANAND ASEAN 53

framework of regional cooperation should, however, be one that is in accordancewith the principles of GATI', and where benefits accrued internally should also

be enjoyed by extra regional countries on a most-favored-nation basis. Japan
stresses the importance of technology transfers within the APEC region. Regarding Japan's future role in regional security, besides the importance of the Japan-

US Security Treaty, and that there must also be political and security dialogue
among countries in the region to further increase a sense of reassurance. It is also

very important to promote economic development among countries in the region,
as a lack of economic development can generate instability.

Thus, open regionalism, AFTA and NAFTA as sub regions of APEC, seems to
be an agreed upon concept in Asia and this seems coincide with the flexible
approach of Asian nations. If one country should become too stubborn in leading
any one scheme, it will not function smoothly. Flexibility is the virtue of Asian
cultures and due process should be taken to be followed in taking further steps.

References

Abe, Shigeyuki (1993) "Nihon no ASEAN Chokusetsu Toshi to ASEAN no Hikakuyui
Kozo (Japanese Direct Foreign Investment to ASEAN and ASEAN's Comparative Advantage)," a paper presented at Development Seminar, Kyoto University, July 17, 1993 (mimeo).
Abe, Shigeyuki (1994) "Nichibei no Sangyonai Boeki (Intra-Industry Trade: Japan andthe U.S.A.)," Kokumin Keizai Zasshi, February 1994.

ASEAN Secretariat (1993) AFTA Reader, Vol 1. euestions and Answers on the CEPT

ofAFTA.
Economic Planning Agency (1992) Economic Survey of Japan 1991-1992: Seeking for a
New Perspective beyond the Adjustment Process, 1992.
Far Eastern Economic Review various issues.
,Goto, J. and K. Hamada (1993) "Economic Preconditions for the Asian Regional Integration", February, RIEB Discussion Paper, Kobe University.
Ichimura, Shinichi (1994) "Regional Integration Issues in Asia", Osaka International
University Discussion Paper.
Kohama, Hirohisa (1992) Chokusetsu Toshi to Kogyoka: Nihon, NIES, ASEAN (Direct
Foreign Investment and Industrialization: Japan, NIES and ASEAN), JETRO,

1992.
Kohsaka, Akira, Yasuhiro Asami, Shigeyuki Abe (1993) "Changing Patterns of Tradein Goods and Services in the Pacific Region," a paper presented at the Pacific

Economic Outlook Specialist Meeting, Septermber 27-28, 1993, Osaka.
Lincoln, Edward J. (1990) Japan's Unequal Trade, Washington: The Brookings Institu-

tion.
Ministry of International Trade and Industry (1993) ASEAN Sangyo Kodoka Vision:
Sangyo Seisaku no Susume (Prospects and Challenges for the Upgrading of Industries in the ASEAN Region)
Seki, Mitsuhiro (1993) Full-Set gata Sangyo Kozo o Koete: Higashi AJ-ia Shin lidai no

54

42 (1997),
KOBE ECO,NOMIC & BUSINESS REVIEVV,

11-54

nakano Nihon Sangyo (Beyond Full-Set Type Industriat Structure: Japanese Industry in the New Era of East Asia), Chuokoron.
Yamazawa, Ippei "On Pacific Economic Integration" The Economic Journal, vol. 102,

November 1992, pp. 1519-1529.

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 55-96

JAPANESE FINANCIAL RELATIONSHIPS IN TRANSITIONKENJIKOJIMA KobeUniversity

Abstract
This paper presents Japanese financial relationships in an international perspective.
The primary purpose of the study is threefold: to identify irnportant features of financial

relationships in Japan and those structural changes; to provide economic rationale forthose relationships and changes; and to develop insights concerning corporate financeand capital market under institutional and regulatory environments. Corporate financein Japan has evolved around the main bank relationships. Finaneial liberalization in
Japan has created difficulties for the main bank relationships. The process of change
will continue, both because of continuing liberalization and because some financial pat-terns change sluggishly. Increasing financial sophistication and capability to exploit
opportunities arising from regulatory changes will also continue to alter corporate finan-cial practices. Financial liberalization tends to undermine the main bank system because
major non-financial firms have greater access to arm's length debt as well as borrowing
from foreign financial institutions.

JEL CItzssification: G21; G32; G33
Keywords: Cross-share holding; Financial liberalization; Financial relationships; Mainbank
1. Introduction

As capital and product markets have become global, the differences in corporate behaviors across the countries have been shown distinct. Since behaviors andperformances of firms substantially depend on institutional and regulatory environments where firms operate, peculiar pattems of behaviors turn out to be therational economic responses to those environments. One of the major differencesin corporate behaviors among different countries can be financing patterns, partiCorresponding Address:
Kenji Kojima
Research Institute for Economics and Business Administration, Kobe University
2-1 Rokkodai-cho, Nada-ku, Kobe 657-8501, Japan
E-mail: kojima@rieb.kobe-u.ac.jp
Fax: ( 81)-78-803-0406

56

KOBE ECOAIOMIC & BUSINESS REVIEW, 42 (1997), 55-96

cularly the financial relationships between the capital market and non-financial
firms. Corporate capital structures and financing practices in Japan appear distinctive, particularly in comparison with those in the United States. Specifically, it iscommonly observed that financial institutions in Japan tend to have much closer,
longer relationships with their clients than do their counterparts in the UnitedStates. In large part, these differences are due to differing institutional and reg-ulatory environments. To the extent that the institutional and regulatory constraints vary systematically across countries, so may financial relationships. Whilelegal and historical considerations help to explain why financial relationships ineach country have followed distinctive trajectories, we need to explain the difference of patterns across the countries as well as the similarity within each country
and their sustainability with providing economic rationale under specific institu-

tional and regulatory environments. The key to answer these questions is compre-

hensive understanding of the financial relationships with a comparative study,
identifying the underlying structure of constraints.

Japanese financial institutions may hold equity and debt at the same time. Besides strengthening the long-term relationships between the financial institutions

and the firm, the simultaneous holding of debt and equity clearly reduces thescope for conflict between stockholders and debtholders over the choice of policies, particularly in situations of financial distress. The significance of the mainbank system is the close information-sharing relationship that exists between thebank and the firm. It is possible to view the main bank system as functioning as a
substitute for the kind of screening and monitoring institutions that are prevalent

in other capital markets such as bond and credit-rating institutions and security

analysis agencies. The close association that the main bank has with the firmmeans that the bank is able to obtain inside access to the firm and its management, which is not readily available to the external capital market. It can beargued that this function of the main bank provides an important substitutemechanism for what in effect is inactive market for corporate control in Japan.

Main bank intervention can take a number of forms, ranging on the one handfrom cases where the main bank stipulates certain measures that requires the firm
to take in exchange for the bank's support during a period of financial difficulty.

Much of corporate finance in Japan has evolved around the main bank relationship. This is changing for many firms, particularly large and highly liquid firms.
Financial liberalization in Japan has created difficulties for the main bank system.

Nevertheless, that system seems likely to adapt and continue to provide valuable

support for medium-sized and rapidly growing firms. Exactly how this will comeabout is not yet clear; however, there are substantial incentives for preserving thesystem's advantages. More generally, the effects of financial liberalization over

57
KOJIMA: JAPANESE FINANCIAL RELA TIONSHIPS IN TRANSITION

the last decades have been enormous. The process of change will continue, bothbecause of continuing liberalization and because some financial patterns change
sluggishly. Increasing financial sophistication and capability to exploit opportunities arising from regulatory changes will also continue to alter corporate financial

practices. Financial liberalization tends to undermine the main bank system be-cause major non-financial firms have greater access to bond market as well as
borrowing from foreign financial institutions. This makes it potentially much moredifficult for the main bank to monitor and control those firms. Consequently, themain bank system could continue to be viable and advantageous for firms whichis restricted the access to alternative debt sources and need strong bank support.

The financing pattern of large Japanese firms is beginning to resemble the morearms-length financing patterns observed in the U.S. The infrastructure in financial

market including rating agencies, disclosure rules, regulation and enforcement of

insider trading are not developed well in Japan. Even though the deregulation
made it possible for major firms to arm's length financing, some firms would still

maintain main bank relationships.
This paper presents major characteristics of Japanese financial relationships in
an international perspective. It examines the structural changes in the financial re-lationships and discusses the future directions. The primary purpose of the study
is threefold: to identify important features of financial relationships in Japan andthose structural changes, to provide economic rationale for those relationships

and changes, and to develop insights concerning corporate finance and capital
market under institutional and regulatory environments.
This paper is organized as follows. The next section presents the major characteristics of financial relationships in Japanese firms comparing with the counter-parts in Germany and the United States. In particularly, it describes one of themost distinctive features of Japanese financial relationships, that is main bank relationships, and discusses its economic rationale. Some aspects of Japanese corpo-

rate finance have changed dramatically over the last decade. Most of thesechanges are the result of changes in the structure of Japanese financial markets,

which in turn can be traced to regulatory changes. Section 3 discusses recent
structural changes in corporate financial policies, and capital and credit markets
in Japan. Finally, section 4 presents concluding remarks.
2. Financial Relationships
2.1 Close Financial Relationships
Non-financial firms have relationships with financial institutions in each coun-try. U.S. corporations borrow from a broader array of sources than their

58

KOBE ECONOMIC & BUSINESS REVIEIJV, 42 (1997), 55-96

Japanese and German counterparts, which rely more heavily on banks for external capital. Their bank financing also differs, since in Germany lenders supply
more long-term financing. With an active equities market, a vigorous commercial
paper market, a strong banking system, and a variety of long-term investors, theU.S. capital market has no equivalent ones in other countries. Yet the widespread use of conventional rules of thumb to determine capital structure and theprevalent reluctance to issue common stock for internal financing purposes negate
this advantage. By setting specific debt-equity goals and by refusing to issue equity for fear of diluting earning per share, U.S. firms arbitrarily limits its available

capital. Consequently, the capital potentially available becomes irrelevant and un-used asset. While U.S. firms draw almost 209o of their external funds frombanks, their relations are not close. The natural conflict between managers, who
are supposed to represent shareholders with residual claims in the firms, and thelenders, who have preferential claims on its assets, never entirely resolves.
Moreover, the need to negotiate terms and restrictive covenants, which constrain

management's latitude, underscore this adverse edge. U.S. Iegislation also pro-hibits commercial bank ownership of non-financial corporations, so U.S. banks
act only as intermediaries on behalf of other investors.i

In Germany and Japan, these relationships are especially close and long-term,
and it has important implications: banks are more likely to provide support whenfirms are in financial trouble, since helping their borrowing firms remain viablereduces the riskiness of their loans; banks support their borrowers' long-term
growth to ensure their own; banks usually have sufficient influence to ensure thatmanagement's decisions are compatible with their own goals. Together with thesmall portion of equity in corporate capital structures, these close relationships

can diminish the importance of shareholder wealth maximization as a prime goalof corporation. Banks enjoy a special position in German industry. The historical-

ly underdeveloped capital market and burdensome corporate tax policy have inclined to firms to finance with bank debt rather than equity. German banks also
own a significant fraction of equity in non-financial firms, although the exact per-centage of bank-owned shares is not known. In addition to direct share owner1 In the U.S., the Bank Holding Company Act underscores it by requiring bank passivity in wielding
stock. The law prohibits not just control of a firrn, but control of any voting stock. It deters taking

proxies, voting trusts, and owning through non-bank subsidiaries. The Bank Holding Company Act

would deter the U.S. banks with either Japanese main bank ownership or German proxy votes
even if the Act allowed day-to-day influence (Roe 1993). Banks and financial institutions areallowed to exert control over non-financial firms by law. Banks assume an important monitoringrole in the restructuring firms, which file for bankruptcy or restructuring their debt privately. Gilson (1990) reports that banks and other financial institutions with debt outstanding to the firm received significant blocks of voting stock in h sample of 111 listed firms that filed for bankruptcy or

restructured their debt between 1979 and 1985.

59
KOJIMA: JAPANESE FINANCIAL RELATIONSHIPS IN TRANSITION

ship, banks serve as depositories for stock owned by other shareholders. At theend of 1988, they held approximately 409e of the total market value of outstand-ing domestic shares. Banks also enjoy Vollmachtstimmrecht, or the right to voteshares held on deposit on behalf of the depositors. Effectively, bank controls vir-tually half of German shares. German law has been amended to require thatbanks solicit voting instructions from shareholders whom they represent and renew the right of proxy for shares held on deposit every 15 months. In the eventof a takeover offer, banks must inform shareholders of pending bids only if theoffer is published. Still, banks continue to obtain wide latitude in the voting ofshares held on deposit. Big commercial banks and central savings banks, or Land-esbanken in Germany, practice universal banking, which includes direct investment in equities and bonds.2 As a result, German bankers held directorships on
the supervisory boards of the firms. German commercial banks facilitated by law
and tax policy, own sizable portions of many large industrial firms. Ownershipgives it the power to block any change in the firm's statues. This has resulted in aconcentration of ownership among major banks. The larger banks also reinforce
their infiuence thorough the proxies they hold.3

2

Most of 4,5oo German banks are universal banks, which may be active in the banking business aswell as the securities. In addition, those banks may participate in the investment business, trade inreal estates, rescue operations for financially distressed firms, get involved in merger and acquisi-tion (Baums, 1992). The Germany system of investment finance in the nineteenth and early twentieth century as being one dominated by universal banks with close ties to industrial firms. It is
commonly argued that universal banking facilitated German industrialization by providing substantial amount of funds and reducing the cost of external finance for industry (Calomiris, 1993). Edwards and Ogilvie (1995) argue, however, that the role of universal banks in German industrialization has been over-emphasized. The distinctive features of the relationship between universal banks
and industrial firms apply only to industrial joint-stock companies, but the majority of the industrial

capital stock in Gerrnany before 1914 was accounted for by firms which were not joint-stock companies. Even for industrial joint-stock companies, careful analysis of the relationship between thesecompanies and universal banks casts serious doubt on the conventional view that the universal
banks provided a substantial fraction of the funds for investment by industrial companies and exerted a significant degree of control on their management. In most cases, internally-generated funds
were be far the most important source of investment finance for industrial companies, and banks
were not in a position to exert any control on these firm's management even though they occupiedseats on the supervisory board. Hoshi (1995b) examines the benefits and the cost of universal bank-ing in the post and pre-war period in Japan. He argues that combination of commercial banking

3and security business allowed in the pre-war period did not increase the probability of bank failures
and universal banking does not increase the risk of financial instability.
If bank relationships can substitute for the small stock market in Gerrnany, a bank should improve

performances of non-financial firms. Gorton and Schmid (1996) shows the evidence that Germanbanks improved the performances of firms to the extent that they held the firms' equity in 1974.
They also found no evidence of conflict of interests concerning bank use of proxy votes. In 1985,
however, German financial market is under structural changes and the findings in 1974 can not bevalid anymore. Fohlin (1995) argues for a conservative interpretation of the role of relationshipbanking in industrial development showing the evidence 'that firms with close bank involvement did
not always experience lower liquidity constraints of investment than independent firms in the periodof the heyday of German universal banks, 1871-1914,

60

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 55-96

German firms tend to have strong relationships with one or a few banks, called

Hausbank. A hausbank would be a primary lender to a firm and would often enjoy representation on the supervisory board or an equity position in the firm. Su-

pervisory board members from such banks are valued for their knowledge of business and economic conditions, as well as for their detailed knowledge of the firm.

In time of financial distress, the hausbank would tend to be more willing to aid

the firm than would other banks. As in Japan, shares owned by hausbank are sel-dom traded. As early as the late 1960s, German banks began to transform themselves in anticipation of reform in German financial market. The hausbank system
has already given way to what is called network system of financing. In the tradi-tional hausbank system, a firm is completely dependent on a single bank for all of

its financing needs. In the network system, by contrast, several banks join
together informally to finance entire networks of firms. Representatives of thebanks in the network sit on the supervisory boards of a particular firm. And often

managers from one firm in the network sit on the board of another firm also fi-nanced by the same of banks (Baum, 1992).
Ties between banks and non-financial firms are close in Japan. Banks still playa central role in financing industries through large group of industrial firms.
Bankers often serve on manufacturing firms' boards and, particularly in periodsof financial distress, become heavily involved in management. Japanese firms
make extensive use of leverage and intercorporate holdings of debt and equity.
Banks' personnel move frequently between banks and firms as part of an ongoing
relationship that involve training, consulting, and monitoring.4 While current law
requires Japanese banks to reduce their equity positions to 59o of outstanding
equity of the firm, they still own about 219o of the outstanding shares of Japanesefirms in the period of 1985 through 1992. In contrast, individual shareholders own
only 239o of common stocks and they exercise little influence over management.

In both Germany and Japan, these close relationships between the financial in-

4 There are the six largest industrial groups, or keiretsu, which have their origins in the 1950s: Mitsu-

bishi, Mitsui, Sumitomo, Fuyo, Dai-ich Kangyo, and Sanwa. Almost half of the 200 largest firms inJapan are members of one of these groups. Firms in the group are more likely to trade with theirmembers than non-members. These trade relationships are reinforced by stable cross-shareholdingin the group. The distinctive feature of the group is the relationships between its manufacturingfirms and financial institutions. Group firms do a substantial fraction of their borrowing from financial institutions in their own group. One of these institutions is usually considered the main bank in
the group, which takes a more active role in arranging financing for the firm, even though the firmborrows from other institutions outside the group. Fair Trade Commission (1994) in Japan provides
the evidence that group firms borrow 17.59o, 17.39o, and 19.59o of their borrowing from theirgroup's financial institutions in 1981, 1987, and 1992, respectively. In addition, group financial in-stitutions typically own equity in the firms to which they lend. Furthermore, the placement of bankpersonnel in top management positions of group firms reinforces the bank's power as shareholders
and creditors.

KOJIMA:JAPANESEFINANCIALRELATIONSHIPSINTRANSITION 61

stitutions and non-financial firms foster a longer-term perspective reducing thepressures from the capital market for short-term stock performance that U.S.
manager's experience. The executives of Gerrnan and Japanese banks who oversee investments in manufacturers manage institutions, not portfolios. Unlike fundmanagers who make the equity market in the U.S., they are committed to their
institutions' growth and not to the short-term performance of their investment
portfolios. In sharp contrast to the high turnover rates that fund managers in the
U.S. generate, financial institutions in Germany and Japan rarely sell their equity

holding. Since banks' capital investments are predominantly loans, they can serve
their economic interests by expanding their business with the firms in which they
invest than by pressing for short-term stock price gains. For them, the greater afirm's growth, the greater the loan demand, and the more competitive the firm,
the higher the quality of the loans. The high degree of leverage that banks inthose countries accept decreases the cost of capital and reduces the level of return

manufacturers need to seek on their investments. As a consequence of these factors, managers in German and Japanese firrns do not focus as intensely on shareholder returns as their U.S. counterparts do, and they are willing to compromiseshareholders interests for growth that serve a broader stakeholders.
Financial institutions in Japan, banks in particular, are more efficient providersof capital, and their equity ownership in client firms represents far more than amere portfolio investment. Through their activities as main banks, they playessential roles in the governance of non-financial firms.5 Their close and long-term relationships with a borrower afford them greater access to privileged information and establish them in the eyes of other lenders as delegated monitorsof their major industrial clients. They effectively function as centers of informa-tion gathering about client firms, and their responses to virtually any aspects of

their client firms' activities represent important signals to other corporate
stakeholders. As significant equity owners, they enjoy direct or indirect board
representation through which they may exercise an active voice in the governingof the corporations in which they invest. Commensurate with their status as lead

lenders and major shareholders, main banks enjoy preferred status in the provision of a wide range of financial services to client firms, and in the yields received

on their loans in Japan. Japanese main banks have been involved deeply in theaffairs of their client firms, requiring detailed disclosures of management and in-vestment plans on a frequent basis. It was common for bank executives to require
modification of these plans as a condition for the continued provision of capital.

5 The large-scale questionnaire survey provides the evidence that more than 989o of public corporations in Japan have main bank relationships (Fuji Research Institute Corporation, 1993).

62

KOBE ECOIVOMIC & BUSINESS REVIEW, 42 (1997), 55-96

Although the securitization of Japanese corporate finance in the 1980s has considerably weakened main bank influence over large and highly liquid firms, theyremain important suppliers of capital to smaller affiliates of these larger clients.

Main banks also have been and remained important providers of auditors anddirectors to many Japanese non-financial firms. Whereas virtually all U.S. firms
have at least one outside director, most Japanese boards of directors are entirely

inside boards with virtually all members being salaried executives of the firm.

One or more members of board in Japanese firms frequently are former executives of the firm's main bank. These appointments arise from the common practice among major Japanese firms, commercial banks in particular, of retiring
those senior managers not being nominated to their own firms boards of directors

and placing them as directors or senior managers of client firms. Japanese mainbanks will often take a leadership role in corporate restructuring, dispute resolution or simply the promotion of new business for client firms.

2.2 Main Bank Relationships
2.2.1 Monitoring
Main banks in Japan have historically been the most likely to intervene becauseof their position as the largest supplier of capital to the group of industrial firms.

In addition to having an equity investment, they have considerable amount ofdebt at stake. Nominally, this debt is in the form of senior collateralized shortterm loans and 90-to 120 days promissory notes, which are usually routinely rolled over indefinitely. However, in the event of impending financial distress, thecharacter of main bank's loans changed dramatically. This is because most mainbanks voluntarily subordinate their debt to that of other banks lending to themain bank's troubled clients. Whereas fear of such equitable subordination keeps
most the U.S. Ienders on the sideline until a loan agreement is formally breached,and even then restraints the degree of intervention, the Japanese main bankeffectively assumes such subordination from the outset and takes far-reaching,early steps to limit the damage.

The main bank acts as an alert monitor of performance and begins to act like aprivate, controlling shareholder well in advance of the time when problems become acute. One effect of this intensive monitoring with early selective interven-tion is to reduce some of the costs normally associated with the hazards of lend-

ing. Opportunities to borrow money and then take extraordinary risks that might

benefit shareholders at the expense of creditors are reduced when banks own
some equity and are able to intervene early when problems are spotted. The costs
normally associated with financial distress are reduced to the extent that problems
are identified and corrected early.6

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KOJIMA: JAPANESE FINANCIAL RELA TIONSHIPS IN TRANSITION

Diamond (1984), among others, argues that banks serve as corporate monitors
who bear the cost of becoming informed about their client firms and who ensurethat they make efficient business decisions. Diamond shows that delegating therole of monitoring to a bank minimizes monitoring costs. The alternative - issuing
securities like public debt and equity - may be inefficient either because monitor-

ing costs are needlessly duplicated among individual security holders or becausemonitoring is a public good that no one has an incentive to provide. He showsthat bank diversification plays a key role in ensuring that banks monitor theirclient firms.

As Myers and Majluf (1984) point out, liquidity is an important determinant ofinvestment when there are informational problems in the capital market. If managers are better informed than investors are about a firm's prospects, the firm's ris-ky securities will sometimes be underpriced, thereby raising the cost of externalfinance. Managers find it more attractive to finance investment with internalfunds. Thus, for firms facing information problems, liquidity wi11 be an important

determinant of investment. Bank monitoring is one way of overcoming these information problems. If bank lend a large fraction of a firm's debt as well as own
a portion of its equity, then they have strong incentives to become informed about the firm and its investment opportunities. It is also in their interest to ensurethat managers make more efficient business decisions. In this case, there should
be little relationship between investment and liquidity for bank-monitored firms.
If firms need funds to finance investment, they can go directly to their informedbank to raise the money. The bank should be willing to provide the capital provided the project is valuable. The close relationship with the bank is likely to
mitigate information problems that typically arise when debt and equity are diffusely held and no individual investor has an incentive to monitor the firm. Since

the independent firms have weaker ties with banks, they are likely to face greaterdifficulty raising capital. Thus, it is relatively easy to distinguish between firmsthat are likely to face information problems and those that are not.7

Sheard (1989) provides an economic rationale for this main bank system focus-

6 Aoki, Patrick, and Sheard (1994) characterize main bank system not just as a system of corporate
finance based on bank lending, but one involving a nexus of relationships comprising a multitude ofrelationships between firms and banks, reciprocal relationships among banks, and relationships between regulatory authorities and financial sector.
7 Rajan (1992) points out that there is a fundamental trade-off between bank debt and arm's-length
debt. The bank can monitor the client firm and control its investment decision. In doing this,however, it alter the division of surplus between itself and the firm. The bank's informational
advantage over outside lenders provides the basis to influence the division of surplus. This causes
the firm to prefer credit from the arm's-length sources, 'It can be shown, however, that bank's expost opportunism can be controlled by making more efficient use of long-term contracting (vonThadden, 1995).

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ing on the role of the main bank as an agent that specializes in the collection,

evaluation, and transmission of information about firms and their management,

and that provides a mechanism which substitutes for the inactive market forcorporate control in Japan.8 The significance of the main bank system is the close
information-sharing relationship that exists between the bank and the firm. It is
possible to view the main bank system as functioning as a substitute for the kindof screening and monitoring institutions that are prevalent in other capital markets such as bond and credit-rating institutions and security analysis agencies. The
close association that the main bank has with the firm means that the bank is able
to obtain inside access to the firrn and its management, which is not readily available to the external capital market.

The main bank system seems to exemplify in concrete way some other important aspects of monitoring: delegated monitoring. The main bank system can becharacterized in terms of banks themselves delegating the monitoring of a particu-

lar firm to one particular bank: the main bank. The bank delegated to be monitoring is not only the bank with the largest loan share but also holds a significant
stake in the firm as a shareholder. Having a sufficient large loan share may be theway in which the bank ensures that it obtains an adequate return on its monitoring outlays. In this regard, it is worth noting the free-rider problem may be miti-

gated somewhat by virtue of the fact that non-monitoring banks will not be able
to imitate the loan portfolio of the main bank in size.9

There are well-known free-rider arguments in Leland and Pyle (1977) and Stiglitz (1985). If knowledge about the firm and its management is a public good, it

may be that no agent will undertake the necessary monitoring since other agentswill free ride on the results. The solution to this problem is to have the monitor-

ing agent buy and hold assets on the basis of its specialized information, under
the assumption that outsiders cannot free ride on the agent's information merely
by observing its portfolio choices. Banks frequently take large positions in a firm;

the nature of the loan contracts enables them to do this without undertaking undue risk. At the same time, the nature of the contract enables them to focus theirattention on information gathering to a particular set of issues: those associatedwith the probability of default and the net worth of the firm in those low-return8 Lichtenberg and Pushner (1994) finds evidence that equity ownership by financial firms in Japan
may effectively substitute for the missing external takeover market by resulting in monitoring andintervention which minimizes the decline in productivity.
9 Aoki (1994) points out the effect of exclusive delegation of integrated monitoring to main banks is
to create a unique corporate governance structure under which main banks are ex ante expected tointervene in management with a high degree of certainty if and only if firms are financially distres-

ses.

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KOJIMA: JAPANESE FINANCIAL RELA TIONSHIPS IN TRANSITION

states.iO They need not concem themselves with either how good the best prospects of the firm are or what the probability is that the firm will make away withloans. There are syndicated loans, in which a single bank takes main bank position and undertakes responsibility for ensuring that the borrower is effectively
controlled from the perspective of the lender. The main bank is also responsible
for ascertaining the suitability of the borrower for the loan. Here, the problem ofcorporate management as a public good is resolved by means of reputation: it isin the interest of each bank to ensure that the loan on which it acts as the mainbank are good, lest other bank refuse to participate in the loan it attempts tosyndicate. The enforcement of cooperation can be attained in the long-term relationship. It would pay each bank to cheat in a single transaction: to syndicate aloan but then to fail to expend the resources required ensuring that the lenderused the funds properly. In the long run, this is not true. A bank that lost its
reputation and could not syndicate its loans would have to bear greater risk. Thisrisk premium can be viewed as the punishment for failing to exercise control.
Note that the number of banks involved is sufficiently small so that each bank canassess the reputation of the other bank. One of the central problems with banks'
exercise of their control is their excessive concern for the possibility of default.
Allowing bank to own equity shares in firms might alleviate this bias. Information

could be shared between the bank and its equity subsidiary; and the bank, in ex-

ercising its control over management, might be induced to look not only towards
the possibility of default, but also towards earning greater return on its equity.

Hoshi, Kashyap, and Schafstein (1991) compare the investment behavior ofthese two sets of firms, which are in a particular industrial group with the bankand independent ones. The basis of comparison is the importance of liquidity as adeterminant of corporate investment. They find that firms in the group are lesssensitive to their iiquidity than it is for independent firms. It shows that liquidity

is a more important determinant of investment for independent firms than forones in the group with close banking ties. This suggests that close relationships
with the bank relax liquidity constraints by lessening information and incentive
problems in the capital market. These results can help to explain the findings forat least two reasons. First, because group-affiliated firms can take on more debt,
10 Although monitoring firms is thought to be a major function of banks, the presence of otherstakeholders reduces a bank's incentive to do this. Thus loan contracts must be structured to enhance the bank's incentives to monitor, Covenants make a loan's effective maturity, and the ability
to collateralize makes a loan's effective priority, contingent on monitoring by the bank. Rajan andWinton (1996) show both covenants and collateral can be motivated as contractual devices that increase a bank's incentive to monitor. The model predicts that collareralization of private debt will
be correlated with financial distress at the firm level and poor business condition and also a bankdemands collateral is stronger when the collateral either depreciated quickly or is quite risky in the
short-run than when the collateral is relatively stable or long-lived.

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they are better able to exploit its tax advantages. This lowers their cost of capital.

Second, group firms that need to raise capital can do so by issuing debt. They
then avoid equity issues, which tend to depress share prices. Thus, reducing thecost of financial distress facilitates investment and relaxes liquidity constraints
even when firms are not distressed.ii

2.2.2 Intervention

An another major characteristic of main bank system that is closely related tothe monitoring is the role of the main bank in corporate intervention. Main bankintervention refers to the fact that the bank will often intervene in various ways inthe management of the firm when it is not performing adequately or is in need ofrestructuring. It can be argued that this function of the main bank provides animportant substitute mechanism for what in effect is inactive market for corporate

control in Japan. Main bank intervention can take a number of forms, ranging on
the one hand from cases where the main bank stipulates certain measures that re-quires the firm to take in exchange for the bank's support during a period offinancial difficulty to cases where the bank sends officers to take over the management and carry out the reorganization of a firm that is on the verge of bankruptcy on the other. In the course of intervening in and managing the reorganiza-tion of the firm, a number of things are commonly observed. First, the bank may

replace the top management, whose incompetence it is that has often expedites
the trouble. The bank will reorganize the management structures and implement
major asset liquidation. Second, the bank will often arrange some kind of tie-up

or merger with another firm, which is commonly a firm also having this bank as
its main bank.

One of unique characteristics in Japanese capital market is the virtual absenceof an active market for corporate control. The absence of a hostile takeover market is related closely to the nature of intercorporate shareholding in Japan. The

management of large firms in Japan has been able to entrench themselves fromexternal market for control by arranging their shareholding structures so that amajority of their shares are held by closely and long-term related firms. There are

known as stable shareholders in Japan and comprise principally long-term business partners and affiliate firms, all of which share the common aim of insulating
themselves from the extemal market for corporate control. Together with the sys-

11 Elston (1996) also examines investment sensitivity for German firms in the 1973-84 and finds the
supporting evidence of the hypothesis that greater sensitivity to liquidity constraints for the groupof independent firms than that of firms with bank ownership. The result supports the notion thatfirms with close banking ties have better access to capital and as a result have investment functions
which are less liquidity constraints,

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tem of stable intercorporate shareholdings, the main bank performs a role thatclosely parallels in its effect the external takeover market: in particular in bring-ing about the displacement of ineffective management and the re-organization of
corporate assets to improve efficiency.

In a sample of large Japanese manufacturing firms in the 1980's, Morck andNakamura (1992) find that banks tend to send new directors to firms that haverecently under-performed their industry firms in terms of stock market performance or that are in industries with depressed stock prices. Intervention is preceded by below average sales growth, investment and especially liquidity and cash
flow as well as by low stock returns. It is thus not clear that bank intervention is

aimed primarily at protecting shareholders. Cash flow and liquidity return to in-

dustry average levels quickly following bank intervention, as does investment.
Sales growth and especially employment growth remain low for several years, but
eventually recover to and even exceed industry average levels. This suggests thatbank intervention is associated with a period of restructuring. Public shareholders

appear to gain little from this, however, as stock market performance contipues
to lag that of industry peers.

Kaplan and Minton (1994) attempt to shed lights on the nature of corporate in-tervention by considering when banks and shareholders intervene or become active in 119 large, non-financial public firms in Japan. They consider an outside in-tervention to have occurred if a firm appoints one or more outsiders to its board
in a given period. The likelihood of a new bank director is most closely associatedwith negative pre-tax income at both one- and two-years. The results suggest thatbank appointments respond to poor firm performance and do so over relatively
short frequencies. The patterns suggest a difference between bank interventions
and corporate interventions. Banks appear to intervene in firms with poor stock
performance and difficulty meeting their financial obligations to the banks. In
contrast, other corporations appear to intervene in firms with poor stock perform-

ance that is not related to an inability to meet financial obligations. Outside
appointments are most closely related to stock performance.i2

The pattern provide additional support for the view that bank directors areappointed in firms and situations where there is a bank loan to protect. In contrast, the appointment of bank directors is not related to the strength of shareholdings and other relationships. This suggests that banks place Iess importance inmaintaining those relationships. Although stock performance remains significant
12 Using data on 270 Japanese firm in 1985-90, Kang and Shivdasani (1995) also find firms with ties toa main bank are more likely to remove top executives 'for poor earning performance. Main bankand large shareholders also play an important role in the likelihood that a new top executive will be

appointed from outside the firm.

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in the determinants of appointments of corporate directors, share ownership andkeiretsu membership are strongly related. These patterns provide additional support for the view that the two types of appointment, although related to performance, serve different purposes and protect different interests. The results suggestthat corporate appointments be meant to protect or support intercorporate share-

holdings and relationships. Such appointments do not appear to be intended toprotect the main bank. Banks, corporate shareholders, and related corporations

respond to poor performance by sending directors to oversee or implement responses to that poor performance. The power of a main bank to appoint directors
comes from its combined role as lender, shareholder, and settler of intercorporate

payment accounts. The power of corporate shareholders to appoint directors
stems from their share ownership and concomitant ability to withhold proxies on

the share they own. Under this interpretation, Kaplan and Minton (1994) argue
that the bank and intercorporate relationships in Japan play a similar role to out-side directors and, particularly, the market for corporate control in the U.S.
There is, however, another interpretation. The injection of an outsider in response to poor performance may be required to signal to suppliers, customers orothers that the bank or the group will support the continuation of the business.
According to this view, the main bank recoups any costs of such insurance in normal times by charging above market fees for services. Similarly, corporate managers are willing to agree to such an insurance scheme in order to maintain theirpositions. The second interpretation suggests that the primary role for the outside
appointment is as insurance rather than as discipline or monitoring. The insurance

and monitoring interpretations have different implications for incumbent manage-

ment. If the relationships serve to insure managers, then the appointment of an
outsider should not affect executive turnover. Alternatively, if the relationships

replace the control mechanisms familiar to the U.S., then outside interventions
should be costly for incumbent management.
The results can be interpreted as a strong evidence that both types of outsider
appointments are disciplinary - top executive turnover, particular that of representative directors, increase substantially in the same period. The fact that theoutsiders tend to be appointed to the director level suggests that outside appoint-ments oversee that transfer of control from one internal management team toanother. Outside interventions have a disciplinary effect on top executives. Over-

all, these results suggest that bank directors be appointed to firms that are in
financial distress or in the process of contracting. After the bank directors arrive,these firms continue to contract, but their performance - as measured by stock re-turns and earnings - does not deteriorate. Other corporations appear to send
directors in response to different problems. After the corporate directors arrive,

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the firm sales and asset growth rebound, and their performance - as measured bystock returns and earnings - do not deteriorate, and, if anything, improve.
As a consequence, the results suggest that the relationship-based corporate gov-

ernance substitute for the market-based in Japanese firms.i3 Appointments ofoutsiders increase signdicantly with poor stock performance; those of bank outsiders also increase with negative current income. Strong evidence is found that bothtypes of outsider appointment are disciplinary - top executive turnover increase
substantially in the same year. The results suggest that bank directors are sent tomanage contraction or financial distress, while corporate directors are sent tomanage reverse temporary problems. Current earnings and, particularly, current
stock returns are important determinants of outside appointments. It can be suggested that a ,firm's current stock price play an important role as a good measureof a firm's current and future prospects in Japanese firms.
2.2.3 Reducing Cost of Financial Distress

Financial distress is costly because free-rider problems and information asymmetries make it difficult for firm to renegotiate problems with their creditors intimes of distress. As Gertner and Scharfstein (1990) point out that free-rider
problems reduce the incentive for creditors to grant financial relief of extend credit: an individual creditor bears the full costs, but shares the benefits. When there

are many creditors it is difficult to negotiate with all of them simultaneously.
Holdout creditors can then free ride on others. Difficulties in negotiating withcreditors may lead to underinvestment and inefficient liquidation. Even if the firmhas valuable investment opportunities, an individual creditor may be reluctant tofinance them because part of the greater future cash flows accrues to the holdout
creditors. Similarly, even if it is efficient for creditors collectively to write down

the debt, a sole creditor may be unwilling to do so because he bears all the costand receives only part of the benefit. Moreover, when credit is diffusely held,
bondholders are not likely to be well informed about the firm and may not knowwhether it is profitable to provide new capital or to give interest and principal
concessions. In this case it is difficult to raise capital from one creditor, let alone

get numerous creditors to agree to a financial restructuring that promotes invest-

ment and avoids inefficient liquidation. These problems can also spill over anddisrupt supplies and sales: supplier may not be willing to provide trade credit and13 Shleifer and Vishny (1995) point out deficiency of relationship-based control by banks. Banks themselves are typically large public-held corporations run by their managers rather than shareholders. It
is possible that banks may accommodate managers of client firms rather than discipline them because of financial relationships established by managers at both sides. Thus maintaining these relationships may not leave rents for shareholders and minority investors.

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KOBE ECONOMIC & BUSINESS REVIEW,

make long-term commitments; and customers may be wary about whether thefirm will be able to meet its implicit and explicit warranties.

Such problems are probably less severe for firms with strong relationships tobanks. Because substantial debt and equity stakes are held by just a few financial

institutions, free-rider problems are less prevalent. In addition, since the mainbank is well informed about the firm and its prospects, problems stemming fromasymmetric information between creditors and firms are likely to be small. A
more subtle reason that free-rider problems may be less severe stems from the re-peated participation of banks in lending consortiums. For example, one mainbank may be the main bank for a firm in the group, but the firm will typicallyborrow from banks outside the group as well. This bank will in turn participate inlending consortiums headed by other banks that serve as the main lenders tofirms outside the group. It is clear to all members of the consortium that the mainbank is responsible for helping the firm in times of distress. Repeated participation in these consortiums ensures that main bank fulfills its implicit contract toprovide relief even though doing so may not seem best in the short run. Furth-ermore, the customers and suppliers in the industrial group in which they own
equity are more likely to maintain their trade relationships. The firm's main bank

may also be the main bank for the suppliers and customers. This financial network could make suppliers more willing to extend trade credit and invest in longterm supply relationships, and customers more wiiling to buy from the firm.
In particular, a firm in financial distress may be unable to continue businesswithout concession by its suppliers and customers. At the same time, thesestakeholders will be suspicious of any plea by the firm for financial concessions

even though they may face substantial costs of switching their trade with otherfirms. Since banks evaluate firm's financial condition routinely, non-equity
stakeholders need not duplicate the bank's monitoring as long as the bank can berelied on to tell the true state about the firm's financial condition. Trustworthi-

ness of the bank depends on the structure of the bank's financial claims on thefirm. An equity ownership of the firm tends to align the bank's interests with thefirm's shareholders against non-equity stakeholders. This can evoke suspicions instakeholders that the bank and firm will collude to extract rents by seeking unwarranted reductions in the stakeholders' contractual claims. On the other hand,

non-equity stakeholders with fixed claims may also be suspicious of statements
made by a bank holding a pure debt claim on the firm if debt claim has greaterpriority than their own. Specifically, a bank with a pure debt and a firm may col-lude to convince stakeholders that the firm's prospects are healthy and that noconcession is required. Then, given the high likelihood of bankruptcy if stakeholders do not scale down their claims, the bank's higher priority allows it to capture

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nearly all of the firm's revenue and the stakeholders are effectively expropriated.

Although a subordinated debt claim would reduce stakeholders' suspicions, it may
be difficult for the bank to credibly subordinate its own debt claim to those of the

firm's suppliers and customer. Hence, bank equity claim on the firm may be theonly means for the bank to credibly subordinate sufficient fractions of its claim to

uninformed stakeholders.i4 Berlin, John, and Saunders (1996) examine how thestructure of an informed lender's financial claim affects its ability to resolve con-flicts between a potentially distressed firm and the firm's non-equity stakeholders,such as suppliers and customers who have a direct interest in the firm's continuing

viability and whose business is essential to the firm's existence. They show how
the debt-equity structure of the bank's clairn affects its ability firm's owners andits fixed claimants and also among the claimants themselves.
Hoshi, Kashyap, and Scharfstein (1990a) show that firms with capital structuresin which free rider and asymmetric information problems are likely to be small
perform better than other firms after the onset of distress. In particular, theyshow that Japanese firms in keiretsu invest and sell more after the onset of. distress than non-keiretsu-affiliated firms sell. Moreover, firms that are not in thegroup, but nevertheless have close relationship with a main bank, also invest andsell more thafi firms without close bank relationship. When member of the grouphelp troubled firms they do not only infuse funds, but also try actively to restruc-ture the firm. If a firm is financially distressed, it performs better than otherfinancially distressed firms do if its capital structure makes it relatively easy to re-negotiate its liabilities. The findings suggest that, when financial claims are spreadamong many creditors, financial distress is more costly than when they are concentrated. In the United States, debt is more diffusely held, with large firms re-lying more heavily on bond financing. They argue that this form of financing ex-

acerbates problems stemming from financial distress and suggests it may havebeen wise for U.S. firms to refrain from high debt levels. Japanese firms havetaken on a larger amount of risky debt, but have established and institutional
structure to cope with high leverage.i5 Gilson, John and Lang (1990) find that
financially distressed firms in the U.S. that rely heavily on bank debt are more

14 If the bank is willing to hold junior debts on the firm, increased bank lending sends a substantial
signal to other investors of the firm's prospects. There are evidences to suggest that stockholders
and debtholders outside firm respond to bank decision when pricing firm's stock and the responses

are larger when banks hold junior debts (James, 1987; Lummer and McConnel, 1989). Banks plays
an important role to transmit firm-specific information to the capital market.
15 Fukuda and Hirota (1996) argue that main bank relationships increase the debt capacity of the firmby reducing the agency costs of debt. On the other hand, firms with high leverage will strengthen
the relationships. They show the evidence to support that high leverage and main bank relationships are simultaneously determined and have positive effects on each other.

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KOBE ECONOMIC & BUSINESS REVIEVV, 42 (1997),

likely to avoid costly bankruptcy filing and thus more likely to restructure out of16
court.
Sheard (1992) identifies major features of the main bank's role and its behavior
when examining a large number of cases financially distresses corporate clients.
The major roles of the main bank are coordinating, overseeing, and in some casesin effect carrying out an informal reorganization of the firm. This typically involves some combination of refinancing of existing debt, provision of bridging fi-

nance, dispatching directors and in severe cases a more comprehensive troubleshooting team that works closely with promising managers in the firm. It may also

involve the displacing or demotion of senior incumbent managers and the formulation and implementation of a restructuring plan centering on a program ofasset disposal, repayment of bank borrowing, and organizational rearrangement.i7 The main bank, by replacing incumbent managers with dispatching its personnel, turns to be an active participant in the corporate restructuring

process directing and implementing various measures. This aspect of the mainbank's role is characterization of bankruptcy via the debt contract triggering ashift in control from the incumbent managers to the creditor.i8

One of the peculiar characteristics of the main bank system is that the mainbank often behaves as if it were a kind of residual risk-bearer among creditorsand even among security-holders as a whole. Sheard (1989) suggests that residual
risk bearing is part of an incentive structure, which serves to economize on theagency cost of the delegated monitoring relationship between main and non-mainbanks. When bank assistance is directed towards a struggling firm or when losses
are incurred as a result of the firm's failure, the main bank commonly assumes a

16 The U.S. banks may abandon borrowers they cannot cheaply save them. Given that courts sometimes punish a bank for intervening in its debtor's affairs, the bank may find rescues more often unprofitable. American judges have looked skeptically at creditors who intervene in debtors' business.
They reason that intervening creditors may try to restructure the debtor to their private interests.
Thus, its claims are often subject to subordination. One does not see in the case equivalent ofequitable subordination in Japan - any series of decisions where judges voided security interests topunish a major secured creditor who intervened in the debtor's affairs (Ramseyer 1994).
17 Large numbers of firms in Japan fail regularly, Average of 13,260 and 11,870 firms with debt ofover 10 million yen went bankruptcy every year during 1985-89 and 1990-94, respectively (Bank ofJapan 1994, 1996).
18 There are a number of cases in which the main bank helps firm work out of financial distress. The
best-known case is Sumitomo Bank's restructuring of Mazda, the automobile manufacturer. Mazda
got involved in considerable financial difficulty after the 1973-oil shock caused dramatically to reduce the demand for fuel-inefficient rotary-engine cars. In responding to these troubles, Sumitomo
Bank sent a number of their executives to serve as directors in Mazda and others to manage key divisions of the firm. Sumitomo Bank lent Mazda money at favorable rates and encouraged the firm
to sell its share in the banks. Sumitomo Corporation, the large trading company of the group, tookcharge of dealer networks and the newly appointed managers worked to improve efficiency in production. The bank also promoted Mazda sales among their client firrns and employees and leaned
on suppliers to sell to the firm at favorable prices (Pascale and Rohlen, 1983).

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significantly larger burden than would be expected. In cases of bankruptcy or ma-

jor restructuring under main bank intervention, the main bank will typicallyabsorb a share of losses exceeding its loan share. The main bank bearing a disproportionately large share of the assistance burden to firms that are in the pro-

cess of undergoing adjustment. This may just reflect that the main bank possesses
superior information as a result of its past and current monitoring and negligenceproblems with transferring information to other banks. At a more general level it

might be claimed that there must be a sense in which the main bank is given thecorrect incentives not to shirk on its monitoring. The implicit convention in Japanthat the main bank bears a disproportionately large share of any losses incurred

can be viewed as part of an incentive mechanism which economizes on the agency
costs of having one set of bank delegate monitoring to one bank.

What are the incentives of the main bank to behave as it does? Since the mainbank is better informed than any other lender, it must be if the main bank refuses
to refinance the firm because its information tells it that it is not profitable to doso. But if it is not profitable for the main bank, which already has prior claims
that must be senior to any new finance, then it cannot be profitable for the supplier of incremental funds. The only time that a main bank would want to cut off
finance would be when the firm is a bad prospect; inferring this, no other lender
will extend finance. The decision on whether a client firm that needs an injectionof finance to remain afloat obtains the required funds or not rests with the mainbank. To the extent that main bank assumes special responsibilities when a client
firm is in financial distress, it must be adequately compensated for the additionalcosts involved. When the firm is in normal tirnes, the main bank enjoys special

benefits associated with its position as a main bank, not available to other
lenders.i9 In particular, it is widely believed that the main bank is able to acquirea disproportionately large share of various banking-related business such as place-ment of corporate bank deposits, operation of settlement accounts, involvement
in bond issues as trustee administer and co-underwriter, handling of foreign exchange transactions, and access to banking business of related firrns.20

Main banks' desire to acquire a reputation for making the right renegotiation
19 Weinstein and Yafeh (1994) examine the effects of rnain bank system on firm performance inJapan. They find that when access to bond and equity market is limited, close bank-firm relationship increase the availability of capital but does not lead to higher profitability or growth. This islargely because banks enjoy more market power when firms do not have easy access to othersources of finance and therefore can charge higher interest rates in exchange for liquidity services
and influence firms to avoid risky but profitable projects. Using the data on a sample of over 700
listed manufacturing firms between 1977 and 1986, they find that the bank is able to capture mostof the rents which client firms may enjoy due to their access to capital, and thus push down firm
profits. They also suggest that conservative investment strategies motivated by the bank's position
as a major debtholder may inhibit firms from growing.

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versus liquidation decision provides them an incentive to devote a larger amountof resources than bondholders toward such evaluation do. Bank loans dominate
bonds from the point of view of minimizing inefficient liquidation; however, firms

with a lower probability of financial distress choose bonds over bank loans. Information production by main banks is particularly relevant when there is a significant possibility that the borrowing firms may be in financial distress. Banks' eva-

luation of the firm's future prospects may affect their decisions about whether torenegotiate the debt of a firm in financial distress or declare the firm in default

and force it into bankruptcy. The important reason why banks' treatment of borrowing firms in financial distress may be fundamentally differcnt from that of hol-ders of publicly traded debt is that banks are long-term players in the debt market and therefore have a desire to develop a reputation for financial flexibility.

Chemmanur and Fulghieri (1994) develop a model in which the ability to acquirea reputation provides banks with an endogenous incentive to devote a larger
amount of resources to information production about firms in financial distresscompared to bondholders, whose decisions are based only on considerations related to a specific situation. They show that, in equilibrium, entrepreneurs who
assess a relatively high probability of being in financial distress find it optimal touse bank loans, despite that fact that banks charge a higher interest rate inequilibrium compared to publicly traded debt; those with a lower probability of
being in financial distress, however, issue publicly traded debt to take advantageof the lower equilibrium yield on such debt. Furthermore, borrowers are willingto pay higher interest rates for loans from bank with greater reputations for flex20 Ramseyer (1991) argues that within the continuing relationships, the legal structure also matters.
Japanese banks and firms bargain over the legal framework that will govern their deals and work
hard to manipulate that framework to their private advantage. The extensive use of mortgages andguarantees suggests that banks and customers consider the rules critically important. VVilling to
make credible their promise to repay their loans, customers regularly acquiesce. The bank use themeasures to improve their bargaining position should their customers later default. The customer
uses the measures to obtain a better deal now. The only merit to mortgages and guarantees lies in
the legal protection they give the borrower. Law did not require these security interests. Banks de-mand mortgages and guarantees to gain the power to negotiate a more favorable contract should
the borrower default. Banks can also strengthen their position by keeping the terms of their loan
short. By negotiating shorter contractual terms, it can use the law to retain the right to refuse to re-

new the loan and thereby protect itself. Its principal advantage from the shorter contractual term is
its ability to reduce the default risks from its borrower's opportunistic behavior. Average of 46% of
the funds Japanese banks lend come due within an year for years 1985-89, compared with the factthat the proportion of bank loan with terms over one year in the United States is the much less(Bank of Japan 1994). Banks seem to be concerned about the chance their clients will increase therisk of the project ex post. If firms did not trust their banks to cooperate and borrowed theirmoney through short-term contracts, they would then need to protect themselves against opportunistic behavior that bank could take at the renewal. One way they could do so is by maintaining
close ties with several other banks. Japanese firms diversify their credit sources broadly: mostobtain less than half of their bank loans from their main bank (Fuji Research Institute Corporation,1993).

75
KIOIIMA: JAPANESE FINANCIAL REL/ITIONSHIPS IN TRANSITION

ibility in dealing with firms in financial distress. Their model concerns reputationacquisition by banks: it is the ability to acquire a reputation that distinguishes

banks from bondholders. Reputation acts as a commitment device enabling banks
to credibly promise borrowers that they will make better renegotiation versus liquidation decisions in the event that the borrowing firm is in financial distress.

Thus reputation acquisition provides incentive even for a bank without any superiority in its evaluation technology to make a lower proportion of incorrect renegotiation versus liquidation decisions compared to bondholders.

One can argue that Japanese banks may rescue large borrowers because theycannot credibly threaten to let them fail.2i Given that Japanese courts will let abank rescue a borrower without jeopardizing its rights in bankruptcy, the bank

may find some rescues profitable ex post. The U.S. banks may abandon borrow-ers because they cannot cheaply save them. Given that U.S. courts sometimes
punish a bank for intervening in its debtors' affairs, the bank may find rescue
more often unprofitable even ex post. If the U.S. banks do threaten to let trou-

bled firms die, they may be able to do so because of the bankruptcy law .they
face. At stake is the doctrine of equitable subordination: for the sake of fairness,

ajudge may subordinate the claims of a creditor than intervenes before Chapter
11 in its debtor's affairs. A bank can lose its priority whenever the bank hastaken control of the debtor, thus assuming the fiduciary duties of controllingshareholders, and then breached those duties to the injury of general creditors.

While equitable subordination does not make bank rescue impossible, it does
make them more costly. When a firm get involved in the bad state, creditors will

seldom lend more money without controlling the way it uses it. Under the U.S.
Iaw, they can do so before a Chapter 11 filing only by gambling all: if the firm
succeeds, the bank recovers its claim; if the firm fails and the other creditors convince the judge the bank indulged its private interests, it potentially loses all. For

the sake of making credible threats, perhaps that risk often suffices. Because ofthis ex post risk to intervention, the U.S. banks may be more able to credibly tothreaten to abandon defaulting debtors ex ante. Japanese judges use no doctrine
analogous to equitable subordination. Whether in the U.S. or Japan, in bankruptcy cases judges wield enormous discretion. Although they may phrase it differently, Japanese judges exercises this discretion in ways that resemble a bit the Amer-ican judicial concerns for equity. Although they may phrase it differently,
21 Dewatripont and Maskin (1990) argue that the inability of lenders to commit ex ante not to refinance long-term projects in financial difficulties may encourage entrepreneurs to seek funding evenfor projects that have negative net present values, If the continuation value of a project in financial
distress is known to be greater than its liquidation value, rational lenders have an incentive to refinance a project in financial difficulties, regardless of the advisability or otherwise starting the project in the first place.

76

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 55-96

Japanese judges exercise this discretion in ways that resemble somewhat theAmerican judicial concerns for equity (Ramseyer, 1994).
3. Structural Changes

3.1 Financial Emancipation
Liquidity in the form of cash and marketable securities for Japanese firms has

been increasing shown in Table 1. Furthermore, the Japanese figure is almost 4
times as large as that for the U.S. firms. Historically, a substantial portion of cash

positions at Japanese firms represented compensation balances on commercial
loans. However, the use of compensation balances has decreased during the 1980s
as Japanese lenders have moved toward market-rate loans and fee-based services.
Much of this liquidity increase occurred relatively suddenly during the second halfof the 1980s in parallel with expansion of money supply, lower interest rates, andrising real estates prices in Japan. Paralleling the liberalization of Japanese corpo-

rate finance has been a dramatic buildup of financial slack on Japanese corporate

balance sheets. During Japan's high-growth periods in 1948-73, Japanese firms
were confronted with a volume of attractive investment opportunities that vastly

exceeded their cash flow and the amount of funds most firms could reasonably
expect to raise externally. Throughout this period, Japanese corporate financeserved simple function. Financial managers raised the cash necessary to fund theapproved projects securing a sufficient volume of external finance. Minimizing
costs of capital was a secondary concern to most of them.
For all practical purposes, there are only two major sources of external funds:
collateralized loans and trade credit. Essentially essentially the same institution -banks, insurance companies, and major suppliers - stakeholders that were also
major shareholders in their firms supplied these, in turn. These stakeholders
monitored client firms closely, even to the point of occasionally injecting new

management to ensure a rational deployment of scare funds. Thus high growth,
the rigors of competition at home and abroad, the heavy use of debt and tradecredit, and the ownership of these claims by institutional shareholders that moni-

tored performance closely were sufficient to ensure the deployment of cash in apattern consistent with the priorities of the suppliers of capital.

Although remarkable growth in Japan had begun to wane even prior to 1973,
the oil shock produced a sudden and dramatic reduction in Japanese economic
growth. The joint effect of investment reduction and cost improvement was tolessen gradually the external capital needs of the firms. Large firms finance inter-

nally from less than 209o in the 1960s and early 1970s to more than 1009o by the

1990s as shown in Table 2. The latter figure reflects the fact that many large

77
KOJIMA: JAPANESE FJNANCIAL RELATIONSHIPS IN TRANSITION

Table 1 Balance Sheets of Manufacturing Firms inGermany, Japan and the United States

Five-Years Average(Percentage)

Germany
1960-64 1965-69 1970-74 1975-79 1980-84
Cash and Equivalents
Account Receivables

11.0
16.4

10.4
17.6

Inventories

22.6
41.7
58.2
22.9
3.3
23.2
41.8
21.6

39.0
61.0
24.0
4.0
24.7
39.0
20.2

Tangible Fixed Assets
Liabilities

Account Payables
Short-Term Debt

Long-Term Debt
Stockholder's Equity

Stock

21D

10.5

13.5

13.3

20.2
22.4
32.8
67.2
26.6
4.0
26.3
32.8
16.7

21.3
25.2
26.1
69.3
29.2
2.9
25.7
30.7
14.8

22.8
26.3
22.7
70.7
30.0
3.6
23.7
29.3
13.3

1985-89 1990-91
16.9
24.3
23.6
21.2
71.2
28.6
4.3
20.9
28.8
12.0

13.9
24.8
23.6
20.5
72.2
28.8
4.7
19.9
27.8
11.3

Japan
Cash and Equivalents
Account Receivables
Inventories
Tangible Fixed Assets
Liabilities

Account Payables
Short-Term Debt

Long-Term Debt
Stockholder's Equity

Stock

19oo-64 1965-69 1970-74 1975-79 1980-84 1985-89 1990-94
13.8
12.8
19.3
15.3
17.0
14.8
10.7
23.4
19.3
21.7
22.7
23.1
25.3
20.4
18.3
16.7
15.5
12.0
13.6
18.9
17.7
25.1
30.2
37.4
26.9
25.7
26.8
34.6
82.1
80.2
75.5
62.1
67.0
75.4
70.2
19.7
18.7
19.0
14.5
16.3
18.5
16.2
18.0
16.8
18.7
14.0
17.0
9.4
18.5
23.9
22.0
21.9
27.7
28.8
26.0
22.3
19.8
17.9
24.5
37.9
33.0
24.6
29.8
6.7
8.6
8.6
6.0
16.8
13.6
7.5

U.S.A

Stockholder's Equity

1960-64 1965-69 1970-74 1975-79 1980-84 1985-89 1990-94
5.8
6.9
5.5
7.1
5.7
10.2
4.9
14.8
15.5
17.6
17.6
16.4
16.7
13.2
20.9
15.5
18.3
23.7
22.7
13.4
23.3
38.1
35.1
39.5
38.2
35.2
33.0
38.7
42.3
46.9
57.1
51.2
47.5
61.8
35.8
9.4
9.1
8.2
9.2
9.7
7.8
9.2
3.8
4.3
3.7
3.3
3.8
4.0
2.8
18.3
14.3
22.9
31.0
25.1
36.5
22.2
57.7
53.1
64.2
52.5
40.2
42.8
48.8

Stock

25.3

Cash and Equivalents
Account Receivables
Inventories
Tangible Fixed Assets
Liabilities

Account Payables
Short-Term Debt

Long-Term Debt

20.1

17.5

15.0

12.5

12.0

12.8

Japan (1974, 1978, 1986, 1993, 1994, 1996), Comparative EconoSource: TheofBank
mlc and Financial Statistics; Japan and Other Countries.
Statistiches Bundesamt, Untemehmen und Arbeitsstdtten, The Bank ofSource Note:
Keieibunseki (Business Analysis on Main Enterprises in Japan), The
Japan, Syuyokigyo
u.s. Department of Commerce, euarterly Financiat Report for Manufacturing, Mining,
and Trade Corporations
greatly from current values beNote: Book assets
values inof Japanese firms differs
cause face values are much lower than market values.

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 55--96

78

Table 2 Net Sources of Funds for Inyestment of Manufacturing Firms inGermany, Japan and the United Startes

Five-Years Ayerage(Percentage)

Germany
Internal Funds
Retained Profits

Depreciations
Stock Issues

Bonds
Loans

1975-79

1980-84

1985-89

1990

80.4
26.5
50.4

92.3

78.1

-1.0

97.4
40.3
55.8
1.2
O.1

4.4

-1.8

O.8

n.a.
n.a.
4.9

312
56.3
4.7

23.6
51.6

3.0
-O.1

Japan
1985-89

1975-79

1980-84

Retained Profits

68.8
15.8

Depreciations".7

Stock Issues

8.3
4.0
9.7

103.3
71.7
22.8
17.7
40.0
58.8
11.9
22.1
6.7
24.8
-18.5
6.3
U.S.A.

Internal Funds

Bonds
Loans

Internal Funds
Retained Profits

Depreciations
Stock Issues

Bonds
Loans

1990-94111.15
18.92

92.23
7.60
-2.66

5.81

1975-79

1980-84

1985-89

1990-94

62.8
25.9
31.8
5.1
10.1
2.0

64.5
16.5
39.6
8.3
7.6
6.9

53.3
3.1
45.5
4.7
17.2
12.1

79.15
6.13
78.54
14.04

6.25
2.94

Source: The Bank of Japan (1974, 1978, 1986, 1993, 1994, 1996), Comparative Economic and Financial Statistics: Japan and Other Countries.

Source Note: Statistiches Bundesamt, Untemehmen und Arbeitsstditten, The Bank ofJapan, Syuyokigyo Keieibunseki (Business Analysis on Main Enterprises in Japan), The
U.S. Department of Commerce, euarterly Financial Report for Manufacturing, Mining,
and Trade Corporations
Note: Book values of assets in Japanese firms differs greatly from current values because face values are much lower than market values.

Japanese firms were using their enormous cash flow during this period to repay
debt and build up liquid assets on the balance sheet rather than to increase di-vidends for shareholders. As a consequence, Japanese firms have accumulated
considerable financial slack in the form of unused debt capacity and temporary in-vestments in marketable securities. The debt-equity ratio by Japan's major manu-

79
KOJIMA: JAPANESE FINANCIAL RELATIONSHIPS IN TRANSITION

facturing firrns has declined more or less steadily since 1980 shown in Table 3.
The buildup of financial slack on corporate balance sheets, the persistence of ex-

cess cash flow throughout the 1980s and gradual financial deregulation have led tofinancial liberation of Japanese non-financial firms from their traditional lenders.

Close, stable relationships between non-financial firms and banks have been
essential elements of Japanese corporate finance. As such, they have contributed
significantly to the mitigation of takeover activity in Japanese capital market. To-

day, however, this stability is being shaken by two major changes in the world offinance: the buildup of financial slacks on balance sheets in Japanese corporationand the globalization and deregulation of the Japanese financial system. The former change is altering the nature of business that banks execute with their majorindustrial clients and generally weakening bank control over these firms. Concurrently, the latter change is causing banks and other institutional owners of equity

to demand greater returns on their holdings of client-firm stock. Together thesetrends are evoking a creeping instability in close financial relationships.

Japanese firms are not liquidity constrained in recent years. It is no paere
coincidence that this period of less liquidity constraints has also been accompanied by weakening firm-bank relationships. The increased availability of internallygenerated cash to fund projects has reduced the need to raise funds externally,
thus diminishing the financial dependence of industrial firms on bank. In addi-tion, the growth and gradual deregulation of capital markets at home and theopening of capital markets abroad have distanced Japanese industrial firms still
further from banks.22 There is a hidden cost to the financial emancipation of past

success, however. In the absence of the discipline exerted by capital market,
Japanese managers now find themselves with far greater discretion in the allocation of corporate resources than ever before. Since firms are unwilling to breachlong-standing implicit contracts with key stakeholders, especially long-term em-

ployment relationships, and unable to execute past strategies of simply growing
themselves out of their current situations, they hold the direction to sustain mar-

ginal businesses and retain unrelated diversification. Thus, the free cash flow ofthese corporations may be reallocated from shareholders to other stakeholders,primarily employees. Despite the low priority traditionally accorded to sharehol-

22 Japanese firms moved quickly to raise capital outside Japan as soon as Japan's Foreign Exchange
Control Law was relaxed in 1980. Total funds raised by Japanese firms in overseas bond markets
leaped from an average of 489 billion yen per year between 1975 and 1979 to 5 tri11ion yen per year
in 1990 through 1994. As a percent of all securities issued by Japanese firms, overseas issues rosesteadily from less than 209o before 1980 to nearly 509o by 1985. Most of the funds raised outside ofJapan were used to repay domestic borrowing. Thus by the late 1980s, large Japanese firms had
already dramatically restructured their liabilities, substituting cheaper foreign capital for domestic

financing.

80

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 55-96

Table 3 Debt-Equity Ratio of Manufacturing Firms in Germany, Japan, and the U.S.A

Five-Years Average(Percentage)

1960-64 1965-69 1970-74 1975-79 1980-84 1985-89 1990-94

Germany 139.48 152.20 196.94 226.08 238.41 248.25 259.79
Japan 236.36 309.91 409.74 460.37 310.72 204.70 164.37

U.S.A. 55.76 73.45 88.24 90.56 105.13 133.62 161.90
Source: The Bank of Japan (1974, 1978, 1986, 1994, 1996), Comparative Economic andFinancial Statistics: Japan and Other Countries.

Source Note: Statistiches Bundesamt, Untemehmen und Arbeitsstditten, The Bank ofJapan, Syuyokigyo Keieibunseki (Business Analysis on Main Enterprises in Japan), The
U.S. Department of Commerce, euarterly Financial Report for Manufactaring, Mining,
and Trade Corporations

ders in Japan, it is unlikely this trend can continue for long. One by-product of
the increasingly global market in which Japanese financial institutions must com-pete, and of their weakening relationships with industrial clients, has been agrowing concern for obtaining higher direct returns on their equity investments.

Although borrowing continued to shrink as a significant proportion of total
funds raised, bank loans continued to dominate security financing in domestic
markets. Moreover, lending practices began to change in the wake of overseas
financing by Japanese firrns and the continued relaxation of domestic financial
market regulation. Continued growth in the certificated-deposits market and theintroduction of large-denomination money market certificated in 1985 contributed
to greater variability in banks' cost of funds. The introduction of a commercial

paper market in November 1987 provided another viable alternative for large
firms in search of short-term funds and further reduced the dependence of corporation on banks. For all practical purposes, lending to large firms has ceased to

be growing business for Japanese major banks.

Over the past two decades, capital market liberalization in Japan has madeavailable financial instruments not previously available to corporate borrowers.

Firms are now free to raise investment funds through a variety of equity, bond,and hybrid mechanisms, and in both domestic and overseas markets. Many large
Japanese firms have taken advantage of these opportunities, and the results has
been a substantial decline in the proportion of external corporate capital comingfrom traditional sources such as bank loans. With the decreasing proportion of
total capital allocation channeled through the traditional prime rate system, theMinistry of Finance and the Bank of Japan are no longer able to exercise theKOJIMA:JAPANESEFINANCIALRELATIONSHIPSINTRANSITION 81

same degree of control over financial markets that they once could. It is also true
that, with the new reliance on securities-based finance, Japanese major securities

firms are now more important in financial markets than in the past. Furthermore,even as banks and other financial institutions account for an increasing share of
securities-based capital, the ability of highly performing non-financial firms tofund their investments through retained earnings has reduced their overall exter-

nal capital dependency and shifted the balance of bargaining power with lending
firms in their direction.

Whereas most firms indicated that banks closely examined their corporate plans
and investments during the 1950-80 period, none reported being subjected to such
scrutiny today. Although meeting with the main bank is still held semiannually orat least annually to discuss perforrnance, these have apparently evolved intolargely perfunctory presentations of past performance rather than substantive dis-cussions of future capital investment. Banks are now more interested in tracking

the overall return earned on their total investment in client firms rather thanmonitoring and infiuencing managerial decision making. The exchange of information historically fostered by placing retiring bank officers in senior manage-

ment positions at client firms also appears to be waning. Major banks have begun
to experience difficulties in placing retiring employees in second careers.

As constraints on corporate finance relax and capital markets deregulate inJapan, competition among banks has further weakened traditional firrn-bankrelationships.23 The securitization of Japanese corporate finance had made financing increasingly price-sensitive transactions in which past relationships count forlittle. A firm's main bank may win a mandate to lead-manage a deal, but only if
it offers a better idea or a competitive quote. Nonetheless, although Japanese
non-financial firms may be distancing themselves from banks, Japanese banks andother financial institutions still own considerable fractions of these firms' out-

standing shares. However diminished the need by no-financial corporations for aclose banking relationship, the Japanese bank will maintain that strong relationships with their clients are still central to the success of their institutions. Even

though large no-financial firms no longer rely heavily on intermediated credit tomeet financing needs, financial institutions still look to these firms for access toaffiliated firms of commercial lending, access to employees for retail banking andinsurance underwriting, and as customers for new products and service offered ona fee basis.

23 Petersen and Rajan (1995) argue that competition in market for financial services is likely to undermine the stable bank-relationships because the banks can no longer extract rents from the client

firms.

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 55-96

82

Table 4 External Sources of Funds by Size of Firms in Japan(Percentage)

1975 1980 1985 1990
Large Firms

Loans
73.6
69.8
21.4 13.1
67.2
Bonds
16.3
6.3
38.6
Stock lssues 10.1 23.9 40.0 19.7
Loans 91.2 89.2 97.1 94.2

Small and Medium Firms

Bonds
O.1
O.3
Stock
lssues
8.8O.1
10.8O.2
2.7 5.5

Source: Economic Planning Agency (1992), Keizal Haksho, 1992 (Economic Survey ofJapan, 1992).

Source Note: Ministry of Finance, Houiinkigyou Toukei Nenpou (Annual Statistics ofCorporations), 1975, 1980, 1985, 1990.

Note: Size of firms is based on their stocks. Large firms have more than 1 billion yen
value of stocks.

Since small-and-medium-size firms continue to depend heavily on bank loans

shown in Table 4,they may derive an important advantage from the main banksystem. However, financial liberalization tends to undermine the main bank system because major non-financial firms have greater access to market debt as well
as borrowing from foreign financial institutions.24 This makes it potentially much
more difficult for the main bank to monitor and control clients' behavior. Hoshi,

Kashyap, and Scharfstein (1990b) examine the investment behavior of Japanesefirms before and after financial deregulation. In the period before deregulation allof the firms in their sample had close ties to a bank or set of banks. After dereg-

ulation, some of these firms loosened their ties to banks and relied more heavily

on direct capital-market financing. Another set of firms maintained their closebanking ties. They found that the firms that have significantly reduced their bankborrowing and increased their direct capital-market financing, exhibit a strong
sensitivity of investment to cash flow after deregulation. By contrast the firmsthat maintained bank ties show no sensitivity of investment to cash flow in both
periods- before and after deregulation. If bank monitoring overcomes information
24 Horiuch (1995a) describes the evolution of Japanese bond market from the early postwar period tothe late 1980s, particularly explaining the process of relaxing eligibility of bond issues and its dis-torted nature. The process of liberalizing the domestic bond market was distorted during the 1980sin the sense that only well-established major firms were allowed to issue convertible and other
equity-related bonds. Small-sized and relatively newly established firms are excluded from domestic
bond market during the recent gradual process of liberalization.

KOllMA:JAPANESEFINANCIALRELATIONSHIPSINTRANSITION 83

problems and relaxes liquidity constraints, why did some firms weaken their bankties? Diamond (1991) argues that young firms, or older ones that have done poorly, will borrow mainly from banks and those older, more successful firms will use
public debt. The idea is that successful firrns have more capital of reputation in

performance at stake and hence have more to lose by taking inefficient actions.
These firms do not need to incur the monitoring costs associated with bank borrowing. By contrast, younger firms have not yet developed a reputation and older, less successful firms do not have a good reputation to lose. It is therefore efficient for these firms to incur the costs of bank monitoring.

The results suggest that monitoring and other costs associated with bank financ-ing must be large. Otherwise, firms wOuld not have chosen to weaken their bankrelationships until they had enough collateral to be able to get around liquidity
constraints. The first cost stems from regulations requiring banks to hold a frac-tion of their assets in non-interest-bearing accounts. This reserve requirementmeans that the costs of funds to banks exceed those of individual investors; as aresult, they will require a higher gross rate of return on their investment. In qddi-

tion, bank loans are generally less liquid than publicly traded debt. The difficultythat bank facing adjusting their loan portfolio may also mean that they will re-quire a higher gross return. Finally, a more subtle cost of bank financing mayarise from the different objectives of banks, managers, and shareholders. Sincebanks mainly hold debt claims, they receive little of gain from unusually good
firm performance. Shareholders, in contrast, care only about maximizes the gain.
This conflict may resUlt in excessively conservative investment policies if bankcontrol corporate investment decisions. It may therefore be efficient to reducebank ties to avoid this problem at the expense of becoming more liquidity con-strained. As firms generate more cash from ongoing operations, they may be
more willing to make this transition. In addition, managers may prefer to havemore control to operating decisions than a bank is willing to allow. Managers may
choose to weaken the firms' bank ties and incur greater financing costs because it
gives them more control despite the fact that it inefficient to do so. Again, as

fimi becomes more liquid, managers may be more willing to incur these costs(Hoshi, Kashyap, and Scharfstein 1990a).
3.2 Financial Deregulation
It is clear that the ongoing financial deregulation in Japan is having important
effects on corporate financing practices. In some respects, financial liberalization

has been taking place since the 1960s; however, the process accelerated dramati-

cally in the 1980s. The revised Foreign Exchange and Foreign Trade Control Law

in December 1980 removed major impediments to offshore financing by Japanese84

42 (1997), 55-96
KOBE ECONOMIC & BUSINESS REVIEW,

firms and improved access by foreigners to Japanese financial markets. Beginningaround 1984, the liberalization process accelerated with a number of regulatorychanges, which were at least partially in response to external pressure for greater

openness of Japanese financial markets.25 Since then a stream of regulatorychanges have eliminated a variety of interest rate restrictions, allowed trading in

new types of securities, relaxed controls on both domestic and foreign financial

institutions, and generally promoted freer and more flexible financial markets.
However, some regulations and practices, which cause distortions and result in
unusual financing patterns still remain. The elimination of one restrictive regula-tion results in a regulatory arbitrage opportunity vvith market participants using
their increased freedom to profitably exploit another, still-existing regulation.
This continues until the consequent pressure on the second restriction forces its
elimination or modification. Consequently, the liberalization process tends to pro-

duce windows of opportunity permitting firms to earn additional profits by exploiting regulatory differences.26

25 Osugi (1990) conducts comprehensive survey for the financial regulation in Japan since 1984. Hoshi(1995a) examines the post-war history of regulation of corporate bond issues and shows how internationalization and deregulation in 1980s broaden the financing opportunities in Japanese firms.
26 The "sushi bond" provides a classic example of such regulatory arbitrage. The sushi bond was aforeign currency bond issued offshore by Japanese firms and purchased by Japanese insurance companies at higher prices than other potential buyers were prepared to pay. The differentiating characteristic of a sushi bond was that Japanese firms were on both sides of the transaction. The
motivation for sushi bonds was a Ministry of Finance regulation which limited the foreign currency
investments of insurance companies to 10% of total assets; however, foreign currency issues byJapanese firrns were not subject to that restriction, Consequentiy, such issues commanded a pre-mium from Japanese insurance companies desiring to increase their foreign currency position
beyond the 109o limit. As Japanese firms became able to issue foreign currency bonds offshore andswap the proceeds into yen, they discovered that this was less costly than a comparable domestic
yen borrowing. Apparently some borrowers simply re-lent the proceeds of their sushi bond issues at
an arbitrage profit. The resulting surge in sushi bond issues caused Ministry of Finance to relax therestriction on insurance companies' foreign currency assets. As a consequence, Japanese insurancecompanies were no Ionger prepared to accept the Iower yields on sushi bonds. Then, issuance ofsuch bonds ceased almost immediately (Hodder and Tschoegl, 1992).

85
KOJIMA: JAPANESE FINANCIAL RELA TIONSHIPS IN TRANSITION

Table 5 Direct Financing of Public Firms in Japan(Percentage)
1960-64 1965-69 1970-74 1975-79 1980-84

1985-89 1990-94

Stock Issues

No. of Cases 63.7 38.4 60.0 53.3 43.2

Amounts 72.2 36.4 43.8 31.2 29.6

38.3
24.3

36.8
12.0

Straight Bonds

Domestic

No. of Cases 35.7 61.0 33.4 29.0 15.0

Amounts 25.7 58.9 42.1 43.0 22.7
No. of Cases O.2 O.2 O.3 5.1 8.4

3.1

8.8

4.6

24.2

Overseas

8.3

19.5

7.6

22.2

22.3
30.8

10.9

9.6
7.0

4.4

O.5
O.7

O.8

Amounts O.4 2.9 O.7 6.9 8.9Convertible Bonds

Domestic

No. of Cases O.1 O.1 6.1 5.0 9.6

Arnounts O.1 O.4 12.9 8.7 14.2

15.4

Overseas

No. of Cases O.3 O.3 O.2 7.6 20.3

Arnounts O.6 1.4 O.5 10.2 21.0

3.6

Warrants Bonds
Domestic

No. of Cases n.a. n.a. na. n.a O.6

Amounts n.a. n.a. n.a. n.a. O.4

2.3

Overseas

No. of Cases n.a. n.a. n.a. n.a. 2.9

Arnounts n.a. n.a. n.a. n.a. 3.2

17.9
25.0

20.2

25.9
36.2

20.5
42.0

35.8
39.6

42.6
46.0

18.7

Sub-Total of Bonds
Dornestic

No. of Cases 35.8 61.1 39.5 34.0 25.3

Arnounts 25.8 59.3 55.0 51.7 37.3
No. of Cases O.5 05 O.5 12.7 31.6

Overseas

Amounts 2.0 4.3 1.2 17.1 32.7

Sources: Tokyo Stock Exchage (1996), Annual Securities Statistics.

There have been several dramatic shifts in funding patterns, which can betraced to regulatory changes. It is also important to understand that the govern-

ment's own financing needs have been an important infiuence on market regulations as well as the general character of the domestic bond market. Indeed, government issues since the mid-1970s with corporate issues representing a relatively

small fraction of the total market have dominated that market. For example, during the 1985-1989 period, straight corporate bond issues accounted for just 39o of86

KOBE ECONOMIC & BUSINESS REVIEI)V, 42 (1997), 55-96

total bond issues in Japan. Table 5 provides additional data on domestic bondissues by Japanese firms during 1960-1994. In recent years, other Japanese firms

have essentially forsaken the domestic straight debt market in favor of otherfunding sources, including offshore bond issues. This striking aversion to domestic

issues has produced enormous pressure for regulatory and procedural changes.
To a large extent, the underiying problems for domestic corporate bond issues
have to do with who determines issue terms and collateral requirements. It was
only after 1979, that Japanese firms were allowed to issue unsecured bonds forthe first time since the 1930s. Initially, only two firms were eligible to make unse-

cured issues. This situation continued until January 1983, when the restrictions onconvertible bonds were further relaxed so that some 30 firms become eligible toissue such bonds without collateral. Subsequently, restrictions for both converti-

bles and straight bonds were relaxed in stage unti} several hundred firms were
eligible for unsecured issues as of November 1988. The official logic for a collateral requirement has been the protection of investors. However, this restriction

has also made bond issuance in Japan relatively unattractive. Not only did corpo-

rate issuers have to pay management fees and underwriting commissions, but theyalso had to compensate a trustee for a variety of services, which substantially increased issue costs. Firms also have to obtain approval on the terms and tirning ofissues from a committee dominated by a group of large banks. This procedure iscumbersome and lacks flexibility regarding issue terms. This bond issuing proce-dure endowed the Japanese banks with considerable control over non-financial
firms' access to debt markets. Under the main bank lending system, such control
was important for dealing with highly levered clients. In recent years, financiallysound firms have naturally tended to view this process as an expensive nuisance.

Consequently, offshore issues have been attractive as a way around cumbersomeand expensive procedures in the domestic market.
Table 6 illustrates the rapid growth in offshore bond issues by Japanese firms
over the last decade. It was not until the early 1980s and Japanese participation
no longer required permission of Ministry of Finance that the offshore market be-

gan to really take off. Total corporate issues during the 1985-1994 period weregreater in the offshore rnarket than domestically. The fact that a very large frac-tion of offshore issues would up in Japanese investors' portfolios provides astrong indication that the domestic market was inefficient. In the domestic mar-ket, convertible bonds have dominated straight issues since 1983. There seem tobe several reasons for this. First, collateral requirements have been relaxed more
rapidly on convertibles - resulting in lower effective issue costs for more firms.

Second, issuing terms on straight corporate debt have been tied to government
bond yields in ways, which made many corporate issues relatively unattractive forKOJIMA:JAPANESEFINANCIALRELATIONSHIPSINTRANSITION 87

Table 6 Direct Financing of Public Firms in Japan(Billion Yen)
1960-64 1965-69 1970-74 1975-79 1980-84 1985-89 1990-94
Stock Issues

No. of Cases 3,O14 1,366 2,342 1,623 1,227 2,106 1,564

Amounts 2,673 1,352 3,743 4,463 6,173 18,376 6,778
Domestic

No.ofCases . 1,689 2,172 1,304 884 427 171 375
Amounts 953 2,187 3,598 6,152 4,725 3,478 13,640
Overseas

No. of Cases 8 8 10 155 240 455 827

Amounts 17 109 55 988 1,848 5,785 12,529

Convertible Bonds •Domestic

No. of Cases 3 3 237 153 272 1,227 '464

Amounts 1 15 1,106 1,246 2,951 23,360 8,648
Overseas

No. of Cases 15 9 9 230 575 529 187

Amounts 61 52 46 1,456
4,364 5,311 2,020'

Warrants Bonds

Domestic .

No. of Cases n.a. n.a. n.a. n.a. 16 26 35
Amounts n.a. n.a. n.a. n.a. 87 544 1,306

Overseas

No. of Cases n.a. n.a. n.a. n.a. 81 983 792
Amounts n.a. n.a. n.a. n.a. 678 18,934 11,279
Sub-Total of Bonds

Domestic

No. of Cases 1,692 2,175 1,541 1,037 715 1,424 874
Amounts 954 2,202 4,704 7,397 7,763 27,382 23,595
Overseas

No.ofCases 23 17 19 '385 896 1,967 1,806

Amounts 78 160 101 2,444 6,890 30,030 25,830
Grand Total

No.ofCases 4,729 3,558 3,902 3,045 2,838 5,497 4,244
Amounts 3,704 3,715 8,548 14,303 20,826 75,788 56,203
Sources: Tokyo Stock Exchage (1996), Annual Securities Statistics.

88

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 55-96

initial purchasers. In contrast, terms on convertibles were more easily adjusted tomake them attractive for purchasers. Third, the lower coupon rate on a convertible coupled with the generally low dividend yield on shares after conversion implies a lower cash flow drain relative to issuing straight debt. Fourth, historically,a firrn could not issue bonds in excess of its paid in capital plus reserves. The

June 1990 revision to the Commercial Code roughly doubled the limit; but eventhis relaxed constraint can be binding for a rapidly growing firm needing extemalfunds. A convertible issue provided immediate funding but, as it was converted
into shares, enhanced a firm's ability to issue additional bonds in the future.
Horiuchi (1995b) shows the supporting evidences that the active issue of converti-

bles by a firm tends to increase its managerial perquisites, thereby deteriorating

the firms' performance from their shareholders' interests. He argues thatJapanese corporate governance which give large latitude to managers did not leadto serious losses for the other stakeholders, mainly because the remarkable
growth of firms covered up the potential confiict of interests among the stakehol-ders. When the economy is faced to the structural changes, however, large discretionary power of managers may not be effective to respond to the change.

The main concern for corporate bond issues during the last decade has been
the shift to issuing overseas. This is clearly due to reduced regulatory constraints

on access to offshore markets where there is greater flexibility and lower costs.

The rise of the offshore primary market has, however, seriously undermined thedomestic primary market. Consequently, efforts are currently underway to reform

domestic bond issuance procedures and make them more competitive with
offshore markets.27 This will presumably require more flexibility with regard to
pricing and issue terms as well as largely eliminating the additional costs imposedby the commissioned bank system. Otherwise the dominance of the offshore markets is likely to continue (Hodder and Tschoegl 1992).

27 Eligibility requirements of issuing bonds were changed to abolish the minimum net wealth and introduce rating in 1990. Since the relative importance of corporate bonds issued by Japanese firms
oyerseas has increased, the Ministry of Finance introduced the regulation to forbid securities companies subscription sale of Eurobonds issued by Japanese firms to domestic investors in 1993 inorder to recover the domestic bond market.

89
KOJIMA: JAPANESE FINANCIAL RELA TIONSHIPS IN TRANSITION

3.3 Reorientation of Financial Institutions

The securitization and globalization of Japanese corporate finance dramaticallychanged the business of major banks in Japan. As no-financial firms have beenchanging the sources of funds, Japanese major banks have aggressively sought tooffer product-oriented, fee-based banking services such as currency and interest

swaps, leveraged lease arrangement, and M&A advisory work. As shown in
Table 7, the rapid growth and low profitability of Japanese banks has led to concern about their capital adequacy. Foreign banks have sought protection from theonslaught of Japanese competition by calling for Japanese banks to operate withcapital ratios comparable to those required in the United States and Europe.
Japanese banks are watching their financial performance carefully. In contrast to

the low-margin, volume-oriented banking practices, Japanese banks are now restraining growth and carefully tracking the profitability of their relationships withclients. Increasingly, banks according to the profitability of the relationship withthem are ranking clients. Just as industrial clients are now short listing the bankswith which they do business, banks are now beginning to identify and terminate
relationships with clients that do not provide them with sufficiently attractive
rates of return.

Table 7 Profit Performances of Commercial Banks in Germany, Japan, and the U.S.A

Five-Years Ayerage(Percentage)

Germany
2.24
2.21
2.10

Japan
1.75
1.35
1.23

U.S.A.
1.99
3.47
3.35

1980-84
1985-89
1990-94

O.54
O.70
O.54

O.53
O.58
O.26

O.90
O.78
1.10

1980-84
1985-89
1990-94

5.89
6.84
8.15

3.69
3.64
4.41

6.19
6.50
7.20

1980-84
1985-89
1990-94

14.06
12.11
10.49

14.43
16.41

15.34
11.13
16.04

Gross Profit Margin

1980-84
1985-89
1990-94
Pre-tax Return on Assets

Equity to Assets

Retum on Equity

6.111996), Economic andSources: The Bank of Japan (1974, 1978, 1986, 1994,
Comparative
Financial Statistics: lapan and Other Countries.

Source Note: Statistiches Bundesamt, Unternehmen
Arbeitsstditten
und The Bank of'(Business Analysis on Main Enterprises in Japan), The
Japan, Syuyokigyo Keieibunseki
Financial Report for Manufacturing, Mining,
U.S. Department of Commerce, euarterly
and Trade Corporations

90

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 55-96

Deregulation of interest rates, which raised the cost of funds to banks, caused

the change of bank portfolio. Coping with decreasing operating margin, Japanesebanks introduced various measures to reduce operating costs and started to compete for deposits and loans more eagerly than ever. Many banks loosed loan examination cutting the staff in the department to reduce costs and accelerate theloan making. Then the bank increased easy collateralized loans to investment inreal estates. Prices of assets have stagnated in the early 1990s in Japan. This
stagnation of asset prices caused the large amount of non-performing loans to investments in real estates. Non-performing loans include four kinds of loans: loans
to bankruptcy; loans overdue in six rnonths; loans with reduced interest rates; andother loans used for rescue. According to the report of Ministry of Finance inApril 1995, the amount of non-performing loans is 23.8 trillion yen in majorbanks. Large amount of non-performing loans has deteriorated banks' equity andmajor banks unable to meet BIS capital requirement. Japanese banks issued thesubordinated debts to recover their capital-assets ratio. Non-performing loans toreal estates caused the serious problems with banks' own balance sheets.

The shifting patterns of Japanese corporate finance and the competitive andregulatory pressures on Japanese financial institutions to increase their return on
assets is collectively resulting in a gradual separating of claims held against non-financial firms. Rather than being key shareholders, lead lenders, and primary
vendors of financial services in long-term relationships with clients, Japanesebanks are now being reduced to the position of minority shareholders that mustcompete fiercely for a client's business on a transaction-by-transaction basis.28

Much of corporate finance in Japan has evolved around the main bank relationship. This is changing for large firms. Financial liberalization in Japan has createddifficulties for the main bank system. Nevertheless, that system seems likely toadapt and continue to provide valuable support for rapidly growing firms. Exactly
how this will come about is not yet clear; however, there are substantial incentives for preserving the system's advantages. More generally, the effects of finan-cial liberalization over the last decades have been enormous. The process ofchange will continue, both because of continuing liberalization and because somefinancial patterns change sluggishly. Increasing financial sophistication and a consequence ability to exploit opportunities arising from regulatory changes will also
continue to alter corporate financial practices for some time to come. It is reason-

28 Horiuchi (1995a) points out that bank regulation in Japan provided banks with a considerable
amount of rent that could be utilized when regulatory authority had a chance to rescue troubled
banks. Furthermore, competition-restricting regulations kept the franchise value in the banking at ahigh level, giving banks incentives not to engage in activities associate with moral hazard that arelikely to prevail under extensive nets,

91
KOJIMA: JAPANESE FINANCIAL RELA TIONSHIPS IN TRANSITION

able to expect that the role of offshore financing will not decline. Untangling the
web of domestic regulations, traditional practices, and conflicting interests of va-

rious financial constituencies will take time. Financial liberalization tends toundermine the main bank system because major non-financial firrns have greater
access to market debt as well as borrowing from foreign financial institutions.
This makes it potentially much more difficult for the main bank to monitor andcontrol those firrns' behaviors. In consequence, the main bank system could con-tinue to be viable and advantageous for small-and-medium-sized firms, which
need strong bank supports.29

Hoshi, Kashyap, and Scharfstein (1993) build on the idea that managers andshareholders may not completely agree about what kinds of investments should
be taken. If managers place a lot of weight on shareholder concerns, then theyshow that firms with more attractive investment opportunities will be more prone
to use public debt to finance investment. The idea is that the managers of firms
with very attractive investment opportunities will find it very costly to forego
these opportunities in order to take a pet project. As a result, they do not need
to be monitored to ensure efficient project selection. One can predict that whenmanagers are closely following shareholders' wishes, firms with high Tobin's q
wM issue public debt, while those with low Tobin's q will issue bank debt. It isalso implied that firms with high net worth - those with valuable assets in place or

low leverage - will use the public debt markets. Because they risk this net worth

when they invest, the managers of these firms have a greater incentive to invest
efficiently. Thus, the model predicts that firms with good performance, valuable

investment opportunities, or valuable assets are more prone to use public debt,
while other firms will rely more heavily on bank financing. They find that highnet worth firms are more prone to use public debt financing. In addition, firms inkeiretsu have responded to deregulation in different ways: the more successfu1
firms have accessed the public debt markets, while the less successfu1 firms continue rely more heavily on bank debt financing. As firms reduce their dependence
on bank financing, they might lose some of the benefits of relationship-based borrowing. They may have a less ready source of financing, and creditors may be lesswilling to help during the time of financial difficulty. Interestingly, the financing

29 Petersen and Rajan (1994) find that borrowing from a single lender increases the availability of credit for small firms. For smaller firms without publicly traded common stock, the benefit of bankmonitoring are likely to be large relative to the potential adverse incentive effects of informationmonopoly by a single bank. Houston and James (1996) examine the determinants of the mix of private and public debt using detailed information on the debt structure of 250 publicly traded corporation in 1980-90. They find reliance on bank borrowing is decreasing in firm size and overall

leverage. They also find that the relationship between bank borrowing and the importance ofgrowth opportunities depends on the firm's use of multiple banking relationships and public debt.

92

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 55-96

pattems of large Japanese firms are beginning to resemble the more arms--length

financing patterns observed in the U.S. This arms-length approach has led todifferent mechanisms of corporate control in the U.S. The shift to the armslength financing system, even if it may emerge, will certainly take time. The infrastructure in financial rnarket including rating agencies, disclosure rules, regula-tion and enforcement of insider trading are not developed well in Japan. Even
though the deregulation made it possible for major firms to arm's length financ-ing, some firms still chose to depend on bank borrowing. The firms seeking thebenefits of firm-bank relationships will continue to have close ties with banks.

4. Conclusion
Corporate financial patterns and practices in Japan appear quite different, particularly in comparison with those in the United States. In large part, these differ-ences are due to differing institutional and regulatory environments. Then, apeculiar financing pattern turns out to be the rational economic response to a
constraining regulation. The key to understanding such patterns are identifying
the underlying structure of constrains.

Japanese financial institutions may hold equity and debt at the same time. Besides strengthening the long-term relationship between the financial institutions

and the firm, the simultaneous holding of debt and equity clearly reduces thescope for conflict between stockholders and debtholders over the choice of policies, particularly in situations of financial distress. The significance of the mainbank system is the close information-sharing relationship that exists between thebank and the firrn. It is possible to view the main bank system as functioning as a
substitute for the kind of screening and monitoring institutions that are prevalent

in other capital markets such as bond and credit-rating institutions and security

analysis agencies. The close association that the main bank has with the firmmeans that the bank is able to obtain inside access to the firm and its management, which is not readily available to the external capital market.

The -main bank system can be also characterized in terms of banks themselvesdelegating the monitoring of a particular firm to one particular bank: the mainbank. The bank delegated to be monitoring is not only the bank with the largest
loan share but also holds a significant stake in the firm as a shareholder. Having asufficient large loan share may be the way in which the bank ensures that it
obtains an adequate return on its monitoring outlays. In this regard, it is worth

noting the free-rider problem may be mitigated somewhat by virtue of the factthat non-monitoring banks will not be able to imitate the loan portfolio of themain bank in size. It can be argued that this function of the main bank provides

93
KOJIMA: IAPANESE FINANCIAL RELA TIONSHIPS IN TRANSITION

an important substitute mechanism for what in effect is inactive market for corpo-

rate control in Japan. Main bank intervention can take a number of forms, ranging on the one hand from cases where the main bank stipulates certain measuresthat requires the firm to take in exchange for the bank's support during a periodof financial difficulty to cases where the bank sends officers to take over the man-agement and carry out the reorganization of a firm that is on the verge of bank-ruptcy on the other. As a consequence, one can suggest that the relationshipbased corporate governance substitutes for the more market-based in Japanesefirms.

Much of corporate finance in Japan has evolved around the main bank relationship. This is changing for large firms. Financial liberalization in Japan has createddifficulties for the main bank system. Nevertheless, that system seems likely toadapt and continue to provide valuable support for rapidly growing firms. Exactly
how this will come about is not yet clear; however, there are substantial incentives for preserving the system's advantages. The process of change will continue
because of continuing liberalization in capital market. Increasing financial sophis-

tication and capability to exploit opportunities arising from regulatory changes
will also continue to alter corporate financial practices.

Financial liberalization tends to undermine the main bank system because major non-financial firms have greater access to arm's length debt as well as borrowing from foreign financial institutions. This rnakes it potentially much more diffi-

cult for the main bank to monitor and control those firms. Consequently the mainbank system could continue to be viable and advantageous for firms which is li-

mited to access to alternative debt sources and need strong bank support. The
financing pattern of large Japanese firms is beginning to resemble the more armslength financing patterns observed in the U.S. The shift to the arms-length financing system, even if it may emerge, will certainly take time. The infrastructure in

financial market including rating agencies, disclosure rules, regulation and en-forcement of insider trading are not developed well in Japan. Even though the
deregulation made it possible for major firms to arm's length financing, somefirms still maintain main bank relationships. The firms seeking the benefits ofmain bank relationships will continue to have close ties with banks.

Acknowledgement
Financial supports from Foundation of Sanyo Broadcasting, The Japan Economic

Research Foundation, Ministry of Education in Japan, Murata Foundation, andZengin Foundation for Studies on Economics and Finance are gratefully acknow-

ledged. The author would like to thank Takeo Hoshi, Enrico C. Perotti andKOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 55-96

94

Yishay P. Yafeh for useful comments and suggestions.
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KOBE ECONOMIC & BUSINESS REVIEVV, 42 (1997), 97-115

ORGANIZATIONAL COORDINATION FOR PROJECTINTERDEPENDENCY IN NEW PRODUCT DEVELOPMENTKENTARONOBEOKA KobeUniversity

Abstract
In many industries, the effective management of concurrent multiple projects thatshare components has become a critical issue. Ftms need to coordinate engineers in
different projects in order to leverage their design work and technical knowledge acrossmore than one product. This study explores the influence of inter-project interdependencies on organizational coordination requirements. A questionnaire survey of
256 component engineers in the U.S. and Japanese automobile firms provides evidence
that the organizational coordination required to manage component dpsign - with andwithout inter-project interdependencies - differs significantly. For example, in projects
with no dependencies on other projects, only cross-functional coordination has a signifi-

cant influence on schedule and cost performance. But in projects with dependencies onother projects, both intra-functional coordination and cross-functional coordination havea strong impact on the performance of component design.

JFL CIassification: Management
Keywords: Product development; Coordination; Project interdependency; Differentiatedmatnx organlzatlon
1. Introduction

A stream of studies on new product development has been exploring the effec-

tive organizations and management of new product development. One of the central issues that many studies have examined is the implications of project-oriented

and function-oriented organizations (Marquis and Straight, 1965; Galbraith, 1974;

Davis and Lawrence, 1977; Allen, 1977; Tushman, 1978; Katz and Allen, 1985;
Clark and Fujimoto, 1991). Most studies have argued that product development
Corresponding Address:

Kentaro Nobeoka
Research Institute for Economics and Business Administration, Kobe University

2-1 Rokkodai-cho, Nada-ku, Kobe 657-8501, Japan
E-mail: nobeoka@rieb.kobe-u.ac,jp
Fax: (81)-78-803-0414

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KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 97-115

organizations require two different coordination mechanisms to achieve two major goals. First, in order to increase the quality and quantity of inputs of technicalknowledge, a high degree of coordination among technical specialties is needed.
Second, in order to integrate all technical knowledge toward well-defined pro-ducts, a high degree of coordination within and around a project is required.
These two aspects of coordination requirements have primarily been discussedwith respect to the issues of the balance between project and function orientations in the new product development organization.
However, there has been one critical factor missing in this perspective. The ex-

isting studies have examined the organizational coordination mostly focusing on
the effective management of a single project. In many industries such as an auto-

mobile, however, large manufacturers have at least several product lines andsimultaneously undertake multiple development projects. In these firms, the extent to which these concurrent multiple projects are related to each other in tech-

nologies and design is an important strategic issue. For example, in order to enjoy the economies of scope, separate projects should extensively share the similar

technologies and other resources. Multiple projects may want to share some portion of design in order to decrease development costs and maximize the scale eco-nomies. In particular, he effective management of concurrent projects can allow
firms to leverage their engineering resources by facilitating quick and efficienttransfer of new technology across multiple products (Nobeoka and Cusumano,1997). In addition, even when component designs are not exactly the same, firms

may also try to manufacture components for a varieCy of projects using a sameprocess equlpment.
This type of strategy selection usually causes interdependencies regarding speci-

fic technologies and components among multiple development projects. The nature of inter-project interdependencies should, in turn, have an influence on orga-

nizational coordination requirements, which should be one of the key determinants in designing appropriate organizational structures and processes. This paper
specifically explores the influence of the inter-project interdependencies on theorganizational coordination requirements in new product development, focusing
on the importance of both cross-functional (i.e., project) and intra-functional
coordinations. In order to examine this question, we conducted a questionnaire
survey of 256 design engineers in ten international automobile firms.

There have been numerous studies on the advantages and disadvantages ofproject-oriented and functional-oriented organizations. In these empirical studies,project-oriented structures, rather than function-oriented structures, generally re-sulted in higher performance particularly in terms of cost and schedule performance, while in some cases functional orientation was appropriate for the technical

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NOBEOKA: ORGA.NIZA TIONAL COORDINA TION FOR PROJECT INTERDEPENDENCY

performance. For example, Marquis and Straight (1965), in their pioneering
work, by investigating thirty eight R&D projects under contract with a government agency, have concluded that function-oriented organizations are more effec-

tive in technical performance, while project-oriented organizations tend to be

more successfu1 in cost and lead time. Katz and Allen (1985) examined the relationship between project performance and the relative influence of project andfunctional managers. They have concluded that performance reaches its highest
level when organizational influence is centered in the project manager and influence over technical details of the work is centered in the functional manager. Lar-son and Gobeli (1988), on the other hand, have found that in all schedule, cost

and technical performances, project-oriented teams tend to be more successful
than function-oriented organizations. In their study of automobile product de-velopment, Clark and Fujimoto (1991) also argued that strong project manager
responsibility (i.e., "heavyweight product manager" in their term) had a positive
influence on project performance in lead time, productivity, and design quality.

These studies have provided useful insights for managing a new product development project. However, few studies have explicitly addressed questions ofinter-project interdependencies in design or engineering, either conceptually or
empirically. It is important to study the influence of inter-project interdependency

on organizational coordination requirements, because it should impose a criticaldimension of contingency on product development organizations. The findings
and frameworks of the existing studies without considering this dimension may
have been misleading and has to be reinterpreted. For example, the existing literature suggests that in order to shorten lead time, project-oriented organization be

the most appropriate structure (Clark and Fujimoto, 1991). However, one of thecritical issues many automobile manufacturers currently face is the way to sharecomponents and technical knowledge among multiple projects. A project organization that is too project-oriented with a relatively autonomous power tends toresult in the development of many proprietary components for each project, andmay require excessive financial and engineering resources. The next question iswhether firms should adopt a traditional function-oriented organization when the
management of the inter-project interdependencies is critical. The inter-projectinterdependencies, however, may not be managed within each functional organization alone. The inter-project management should also be affected by theneeds of a separate individual project. This study specifically focuses on theseissues related to the management of inter-project interdependencies.
In the next section, we discuss the potential influence of inter-project interdependencies on organizational requirements, particularly with respect to cross-functional and intra-functional coordinations in new product development orga-

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KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 97-115

nizations. The cross-functional coordination is directly related to coordination
around project, and the intra-functional coordination is to that of each function.

The following sections explain our research methods and the results from a questionnaire survey of automobile design engineers. In these sections, we provide anevidence that the organizational coordination required to manage component design differs significantly depending on the nature of inter-project interdependen-cies. In the final section, we discuss theoretical and managerial implications
drawn from our survey results.

2. Framework and Hypotheses
New product development organizations at large automobile firms appear to bea matrix organization, although there are some variations with respect to theorientation of either project or function (Clark and Fujimoto, 1991). In order toexamine the influence of inter-project interdependencies on the organizational
coordination, our study used two separate simplified patterns of component design engineering as a research framework. In the first pattern, an engineer designs

components for a new vehicle project that has no direct interdependency with anyother on-going product development projects. In the second pattern, on the other

hand, an engineer designs components for a new vehicle development project thathas some direct interdependency with equivalent components in at least one ofother on-going projects.

The inter-project interdependencies can exist when two projects share at least

some portion of component designs or divide some tasks to avoid duplications inengineering and financial resource usage. Consideration of utilizing the same pro-

cess equipment may also cause some interdependencies between different vehicle
projects. Figure 1 and Figure 2 explain the differences in a simplified model of amatrix product development organization, positioning design engineers in an engineering function at the center of the matrix.

2.1 Hypotheses on Component Design without Inter-Project Interdependency
Figure 1 shows the first pattern, in which an engineer designs a component for
Project A that does not have particular types of interdependencies with those for

Project B. Each design engineer works both for a functional manager, primarily
on issues pertaining to technical or component questions (indicated by 2 in Figure1), and for a project manager, on issues pertaining to the integration of inputs
and intermediate outputs into a specific final product (1 in Figure 1). In addition,

many engineers formally or informally interact with engineers in other functions

such as manufacturing and other components, who work for the same new pro-

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NOBEOKA: ORGANIZATIONAL COORDINATION FOR PROJECT INTERDEPENDENCY

duct project, to integrate technical outputs across functional areas (3 in Figure 1).

Furthermore, even in this model, engineers may also want to have some interactions and coordination with engineers in the same technical discipline, including
those who work for other projects, to update and refine "state-of-the-art" technologies (4 in Figure 1).

Figure 1 Cross-Functional Coordination and intra-Functional Coordination

Project OtherManager Engineering Engineering&Staff Function Functions
ManageroProject A

Cross-Functionalo(Project)
Coordination

Project B

intra-Functional

Coordination

In the framework, as shown in the figure, cross-functional coordination is de-fined as the degree of coordination between the design engineers and a project
manager (including his or her staff) as well as engineers in other engineeringfunctions. "Other engineering functions" consist of design engineers for othercomponents and manufacturing engineers who work for Project A. Intra-function-

al coordination refers to the degree of coordination between engineers and afunctional manager as well as engineers in their same technical function or systemarea who work for other vehicle projects. The same definition of coordination is
also applied to the next model shown in Figure 2.
Based on the past studies discussed above, we hypothesize that, without inter-

project interdependencies with respect to certain components, cross-functional
coordination may have a particularly strong positive infiuence on operational per-formance such as cost and schedule. In addition, intra-functional coordination
may be more important than cross-functional coordination particularly regarding
technical performance.

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42 (1997),
KOBE ECONOMIC & BUSIIVESS REVIEI)V,

97-115

2.2 Hypotheses on Component Design with Inter-Project interdependency
The model in Figure 2 shows the next hypotheses regarding possible influencesof inter-project interdependency on the degree of organizational coordination.
The potential additional organizational requirements for coordination are indicated by the dotted lines, This model assumes that there is an interdependency
between two projects regarding at least the design of a particular component, on
which the engineer in the center of the figure works. In the particular model out-

lined in Figure 2, the engineer in the new product project develops a design inconjunction with another project, Project B, in which the engineer is not directly

involved. We chose this research framework, as opposed to an alternate potential

model in which the same engineers work on component design for multiple product projects, because our research aim here is to explore the requirements fororganizational coordination when multiple projects are interdependent and yet
engineers in these projects are separate.

Figure 2 Influence of Inter-project interdependencies

Project OtherManager Engineering Engineering&Staff Function Functions

Cross-Functional
Project A(Project)
Coordintttt'on

Project B

Intra-Functional

Coordination

NOBEOKA:ORGANIZATIONALCOORDINATIONFORPROJECTINTERDEPENDENCY 1

Assume that requirements for the component's design are not likely the same
between these two projects, and that these two vehicle projects target different

customer groups and compete against different competitors. In other words, engineers for Project A and B may not use exactly the same design, but try to sharesome resources or some technologies. In this case, additional coordination between engineers involved in these two different projects may be needed in orderfor engineers to minimize task duplications or to share as much of the design as
possible (indicated by 4 in Figure 2). This coordination efforts may also have to
be overseen by the functional manager (2 in Figure 2). The degree of intra-functional coordination, therefore, may have a stronger influence on project performance in this kind of design work than in a project without any inter-project inter-dependencies. In other words, more coordination may be needed within the functional group because of the interdependency.
More importantly, in addition to this relatively direct requirement of the intra-

functional coordination between engineers on the two projects, requirements forcross-functional coordination may also be higher than in projects without inter-

project interdependencies (1 and 3 in Figure 2). A product development projectis a system consisting of multiple closely coupled engineering functions (Rosenberg, 1982; Iansiti, 1993). Uncertainty in any part of the vehicle system increases

the requirement for coordination across sub-systems (Tushman, 1979; Clark andFujimoto, 1991). In other words, uncertainty in the design of each component
within a functional sub-system increases the coordination requirement across theentire system Qf a nevir product project. Uncertainty in the engineer's task withina function, in this model, is higher than that in a project without any interdependencies with other vehicle projects.
For example, suppose that engineers for Project A have to modify design specifications of a certain component in order to share some portion of the design withan equivalent component for Project B. In this case, a design change in Project A

is caused by its interdependency with Project B. The change must be also incorporated into the whole set of vehicle system within Project A. Therefore, thedesign change should require additional cross-functional coordination within Pro-

ject A, in addition to coordination between engineers in Project A and B within
the function. Thus, we hypothesize that in a component design that is interdependent with another project, the infiuence of the cross-functional coordination on
design performance is also stronger than in projects without inter-project inter-dependencies. In addition, the more interdependent components are with othercomponents within a project, the more difficult it may be to coordinate component design between multiple projects.

We sum up the hypotheses for additional coordination requirements for compo-

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KOBE ECONOMIC & BUSINESS REVIEVV, 42 (1997), 97-115

nent design with interdependencies as follows: the importance of both cross-func-

tional cooperation and intra-functional cooperation for design performance may
be significantly higher in projects with inter-project interdependencies and interactions than in those without this type of inter-project interactions.

3. Sample and Measures
To examine these hypotheses, we conducted a questionnaire survey of design
engineers at seven Japanese and three U.S. auto manufacturers. The questionnaires were distributed in Apri1 1992 and were collected between May and August in the same year. One central contact at each company distributed questionnaires to design engineers. We asked the contact persons to distribute the questionnaires to engineers in as many different engineering divisions as possible, suchas chassis, body, and engine. In addition, we requested that the questionnaires befilled out by junior engineers who actually designed components rather thansenior engineers or managers. In our research framework, the questionnaires
were not supposed to be filled out by functional managers. Of 280 questionnaires
sent to Japanese firms and 90 questionnaires sent to U.S. firms, 224 (return rateof 809o) and 32 (return rate of 369o) were retumed, respectively, which resulted
in a total sample of 256 responsesi. The low return rate from the U.S. firms may

have resulted from the U.S. firms' reluctance to provide data on poorly-implemented projects, a reticence which we noticed in discussions with them. Because the primary purpose of this study is not a comparison of performance between U.S. and Japanese firms, we believe that this return rate does not affectthe issues probed by this research, although we also used control variables to detect possible differences between the two samples.

In the questionnaire, each respondent chose one specific component that he or
she recently had worked on for a specific product development project, excluding

components built for basic research or for general use. One of the questions
asked whether there was at least one other on-going vehicle development projectthat had interdependencies with the vehicle project he or she had worked on,particularly with respect to the design of his or her component. Specifically, thisquestion asked whether, in conjunction with the vehicle project for which the re-spondent worked, there was at least one other new vehicle development project1

These return rates are not actual return rates in the meaning of the term that is commonly used.
The aÅëtual number of questionnaires distributed to engineers and the selection of engineers were
decided primarily by the contact persons. The only guideline with respect to the number of questionnaires was to distribute the questionnaires to at most 35 engineers in as many different design
functions as possible within a firm.

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NOBEOKA: ORGANIZA TIONAL COORDINA TION FOR PROJECT INTERDEPENDENCY

that was using similar component designs and was sharing some of the technology
or designs of the respondent's project, which necessitated some inter-project in-teractions. Respondents were asked to think only about other projects in which
they were not directly involved, so that the issue of coordination could be expli-

citly explored. Among 256 component developments, 122 appeared to have atleast one other project with which they had this type of inter-project interdependency. Thirteen of the 32 U.S. component developments (419o) and 109
out of 224 Japanese component developments (499o) exhibited inter-project inter-dependencies. We analyzed data separating these two sample groups to explore
how organizational requirements differed between these two component development types.

3.1 PerformanceMeasurements
The questionnaire asked respondents to rate on a 7-point Likert-type scale

whether each component development performed above or below their expectation in schedule, cost, design quality, and the degree of match with customer
needs. Cost and schedule performance data were averaged to measure the operational performance, because these variables are highly correlated and seem tocapture a common factor both conceptually and statistically (9e explained by the

first principal component = 839o). For the same reason, performance ratings ofdesign quality and the degree of match with customer needs were also averaged
to measure design quality performance (% explained by the first principal compo-

nent =879o).
3.2 Measurements of the Degree of Coordination
There is no single best measurement of the degree of coordination. The degreeof coordination among different groups rather than the specific means of coor-dination needs to be stressed in this particular analysis. The degree of communication could possibility be used to measure coordination (Allen, 1977; Tush-man, 1978). However, the degree of communication is not a good measure of thedegree of coordination when extensive communication is needed to solve problems or conflicts. The degree of goal sharing among different groups could be analternative measure. Lawrence and Lorsch (1967) used it to measure the degreeof integration. This is not a good measurement for this study either, because allgroups which responded to the survey are in a specific new product development
project, and there may not be enough natural variations in their goals. Thus, inthis study, the degree of satisfaction with the cooperative working relationship on

the particular engineering task that each respondent chose was used as a proxy
for the degree of coordination between different groups. This variable captures

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KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 97-115

the willingness of engineers and managers in one group to coordinate with thosein other groups. Respondents rated the satisfaction level of their working relationship regarding a specific component development with people in different

groups: a functional manager, a project manager, product engineers in otherfunctions, manufacturing engineers, as well as engineers in their same technicalfunction working for other product projects.

First, ratings regarding product engineers in other functions and manufacturing
engineers were averaged to measure the degree of coordination (i.e., satisfaction
with the working relationships) with engineers in other functions. Second, as indicated in the model shown in Figures 1 and 2, the degrees of cross-functional coor-dination and intra-functional coordination were calculated. The degrees of coordination with a project manager and with engineers in other functions were averaged to measure the degree of cross-functional coordination. The degrees of coordination with a functional manager and with other engineers in the same function
were averaged to obtain the measure of intra-functional coordination.

3.3 Control Variables and the Entire Analytical Framework
Other variables of component design task characteristics that may affect the re-lationship between component development performance and any type of organizational coordination are summarized in the analytical framework in Figure 3.
These control variables are added because they may identify additional task com-

plexity, which might make component design more difficult and lead to lower
performance ratings regardless of the degree of coordination. These variables

might also have different influences on design performance depending upon
whether there are inter-project interdependencies.

First, we asked respondents to estimate the percentage of new design as
opposed to carry-over portion of the design for each new component development. Many new designs are not usually 1009o new, because engineers often use
existing designs as a base. This ratio should be controlled, because components

with more new design may require more inputs from other engineers within thesame function, including engineers working for other projects. On average, 799oof the designs in the component developments with inter-project interdependencies were newly designed, and 869o of the designs were new in projects without

inter-project interdependencies. Second, respondents estimated a component's
inter-functional interdependency with other parts of the product by rating, on a 7point Likert-type scale, the extent the component design affects the other parts ofthe product. Third, respondents estimated the percentage of design that suppliers

engineered for each component design. On average, 349o of the design was doneby suppliers in component designs with inter-project interdependencies and 319e

107
NOBEOKA: ORGANIZA TIONAL COORDINA TION FOR PROJECT INTERDEPENDENCY

in those without interdependencies.

Figure 3 Analytical Framework of the Relationshipbetween Coordination and PerformanceWith or Without
Inter-projectInterdependency

11l1
Degree of Coordination' Cross-Functional' Intra-Functional

1
1
1

1

l
1
l
1
1

Perforrnance11' Schedule / Cost

' Design Quality

Control Variables

Desing Task Characteristies' New Design Ratio' Componcnt Interdependecy' Supplier Design Contribution

4. Results

Descriptive data and a correlation matrix are shown in Table 1 for component

developments with inter-project interdependencies (top halD and those without(bottom halO. On average, engineers who work on component design without
inter-project interdependencies rated the component's performance higher thanthose who worked on component design with interdependencies. The degree oforganizational coordination is also rated higher in component design without
inter-project interdependencies, which indicates that achieving high levels of coordination is generally more difficult in component design with inter-project inter-dependencies. The current research, however, focuses on the differences between
these two types of component design in the relationship between the performanceand different types of coordination, rather than the differences in performance or
the degree of coordination alone.

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KOBE ECONOMIC & BUSINESS REVIEIJV, 42 (1997), 97-115

Table 1 Descriptive Data and Correlation Matrix
With Inter-project Interdependencies (N=122)

Mean S.D.
1Performance:SchedulelCost

3.47

.86

2Performanoe:DesignQuality

4.37

.96

.36ttt3Coordination:Cross-Functional

4.36

1.oo

.39ttt.38ttt

4Coordination:Intra-Functional

4.50

1,10

.37ttt.34ttt.59ttt

5ComponentInterdependency

4.82

1.73

-.06.24ttt.35ttt.13

6NewDesignRatio

.79

.29

7Supplier'sDesignContribution

.34

.25

.02.02.06.03.13-.11-.12.02.13-.04-.03

Without Inter-project Interdependencies (N== 134)

Mean S.D.
1 Performance:Schedule/Cost

3.69

1

2

3

4

5

2 Performance:DesignQuality

4.69

.99

.37ttt3 Coordination:Cross-Functional

4.66

1.00

.2sttt.Igtt

4 Coordination:Intra-Functional

4.66

1.oo

.15

.26ttt5 ComponentInterdependency

4.90

1.57

-.04

.02

6 NewDesignRatio

,86

.24

.14

.12

7 Supplier'sDesignContribution

.31

.23

-.06

-.13

.5sttt•
.03

.Ol

.11

.05

.05

.12

.

--

3ottt
16

tt p < .o5 ; tttp < .Ol

Performance variables, in general, are correlated more strongly with the coor-dination variables in component developments with inter-project interdependen-cies than those without the interdependencies. Specifically, in component developments with inter-project interdependencies, both measurements of performance, those for schedule/cost and design quality, are strongly correlated with bothcross-functional and intra-functional coordination variables. On the other hand, in

those developments without inter-project interdependencies, schedule/cost performance is significantly correlated only with cross-functional coordination, while
design quality is strongly correlated only with intra-functional coordination. The

results-from the simple correlation matrix show that component design with interproject interdependencies requires both cross-functional and intra-functional coor-dination to be successful. Component design without the interdependencies particularly requires cross-functional coordination for schedule and cost, and intrafunctional coordination for design quality. These results with respect to component design without inter-project interdependencies fit with past studies (for example, Marquis and Straight, 1965; Katz and Allen, 1985). The following analyses
explore these relationships more precisely, using regression analyses in which thecontrol variables are added.

6

1.05

-.12

NOBEOKA:ORGANIZATIONALCOORDINATIONFORPROJECTINTERDE]PEIVDENCY 10

4.1 Schedule/Cost Performance
Table 2 shows the regression results for project perforrnance in terms of schedule and cost. The results show that the organizational coordination required toperform well differs significantly between component design with and without
inter-project interdependency. The differences generally support our hypotheses.
Table 2 Regression Analysis for Performance in Schedule and Cost

Independentvariables
Constant

DegreeofCoordination
Cross-Functional

WithInter-project

WithoutInter-projectInterdependencies

Interdependencies(N-122)(N-134)ModellMode12

o.ooo.oo

Model3Mode14

o.ooo.oo

O.34ttt

O.19t

O.2ot

O.Ol

ComponentInterdependency-O.10-O.23ttt

Supplier'sDesignContribution-O.14-O.17t

NewDesignRatio
Nation(US=1,Japan=:O)
AdjustedSquaredMultipleR

O.06O.04-O.13-O.12-O.06-O.05

Intra-Functional

O.16tO.14

O.19ttO.12

O.23tttO.19tt

O.02O.22

O.06O.08

Coefficients are standardized numbers. 'p<O.1, ttp<O.Os, "'p<<o.ol

First, in component design without inter-project interdependencies, as most of
the past studies found, cross-functional coordination, not intra-functional coordination, is particularly important to high performance in terms of schedule andcost. Second, in component design with inter-project interdependencies, intrafunctional coordination is important to manage inter-project coordination evenfor schedule/cost performance. Third, the influence of cross-functional coordination is stronger in component design with inter-project interdependencies than indesign without interdependencies. These results support the view that, in order tomanage interproject interdependencies, not only strong intra-project coordination is required to deal with inter-project interdependency, but also cross-func-

tional coordination is required to absorb within each project any uncertainties
caused by inter-project interdependencies.
In addition to the differences in the influence of organizational coordination
variables, other design task variables also affect performance differently between

these two types of component design. First, as our hypothesis suggests, a component's interdependency with other parts of the vehicle causes more difficulties incomponent design with inter-project interdependencies. When the cross-fufictional

component interdependency is strong, interproject interdependency cannot be

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 97-115

110

managed within each function. Second, the extent of supplier contribution has asignificant negative effect on performance only in component design with interproject interdependencies. This result may imply that it is difficult for multiple
projects to manage a supplier relationship jointly.

These independent variables, especially the organizational coordination vari-ables, explain more about schedule and cost performance in component design
with inter-project interdependencies (adjusted R2=O.22) than in design situations

without interdependencies (adjusted R2=O.08). This difference may imply thatcoordination variables are particularly important in component design with interdependencies, because of its complicated nature in coordination tasks.

4.2 Design Quality Performance
Design quality performance is also significantly affected by both cross-function-

al coordination and intra-functional coordination in only component design withinter-project interdependencies, as shown in Table 3. In design without interdependencies, intra-functional coordination is particularly important, which again
generally fits with the results from the past studies discussed earlier. In addition,a supplier's contribution to the design also again has a stronger negative influence

on design quality performance in component design with inter-project interdependencies.
Table 3 Regression Analysis for Performance in Design Quality

Independentvariables
Constant

DegreeofCoordination

WithInter-project

WithoutInter-projectInterdependencies

Interdependencies(N=-122)(N-134)ModellMode12 Mode13Mode14

o.ooo.oo

o.ooo.oo

Cross-Functional

O.2ot

-O.02

Intra-Functional

O.17t

O.20ttSupplier'sDesignContribution-O.17ttO.19-O.16t-O.18tt

NewDesignRatio
Nation(US=1,Japan=O)

O.35tttO.3ottt

O.41tttO.38ttt

O.16O.25

O.17O.19

ComponentInterdependency

AdjustedSquaredMultipleR

O.05O.03

Coefficients are standardized numbers. 'p<O.1, "p<O.05, ""p<<o.ol-O.09-O.08-O.13-O.10

O.11O.11

NOBEOKA:ORGANIZATIONALCOORDINATIONFORPROJECTINTERDEPENDENCY 1

As both Table 2 and Table 3 indicate, respondents at the U.S. firms tended torate their performance higher than the Japanese respondents. This may have beencaused by the low return rate from the U.S. ftms, who may have returned surveys only for high-performing component design projects, as pointed out earlier.
This difference may also have reflected the difference in language, either in English or Japanese, used in the questionnaire, In any case, this bias does not affectthe results regarding the general theoretical propositions posed.

4.3 Summary
Table 4 summarizes the influence of coordination and task variables on design
perforniance. It is evident that organizational requirements significantly differ be-

tween component design with and without inter-project interdependencies.
Table 4 Summary of the Regression Analyses

Cross-

Intra-

Functional
Coordination

Functional
Coordination

SchedulelCost

ttttInterdependencies

DesignQualityttWithout

SchedulefCost

'

With

ComponentInter-

dependency

Supplier's

DesignInvolvement

ttt'

Neativet'
Neativett'Neative

Interdeendencies DesinQuality
Statistically significant at: 'tt19o Level, "t59(o Level, '109o Leveltt

In component design development in the context of inter-project interdependencies, organizational coordination in general tends to have a stronger impact on performance than in designs without those interdependencies. Specifically, the influences of both cross-functional coordination and intra-functional coordination are strong in designs with inter-project interdependencies. Intra-functional coordination, which directly involves engineers across multiple projects, affects

schedule/cost performance only in those designs with inter-project interdependencies. In addition, design quality is affected by cross-functional coordination onlyin component design with inter-project interdependencies. With respect to coordination requirements for component design without inter-project interdependencies, our data basically fit the findings from past studies. In a component design
without inter-project interdependency, cross-functional coordination is particularly

important for operational performances such as schedule and cost. Design quality
is more greatly influenced by intra-functional coordination among engineers in the

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KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 97-115

same technical discipline than cross-functional coordination.

Complexity caused by other task characteristic elements, such as component interdependency with other parts of the product and the degree of supplier involve-

ment in design, seems to impose greater penalties on component design withinter-project interdependencies. This may be because component design without
inter-project interdependencies is simpler than design with interdependencies, andthus it may be easier to manage the complexity of component interdependency
and a supplier's involvement more effectively. In addition, this result reflects our

hypothesis, in which we argue that interdependency with other components
makes it difficult to manage inter-project interdependencies. Otherwise, a traditional functional organization could manage inter-project interdependencies within each function.

5. Discussions and Conclusions

The results of this survey indicate that in order to'effectively manage
schedules/costs and design quality for component design across multiple projects,
not only stronger intra-functional coordination but also stronger cross-functional

coordination is needed than for single project component design. In addition,other factors that impose further complexity on the organization, such as component interdependency and supplier involvement, tend to cause greater difficulties

to the organization engaged in component design with inter-project interdependencies. This result theoretically implies that different models are required
to predict the relationship between organizational coordination patterns and pro-

ject performance, depending on the nature of interproject interdependencies. In

our sample, about a half of engineers designed components dealing with somedirect interdependencies with other vehicle projects. A simplified theory based on
the context of a single project management cannot directly apply to this type ofmulti-project management.
This study has also provided managerial implications. The coordination requirements for component design with inter-project interdependencies are so different
from those without interdependencies that different organizational structures andprocesses are likely to be needed. For example, this study has supported the existing studies, which have argued that in order to shorten lead time in the single-

project context, project-oriented organization should be adopted. However, thisstudy concludes that this solution is appropriate only when the inter-project inter-dependency is not an issue. At the same time, even when the interdependency
exists, this study has implied that organizational structures and processes should

not be purely opposite reactions to a project-oriented management system.

113
NOBEOKA: ORGANIZA TIONAL COORDINA TION FOR PROJECT INTERDEPENDENCY

Rather, organizations should be aimed at achieving both cross-functional coordination and intra-functional coordination simultaneously through the active coor-dination of multiple projects. This goal cannot be achieved by either traditional

project-oriented or function-oriented organizations. The interproject interdependencies must be coordinated within the context of a specific project as asystem. In other words, firms need organizational structures and processes thatenable system-level coordination across multiple projects.

As the product development competition becomes more sophisticated, firms
may have to place more importance on the management of concurrent multiple
projects. In our follow-up interviews2, we found that some firms have actually in-troduced a few new concepts to their organizations to deal with the inter-projectinterdependencies. First some Japanese automobile firms have employed the ideaof extensively differentiated mechanisms within a matrix organization. They are
creating a variety of working structures to manage the development of different
design tasks based on an explicit recognition of the degree of inter-project andcross-functional interdependencies. Figure 4 depicts an example of a differenti-

ated matrix from one of the Japanese automobile firms. Depending on the nature
Figure 4 An Example of Differentiated Matrix Organization

Body Chassis Interior Engine Electonics
Mixed- Multiproject Multi-project Component Component

Team Team Team Team Team

Project A.Project B

Project C

Project D

2

Our field study includes three trips to Japan, one to Europe, and several to Detroit, augmented bynumerous interviews around Boston with International Motor Vehicle Program participants. We
conducted in-depth interviews with approximately 130 engineers and 30 new product project managers at five Japanese, three U.S,, and four European firms between August 1992 and July 1994,

114

KOBE ECONOMIC & BUSINESS REVIEVV, 42 (1997), 97-115

of the interdependency, there is flexibility in changing task partitioning and organizational structure.

For example, components like batteries and audio systems in the electronics de-sign division tend to be developed by a pure component group, while platform

components are developed by a multi-project team. Engineers working on somebody components are totally devoted to a single project through a projectoriented group. Because the nature of both cross-functional and inter-project in-terdependencies changes all the time depending on the combination of projects
being developed and their strategies, they should be able to quickly and dynamically change this micro-level structure. In future research, we plan to explore thisconcept of a "dynamic" differentiated matrix structure both empirically andtheoretically.

Second, some firms introduced a level of strong control above project managers

and now have "group" project managers, who are responsible for multiple concurrent projects, so that coordination among multiple projects can be effectively

achieved. One common mechanism for control is to divide the whole project
portfolio into several groups and to place general managers above the individual

project managers for individual projects. A good example can be seen in the re-cent Toyota's major reorganization in 1992. Toyota, by the late 1970s, hadalready shifted from functionally-oriented organizations to project manager-based

structures. Its "shusa" system or heavyweight project manager system has been
widely discussed as an example of an effective project-oriented organization(Ikari, 1985; Shiosawa, 1987; Clark and Fujimoto, 1991). However, Toyota now
has a chief engineer who is responsible for several concurrent projects above individual project shusas. The person in this position assumes some of authorities thata powerful leader for a single project, a shusa, used to have. One of the primary
purposes of creating a position more powerful than the shusa is facilitating thetransfer and sharing of new designs among multiple projects (Fortune, January
25, 1993, p. 78). This shift at Toyota represents a growing importance of managing the inter-project interdependencies at an automobile firm.

We believe the research presented here provides a new perspective on the man-agement of new product development and important findings for organizational
implications on the inter-project interdependencies. This study is, however, oneof the first explorations of the effectiveness and efficiency of managing linkages ofmultiple projects. Because past studies on product development have mostly focused on the management of a single project, researchers need to pay more atten-

tion to the management of the inter-project interdependencies from the multiproJect management perspectlve.

NOBEOKA:ORGANIZATIONALCOORDINATIONFORPROJECTINTERDEPENDENCY 1

References
Allen, T. 1977. Managing the Flow of Technology, Cambridge, Mass.: MIT Press.
Clark, K., and T. Fujimoto. 1991. Product Deveiopment Performance: Strategy, Orga-nization, and Management in the World Auto Industry, Boston, MA, Harvard
Business School Press.
Davis, S. and P. Lawrence. 1977. Matrix, Massachusetts, Addison-Wesley.
Fortune: New York, NY, Time Inc. Magazine Company. Biweekly.
Galbraith, J. 1974. "Organization Design: An Inforrnation Processing View", Interfaces,

4, May, 28-36.
Ikari, Y. 1985. Toyota tai Nissan: Shinsha Kaihatsu no Saizensen (Toyota versus Nissan:

The Front Line of New Car Development). Tokyo, Diamond.
Imai, K., I. Nonaka and H. Takeuchi. 1985. "Managing the New Product Development
Process: How Japanese Learn and Unlearn," in K. B. Clark et al., ed., The
Uneasy Alliance: Managing the Productivity-Technology Dilemma, MA, Harvard Busincss School Press).
Iansiti, M. 1993. "Technology Integration: Managing technological evolution in a com-plex environment." Working paper 93-057, HBS.
Katz, R. and T. Allen. 1985. "Project Performance and the Locus of Influence ip the

R&D Matrix", Academy of Management Journal, 28, 1,67-87.
Larson, E. and D. Gobeli: 1988. "Organizing for Product Development Projects", Jou/r
nal of Product Innovation Management, 5,180-190.

Lawrence, P. and J. Lorsch. 1967. 0rganization and Environments: Managing Differentiation and Integration, Homewood, IL, Irwin.
Marquis, D. and D. Straight. 1965. "Organizational Factors in Project Performance",

Unpublished Working Paper, MIT SIoan School of Management.
Nobeoka, K. and M. Cusumano. 1997. "Multi-Project Strategy and Sales Growth: The
Benefits of Rapid Design Transfer in New Product Development", Strategic
Management Journal, Vol.18, Bo.3, 169-186.
Rosenberg, N. 1982. Inside the Black Box: Tecltnology and Economics, Cambridge,
MA, Cambridge University Press.
Shiosawa, S. 1987. The Chief Engineer: Proiect Teams of Toyota, Tokyo, Japan, Kodan-sha.
Tushman, M. 1978. "Technical Communication in R&D Laboratories: The Impact ofProject Work Characteristics", Academy of Management lournal, Vol. 21, No.
4, 624-645.

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 117-136

A REGIME SHIFT IN LONG-RUN MONEY DEMAND
IN THE UNITED STATESRYUZOMIYAO KobeUniversity

Abstract
This paper presents evidence for a regime shift in an equilibrium Ml demand relationin the postwar United States. It is first shown that there is no robust evidence for thepresence of Ml cointegration from conventional cointegration tests that do not allow fora possible break in the cointegrating vector. Once a regime shift is taken into account,however, strong evidence for Ml cointegration emerges through a procedure proposedby Gregory and Hansen (1996). With the restriction of the unit income elasticity, test
results consistently support the case for a shift in the interest semielasticity and the in-tercept. The breakpoint is estimated to be 1976. The estimate of the interest semielasiticity is -O.07 prior to the break and -O,02 after the break.

JEL classipication: E41

Keyworcis: Long-run money demand; Cointegration; Regime shift.
1. Introduction

An equilibrium relation of money demand has been used in many empirical
rnacroeconomic models as a key building block that connects real and nominal
variables in the economy. Recent developments in cointegration econometrics
have renewed research interests on long-run money demand. It is fairly wellknown by now that when the variables constituting a money demand relationship-most typically, real money balances, real output and nominal interest ratesare cointegrated, one can obtain super-consistent estimates of the cointegrating
vector which correspond to money demand elasticities. Previous analyses of coin-tegration in the U.S. money demand (for Ml, the commonly used narrow measure of monetary aggregates) include Hoffman and Rasche (1991), Friedman andCorresponding Address:

Ryuzo Miyao
Research Institute for Economics and Business Administration, Kobe University

2-1 Rokkodai-cho, Nada-ku, Kobe 657-8501, Japan
E-mail: miyao@rieb.kobe-u.ac.jp
Fax: (81)-78-803-0390

118

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 117--136

Kuttner (1992), Stock and Watson (1993), Hoffrnan, Rasche and Tieslau (1995),
Gregory and Hansen (1996), among others.i
It appears, however, that there is no agreement in the previous studies as tothe evidence on Ml cointegration in the postwar period and the related, andmore important issue of the stability of parameter estimates. On one hand, Fried-

man and Kuttner (1992) demonstrated that cointegration disappears for the post-

war period of 1959-1990, and in particular in the 1980s, by using Johansen's(1988) maximal likelihood tests. Based on the same methodology, on the other

hand, Hoffman and Rasche (1991) and Hoffman, Rasche and Tieslau (1995)
argued that cointegration prevails for the similar postwar sample with a dummy
variable. The latter study further provided evidence for the parameter constancy

in Ml demand. In a more recent paper, Gregory and Hansen (1996) proposed aformal residual-based test for cointegration with possible breaks in the cointegrat-

ing vector ("regime shifts"). As an example, they applied the procedure to the

U.S. money demand. The evidence suggested that Ml cointegration exists with aregime shift for the period of 1960-1990.

This paper reexamines evidence on Ml cointegration in the postwar U.S. andattempts to resolve the disagreement raised by earlier work. In summary, there

are at least three working hypotheses to examine: (Hi) no cointegration in Ml
demand, (H2) Ml cointegration with the constant cointegrating vector(s), and(H3) cointegration with a regime shift. Our investigation starts with testing thenull of Hi against the alternative of H2. This is of course carried out by conventional tests for cointegration. If we obtain robust rejection results in this stage,then we are able to proceed to the test of H2 against H3 to examine the parameter constancy, as Hoffman-Rasche-Tieslau did.2 If not, we can altematively im-

plement Gregory-Hansen's test of Hi against H3.
The analysis is based on a trivariate model of (M-P, Y, R) and a bivariate mod-el of (M-P-Y, R), where M, P, and Y denote the logs of Ml, the price level andreal output, respectively and R denotes a measure of short-term interest rates, forwhich we use the level of three-month Treasury bill rate. The bivariate specification imposes the restriction of the unit income elasticity, which has been seen as a

key to stability especially for the postwar period (see e.g. Lucas (1988)). We use

the U.S. quarterly observations for 1959:1-1996:3, taken from International
Financial Statistics database.3
1 For broadly defined aggregates (M2), see e.g. Miyao (1996) that reexamines evidence of cointegration in the postwar United States,
2 Other procedures to test H2 against H3 include Hansen (1992).
3 All the data are seasonally adjusted except for the interest rate. The precise variable codes in the
IFS are 59mac (Ml), 99b.r (gross domestic product in 1990 prices for Y), 99b.c (nominal grossdomestic product used to obtain the price deflator P) and 60c (the three-month Treasury bill rate).

119
MIYAO: A REGIME SHIFT IN LONG-R UN MONEY DEMAND

The following results emerge from our investigations. First, it is shown in Section 2 that there is no robust evidence for the presence of Ml cointegration fromconventional cointegration tests. Friedman-Kuttner's result of disappearance inthe 1980s is replicated especially under the bivariate model. On the other hand,the use of a dummy variable does not restore Ml cointegration, as opposed to
Hoffrnan-Rasche-Tieslau's evidence.
Second, using Gregory-Hansen's test for a regime shift, we obtain evidence forMl cointegration with a shift in the intercept and slope coefficients of the cointeg-

rating vector (Section 3). The breakpoint is estimated to be 1976. It is important
to note that the evidence is found with the restricted bivariate model. This sug-gests that the income elasticity of Ml demand remains constant without a breakin the postwar period examined.

Third, in Section 4, we estimate the Ml demand cointegrating vector with astructural shift using a dynamic OLS procedure of Stock and Watson (1993). With
the restriction of the unit income elasticity, the point estimate of the interest
semielasticity is -O.07 prior to the break and -O.02 after the break, The shift is statistically significant and quantitatively nontrivial as well.

2. Tests for Ml Cointegration without Regime ShMs
2.1 Disagreement in Previous EvidenceThis section investigates previous evidence on the postwar Ml cointegration
which was shown through usual cointegration tests with no allowance of regime
shifts. In particular, we examine two recent, quite contrary pieces of evidence:

One is Friedman and Kuttner's (1992) evidence of no Ml cointegration and theother is Hoffman, Rasche, and Tieslau's (1995) evidence for the presence of Ml
cointegration. More precisely speaking, Friedman and Kuttner demonstrated that
Ml cointegration is detected in the subsample before 1980s but then disappears in

the full sample that ends in 1990. Hoffman and others showed that Ml cointegration prevails even in the 198es from their estimations in which the sample ends in
1974, 1975, ..., and 1990, recursively.

The two analyses share a lot of similarities. Both studies used the same maxim-

al likelihood methodology of Johansen (1988) and Johansen and Juselius (1990)
with a similar lag structure: the maximal-eigenvalue test with four lagged differences for the former paper, and the trace test with three lags for the latter. The
full sample is alike: 1959:1-1990:4 and 1955:2-1990:4, respectively. Both are also
based on similar model specifications with short-term interest rates: trivariate andbivariate models with the level of 4-6 month commercial paper for the former,
and a trivariate specification with the log of 3-month Treasury bill rate for the lat-

120

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 117-136

ter. The only qualitative difference seems to be that Friedman and Kuttner did

not include a dummy variable in the estimation, while Hoffman and others employed a dummy equal to 1.0 after 1981:4.

The fact that the two studies provided completely opposite test results -no
cointegration vs cointegration- is al1 the more controversial because of thosesimilarities. More importantly, the disagreement implies two conflicting views on

long-run money demand: no presence vs presence of a long-run Ml demand relationship. In the following two subsections we carefu11y reexamine each evidence
and attempt to resolve the controversy.

2.2 Tests without a Dummy Variable
The first task here is to test for Ml cointegration without using a dummy vari-able. Johansen's trace and maximal eigenvalue tests are conducted with four andeight lags. The estimations are based on the fu11 sample, 1959:1-1996:3, and subsamples that end in 1975:4, 1980:4, 1985:4, 1990:4 and 1993:4, to account for thedevelopments in the 1980s and 1990s. Both trivariate and bivariate specifications
are investigated with the three-month Treasury bill rate (the level) as our measure of short-term interest rates. All tests are detrended and the critical values

are tabulated by Osterwald-Lenum (1992) (p,468, Table 1).
Table 1 displays the test results. Original ("uncorrected") test statistics are re-ported in the third and fifth columns. In addition, following the procedure proposed by Cheung and Lai (1993), we compute test statistics to correct possible size

distortions of Johansen's procedure in finite samples (we call them "corrected"
statistics). It is well known that the Johansen procedure tends to over-reject thenull of no cointegration due to its poor finite sample properties. The proposed
factor is (T-nk)IT where T, n, and k denote the numbers of observations, dimension in the system, and lagged differences, respectively. An original trace or maximal eigenvalue statistic times the correction factor yields the corrected statistic

shown in fourth and sixth columns.

121: A REGIME SHIFT IN LONG-R UN MONEY DEMANDMIYAO

Table 1 Test for Ml Cointegration

Trace
Sample Lag

Uncorrected

Max-eigenvalue
Corrected

Uncorrected Corrected

A. (M-P,Y, R) system
96:3
93:4

4

21,o'4830.52*

19.77
25.36

4

21.09
29.25t

19.43

8

90:4

4
8

85:4
80:4

13.89
14.52

19.22

14.72

13.41

23.89

18.04

14.74

26.67

15.27
20.70

13.78
16.53

4

24.09

16.96

45.45**

21.29
34.43**

19.20t8

33.19**

25.14*

4

24.76
31.20*

21.18
21.72

14.54

21.39**

12.44
14.89

4

24.46

8

41.85**

19.80
24.82

25.84**

13.56
15.33

8

75:4

21.53
33.41*

15.14
17.47

16.75

B. (M-P-Y,R? system
96:3

9.11
8.93

8.61
7.92

6.89
7.55

6.51
6,70

12.20
12.17

11.47
10.69

7.82
6.61

7.36
5.80

13.03
13.52t

12.19

9.45

8.83

11.70

9.20

7.96

16.81*
20.58**

15.51*
l7.25*

13.95t12.86t16.98*

14.23*

4

16.41*

14.83t16.36*

14.79*

8

21.79**

17.38*

21.72**

17.32* -4

21.11**
30.05**

18.43*
21.90**

21.11**
29.99**

21.86**

4
8

93:4

4
8

90:4

4
8

85:4

4
8

80:4

75i4

8

18.43*

iVotes: Each entry reports Johansen's (1988) trace and maximal eigenvalue
statistics testing fot Ml cointegration in the trivariate and bivariate models(Panels A and B), All tests are detrended and use the U.S. quarterly observations
running frorn 1959:1 to the end of the sarnple period indicated in the first column.

For each test, corrected statistics are cornputed using a factor to correct size
distortions of Johansen's procedure in finite samples suggested by Cheung andLai (1993). Critical values are tabulated by Osterwald-Lenum (1992), Table 1:

A. 7}'i'van'ate B. Bivariate
109o(t) 59o(') 19o(") 109o(t) 59o(') 1%(")

Trace 26.79 29.68 35,65 13.33 15.41 20.04
IIax-eigenvalue IS.60 20.97 25,52 12.07 14.07 18,63

122

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 117-136

Our test results of Table 1 indicate that Ml cointegration disappears in the late1980s, especially based on the bivariate model. In Panel B, both test statistics,

trace and max-eigenvalue, show strong rejections for aH the subsamples prior to1985. It should be emphasized that those rejection results are obtained not only
from uncorrected test statistics but also from corrected statistics. Then all the re-jections disappear for the longer samples that extend in the 1990s. With the trivariate specification (Panel A), the rejections before the late 1980s are less ob-

vious. The unstable estimation results in Panel A can be attributed to theobservations by Lucas (1988) and Stock and Watson (1993). Real output and interest rates in the postwar data contain a similar upward linear trend until theearly 1980s. Those two studies pointed out that the multicollinearity makes theunrestricted trivariate estimation unstable for the postwar period. The results here
provide another illustration that the unit income elasticity is a plausible restriction

to impose in the analysis.4

Summarizing the results of Table 1, the Friedman-Kuttner's (1992) evidence ofdisappearance has been well replicated in our exercise. Ml cointegration remains
non--existent for the full sample period of 1959-1996.

2.3 Tests with a Dummy Variable
Next we examine the evidence of Hoffman, Rasche and Tieslau (1995) for thepresence of Ml cointegration. We implement exactly the same analysis as above,
except for including a dummy variable set to be 1.0 after 1981:4 into all the re-gressions. Hoffrnan and others included the dummy to take into account a possible break in the deterministjc trends in Ml velocity and interest rates around thattime.5 Note again that the use of the dummy variable in their analysis appears the

only qualitative difference from Friedman-Kuttner's approach.
Table 2 shows the test results. There are virtually no rejections found in thetable (except for only some rejections from uncorrected statistics in the trivariate
test of Panel A). This is especially true for the bivariate result in Panel B, which

is presumably more reliable in light of the earlier discussions on the multicollinearity. It is apparent that we fail to replicate the Hoffman-Rasche-Tieslau's evidence in this exercise.

4
5

Indeed, the property that the trivariate estimation generates imprecise results will be seen in thewhole empirical exercises of this paper.
As they pointed out, the inclusion of a dummy in the regression may account not only for a shift in
the linear trends of the variables but also for a possible shift in the intercept of the cointegrating re-lation. Hence the alternative hypothesis here includes both cointegration with the constant relationship and cointegration with a break in the intercept. Those two cases need to be distinguished explicitly in a subsequent analysis in case the test rejects the null of no cointegration.

123
MIYAO: A REGIME SHIFT IN LONG-RUN MONEY DEMAND

Table 2 Test for Ml Cointegration with a Dummy Variable

Max-eigenvalue

Trace

Sample Lag

Uncorrected CorrectedUncorrected Corrected

A. (M-P, Y, R? system
96:3

4
8

93:4

90:4

87:4

29.63t

8

21.12
23.30

4

23 .438

29.53t4

18.28
31.29*

48

85:4

27.04t

4

18.88

8

35.02*

24.82 15.03
24.63 12.40
19.24 13.78
19.03 12.21
21.14 12.45
23.57 14.23
16.30 12.20
24.27 21D3*
16.68 12.68
26.53 24.44*

13.80
10.31
12.55
9.97

11.24
11.36

10.88
16.31

11.21
18.51

B. rld-P-Y, R? system
96:3

4
8

93:4

4
8

90:4

4
8

87:4
85:4

12.14
12.76
9.87
9.69

12.50
12.79

8

9.43
8.54

4

12.24

8

15.51*

4

11.47 11.18
11.32 10.24

9.29 9.61
8.51 9.35

11.69 11.87
11.07 11.77

8.75 9.39
7.26 8.51

11.29 11.92
13.01 15.50*

10.56
9.09
9.04
8.21

11.10
10.19
8.71
7.24

11.00
13.00tNotes: See the notes to Table 1. AII tests include a dummy variable equal to
1.0 after 1981:4.

In the Appendix, we also report more complete results with additional lag
structures -three and six lags- in Table Al and A2, which correspond to Table
1 and 2 of the text. Note that Hoffman, Rasche and Tieslau used three lagged
differences in their analysis. In Table A2, the trivariate tests (Panel A) with threelags indeed detect some rejection results for the samples that end in the late1980s and 1990s. But the tests with higher lags andlor the bivariate model' do notprovide rejection results. We find a similar pattern in Table Al where the nulltends to be rejected with three lags in the 1990s samples. Those rejection results

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 117-136

124

with three lags in Table Al and A2 and in Hoffman, Rasche and Tieslau (1995)
can be attributed to the under-parametrization of the lag structure. Cheung andLai (1993) reported simulation results that the size distortions of Johansen proce-dure become larger when the lag length is shorter than the true length, i.e.,under-parametrized.
The additional exercises above further strengthen our contention that there is
no strong evidence for the existence of Ml cointegration even with the use of adummy variable. The evidence is regarded as the prerequisite for Hoffman andothers to proceed to their formal analysis of the stability in Ml demand parameters. Accordingly our test results cast doubts on their argument for the parameter constancy as well.
3. Tests for a Regime Shift in Ml Cointegration

3.1 The Test Precedure
In this section we investigate evidence on Ml cointegration with allowance of aregime shift, or equivalently, a shift in the cointegrating vector. We first describe

the testing method used here, a residual-based test proposed by Gregory andHansen (1996). The procedure tests the null of no cointegration against thealternative of cointegration with a break in the intercept and slope coefficients.

The timing of the break is treated as unknown in the procedure, so that we canestimate the breakpoint as well.

Let yt and xt denote a scalar variable and a vector of m variables (xt =(xit,...,xmt)') in our dataset. All the variables are characterized as integrated oforder one (I(1)). A standard cointegration model without regime shifts can be described as a static single-equation model:

yt=Bo+P'Xt+et, t=1,....,T (1)where Bo and i9 = (K?i,..., B.)' correspond to the intercept and slope coefficients of the cointegrating vector and e' is an I(O) disturbance term. To introduce a structural break in the cointegrating vector, the following dummy variable
is defined:DT`=I 8[8 [8i:hLTrwll'lsl) (2'where T is the unknown timing of the structural break in a relative term definedover the (O, 1) interval and [•] is its integer part. Therefore [T 71 denotes thebreak date. Using this dummy variable, a cointegration model with a structuralshift can be written as:

yt=Bo+B'Xt+ 7oDrt+7'XtDTt+eTt, t= 1,....,T (3)l25
MIYAO: A REGIME SHIFT IN LONG-RUN MONEY DEMAND

where 7o and 7 == (7i,..., 7.)' denote the changes in the intercept and slope
coefficients.6

Under this model, the test for the presence of a regime shift can be implemented as follows. We estimate the model (3) by OLS for each possible breakpoint T , and obtain the estimated residual e . t. The augmented Dickey-Fuller(1979) (ADF) test is then applied to each residual series and the corresponding
ADF statistic is calculated. Of all those ADF statistics, we report the smallest
value as the test statistic for a regime shift, denoted by ADF. For the actual com-putation, we consider T as a step function over (O.15, O.85) jumping every 11T

period. Thereby the possible breakpoints here consist of all integers over([O.15n, [O.85ny).

3.2 Test Results for a Regime Shift

Using the Gregory-Hansen's procedure described above, we now test for a regime shift in Ml cointegration. As in the previous section, both trivariate andbivariate models are examined. That is, yt = Mt - Pt and xt = (Yb Rt)' for thetrivariate model (m=2), and yt = Mt - Pt - Yt and xt == Rt for the bivariate mod-el (m= 1). To examine robustness, we employ the samples of 1959:1-1990:4,
1993:4, and 1996:3. For the optimal lag included in each ADF test, we ehoose it

using the stepdown (reducing-lag) procedure proposed by Campbell and Perron(1991) with the maximum lag length equal to eight. Critical values are tabulated

by Gregory and Hansen (1996) (Table 1, p.109).
Table 3 indicates the test results. Based on the trivariate model, we could not
find rejections (Panel A). However, the restricted bivariate tests, shown in PanelB, provide support for a regime shift for all the samples examined. The breakpoint is estimated to be consistently 1976:3. Figure 1 plots the series of the ADF
statistics for all the possible breakpoints based on the bivariate test with the fullsample. The smallest ADF is accomplished at 1976:3, but other ADF statistics in1976 all indicate rejections at the 59o significance level (the statistics are -5.29, -5.43, and -5.02 for 1976:1, 1976:2, and 1976:4, respectively). The figure clearly indicates that there is a shift in the Ml cointegrating vector in 1976.7

6

In addition, Gregory and Hansen (1996) consider two simpler models that incorporate a shift in theintercept only ("level shift") and the intercept shift with a time trend ("level shift with trend"). The

regime shift model used here is the most general version in their testing framework.
7

I also performed the tests using the optimal lag length chosen by the Schwarz-Bayesian information
criterion (SBIC). The bivariate test with the full sample also rejects the null at the 59o significancelevel and the breakpoint is estimated to be 1976:2,

126

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 117-136

Table 3 Test for a Regime Shift in Ml Cointegration

Sample

ADF*

Lag

(r)

Breakpoint

A. (M-P, Y, R? syste7n
96:3

-4.85

6

76:2

(O.46)

93:4

-5.02

o

75:1

(O.46)

90:4

-4.95

o

75:1

(O.51)

B. (M-P-Y, R? system
96:3-5.48**

5

76:3(O.47)

93:4-5.33*

76:3(O.51)

90:4-5 .07*

5
5

76:3(O.55)

iVotes: ADF' is Gregory and Hansen's (1996) statistic testing
the null of no cointegration against cointegration with a break inthe cointegrating vector (both intercept and slope coeMcients).
The test statistic is obtained as the smallest vaiue of residualbased augmented Dickey-Fuller (1979) statistics for all the possible breakpoints (r) in the sample. The lag Iength is chosen basedon the stepdown procedure of Carnpbell and Perron (1991) withthe maximum length equal ;o eight. Critical values are tabulated

by Gregory and Hansen (1996), Table 1:

A. Tm'vart'ate B. Bivariate

10%(t) 59o(') 19o("') 10%(t) 59o(') 1%(")

ADF* -5.23 -5.50 -5.97 -4.68 -4.9r) -5.47

The evidence here is consistent with the earlier finding by Gregory and Hansen(1996), in which they found Ml cointegration with a structural shift based on atrivariate model for the period of 1960:1-1990:4.8 Compared to the Gregory-Hansen's evidence, we provide the evidence for a regime shift through the restrictedbivariate tests. This suggests that the structural break took place in the interest
semielasticity as well as the intercept while the income elasticity remains constant
without a break. It should be stressed that this paper supports the case for the parameter stability with respect to the income elasticity.

8

Gregory and Hansen found a regime shift not from the ADP' procedure but from Phillips (1987)
type residual-based tests (Zt' and Z. ' tests in their notation). The failure for the trivariate ADP
test to reject the null is associated with its lower power in the finite samples that include the periodof the strong collinear movements in income and interest rates.

127
MIYAO: A REGIME SHIFT IN LONG-R UN MONEY DEMAND

The evidence of the last section that Ml cointegration disappears in the late1980s -a replication of the Friedman-Kuttner's (1992) evidence- can be also reconciled with the evidence here. When there is indeed ashift in the intercept andslope coefficients, conventional tests for cointegration which assume the constantrelationship may not be able to detect cointegration. Gregory and Hansen illustrated a low power of a standard cointegration test in their Monte Carlo experi-ment. Moreover, rejections found in the late 1970s and early 1980s samples inTable 1 (particularly in Panel B) are consistent with the presence of a constant
Ml cointegrating relation before the structural shift. The allowance for a break in
the intercept and slope coefficients restores the long-run cointegrating relationshipin the 1980s and 1990s.
It is true that our evidence sharply conflicts with Hoffrnan, Rasche and Tieslau(1995)'s evidence for the stability of Ml cointegration. The two studies are indeed

contrary because both of them use the restricted bivariate model. However, as
was demonstrated in the last section, especially in Panel B of Table 2 and Table
A2 in the appendix, we could not replicate their evidence for Ml cointegration in

the late 1980s and 1990s even with a dummy variable, which is the key evidence

for their argument of the stability. Having shown the weakness of Hoffman andothers' evidence and the strong evidence for a regime shift here, we are able toconclude that there exists Ml cointegration with a structural shift in the postwar
United States and that the shift occurred in the parameters of the intercept andthe interest semielasticity in 1976.

3.3 A Monte Carlo Study to Examine Size Distonions
Since our evidence for a regime shift shown above is drawn from purely statistical tests, it is always important to further examine small-sample properties of
the test. I conduct a Monte Carlo analysis to check possible size distortions (or"Type I error") of the rejection results in our finite sample.9 In this experiment,
the data generating process under the null of no cointegration is assumed to be avector autoregressive (VAR) model of (A(M--P), A Y, AR) with four lags and aconstant. The coefficients and covariance matrix of the model are obtained from
actual estimates of the regression with the full sample. Then we generate 1000 re-

plications of the data from random drawings and count how many times the nullof no cointegration is rejected from the bivariate ADF" test (with the CampbellPerron lag length) using the critical values employed above.
The simulation results indicate that size distortions of the test are in fact not
9 It is a legitimate concern because Gregory and Hansen (1996) reported some degree of size distortions in a Monte Carlo experiment, where the proposed test rejects the null by 109o using the 59ocritical value with 100 observations.

128

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 117-136

large. Using the 109o critical value, the null hypothesis is rejected by 11.89o in
our experiment (that is, 118 times out of the 1000 replications). Similarly, the rejection rates are 6.89o and 1.8% with the 59o and 19o critical values, respectively.
We can regard our evidence for a regime shift as reliable from this exercise.

4. Estimating the Shift in the Ml Demand Cointegrating Vector

Having established the existence of a regime shift in Ml demand, we now
address a more practical question: What are the estimates of the elasticities ofmoney demand before and after the structural break? The use of correct estimates which incorporate the shift will have a potential impact on existing monetary analyses (e.g. King, Plosser, Stock and Watson (1991)).

To estimate the shift in the money demand cointegrating vector, we use a dyna-

mic OLS procedure proposed by Stock and Watson (1993). Under the maintained
hypothesis that the parameters of short-run dynamics stay constant, the following
two regression models can be considered. For the trivariate specification,

Mt-'Pt= Bo + PyYt +BrRt + 7oD76:3 + 7yYtD76:3 + 7rRtD76:3+dy(L)AYt+dr(L)ARt+et, (4)and for the bivariate system,

Mt-Pt'Yt =Bo + BrRt + 7oD76:3+ 7rRtD76:3 + dr(L)ARt + eb (5)where D76:3 is a dummy variable equal to 1.0 after 1976:3 and di(L), i=r, y is apolynomial of the lag operator which contains both leads and lags (di(L) = 2f•--K dijLj and K is the number of leads and lags). Clearly,(Po, P,, B,) is the coin-tegrating vector before the break and (7o, 7y, 7,) represents the change in thosecoefficients. Based on those models, we compute the estimates using four leads
and lags. The sample starts in 1959:1 and ends in 1990:4, 1993:4 and 1996:3 to ex-

amine the development in the 1990s. Standard errors are computed using Newey
and West's (1987) covariance matrix with the truncation of four lags.

Table 4 indicates the estimation results, which pan be summarized into the following three sets of evidence. The first concerns the results before the break. In
the trivariate estimation (Panel A), the point estimates of the income elasticity
and interest semielasticity are (O.25, -O.O05), respectively. The too low point esti-mates can be attributed to the unstable estimations of the trivariate model. Oncethe restriction of the unit income elasticity is imposed, the estimate of interest
semielasticity becomes a plausible value of -O.070 with a small standard error (seePanel B). The estimates are stable across the samples and quite similar to someof the earlier estimates. For instance, Stock and Watson's (1993) 959o confidence129
MIYAO: A REGIME SHIFT IN LONG-R UN MONEY DEMAND

interval for the interest semielasticity is (-O.13, -0.08) for the period of 1900-1989.

Lucas (1988) reported the same point estimate -O.07 based on the various prewar
and postwar estimations.
Table 4 Ml Demand Cointegrating Vectors with a Regime Shift

Sample

Po

By

fir

7a

"ty

7r

Wald Stat.
(p-vaiue)

A. (M-P, Y, R? system
96:3

5.075
(O.918)

93:4

5.147
(O.920)

90i4

5.067
(O.947)

O.252(e.o63)-O.O05 -10.230 O.672-O.O14177.23(O.O06) (1.144) (O.077)(O.O06)(o.ooo)O.247(O.064)-O.O04 -10.104 O,664-O.O14

174,95(O.O06) (1.167) (O.079)(O.O06)(o.ooo)O.252(O.066)-O.O13(O.O06) (1.223) (O.083)

165.69(o.ooo)-OO06 -9.922 O.652(O.O06)

B. (M-P- Y, R) system
96:3

93:4

-5.798.
(O.042)

1. .OOO-5.793

1.-OOO(O.O09) (O.044) --5.790(O.042)-O.071 -O.508 O.OOO(O.O09) (O.045) -(O.042)
90:4'-O.070-O.517 O.OOO

1:O.IOO--

O.071 -O.490 O.OOO(O.O09) (O.050) -O.048

219.67(O.O08)(o.ooo) •O.048

174.48(O.O08)(o.ooo)O.046

117.58(O.O08)(o.ooo)IVotes: Ail the estirnates ate computed using the dynamic OLS procedure of Stock andWatson (1993) with four leads and Iags. See equations (4) and (5) in the text for the
regression models. The sample begin$ in 1959:1 and ends in the period indicated in thefirst column. Standard errors, shown in parentheses, are calculated using the Newey-West(1987) covariance matrix with four lags to account for autocorrelation. Wald statistics
reported in the last coiurrm test the hypothesis that ali the shift parameters (or's) are
jointly equal to zero and have x2(3) and x2(2) distributions for the trivariate and bivariate
tests, respectively. Below the Wald stat,istics are the p-values shown in parentheses.

Secondly, we turn to the results after the break. All the estimates of 7 's that
represent the structural change are significantly different from zero. In particular,

under the bivariate model with the full sample, the change in the interest semielasticity is estimated to be O.048 with a standard error O.O08. The estimate of theinterest semielasticity is now shifted to -O.022 from -O.070, and the degree of its
shift can be viewed as significant statistically and quantitatively. Moreover, thetrivariate point estimates after the break, i.e. (O.92, -O.O19), are very similar to
the assumed unit income elasticity and the bivariate estimate of the interest semi-

130

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 117-136

elasticity. The problematic comovements in income and interest rates are now
largely absent for the post-break period, which leads to the similarity. This provides further support to our result that the interest semielasticity shifted to -O.02
while the income elasticity remains unity without a shift.

0ur third evidence concerns the test for the significance of the structuralchange in this regression model. We compute Wald statistics to test the null
hypothesis that the coefficients of 7 's are jointly equal to zero. The statistics,

shown in the last column of Table 4, have X2(3) and X2(2) distributions for thetrivariate and bivariate systems, respectively. It is obvious that the null is rejected

at all the conventional significance levels for both models (the p-values are all
O.OOO). The estimates of the shift parameters 7 's are all significant jointly aswell.

5. Conclusions
The main contributions of this paper can be summarized as threefold. The firstis that this study has disentangled three conflicting views on Ml cointegration in
the postwar United States raised by previous work: (i) no Ml cointegration, (ii)
Ml cointegration with constant cointegrating vector, and (iii) cointegration with ashift in the cointegrating vector. Through the investigations based on the test pro-cedure of Gregory and Hansen (1996) as well as conventional cointegration tests,
we have concluded that there was a regime shift in an Ml cointegrating relationship for the period of 1959-1996. The breakpoint is estimated to be in 1976.

Secondly, this paper has demonstrated the case for the parameter stability as
well with respect to the income elasticity. We have shown the evidence for a regime shift using the bivariate system where the restriction of the unit income elas-ticity is imposed. The robust evidence for Ml cointegration before the 1980s is
also obtained with the restricted bivariate model. All those results consistently
suggest that while the interest semielasticity and the intercept went through thestructural change, the income elasticity can be considered as constantly unity
without a break.
The third contribution is that this paper have presented the actual estimates oflong-run Ml demand before and after the regime shift. The point estimate of theinterest semielasticity before the break is -O.07 and is shifted to -O.02 after the
break. The estimates of the regime-shift parameters are all statistically significant
individually and jointly.

In conclusion, taking the prewar evidence by Lucas (1988) and Stock and Watson (1993) together with our postwar evidence, it is safe to say that the parameterof the income elasticity has been a "numerical constant" over this century. The

131
MIYAO: A REGIME SHIFT IN LONG-RUN MONEY DEMAND

parameter of the interest semielasticity had also been stable until the mid 1970s in
this century, when it shifted to a significantly lower level. The empirical finding
then raises a further question. Why did the shift happen only in the interest elas-ticity, and not in the income elasticity? What sort of theoretical model would beconsistent with such a finding?

One possible explanation is based on a cash-in-advance model illustrated by
Lucas (1988). He provided a money demand relationship under a tight theoreticalframework, in which the interest elasticity is written as a function of the parameters describing preferences and the transaction environments. The income elas-ticity is, on the other hand, exactly shown as unity. Using this illustrated
framework, it is possible to argue that some major events around the late 1970s,

such as the monetary target regime by the Federal Reserve that caused large andvolatile movements in interest rates and the introduction and rapid growth ofinterest-bearing checking accounts, might have shifted behavioral parameters,
leading to the break only in the interest elasticity. A detailed analysis is neededon this subject and is left for future research,

Acknowledgment
This research was conducted during my visit at Australia-Japan Research Centre,
Australian National University. I wish to thank Peter Drysdale, Director and staff

members at the centre for their warm hospitality. I also thank Adrian Pagan andPaul Lau for their helpful comments.
References
Campbell, John Y. and Pierre Perron, "Pitfalls and Opportunities: What Macroeconom-

ists Should Know about Unit Roots," NBER Macroeconomics Annual, Vol.6(1991), 141-201.
Cheung, Yin-Wong and Kon S. Lai, "Finite-Sample Sizes of Johansen's Likelihood
Ratio Tests for Cointegration," Oxford Bulletin of Econornics and Statistics, 55(1993), 313-328.
Dickey, D. A. and W. A. Fuller, "Distribution of the Estimators for Autoregressive
Time Series with a Unit Root," Journal ofAmerican Statistical Association, 74(1979), 427-431.

Friedman, Benjamin M. and Kenneth N. Kuttner, "Money, Income, Prices, and Interest Rates," American Economic Revierv, 82 (1992), 472-492.
Gregory, Allan W. and Bruce E. Hansen, "Residual-Based Tests for Cointegration in
Models with Regime Shifts," Journal of Econometrics, 70 (1996), 99-126.
Hansen, Bruce E., "Tests for Parameter Instability in Regressions with I(1) process,"
Journal of Business and Economic Stattstics, 10 (1992), 321-335.

Hoffman, Dennis L. and Robert H. Rasche, "Long-Run Income and Interest Elastici-

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 117-136

132

ties of Money Demand in the United States," Review of Economics and Statistics, 73 (1991), 665-74.

Hoffman, Dennis L., Robert H. Rasche and Margie A. Tieslau, "The Stability of LongRun Money Demand in Five Industrial Countries, " Journal of Monetary Economics, 35 (1995), 317-339.
Johansen, Soren, "Statistical analysis of Cointegrating Vectors", Journal of Economic
Dynamics and Control, 12 (1988), 213-54.
Johansen, Soren and Katarina Juselius, "Maximum Likelihood Estimation and Infer-ence on Cointegration with Application to the Demand for Money," Oxford
BuUetin of Economics and Statistics, 52 (1990), 169-210.
King, Robert G., Charles I. Plosser, James H. Stock and Mark W. Watson, "Stochastic

Trends and Economic Fluctuations" American Economic Review, 81 (1991),
819-840.
Miyao, Ryuzo, "Does a Cointegrating M2 Demand Relation Really Exist in the UnitedStates?" Journal of Money, Credit and Banking, 28 (1996), 365-380.

Newey, Whitney K. and Kenneth D. West, "A Simple, Positive Semi-Definite, Heteroscedasticity and Autocorrelation Consistent Covariance Matrix," Econometrica,
55 (1987), 703-708.
Phillips, P. C, B., "Time Series Regression with a Unit Root," Econometrica, 55(1987), 277-301.
Stock, James H.- and Mark W. Watson, "A Simple Estimator of Cointegrating Vectors
in Higher Order Integrated Systems," Econometrica, 61 (1993), 783-820.

-1.0

-1.5

-2.0

-2.S

-3,O

-3,S

-.o
--.s

-s.o

-s.s

6-

67

70

73

7S

79

82

Figure 1: ADF Statistics with a Regime Shift- Horizontal line: possible break date -

es

ee

133
MIYAO: A REGIME SHIFT IN LONG-RUN MONEY DEMAND

Appendix
Table Al. Test for Ml Cointegration: Complete Results

Trace
Sample Lag

Max-eigenvalue

Uncorrected CorrectedUncorrected Corrected

A. (M-P, Y, R? system
96:3

3

80:4

15.44
14.52

26.59

21.67*

20.23t

14.72
16.32

13.41

18.04

14.74

30.52*

3

28.48t

4

21D9

19.22

6

25.58
29.25t

22.12
23.89

24.79

20.95t19.43t

19.43

15.27

13.78

6

26.73
21.53
28.37t8

16.21
20.70t13.79

33.41*

24.15
26.67

3

27.72t22.78*

20.81t4

24.09

19.20t6

16.96
19.90t8

33.09*
45.45**

3

29.04t

3

4
6

75:4

17.65
17.47

8

4

85:4

24.97
25.36

21.54
28.54t8

90:4

20.45t19.77

21.79*
15.14

26.16

6

4

93:4

27.87t24.76
26.93t25.32
21.29
27.19t34.43*

24.21*
33.19**
19.87t

25.93
21.18
20.95
21.72

14.54
20.75t19.28t831.20*

3

25.80
24.46

22.17
19.80

1615

35.90**
41.85**

25.31
24.82

25.47*
25.84**

4
6
8

21.39*

13.89

14.12

16.53

25.14*
17.74
12.44
16.14
14.89
16.57
13.56
17.95
15.33

(1997),
KOBE ECONOMIC & BUSINESS REVIEIJV,
42 117-136

134

Table Al. (continued)

Max-eigenvalue

Trace

Sample Lag

Uncorrected

Corrected
B. rM-P- Y,

96:3

93:4

3

10.73

4

9.11

85:4

80:4

7.19
6.89
9.15
7.55

6.89
6.51
8.39
6.70

6

10.42
8.93

9.55
7.92

3

14.24t

13.61t
11.47

8.83
7.82

8.44
7.36

6

12.20
13.85t12..60

8.67

8

12.17

10.69

6.61

7.89
5.80

3

15.07t14.34t

4

13.03

8

15.59*
13.52t10.03
9.45
12.16t

9.55
8.83

6

12.19
14.05t
11.70

9.20

7.96

3

18.r)8*17.51*

13.89t4

16.81*

14.74*
13.95t18.79**
16.98*

16.55*
14.23*
11.63

10.96

12.86t6

21 .46**

8

20.58**

15.51*
18.91*
17.25*

3

12.74
16.41t11.83
14.83t12.53t16.36*

14.79*

14.93t17.10*

8

17.53*
21.79**

17.38*

21.72**

14.57*
17.32*

3

16.70*

15.13t16.55*

4

21.11**

21.11**

15.00*
18.43*

6

18.23*
30.05**

18.43*
14.64t18.22*
29.99**

21.86**

4
6

75:4

R] system

8

4

90:4

10.29
8.61

Uncorrected Corrected821.90**

IVotes: This table shows complete test results
sponding to Table 1 of the text. Additional results
and six lags. See also the notes to Table 1.

14.63*

for Ml cointegration,
are reported here withcorre-three135
MIYAO: A REGIME SHIFT IN LONG-R UN MONEY DEMAND

Table A2. Test for Ml Cointegration with a Dummy: Complete Resuks

Max-eigenvalue

Trace

Sample Lag

Uncorrected 'CorrectedUncorrected Corrected

A. rM-P, Y, R? system
96:4

93:4

3

35.32*

4

27.04t

6

2720t

8

29.63t3

29.59t

4

21.12
21.07
23.30

6

8

90:4

3

4
6
8

89:4

8

30.99*
23.30
24.43
27.89t328.37t

4

20.40
22.42
24.17

3

4
6

88:4

6

8

87:4

3

8

26.64
18.28
29.74*
31.29*

3

29.62t

4
6

86:4

6

20.79
27.88t832.15*

3

25.70
18.88
28.46t4

85:4

31.44*
23.43
25.05
29.53t4
6835.02*

33.15*
24.82
23.80
24.63
27.63t

19.24
18.22
19.03
29.16t
21.14
21.33
23.57
28.67t
20.95
20.67
22.07

23.13*

21.72*

15.03

13.80

12.02

10.52

!2.40

10.31

21.81*
13.78

20.36t

10.51
12.21

12.55
9.08
9.97

20.77t19.26t

12.45
10.26

11.24
8.73

14.23

11.36

21.07*

19.49t

13.22
9.59

8.12

12.66

10.02

26.17
18.27
18.85
18.95

20.58t18.98t

12.51
10.92

11.21
9.18

13.00

10.19

24.50
16.30
24.83
24.27
27.15t20.14t

18.53
10.88
18.57
16.31

18.46
23.10
24.66

12.09

17.83
10.73

21.25*
22.65*

17.60
17.37

19.24t

17.58
11.21

23.48
16.68
23.39
26.53

12.20

22.25*
21.03*
19.45t12.68
20.94t24.44*

11.89

17.21
l8.51

136

42 (1997),
KOBE ECONOMIC & BUSINESS REVIEW,

11 7-136

Table A2. (continued)

Trace
Sample Lag

96:4

3

4
6
8

93:4

90i4

89:4

85:4

B. rM-P-Y,

Rl system

13.11

12.10t12.14
14.66t

11.47
t3.44

11.18
12.93t

11.85

12.76

11.32

10.24

9.09

10.85
9.29
11.08
8,51

10.62
9.61
11.56
9.35

10.15
9.04
10.52

ll.61

10.56

11.35
9,87

6
8

l2.18
9.69

3

14.24t13.55t12.85t12.23t

4

12.50

11.87

6

15.60*

li.69
14.05t11.10
13.34t

8

12.79

11.07

3

13.95t

13.25
11.38

6

12.21
14.76t

8

11.58

3

12.96

4

11.41
13.82t13.25
9.96

14.81*
11.77
12.59t

8.21

10.19

11.62
14.01t11.96
10.84
12.57t

10.61

9.14
11.42
10.39
12.13t

12.35

12.04
11.16
13.57t

9,83

8.41

9.77

8.36

3

10.89

4
6

9.43
11.76

10.30
8.75
10.47

10.33
9.39
11.74

8

8.51

9.78
8.71
10,45
7.24

8

86:4

Uncorrected Corrected

3

6

87:4

13.66tCorrected

4

4

88:4

Uncorrected

Max-eigenvalue

12.28
10.62

8.54

7.26

3

10.09

9.53

10.00

9.45

4

8.58
13.54t

9.19

6

9.27
15.29t15.21*

8.50
13.47t815.28t12.91

14.76*

12.47t3

13.58t6

12.24
17.69*

12.79
11.29
15.59*

8

15.51*

13.01

4

12.46t11.92
17.64*
15.50*

11.74
11,OO
15.55*
13.00tNotes: This table shows complete test results for Ml cointegration with adummy variable, corresponding to Table 2 of the text. Additional results arereported here with three and six lags and with the samples that end in 1986:4,
1988:4 and 1989:4. See also the notes to Table 1.

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 137-161

THE COMPETITION BETWEEN REGIONAL STANDARDS AND
THE SUCCESS AND FAILURE OF FIRMS IN THE WORLDWIDE MOBILE COMMUNICATION MARKETJEFFREYL.FUNK KobeUniversity

Abstract
This paper describes the evolution of competition in the world-wide mobile com-munication market. Most firms have succeeded with products (infrastructure andphones) and phone services that are based on domestic standards, while relatively few
firms (Ericsson, Motorola, and Nokia) have succeeded in the development of infrastruc-ture and phones that are based on non-domestic standards. The lack of firms whichhave succeeded in non-domestic standards means that firms are given a significant competitive advantage when their countries create or adopt early a system which eventually

becomes a world-wide standard. Systems that were adopted early and were open interms of both content and the standard-setting process became world-wide standards.

JEL classification: L96; Mll

Keywords: Cellular; Standards
1. Introduction

The growth in the mobile communication market is expected to continue wellinto the 21S' century at a rate that is far faster than the wireline market. This
growth has of course had a strong effect on the direction of many telecommunica-tion equipment firms. For example, Ericsson, Nokia, and Motorola (which does

not produce wireline equipment) had much higher sales of mobile communications equipment in 1996 than traditional wireline equipment. The growth rates in

the mobile communications field for other major telecommunication equipment
firms such as Alcatel, Lucent, Northern Telecom and Siemens also exceed their
growth rates in the wireline equipment markets. Further, the mobile communicaCorresponding Address:
Jeffrey L. FunkResearch Institute for Economics and Business Administration, Kobe Uniyersity

2-1 Rokkodal-cho, Nada-ku, Kobe 657-8501, Japan
E-mail: funk@rieb.kobe-u.ac.jp
Fax: (81)-78-803-0399

138

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 137-161

tions equipment market may actually become bigger than the traditional wirelinemarket as many developing countries become more dependent on mobile thanwireline communication systems. (Egan, 1997; Frieden, 1997).
This paper argues that the successi of firms in the mobile communications market is strongly related to the evolution of standards. In each generation of tech-

nology, the most successful firms are from countries or regions whose mobile

communication systems become world-wide standards. Few firms have been able
to succeed in services, infrastructure, or phones that are based on what I shall calla "non-domestic standard" (i.e., a standard that was not adopted early in the
firm's home country). Since the country or region that has been the source of theworld-wide standards has changed each time the technology has changed, few
firms (the exceptions are Ericsson, Motorola, and Nokia2) have had a large degree of success in more than one generation of technology.
Most firms have to a large extent ignored the standards that have been createdoutside of their own region. This is in spite of the fact that these firms have op-

erations in most major countries as suppliers of central office switches, private

branch exchanges, consumer electronics products, andlor mobile communication
products. In cases where firms have attempted to develop products based on a
non-domestic standard, most have failed due to a variety of reasons such as latemarket entry, a lack of good products, poor distribution systems, patent problems, a lack of design engineers with skills in the non-domestic standard, andpoor access to the chips and discrete components developed for these standards.

This is even the case when the firms have had a large technological advantage

1

Success is measured in terms of market share since market share is considered a good surrogate for
profitability. Nevertheless, there are variety of ways used to measure market share in the mobile

communications industry and even when the same method is used, the numbers often vary bysource. In particular, the shares released to the press are typically inflated or use a measure thathas the highest share for the particular firm. For phones, market share is typically measured on a
per unit basis. US numbers are from Herschel Shosteck and Associates, Japanese numbers are from

Nomura and Yano Research Institutes and Telecommunication Magazine (in Japanese), and theEuropean numbers are from Yano Research Institute. For infrastructure, market share is typicallymeasured in terms of the percent of subscribers connected to a firm's infrastructure. However,since this data is not available for all firrns and standards, data from the US Department of Commerce on the percent participation in orders is used. Similarly, for services, although market share2

is typically measured in terms of the percent of subscribers connected to a particular carrier, since
this data is not avaitable for all countries and does not specify the participation by ali caniers in aparticular service (particular services usually include multiple investors), the percent participation in
servjces is used. Nevertheless, since the percent partjcipatjon does not account for the number ofsubscribers in the particular service, this method overestimates the market share for firms who have
either supplied infrastructure to many small carriers or carriers who are operating particularly as aminority investor in many small markets.
For a discussion of the reasons behind the suecess of Ericsson, Motorola, and Nokia, see Funk, Jef-

frey, "Creating Influence in Standards Development Through Success in "Non-Domestic" Standards," Kobe University Working Paper, August, 1997.

FUNK: THE COMPETITIONBErwEENREGIONALSTAIVDARDSAND THESUCCESSAND FAILURE OF FIRMS 139

such as the advantage held by Japanese mobile phone producers in consumer
electronics' technology.

The lack of firms which have succeeded in non-domestic standards means thatfirms are given a significant competitive advantage when their countries create or

adopt early a system which eventually becomes a world-wide standard. Therefore,
the factors which drive the selection of standards and the social and political fac-

tors that cause certain countries to create systems that became world-wide standards is of great interest to firms and policy makers. This paper first summarizes
the evolution of standards. Second, it compares the degree of success by firms ineach generation of technology. Third, the factors which drive the selection ofstandards and fourth the social and political factors that cause certain countries tocreate systems that became world-wide standards is described. Fifth, future competition in third generation systems is discussed,

2. The Eyolution of World-Wide Standards
Table 1 shows the evolution of standards in countries which contain the world's

leading producers of telecommunication products. The major advantage of digitalsystems (second generation) over analog systems (first generation) are in voice
quality and in the level of efficiency which with they use the frequency spectrum.

Low mobility digital systems are cheaper to install than conventional digital systems in high density areas3 but the phones cannot be used in fast moving vehicles(PHS, DECT, and er-2) and cannot be used to receive calls in the case of CT-2.
Third generation systems are expected to include higher than existing frequency
spectrum efficiencies and much higher than existing data transmission rates (grea-

ter than 1 Mbps) than second-generation cellular systems along with multi-media
capability and world-wide roaming.

3

The cost effectiveness of PHS is debatable considering the deficits being run by the PHS operators.
The PHS operators are unfortunately dependent on NTr's wireline system which is one if not themost expensive wireline system in the industrialized world. As a result, the PHS operators pay half
their revenues to N'IT. Nevertheless, there is widespread agreement that the capital costs for PHS
are lower than that for existing cellular systems in high-density areas. Not only are switching stations not needed but PHS base stations are much less expensive than existing cellular base stations.
For example, a PHS base station that covers a 100 meter radius can handle three calls and costs about $2000 to implement. A cellular base station that can handle 1oo calls costs about (covers an
area with a radius of 1 km) $IM. Therefore, the base station cost per potential call is $600 for PHS
and $10,Ooo for cellular. In low-density areas, where coverage not capacity is the issue, cellular systems have lower capital costs per subscriber or per call.

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 137-161

140

Table 1 Evolution of Mobile Communication Standards in Major Countries

and the Year in Which Service Began
Countryus

IStGeneration

2ndGeneration

AnalogCellular

DigitalCellular

AMPS(83)

3rdGenerationDigital

LowMobility

Cellular

Cellular

DAMPS(92), Wide-BandIS95CDMA

none

GSM(95),IS95CDMA(96)

Wide-BandCDMA(99)

PHS(95)

NTT(79)

PDF(93)

TACS(89)

IS95CDMA(98)

NMT(81)
TACS(84)

GSM(92)?

GSM(92)

?

none
CT-1

Italy

RTMS-450(85)GSM(92)?

DECT(98)

FranceRC200(85)

GSM(92)?

none

Germany

NMT(89)CNETZ(85)

GSM(92)?

PHSorDECT(98)Japan

Scandinavia

UK

TACS(89)

In countries where a single standard was not chosen, the most widely used stan-dards are shown in Table 1. For example, although a single digital standard was

not adopted in North America, DAMPS, GSM, and IS95-CDMA are the mostwidely used digital standards. DAMPS was the most widely used standard in theearly-to mid 1990s and IS95-CDMA and GSM are the most widely used standards
in the new personal communication services which are being started in 1997 and1998. Several of the standards are very similar. Since the only difference between

AMPS and TACS are their channel spacings, they are often referred to as thesame standard in this paper. Although PDC, DAMPS and GSM are all based on
TDMA technology, there are many more differences between these three standards than between the AMPS and TACS standards4.

4 The major differences between the three standards are in channel spacings, the number of timeslots per channel (the number of calls per channel), and the number of cells which cannot reuse thesarne frequency. Although DAMPS uses the same channel spacing as AMPS (30kHz), there arethree time slots per channel with DAMPS as compared to 1 time slot per channel with AMPS,
PDC, like TACS, has 25 kHz channel spacings but like DAMPS, there are three time slots perchannel. GSM has 2oo kHz channel spacing and 8 time slots per channel. Further, with GSM thenumber of adjacent cells in which the same frequency cannot be reused is 113 that of PDC.

FUNK: THE COMPETITION BET;VEEiV REGIONAL STA?VDARDS AND THE SUCCESS AND FAILURE OF FIRMS 141

Table 2 The Evolution of World-Wide Standards
Generation

Gommunication

The

NumberofStandard

Standards

ofAdopting

Numberand
PercentofGenera--1

Technolo-Countryor

Countries

tlons

gy

RegionofOrigin(endoro6)

Subscribers

endendlst

AMPSITACS NorthAmerica

Generation(83)&Britain

Analog(84)Scandinavia

le3

Cellular

NMT

(81)

39

2nd

GSM

Europe(92)101IS95-CDMA?

USandKorea

3

orv2ore6
17.664.0
809o909e

2.25.0109o69e
729e

Generation
DigitalPHS?

Japan(95)1

Digital

Cellular

Generation

4.0

gsqo

Mobility

3rd

1.0

29o

(96)

Cellular

Low

36.0

Wide-Band

Japan?(2001)

CDMA

US?(?)

Digital

CellularTable 2 shows the evolution of world-wide mobile communication standards.
The degree to which a standard has become a "world-wide standard" is defined interms of the number of countries which have introduced services and the numberof people who have subscribed to a service which are based on the standard. For
example, although there were only 5 million subscribers to systems based on the

NMT system, 36 countries had introduced systems based on the standard by theend of 1996. For second-generation digital systems, the non-GSM or non-IS95
CDMA subscribers have primarily subscribed to services based on Japan's PDC
system in Japan and to a lesser extent to North America's DAMPS standards.
The country or region of origin refers to where the standard was first widely
used.

Question marks are placed next to PHS, IS95 CDMA, and the third generation
digital cellular systems since it is still unclear whether PHS, IS95 CDMA or which142 KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 137-161

third generation digital cellular system will become a world-wide standard.

Although PHS systems have more subscribers than NMT and IS95 CDMA, there
are more countries that have adopted both of the latter systems than PHS. Furth-er, more than 20 countries are expected to begin services based on the IS95
CDMA system and these services are expected to have more subscribers than ser-vices based on PHS by the year 2000. Therefore, most people believe that IS95

CDMA has a much greater chance of becoming a "world-wide" standard thandoes PHS.
Although it is still too early to make a definitive forecast about third generation

systems, it appears that more than one system or a hybrid of the Japanese andUS systems will become the world-wide standard. The Japanese system is backed

by NTT Docomo, major European (including Ericsson and Nokia) and Japanesemanufacturers, and numerous non-Japanese service providers. The US system isbacked by Motorola, Qualcomm, Lucent, Northern Telecom and several service
providers.

Further, there will be continued competition between GSM, IS95 CDMA andthird generation systems probably into the 21S' century. The competition between
these systems will depend on at least five factors. First, it will depend on the ex-tent to which countries and carriers value world-wide roaming. The popularity of

the GSM digital system provides the GSM system with a very large advantage
over the other systems. GSM can be used in over 100 countries versus three
countries for IS95 CDMA and presently none for both wide-band CDMA systems. Further, most areas within the three countries that have adopted IS95 systems do not have significant coverage and may never have significant coverage by

IS95 systems. Therefore, carriers who have implemented IS95 systems are selling

dual mode phones that are much heavier, larger, and more expensive thanphones being used in alternative systems such as GSM or AMPS systems. It may
be very difficult for these carriers to attract subscribers until the size, weight, andprice of these phones decline substantially.

Second, the competition will depend on the extent to which countries and car-riers value data communication. When wide-band CDMA is implemented in theyear 2000, it is expected to have a 2 Mbps capability vs. projections of 384 kbps

for IS95 wide-band CDMA and 115 kbps capability for GSM (Global Packet
Radio Services). However, it's not clear there are a large number of applications
for a 115 kbps service much less a 384 kbps or 2 Mbps service. As of early 1997,

PDC had a 28.8 kbps (packet communication service), GSM a 9.6 kbps, and IS95

CDMA a 14.4 kbps capability. Both IS95 CDMA and GSM are expected to havea 64 kbps capability by the end of 1997. Nevertheless, it is estimated that fewer

than 59e of the subscribers in the US, Europe, and Japan have the capability toFUNK: THE COMPETITIONBETVVEENREGIONAL STAIVDARDSAND THE SUCCESSAND FAILURE OFFIRMS 143

send data using their phones and less than 39e of the traffic is for data transmission.

Third, the competition will depend on the extent to which countries and car-riers value frequency spectrum efficiency. Wide-band CDMA has 2-3 times thefrequency spectrum efficiency of IS95 CDMA which has about twice the current
frequency spectrum efficiency of GSM. Frequency spectrum efficiency is of large
importance to Asian countries where population densities are high.

Fourth, the competition will depend on the expectations of countries and car-riers; which standards do countries and caniers expect to become widely operational and thus costs decline and world-wide roaming becomes possible? The low
cost, extensive features, and large diffusion of GSM systems provides it with asignificant advantage over other systems. The backward and forward compatibilityof the US consortium's wide-band and narrow-band system and the early imple-

mentation of N'IT Docomo's system in Japan and Korea may increase the carriers expectations for these systems.

Fifth, the competition will depend on the type of system that is chosen by theInternational Mobile Telephone Group (IMT) for the Future Land Mobile Telephone System (FLPMTS). This system is supposed to provide many of the capabilities that are expected in third-generation cellular systems of which internation-

al roaming appears to be the most important capability. Japan has alreadyannounced its intention to propose NTr Docomo's wide-band CDMA system,
North America is expected to propose a wide-band version of IS95 CDMA, andEurope is expected to propose a modified version of NTI" Docomo's wide-band
CDMA system. The decision will be finalized before the year 2000.
3. The Relative Success of Firms

Table 3 shows the degree of success by selected country/region for firms in
mobile communication services, infrastructure, and phones in each generation oftechnology. Table 4 shows the most successful firms in these countrieslregions. As

shown in Table 3 and Table 4, most firms have succeeded with products and ser-vices that are based on the standards adopted in their home market (domestic
standard) and they have failed to succeed in products or services that are basedon a'standard different from the standard (non-domestic standard) used in theirhome market.

42 (1997),
KOBE ECONOMIC & BUSIIVESS REVIEW,

144

137-161

Table 3 Degree of Success in Communication Standards (the cases of domestic standards

are outlined) by Fimis in Major Countries/Regions

New Communication Product North American Japanese Scandinavian Other European

JT!-ggpgg!ggyhl Standard TL-ypg Firms Firms Firms Firms

Analog AMPSfTACS Service tLigLt none none none
Cellular Infrastructure !t!gbh none Ericsson- nonehighPhones !tllg!!h low Nokia-med, TechnophoneEricsson-low low

NMT Service none none tLitgt!h none
Infrastructurenone none !tligbh !tlbi!ipfi:!ghl1

Phones iow none !t!lg!!ih none
Digjtal

GSM Service none none
Infrastructure Motorola- none

Cellular!t!lgbh !t!ig!}h!tngbh tLigitL

mediumPhones medium none

DAMPS Service tLi/gbh none
Infrastructure !t!lghh none!t!!ghh low

none none
Ericsson- none

mediumLow Mobility

Phones !t!lgbih none

rnedium nonepDC Service none tLigttL

none none

Infrastructure Motorola-med tLigLt

Ericsson-med none

Phones none !t!ig!}hnone none

PHS Service none ltligtlh

DigitalPhones none !t}igbh

none none
none none
criteria: High is >Authors estimatesbased on data sources cited in article
theusing
follow

209o409e or >309o,medium is between 259o and 399e
andor299o,and 25% or 109oand 199o
services respectively.

and low is between 15%

for infrastructure (plus orders from multiple carriers)and phone orFUNK: THE COMPETITIOIV BETVVEEIV REGIONAL STANDARDSAND THE SUCCESS AND FAILURE OFFIRMS 145

Table 4 Most Successful Firms in the Worldwide Wireless Communication Industries

Product

Most Communication

TLgghulg!ggyl TLypg

Successful Firms Standard

Analog Service

AT&T, Baby Bells AMPSfTACS
Scandinavian Carriers NMT

Cellular

Infrastructure

Motorola, Lucent, Northern AMPSITACS
Telecom(NT), Ericsson

Ericsson, Nokia NMT

Motorola, Nokia AMPSfTACS

PhonesNokia, Ericsson HMT
DigitalService

European
AT&T, Baby Bells

Cellular

Japanese
Infrastructure

Ericsson, Motorola,

GSM
DAMPS
PDC
GSM

Siemens, Alcatel, Nokia,

AT&T, Ericsson, Motorola, NT
NEC, Fujitsu, Ericsson, Motorola

PhonesNokia, Ericsson
Motorola, Nokia, Ericsson

Low Mobility

Service

DDI Pocket, NTr Personal

DigitalInfrastructure

Kyocera, NEC

CellularPhones

Sharp, Kyocera

DAMPS
PDC
GSM
DAMPS
PHS
PHS
PHS

146

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 137-161

3.1 Analog
North American firms are the largest suppliers of analog services, infrastructure

and phones since AMPS is the most widely used analog standard in the world andit was originally adopted in North America. As of 1993, North American carriers

had been awarded 489o of the non-North American analog cellular licenses that
had been awarded to foreign firms. North American infrastructure suppliers (SeeTable 5) participated in 539e of the non-North American analog infrastructure
contracts5. Motorola is the largest supplier of analog phones in the world with ab-out 409e market share.
British firms also benefited from the early adoption of the TACS system and its

similarities to the AMPS system. Technophone was one of the largest producersof TACS and AMPS phones in the world (third in Great Britain) until its acquisi-tion by Nokia in 1991. Vodaphone and Millicom operated or had started TACSand AMPS-based services in 14 and 17 countries respectively as of 1994.

Scandinavian carriers along with Nokia and Ericsson are the leading suppliersof NMT-based products and services in the world. Scandinavian carriers had thesecond highest participation rate (239o) after the North American carriers in ser-vice contracts awarded to foreign firms for analog services since NMT was thesecond most widely adopted analog standard. For the same reason, Nokia andEricsson are the major suppliers of NMT-based infrastructure (See Table 5 underanalog domestic standards). As of January, 1996, Ericsson had supplied NMT
based systems to 28 countries which served 679e of the 4 million total NMT
world-wide subscribers.

5 Since sales figures for mobile communication infrastructure are not available, the number of subscribers served by a particular firm's infrastructure is typically used to measure market share.
However, since this data is not available for all firms and standards, I have used participation inorders as a proxy for market share. Like the data on number of subscribers, one problem with thisdefinition is that some firms supply a larger percentage of a mobile communication system thanother firms. Further, an additional problem with using participation in orders as a proxy for market
share is that some orders are much bigger than other orders.

FVNK: THE COMPETITION BETWEEN REGIONALSTANDARDS AND THE SVCCESS AND FAILURE OF FIRMS 147

Table 5 Percent Participation** in Non-US Infrastructure Orders for Both Domestic

and Non-Domestic Standards

mpA1 Stdd pmttlStdd BothDomesticandNon-Domestic
Firm Domestic Non-Domestic Domestic Non-Domestic tA!pa!ggnal tLigi!tg!1

Motorola (AMPS) 369o 289e (DAMPS) 509o 349o 269o 339o
Northern Telecom(AMPS) 279o Ooro (DAMPS) O% 4% 129o 89e

Lucent (AMPS) 169o 29o(DAMPS) 49o 49o 79o 49oplexsys (AMps) 2sqo oqe (DAMps) sqo o% leqo <1%

TotalNorthAmerica 539o 449e

Ericsson (HMT) 769o 309o (GSM) 309o 28% 399o 349o

Nokia (HMT) 359o <19e (GSM) 17% 29e 89o 14qo
Siemens (CNETZ) 759e 09e(GSM) 209o 29o 19o 16%
Alcatel (RC2000) 09o 19o (GSM) 20qe 29o 29o 169e

Other NA 39e 79e (GSM) 79o O% 5% 29o

TotalEurope 399o 619o
Japan (N'IT) 1009o 89o (PDC) 919o 49o 99o 29oTotal" 100ero lO09o" The sums of percent partibipation for individual firms is greater than 1009o since multiple
firms participate in most orders" " analog orders and 280 digital orders (through 3/97)

3.2 Digital

European firms are the largest suppliers of digital-based services and productswith the adoption of GSM as a world-wide digital standard. European carriers

such as Cable & Wireless, Vodaphone and the national telephone companies ofFrance, Germany, Italy, Sweden, Norway, Denmark, Britain, and Spain are leading exporters of digital mobile communication services. For mobile phones, Nokia

has become the largest, Ericsson the second largest, and Siemens the fourthlargest producers of phones in Europe, Ericsson has used its knowledge of soon-

to-be introduced features in GSM systems (e.g., frequency hopping and output
power control which are important to raise system capacity) in order to be thefirst firm to develop and introduce phones that are compatible with these new fe-

148

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 137-161

atures.

In infrastructure, as shown in Table 5, European companies participated in agreater percentage of non-US digital equipment orders than US firms, a reversal
from the analog situation. Further, without Motorola's success in supplying GSM-

and PDC-based infrastructure, the percent of non-North American infrastructureorders which had participation from North American suppliers would have dropped even further than the 539o to 449o drop which occurred in the change fromanalog to digital technologies. Ericsson, Nokia, Alcatel and Siemens are the lead-ing European suppliers of GSM-based infrastructure. In January, 1996, there
were 18 million GSM subscribers in more than 80 countries and half of the subscribers were connected to an Ericsson system. Siemens and Alcatel, who are twoof the largest producers of wireline switching equipment in the world increased
their participation in non-North American infrastructure orders from about zeroin analog infrastructure (the market for CNETZ equipment was very small) to
209o in digital infrastructure.

With the success of GSM, it has been largely forgotten that in the late 1980s

few people expected the non-Scandinavian European firms to become successful
in the mobile communications field. The weakness of European firms in the information, consumer electronics, and semiconductor industries made most people

believe that the European market would be dominated by US and Japanesefirms6. Even Ericsson was pessimistic about succeeding in digital phones due tothe strength of Japan's chip industry7. However, not only do the European firms

largely dominate the European digital market, the success of GSM has enabled
European firms to become the leading suppliers of digital mobile communications
equipment and phones in the world.
3.3 Low Mobility Digital Cellular

Since there is almost no participation by foreign firms in the Japanese PHS
market, Japanese firms are expected to dominate the foreign, albeit small foreign

market for PHS. As of the end of 1996, Japanese firms had received 10 billion
Yen in orders and they expected to receive 100 billion yen in orders per year
through the year 2000. Most of these orders were expected to come from carriersin Thailand, Hong Kong, China, the Philippines, Indonesia and Australia.

6 Doubts raised over Europe's ability to meet date for digital radio, Financial Times, October, 21,
1986, p. 15.
7 Financial Times conference on world mobile communication, November 9, 1986, p. 12,

FUNK: THE COMPETITION BETIVEEN REGIONALSTANDARDSAND THESUCCESSAND FAILUREOFFIRMS 149

4. Factors Driving the Selection of World-Wide Standards
Table 6 Selected Information for Selected Mobile Communication Systems
Generation

SystemofIntroduction

The

InCountryorRegionof

DateStandard's

Originsoonafter

DegreeCountryor

introductionofTechnology

Regionof#of

Petetration

OriginSubscribers

Rate(1000s)First

Generation

Analog
Systerns

AMPS

1983

NMT

1981

TACS

(9o)

us

400(86)16(86)High

Scandinavia

310

1.5

High

1984

UK

150

.28

High

CNETZ

1986

W.Germany<.Ol

RC20001985

France

<.Ol
<.Ol

Low
Low
Low
Low

N'IT

1979

SecondRTMS
DAMPS 1992

Generation

GSM

1985

1982

Digital

Japan

PDC

1993

50

Italy

<.05

us

<10(93)<.Ol(93)High

Western500(92)>.4cre(93)HighEurope>1000(93)>1.69o>4000(94)(94)<10(93)<.O19o(93)600(94).59o(94)

Systems

Low

Openness

Japan

Low

IS95

1995

USandKorea1000(96).3%(96)

High

PHS

1995

Japan

4000(96)

39o(96)

MediumCT-2

1994

HongKong 175(96)19o(96)High

Mobility
Digital

CellularTable 6 summarizes for selected cellular systems a number of factors that are
generally believed to affect the choice of standards: date of introduction of service, the initial growth rates of service both in terms of the number of subscribers

and penetration rate, and the openness of the standard. Similar to other non-mobile communication industrial standards, services based on the world-widemobile communication standards were introduced very early and acquired users
very quickly. For example, services based on AMPS, TACS, and NMT which canbe defined as the analog world-wide standards had acquired more than 80% of
the world's subscribers by the end of 1986 - this was less than three years after

150

KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 137-161

service had been started in the US and UK. Further, in spite of the small popula-tion in Scandinavian which was where the NMT system was conceived, almost
one-fourth of the world's subscribers were using an NMT-based system at the endof 1986. The high penetration rates achieved in Scandinavia (almost ten times
that of the US at that time) caused a large number of countries to adopt services

based on the NMT system. Further, many countries, for example Belgium, theNetherlands, Luxembourg, Spain, and Austria decided to adopt the NMT systembefore services had started in the US. The early introduction of service and acquisition of subscribers is also characteristic of the world-wide digital standard,

GSM. At the end of 1993 and 1994, more than 999o and 809o respectively of theworld's digital subf cribers were connected to a GSM-based system.
However, in addition to the early introduction of service and acquisition of subscribers, the degree bf openness is also an important characteristics of those sys-

tems which became world-wide standards. Openness is measured in terms of theextent to which: 1) the system's specifications are made available to all interested
parties; 2) the standard setting process is clear and participation is open to all
firms including foreign firms; 3) the reasons for decisions within the standard setting process are specified in the resulting specifications; and 4) rules concerning

intellectual property rights are made clear. As shown in Table 6, the systems
which became analog and digital world-wide standards are considered very open
in terms of these four factors and they are considered much more open than thesystems which did not become analog and digital world-wide standards.
For example, it is generally agreed that a lack of openness in Japan's analog(NTT), digital (PDC), and its low mobility digital cellular systems (PHS) are key

reasons why the NTT and PDC systems did not become and PHS may not become a world-wide standard. Although the N'IT system was introduced two years
before the NMT system was introduced in 1981, no other countries have adopted
the NTr system. PDC was introduced only slightly later than GSM, it is similar
in terms of both technology and performance to GSM (better efficiency in the useof the frequency spectrum), and by the end of 1994, Japan had more digital sub-scribers than any other country in the world. Nevertheless, whereas more than
100 countries have adopted GSM-based services, no other country besides Japan
has adopted PDC-based services. It is generally agreed that NTI' Docomo controls the PDC standard including the standard setting process and this is a major
reason for its lack of adoption by other countries.

PHS has also not been adopted by the rest of the world to the extent that its
rapid growth in subscribers in Japan and its relative low costs suggests that it

would be adopted. In comparison to other low-mobility systems, Japan's PHS sys-

tem is vastly superior in performance to CT-2 and similar to DECT which was

FUNK: THE COMPETITION BETiVEENREGIONALSTANDARDSAND THE SUCCESSAND FAILURE OFFIRMS 151

not scheduled to be first installed until two years after PHS was installed. There-

fore, many people expected PHS to become the world-wide standard in the market for low-mobility cellular systems which were also expected to become an im-

portant niche market in mobile communications. Nevertheless, PHS is only enjoying a modest level of success in that only two countries are expected to begin
PHS-based services in 1997. It is generally agreed that the delay in opening details of the PHS system to foreign infrastructure and phone producers has discour-

aged many countries from adopting PHS. Foreign firms were not invited to participate in the standard setting process and the system specifications were notmade public until one year after service was started in July, 1995.

Further, contrast the openness of the mobile communication systems which be-came world-wide standards with that of a well-known industrial standard, theWintel computer standard (Microsoft windows and Intel microprocessor) in termsof the four factors presented above. First, the Wintel computer standard is only
made available to certain firms and even then it is often alleged that key interfaces of the latest software are kept secret. Second, in spite of the fact that theWintel computer standard constantly changes, the standard setting process is
closed; it is only open to a limited extent and only to those firms whom Microsoft
andlor Intel invite to participate. Therefore, third, the reasons for decisions about

the standards are not made available in public specifications. Fourth, the intellec-

tual property rights concerning the use of the standard are not made clear; they
are under are constant negotiation between Microsoft, Intel, and other firms.

This comparison between the Wintel computer standard and the mobile communication standards highlights the importance of openness to the mobile communication standards. Whereas most of the products and services that have become standards in other industries, in particular defacto standards have been cre-ated by individual firms, the degree of openness needed to create world-widemobile communications standard has required different strategies for success. The

systems which have became world-wide standards have been created by government sponsored organizations in order to ensure a high degree of openness. Eachstandard setting process including the degree of openness in this process has reflected a country's or region's institutional, philosophical and market characteristics at that time.

5. Social and Political Factors that Caused the Creation of Systems that Became

World-Wide Standards
Institutional, philosophical, and market differences have caused government

sponsored organizations to make different decisions concerning mobile com-

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munication standards. This section discusses these differences.

5.1 Analog

North America (AMPS), Scandinavia (NMT), and Great Britain (TACS) each
adopted a single analog communication standard that was open to all firms. All
three countrieslregions believed that a single standard was necessary in order topromote inter-connectivity and economies of scale. For example, in order to reduce the risk of obsolescence to early users in North America, all subsequently

made phones were required to be compatible with the AMPS standard. GreatBritain's carriers, in particular Vodaphone, wanted to adopt the AMPS standard
in order to benefit from the potential economies of scale in handsets. However,since AMPS was not perfectly compatible with the frequencies allocated tomobile communication in Great Britain, Vodaphone and Cellnet adopted a version of AMPS that was modified for the British market (TACS). North America
and Great Britain subsequently experienced falling service prices through competition between carriers (a duopoly was introduced in each region).
Scandinavian countries realized falling prices through the desire by carriers toincrease demand. The Scandinavian carriers cooperated on the creation of NMT
through the oversight of each countries Ministry of Public Telecommunications.
The ministries and carriers believed that the potential market for mobile com-munication was large due to the Iack of an adequate wireline system, concerns
about safety on the roads in the long, cold winters in Scandinavia, and the relative success of the pre-cellular mobile communication systems in Scandinavia.

Other European countries and Japan allowed their public telephone companies
to control the analog mobile telecommunication services and the result was the
adoption of unique standards and the slow introduction of competition. For ex-

ample, Germany (CNETZ450), France (RC2000), Italy (RTMS-450), and Japan(NTI' System) initially adopted standards which have not been used much outsideof the country of origin. Although Germany and France attempted to collaborate
with Great Britain on the creation of a world-wide standard the efforts were too'late and the firms in the countries were unable to overcome their competitive
rivalries. Germany, France and Italy did not introduce competition until GSM
was introduced in 1992 and Japan did not introduce competition until 1989 when
DDI and IDO began providing service. Further, unlike the Scandinavian carriers,
the public telephone companies in these countries did not attempt to create demand with lower prices. Instead, they took a very cautious approach in capitalspending and user fees.

For example, N'IT did not believe there was a large market for mobile communication services in Japan and thus did not install many base stations and set

FUNK: THE COMPETITION BETWEEN REGIONALSTANDARDSAND THE SUCCESSAND FAILUREOFFIRMS i53

user fees at high levels (Wakabayashi, 1984). Further, Japan's Ministry of Public

Telecommunications (MPT) originally started the mobile communications service
in order to create an amukudari post for an MPT official. The MPT attempted tominimize complaints by setting fees high to prevent people from subscribing who
could not afford the service. Therefore, it set a basic monthly charge of 40,OOO

Yen (US$333 at August, 1997 exchange rates) and it rented the phones because it
thought the purchase of phones would confuse users. It also restricted the hours

of service to 8-12 AM and 1-5 PM. The MPT was also influenced by the Ministryof Transportation whose offices were adjacent to the MPT at the time. The MPT
controlled the renting of phones and the awarding of spectrums like the Ministryof Transportation controlled vehicle licenses8.

5.2 Digita1

With digital technology, North America took a very different approach thanwith analog technology. North America used its success in the personal computerindustry as a model for setting standards in digital cellular and personal com-munication services. It has approved a number of communication standards andencouraged competition between them in the expectation that the best "defacto"

standard would emerge. In the case of digital cellular (beforg personal communication services), it required that the digital systems be constructed such that

analog phones could also be used in them. Although the cost to change the infrastructure from analog to digital was relatively small due to the design of themost widely used digital standard (DAMPS) and AMPS, dual-mode phones wererequired which were more expensive and heavier than the AMPS phones. Since
the carriers felt that users would not be interested in these phones, this naturally

discouraged the implementation of digital systems.
Further, North America has less of a need for digital cellular than many othercountries due to its lower population densities and lower traffic. One of the majoradvantages of digital cellular is that it uses the frequency spectrum more effective-

ly than analog cellular. However, the low population densities that exists in mostparts of North America means there are few shortages of frequency spectrum.
Further, there is lower traffic in North America due to the fact that owners ofmobile phones must pay for both outgoing and incoming calls in North America
which reduces the incentive for users to either pass around their phone numbersor leave the power on. North American mobile phone numbers are not distinguishable from wireline numbers so from a consumer advocate's stance it would'

be unfair for someone to pay for a more expensive mobile phone call when they
8 Personal communication with NTI' Docomo official who wishes to remain anonymous,

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KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 137-161

didn't realize they were calling a mobile phone.

In Japan, N'I'T Docomo (NTT Docomo was spun off from NTT in 1992) continued to dominate the mobile communication standard setting process with themove towards digital technology. Further, since NTT Docomo was not allowed tooperate services overseas, it had little interest in creating a world-wide standard.

Although Japan's MPT did require NTI" Docomo to use the same TDMA technology that GSM and DAMPS are based on, the frequencies that it allocated for
digital cellular systems were not compatible with these systems. The result wasthat NTT Docomo used its control of the standard setting process to create a relatively closed unique standard that continues to help it to dominate the Japanesemarket.

Europe on the other hand, had multiple analog standards and it wanted toadopt a single digital standard (GSM) in order that the same phone could be usedin different countries. Discussions concerning a digital standard began in the early

1980s between European service providers, infrastructure makers and ministriesof telecommunications from multiple countries and they occurred simultaneouslywith discussions to create a single European common market. These firms andministries decided to move to digital very early due to their optimistic forecasts
about digital technology. The multi-country standard-setting process created a ful-

ly documented standard in which there were more than 10 times the amount of
documentation than with Japan's PDC system. It was also flexible in that thestandard could be used with three different frequencies (900 MHz, DCS 1800

MHz, and PCS 1900 MHz).
It is interesting to speculate on what would have happened if Japan had allo-cated frequencies that are compatible with GSM and adopted the GSM standard
instead of the PDC standard. Since Japan has much more expensive cellular ser-vice than European countries, Japanese consumers would probably have benefited from a lower-cost GSM service. Further, the adoption of GSM would havehelped Japanese producers of mobile phones and infrastructure. The early adop-tion of the GSM standard certainly would have solved the patent problems thatwere faced by Japan's mobile phone producers and thus enabled them to be more
successful than 'they are now in the GSM mobile phone market. It would probably have also helped Japan's producers of infrastructure compete in the GSM
market in that the Japanese firms could have been the firms that solved GSM's
frequency spectrum weakness and thus filled this niche in the supply of GSM infrastructure. The major weakness of GSM is that its initial versions were not very

efficient in terms of using the frequency spectrum. Since Japan now has thegreatest needs in terms of frequency spectrum efficiency, Japanese firms could
have been the firms who first solved these problems as opposed to Ericsson who

FUNK: THE COMPETITION BETWEENREGIONALSTANDARDS AND THE SVCCESS AND FAILURE OF FIRMS 155

is now steadily increasing the frequency spectrum efficiency of GSM for the Asianmarkets where this is required. As of 1997, the frequency spectrum efficiency of
GSM is now equal to full rate PDC9 and Ericsson believes that it will be possible
for GSM to equal half-rate PDC in the futureiO.

5.3 Low-Mobility
In low mobility cellular communications, it appears as if Japan's standard(PHS) has the greatest chance, albeit a relatively small chance, of becoming aworld-wide standard. Japan adopted a significantly different philosophy thanNorth America and Europe in their approaches to personal communication services. The Japanese Ministry of Posts and Telecommunications would only
approve a system that was 1/4 as expensive as cellular technology in order toopen a new mobile communication market for the masses. This directive required
Japanese firms take full advantage of the low cost potential of the small cell,small base station approach whereas Europe and North America (as of early1997) decided to create personal communication systems that are almost identicalto digital cellular. Because both North America and Europe have decided that
communication in a fast moving vehicle is a necessary capability in a mobile com-munication system, their personal communication systems do not utilize as smallof cells as the Japanese system and they include complex switching equipment
which also raises the costs of the system.

The MPT also wanted PHS to become a world-wide standard and for Japanesemanufacturers to become the leading suppliers of the PHS-based phones, infrastructure, and services. In particular, it believed that countries with high-popula-tion densities, for example Asian countries would introduce services based on the

PHS standard. However, the MPT underestimated the importance of an open
standard and the extent to which foreign firms could use the lack of openness todiscourage the adoption of PHS. Similar to the behavior often attributed toJapan's Ministry of International Trade and Industryii, the MPT delayed theopening of the standard in order to give Japanese manufacturers an advantage.
9 Although PDC has lf3 the channel width per call (25 kHz for 3 calls) of GSM (2oo kHz for 8 calls),
with GSM the number of cells in which the frequency cannot be reused is 1/3 that of PDC. For example, for the same cell size, PDC requires 21 adjacent cells to use different frequencies vs. 7.5
cells with GSM (although the actual numbers change with the size of the cell, the ratios of cells for

PDC and GSM do not change). Further, GSM includes the concepts of micro-cells within macrocells where different frequencies are used in both the rnicro- and macro-cells. This enables GSM toeffectively use the frequency spectrum in the areas of a city which have the highest traffic, Smart

Tone has this type of GSM system operating in Hong Kong.
10 Personal communication with Dr. Martin Hallerdt, Senior Manager, Telecom Standards and Regulations for Nippon Ericsson KK.
11 Trading Places: How We Allowed Japan to Take the Lead, Prestowitz, C.V. Jr, 1988, NY: Basic
Books; MITI and the Japanese Miracle, Johnson, C., 1982, Stanford University Press)

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KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 137-161

Although Japanese manufacturers now dominate the PHS markets both in Japanand elsewhere, it is generally agreed that the size of the market is much smaller
than it would have been if foreign manufacturers had been allowed to participate
in the standard-setting process.

5.4 Third Generation Systems

By the mid-1990s, general agreement was reached among most participants on
several key characteristics of the mobile communication industry. First, the rnar-

ket was very large; the market had surpassed every forecast. Second, firms fromcountries whose system becomes a world-wide standard have a large competitive
advantage over other firms. Third, systems will only become world-wide standards if they are open both in terms of content and participation by domestic andforeign firms. Fourth, the decision by the ITU to choose a single world-wide stan-

dard in 1999 encouraged firms to begin efforts to create a world-wide standard
without first creating a country or regional standard.

These four factors plus key aspects of the Japanese market caused NTT Docomo to be the first firm to propose a third-generation system. Key aspects of theJapanese market include NTT Docomo's large profits through its domination of
the Japanese market, its easy access to N'IT's well-funded (by Japanese tax dollars) research programs, changes in NTT's charter which will enable it to operate

services overseas, and MPT's pressure on N'I'T Docomo to either create or adopt
a world-wide standard. N'IT Docomo's large profits and its access to N'I'I"s re-search programs made the development of a third generation system possible.
The ability to operate overseas and MPT's pressure either to create or adopt aworld-wide standard caused N'IT Docomo to promise the creation of an open
standard and to invite foreign participation.

In early 1997, N [T Docomo announced that it would work with Korea Mobile
Phone, China Telecom, Australia Telstra, and Singapore Telecom and that it had

invited carriers from North America (including AT&T), Great Britain, Sweden,
France, Germany, Italy, Thailand, Malaysia, Indonesia, and New Zealand to participate (these carriers are not installing IS95 systems) in the development of awide-band CDMA systern. It also announced that it had invited Ericsson, Lucent,Fujitsu, NEC, and Matsushita to supply infrastructure and Motorola, Nokia,
NEC, Matsushita, Mitsubishi, Sharp, and Toshiba to supply handsets for the experimental systems.

In May, 1997, a four-firm US group consisting of Motorola, Qualcomm, North-em Telecom, and Lucent announced the development of a wide-band version ofIS95 CDMA. Within a few days of the announcement, Ericsson, Nokia, and Sie-mens announced that they would support N'IT Docomo wide-band CDMA sys-FUNK: THE COMPETITION BE7'WEEN REGIONALSTANDARDSAND THE SUCCESS AND FAILURE OF FIRMS 157

tem. Rumors suggest that there is large chance that N'IT Docomo will adopt a
GSM network interface in the wide-band system at the request of Ericsson andNokia. This network interface will make it easier for carriers to adopt Docomo's

wide-band system particularly since Docomo's original proposal included an ISDN
network interface and most countries have not installed ISDN in their wireline

12 .
sy
stems
At the same time that Ericsson, Nokia, and Siemens agreed to support Doco-mo's wide-band system, Japanese carriers who had previously agreed to adopt
IS95 CDMA complained about their lack of invitation and were invited to partici-

pate in the development of a wide-band version of IS95 CDMA. Therefore, within one months time, it was determined that both of the competing systems were
to be developed by not just regional consortiums but multi-regional consortiums.

Further, these events also demonstrated the importance of openness and foreign
participation to the creation of world-wide standards in the mobile communications industry.

It will be interesting to see how much the US consortium and N'IT Docomo
continue to open their standards to foreign participation. Qualcomm, the largest

holder of IS95 patents and a member of the US consortium is charging relatively
high royalties for the patents and it is attempting to control the production of key

chips for the handsets in the case of IS95 CDMA. Similar actions with the wideband system will reduce the rate of cost reductions in handsets and thus discourage carriers from adopting the US consortium's standard.
N'I'I' Docomo has created an international team and it claims that it will open

its standard much more than it has done in the past with its second generation
digital standard, PDC. Nevertheless, its recent actions in the Japanese market
suggest that it will use the propriety of PDC to gain market share and it will not

be satisfied unless it has a complete monopolyi3. An important question is how

much pressure will Japan's MPT put on N'IT to create a system that has a highchance of becoming a world-wide standard.

12 If a GSM network interface is used in the wide-band CDMA system , operators who have alreadyadopted GSM can use their GSM switching equipment in the wide-band CDMA system. Further,many countries, particularly third-world countries do not have a public telephone ISDN network so
if an ISDN network interface is a required part of the wide-band CDMA system, a country thatwanted to adopt N[IT Docomo's wide-band CDMA system would have to install a public ISDN sys-tem.
13 NTT Docomo was able to delay the introduction of digital cellular systems by other carriers
through its slowness to release key information on PDC. It has also restricted the sale of handsets
by other carriers for the PDC system and it has not made its 28.8 kbps or its messaging services
available to other Japanese carriers. Since December, 1996, it has used these advantages (alongwith its financial advantage from having a ten year monopoly until 1989) to gain more than 809o of

new subscribers in the Osaka and Tokyo regions.

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KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 137-161

6. Future Competition Between Firms
It is still too early to forecast whether IS95 or either wide-band CDMA system
will become a standard on the level of GSM or AMPS. Further, it is still to early

to say which firms other than Qualcomm and N'IT Docomo will succeed in products and services that are based on narrow-band or wide-band CDMA technology. Nevertheless, it is safe to say that if a form of CDMA becomes a world-widestandard, the firms located in the country or region where it is initially heavily

adopted will receive a significant advantage in the world-wide market. Thesefirms will be able to develop experience in their home markets and based on thisexperience will be able to sell services, infrastructure, and phones to the rest of
the world.

It is also possible to summarize the advantages and disadvantage of countries.

In other words, which country has the best chance develop a large amount of experience in the standards that will be installed the most in the early years of the

21St century? Currently, it appears that these technologies will be IS95 and wide-band CDMA and improved versions of GSM. The Korean and North American
advantages lie in their early development and implementation of IS95 CDMA andin the case of North America its strong infrastructure suppliers, primarily Motor-

ola. At the end of 1996 there were more than 700,OOO IS95 subscribers in Korea

and a few thousand in North America (plus about 60,OOO in Hong Kong). This
provides Korean firms with their first opportunity to be a major producer ofmobile communications products. However, it is expected that by sometime in1999, there will be more IS95 subscribers in North America than in Korea. The
experience from implementing and operating these systems will provide a large
initial advantage to North American firms such as Motorola, Lucent, and North-ern Telecom.
The disadvantages for North America include the lack of a single standard andslow market growth. Since the lack of a single North American digital standard in

the late 1980s and early 1990s was one reason the rest of the world chose GSM,
the lack of a single standard with respect to personal communication services does

not encourage firms to adopt North American standards such as IS95 CDMA.
The recent slow growth in the North American market raises questions about
what will drive a large scale diffusion of IS95 or wide-band CDMA in North
America. And unless there is a great deal of diffusion of either IS95 or wide-band

CDMA in North America, North American firms may not develop the experience

necessary to be the major suppliers of CDMA services, infrastructure, andphones in the world-wide market. Forecasts for a slow growth in subscribers(259o a year) and voice traffic (even lower growth rates) in 1997 in North Amer-FUNK: THE COMPETITION BETWEEN REGIONALSTAIVDARDSAND THE SUCCESS AND FAILURE OF FIRMS 159

ica coupled with its low penetration rate (209o as of 8197) as compared to Scandi-

navia and recently Japan (see below) suggest that expansion of system capacity

will not drive a large scale diffusion of IS95 CDMA. Further, the recent slow
growth and low penetration rate in North America also suggests that the needsfor data communication in North America are much lower than those in Scandinavia and Japan. Therefore, expansion of systemscapacity for either voice or data
communication will most likely not drive a large scale diffusion of IS95 CDMA orwide band CDMA in North America.
The financial problems that North American carriers are experiencing will also

reduce the chances for both a large scale adoption of IS95 in North America andexports of infrastructure based on the IS95 standard from North America. Many

carriers, in particular the new carriers who are implementing IS95 CDMA
(AT&T did not implement IS95) are having difficulty paying the US government
for the frequency space they acquired in the auction and acquiring financing forthe construction of infrastructure. These problems wi11 most likely increase as thenext wave of auctions results in lower prices for the frequency spaces than were
paid in the first wave of auctions. Many infrastructure makers are forced to pro-vided more than 1009e financing in order to receive an infrastructure order.
While Ericsson is reportedly turning down orders that contain such requirements,

Lucent (AT&T) and Northern Telecom are apparently aggressively pursuingthese orders. The financing of these orders will reduce the funds available tothese firms for the development of improved CDMA infrastructure and the salesof CDMA in foreign markets.
Japan's advantages include the fastest growing market for mobile communication (including PHS and cellular) and the largest shortage of frequency spectrum.
The number of subscribers has been growing about three-to four times faster thanother major countries in 1994 (1009o), 1995 (2009e), and 1996 (150%). The market for mobile phones in Japan is now the largest in the world and its penetration
rate (259e) is several percentage points higher than the North American penetration rate. If present trends continue (800,OOO cellular and 300,OOO PHS per monthor increasing at 19o a month), Japan's penetration rate will become equal to the
Scandinavian penetration rates by the end of 1998. Further, voice traffic is muchhigher in Japan than in North America; for example, while the average income
per subscriber was about 17,OOO Yen (about $140) per month in Japan in 1996, it

was less than $501month in North America. The high voice traffic, penetration
rates, and rapid growth in penetration rate suggest that there may also may berapid growth in data communication traffic which combined with the increasing
voice traffic and high population densities means that IS95 and even wide band

CDMA may be implemented on a wide-scale due to shortages in the frequency

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KOBE ECONOMIC & BUSINESS REVIEW, 42 (1997), 137-16I

spectrum. Even with the full use of half rate PDC or IS95 CDMA (both roughly
equivalent in terms of the frequency spectrum efficiency), only 40 million users

can be accommodated in Japan. If present trends continue, Japan will have 40
million cellular subscribers before the year 2000. If this occurs, N'IT Docomo willneed to begin changing its half rate PDC systems to wide-band CDMA and DDI
and IDO will need to change not only their analog but also their PDC systems toIS95. Naturally, the allocation of frequency spectrum for wide-band CDMA by
Japan's Ministry of Posts and Telecommunication will also force carriers towards

wide-band CDMA.
Japan's disadvantages are its inability to agree on standards and its poor performance in international standard setting activities. Japan adopted unique stan-dards in both analog (N'IT) and digital technology (PDC) due to NTT Docomo's
dominance of the standard-setting process. Although the successful implementation of PHS may suggest that Japan is capable of agreeing on a single effective
standard, the inability of the PHS carriers to choose a single data communication

standard (32 kilobit standard), the decision by IDO and DDI to choose IS95

CDMA over PDC, and the inability of N'IT Docomo and the other carriers towork together on wide-band CDMA suggests otherwise. Several firms have publicly announced they will not support NTr Docomo's standard in the committees
which will choose the nation's wide-band CDMA standard in the Association ofRadio Industry Business unless NTr Docomo allows handset suppliers to sell
their phones to other carriersi4.

Europe's advantages are its high penetration rates in Scandinavia, its successwith GSM, and its strong infrastructure suppliers - Ericsson and Nokia. The highpenetration rates of Scandinavia suggests that it may also be an early user of data

communication and thus an early adopter of high data communication services in

its GSM system. Further, the success of GSM both has taught European firms toeffectively write specifications for large scale communication systems and suggeststhat the rest of the wortd will be looking to Europe for leadership in FLMTS.

Europe's disadvantages are its slow growth outside of Scandinavia and GreatBritain. For example, three of its largest countries, Italy (10.39o), Germany(6.89(o) and in panicular France (3.89(e) had very low penetration rates at the endof 1996; far less than the levels of the US and Japan. These low penetration rates

suggest that there is little need for systems (either IS95 or wide-band CDMA or

14 NTT Docomo requires its handset suppliers to wait about six months before they sell their newest
handsets to other carriers which enables NTI" Docomo to sell better handsets than the other carriers. Nikkei Shinbun, 81719, p. 9. Anxieties about Docomo's Technology Monopoly in the Warped
10 Years of Dominating Mobile Communication - The Obstacle of Allowing Outside Sales (Ido de-

nwa kokufuku dekiruka 10 nen no yugami docomo no gijtsu dokusen ni kenmei - gaihan kyodakukabe).

FUNK: THE COMPETITION BETWEEN REGIONALSTANDARDSAND THE SUCCESSAND FAILUREOFFIRMS 161

improved GSM) with higher data communication rates or higher efficiencies in
the frequency spectrum. Therefore, European firms will have trouble developing
experience in these areas. Their best chance of developing these experiences isprobably in the US and Japanese markets.
7. Conclusions

This paper describes the evolution of competition in the world-wide mobile
communication market. Most firms have succeeded with products (infrastructure
and phones) and phone services that are based on domestic standards, while re-latively few firms (Ericsson, Motorola, and Nokia) have succeeded in the de-velopment of infrastructure and phones that are based on non-domestic standards. The most successful firms are from those countries which have created sys-

tems which became world-wide standards. Systems that were adopted early andwere open in terms of both content and the standard-setting process became
world-wide standards.

Although the openness of these systems was partly due to the role played bygovernment sponsored organizations in their creation, the next generation of systems will be created without the sponsorship of a single country's or region's gov-

ernment. Instead, firms are attempting to create an world-wide standard without
first creating a country or regional standard. They are doing this by creating an
open, international standard-setting process.

& BUSINESSKOBE ECONOMICREVIEW
CONTENTS
NO.37 (1992)
Corporate Behaviors on Disclosure of Social Responsibility

Information and Distrust Dissolution Accounting-A Survey of Researches Not Based on Rigorous Models "'••••""'••• Isao Nakano
Local Entrepreneuership and Reverse

Technology Transfer-Messages
from Foreign Companies in Japan- ••••••••••"•••••••'••••••••"•••••••" Hideki Yoshihara'Ihe Forms of Enterprises and Transactionin General Equilibrium: A Note on
Analytical Framework "•••••"""••••••••••••••••••••••••••••••'••••••••••••• Kazuhiro Igawa

A Note on the Ftatness of theTransformation Surface •••••••'•••••••••••••••••'•••••••••••••••••"•••••• Kazuo Shimomura

The Long - Term Relationship in theJapanese Distribution System:
Game-Theoretic Viempoints •••••••••••••••••••••••••••••••••••••••••••••••••••••• Kenji Kojima

Recent Developments in the Theoryof Trade with ImperfectCompetition •••••••••••••••••••••••••••••••'•••••••••••••••••'••••••••"'••••• WinstonW. Chang

Seiichi Katayama
Long-term Expectations and Economic

Growth-A Post Keynesian Theory
ofLong-termGrowth- ••••••••••••••••••••••••••••••••••••••••••••••••••••" HideyukiAdachi

NO.38 (1993)
Generalized Lower-of-Cost-or-Market Rule for Inventory
Valuation for Quasi-rational Managers, ••••""•••••""""•'•"•••••""•••• Isao Nakano
Effects of Financial Deregulation on Australian Financial
System •••••••••••••••••••••••••••••••••••••"•••••••'•••••••••••••••••"•••••••""' Kenichi Ishigaki

NAFI'A and Asia-Pacific Economic Relations ••••••••••••••••••••••••••••""'••••" Seil'i Naya

The Asian Development Experience and Its Relavance toAfricanDevelopmentProblems ••••"•"•••••••••••••••••••••••••••••••"""""' SeiJ'iNaya

Robert K. McCleery
A Qualitative Assessment of the Effects of NAFrA on Japan'sForeign Investment and Trade with East Asia and Mexico:
Opportunity or Diversion? •"'••••••"'"••••'••••••••"'••••••"•••••••" William E. James
Dynamic Effects of Tax Polieies in A q

Model of Investment •"•••••••"""•••"""'•••""""""""•"""•••""' Takao Ohkawa

Kazuo Shimomura
Corporate Governance in Gerrnany, Japan, and theUnited States:A Comparative Study '••••••"'••••••"'••••••"•••••••'••••••• Kenji Kojima
Economic Issues in International Debt:A Survey ""••••""'•••••••••••••••••••• Hideki Izawa

A Note on the Estimation of Scale Economies and their
Use in Modeling Free Trade Agreements ••••••••••••••••••••••••••• Robert K. McCleeryNO.39 (1994)
Labour Unions and Nominal Prices •••••••"'••••••'•'"••••••'""•••••""'

Kazuo Shimomura

An Intemational Perspective on Japanese Corporats Finance ••••"'••
Measuring Natural Resource Rents and Their
Macroeconomic Significance for Developing Countries,""" Kenji Kojima

with Reference to Latin Arnerican Suger Producers "••••'"'"The Infiuence of Product Development Strategy on

Robert K. McCleey

Inter-Project Learning •"""••••••••••',••••••••••••••••••••"•••••••""••

Kentaro Nobeoka

A Comparison of Japanese and UK Welfare ••••""'••••"""'•"""'"'••

Stephen J Davies

NO.40 (1995)
Financial Relationships in Japan:
An International Perspective ••••••••••••••••••••••••••••••••••••••••••••••••••• Kenji Kojima

Structual Adjustment and Economic Growth in Mexico:With Comparisons to Indonesia ••••••••••••••••'`••••••""'••••""" Robert K. McCleer.y

Reorganizing for Multi-Project Management:
Toyota's New Structure of ProductDevelopment Centers ••••••••••••••••••••••••••••••••••••••••••••••••••••••••• Kentaro Nobeoka

Production Subsidies, Local Content Requirements
and Foreign Direct Investment:
ATheoretical Analysis ••••••'••••••••••'•••••••••••••••••••••••••••••••••••• Roger N. Strange

NO.41 (1996)
Implications of the Asia-Europe Meeting for the World Trading System:
AnIssue-OrientedReview '•••••••••"••••••••••••••••••••••••••••••••••••••• ShigeyukiAbe

Michael G. Plummer
Reconsideration of Averch-Johnson Argument ••••••••••••••••••••••••••"•• Seiichi Katayama

Fumio Abe
Supplier Relations in Japan:
An International Perspective ••••••••'•••••••••••,•••••••••',••••••••"'•••••••' Kenji Kojima

Alternative Component Sourcing Strategies
within the Maunfacturer-Supplier Network:
Benefits of Quasi-Market Stategy
in the Japanese Automobile Industry •••••••""•••••••""•••••••""'•• Kentaro Nobeoka
Value Networks, Industry Standards, and Firm Performancein the World-Wide Mobile
Communication Industries ••••••••••••••'••••••••••••••••••••"••••""'"••'•" JeLffrey L. Funk

The Effects of Transport Infrastructure and Urban Development Investment
in London's Docklands with Particular Reference
to Leisure and Tourism 1970-1997 •••••••••••••••••••••""•••••••••" T. S. Mervyn JonesPublished on February 1998

byResearch Institute for Economics & Business

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