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Japanese Foreign Direct Investment to East Asia and Exchange Rate Policies : Some Longer
Term Policy Implications after the Crisis
佐々波, 楊子(Sazanami, Yoko)
Yoshimura, Seiji
Kiyota, Kozo
Keio Economic Society, Keio University
2003
Keio economic studies Vol.40, No.1 (2003. ) ,p.1- 26

Journal Article
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KEIO ECONOMICSTUDIES 40(1), 1-26 (2003)

JAPANESE—SOME

LONGERFOREIGN
DIRECTINVESTMENTTO EAST ASIA
AND EXCHANGE
RATE POLICIESTERM POLICYIMPLICATIONSAFTER THE CRISIS—

Yoko

SAZANAMI

Faculty of Comprehensive Business Administration, Toyogakuen University, Tokyo, Japan,
Keio University, Tokyo, Japan and Meikai University, Chiba, Japan

Seiji YOSHIMURA
Institut CEDIMES, University Paris II (Pantheon-Assas),
Kozo

Faculty of Business Administration,

Paris, France

KIYOTA

Yokohama National University, Kanagawa, JapanFirst version received December 2001; final version accepted March 2003

Abstract:
This paper examines the policy implications of the changes in East Asianexchange rate policies after the financial turmoil in 1997 on Japanese foreign direct investment (FDI) to East Asia based on data covering 1978 to 2000. Our estimates revealthat Japanese FDI have been stimulated by the decline in East Asian real exchange rates(RER) against the yen and by establishment of Japanese production networks in the hostcountries. In exchange rate policy perspective, we recommend East Asian countries toavoid volatility and misalignment of their RERs against both the yen and the dollar. Regional arrangements aimed to stabilize the RERs between ASEAN members will help
to promote Japanese FDI.
1.

The appreciation
tivated Japanese

INTRODUCTIONof the yen against

multinational

the dollar

after the Plaza Accord

firms to shift their production

network

in 1985 mo-

to East Asia as

Acknowledgement.
An earlier version of the paper titled "Japanese Foreign Direct Investment Flows toEast Asia and the Real Exchange Rate—Lessons from the Asian Financial Crisis—" was presented at the international conference titled "Location of Economic Activity, Regional Development and The Global Economy," at the University of Lc Havre (France) on 26-27 September 2001. (Forthcoming in Economic Integration and Multinational Investment Behavior from Edward Elgar (New Horizons in International Business
Series, General Editor: Peter J. Buckley).) We are grateful to the participants at the conference and to theanonymous referee for helpful comments on an earlier draft.

Copyright © 2003, by the Keio Economic Society

Table1.

Regional Distribution of Japanese FDI Outflows, 1978-2000.
Value (1,000$), Fiscal Year (April/March)

1978

1979

1980

1981

1982

1983

1984

1985

World

4,541,869

4,931,767

North America
Europe & Central Asia
East Asia

1,386,207
321,080
1,337,369
n.a.

1,439, 811
418,418
967,00213,5004,632,737
1,602,185

8,858,815
2,554,101

7,649,567
2,909,786

572,734
1,177,204
11,86335,083
155,805
47,217
139,888529,396

1,769,423
2,955
129,042

329,101
54,437
266,3382,434,148

47,94253,476
31,648541,397

33,457102,200
54,543
1,154,922

146,337
78,31833,297555,080

401,01354,645
180,256
409,650
82,534

562,524
103,023
322,065
373,562
139,637

1,602,366
114,194
106,702411,723

12,180,685
5,643,244
1,918,150
1,414,433

94,759224,715
38,667
255,381
149,780865,734
1,378,070
18,493103,165

10,113,146
3,572,938
1,926, 123

222,133
158,494
39,549173,945
610,182

793,153
3,316,645
25,79573,194

8,103,357
2,714,933
981,759

955,816

951,614725,534

34,13994,175
1,451,115
1,044, 862

64,94871,667
1,787,879
849,363

China
Korea
Hong Kong
TawianSingapore
Indonesia
Malaysia
Philippines
ThailandLatin America & Caribbean
OthersWorld
North America
Europe & Central Asia
East Asia
China
Korea
Hong Kong
TawianSingapore
Indonesia
Malaysia
Philippines
ThailandLatin America & Caribbean
Others31,047
71,94730,638
1,124,571
1,070,345

99,858
133,767
131,068
114,142

1987

1988

1989

22,270,115

33,311,056

46,973,115

10,456,881

15,393.304
6,566,356
4,838,754
1,226,499

22,665,280
9,099,299
5,526,397
296,234
482,904

65,481,872
33,184,177

1986

3,456,539
2,309,025
226,356
435,533
502,301
290,525
302,176

64,691
224,810
373,825
142,143
45,655338,969
408,266
79,29660,654

118,6232,189,374
822,345

48,413
2,399,843
805,015

4,643,118
1,404,552

249,769
158,035
20,581
123,749

646,858
1,072,488
367,401
494,399585,507387,135
134,480
858,887
5,914,383

654,146
195,209
1,234,546
4,730,647

1,937,305

3,767,756

5,430,560

1999

2000

49,821,463
13,143,692
25,030,158

1990

1991

1992

1993

1994

1995

1996

1997

57,688,280
27,962,684
14,461,731

42,211,340
19,359,276
9,470,436

54,738,724
21,891,033

39,852,221
10,719,232

65,307,654
24,397,939

11,363,449
11,251,465
2,015,076
448,430
704,937

13,686,643
6,033,689
1,041,282
295,978588,580

25,267,543
6,682,952
735,266
959,186
950,424

621,556
1,208,905
892,656
205,275

1,757,001
260,167
1,301,579
308,396661,289

7,634,580
11,387,952
2,599,316
430,478
1,539,543

850,653
1,115,685
736,591
264,597

1,090,524
229,465
762,489
296,879
690,559

41,883,453
19,155,369
6,383,884
9,478,886
2,625,147

49,728,192
24,365,107

5,945,972
584,134
264,693935,586
411,493

37,333,091
16,346,013
8,277,451
6,769,825

52,698,502

7,033,773
352,890
289,0811,802,348
450,729

34,987,999
15,237,077
7,241,182
6,322,587

1,690,985
725,348
166,086

456,373
1,849,683
2,549,752
802,407219,121622,459
1,052,366
502,723

279,430
942,295
899,040
514,613

1,171,200
3,272,443
4,957,649

821,672
2,525,370
4,910,287

856,472
801,858
211,865
611,198

539,782
1,154, 809
2,500,060

531,023
1,893,785
5,537,561
4,695,217

370,490
1,340,690
6,131,072
3,281,586

603,905
798,792
6,022,466
2,936,755

Note: Data is notification and fiscal year basis.
Source: http://www.mol.go.jp (accessed date 08/07/2001)

670,251
2,392,646
3,794,506

2,904,396
3,035,405

411,367
1,153,755
285,985
1,077,264
1,768,609
755,117668,607733,035
4,091,637
2,773,677

1,175,999
467,066
1,215,495
1,645,893
589,584735,555
1,271,130
3,375,222
4,111,223

591,879
578,880
1,453,203
3,295,572
3,044,981

1,813,874
479,683
1,864,743
609,111545,445
163,324
72,379249,961
4,575,337

1998

24,262,957
8,795,604
12,153,496
4,592,142
460,633

1,661,781
372,367
747,102

14,280,958
7,855,531
425,319
578,900

5,857,384
1,019,942
834,167
959,532
522,758
434,417424,377
237,777
469,336
955,078
4,795,666
994,562

O
Cri
0z
O

C7

z

Table 1 (continued).
Regional Distribution of Japanese FDI Outflows, 1978-2000.
Share (World=100), Fiscal Year (April/March)
1978

World
North America
Europe & Central Asia
East Asia
China

1979

100.0
30.5
7.1
29.4
n.a.
4.9
3.5
0.9
3.8

0.3
0.8
3.4
1.0

37.4
0.3
0.8
3.7
0.6

13.4
1.1
1.2
0.7

3.0
0.7
2.1
1.1

3.0
11.4
3.2
1.7

11.9
21.0

23.4
19.3

0.7
12.0
15.7

Others1990

TawianSingapore
Indonesia
Malaysia
Philippines
ThailandLatin America & Caribbean
Others

1982

0.3
1.9
4.6
0.8
5.2

Indonesia
Malaysia
Philippines
ThailandLatin America & Caribbean

East Asia
China
Korea
Hong Kong

1981

100.0
34.6
12.4
25.4

Korea
Hong Kong
TawianSingapore

World
North America
Europe & Central Asia

1980

100.0
29.2
8.5
19.6

1991

1992

100.0
28.8
9.0

1983

1986

1987

1988

100.0
46.3
15.7

100.0
47.0
15.5

100.0
46.2
19.7

0.2
1.3
5.2
0.7

21.8
0.0
1.6
6.9
1.3

15.8
1.1
1.1
4.1

11.6
0.8
1.1
1.1

14.5
3.7
1.9
3.2

3.0
27.5
0.4
0.8

2.4
5.4
1.1
0.4

4.0
4.6
1.7
0.8

0.6
2.2
3.7
1.4

0.9
2.8
3.4
0.7

10.4
1.0
2.0
2.3
1.3

0.3
12.7
12.1

1.2
19.0
13.7

0.9
22.1
10.5

0.5
1.2
21.6
8.1

0.5
0.4
19.7
6.6

1994

1995

100.0
45.9

100.0
43.5

100.0
43.8

100.0
45.7

25.1
12.2
0.6
0.5

22.4
14.1
1.4
0.6
2.2

20.7
18.1
3.1
0.7

22.2
18.1
4.7
0.7

15.2
22.6
6.3
1.0

1.0
1.5
2.9
2.1

2.2
0.8
2.0
4.8
2.1

3.5
0.8
1.8
2.3
2.1

2.8
0.7
2.6
4.2
1.8

0.5
1.9
6.0
11.6

0.5
1.9
6.8
10.8

0.6
1.6
7.8
8.1

1.6
1.8
9.8
6.6

0.5
2.0
5.7
8.6

1985

100.0
35.3
19.0

100.0
48.5

3.1
0.8
1.5
1.9
1.3

1984

100.0
33.5
12.1

1993

100.0
38.0
11.3
18.0

1996

1997

19.4
11.8
0.6
1.0

21.8
12.0
0.6
0.9
2.8

3.5
0.8
1.6
1.2

0.5
0.2
0.8
13.7
5.8

0.8
0.3
1.8
12.6
8.0

0.1
0.6
20.8
6.3
1999

2000

100.0

100.0

100.0

100.0

46.0
16.7
23.1
8.7
0.9

49.0
15.4
22.9
5.2
0.9

40.0
20.8
20.6
3.7
0.8

26.9
34.3
15.1
2.6

100.0
37.4
38.7
10.2
1.1

2.2
0.9
2.3
3.1

3.1
1.1
2.3

1.3
0.8
3.4
4.7

0.7
1.5
0.5
1.6

1.5
1.5
0.4
1.4

2.6
1.3
0.9
3.4
15.4
8.2

1.4
0.8
0.9
1.2
9.2

0.9
0.9
0.5
0.9
1.9
9.6

4.5

2.0

1.1
1.4
2.4
6.4
7.8

5.0
1.2
1.2
2.9
6.6
6.1

1.5
1.0
3.5
10.1
8.6

N

100.0
50.7

1.1
1.5
1.6

1.4
1.1
0.7

1998

1989

100.0
48.3

100.0
26.4
50.2
11.8
2.0
1.7
1.9
1.0

0.7
2.8
0.9
1.0
0.3
1.9
7.2
8.3

z

H

Ym
Ch
O
Ch
C7 7

Hz
m
H
mz
H
H
O
m
H
r
Y

Cr..)

4

KEIO

ECONOMICSTUDIESthe real exchange rate (RER) of East Asian currencies depreciated against the yen incountries adopting a de facto dollar pegged exchange rate regime. As shown in Table
1, Japanese FDI to East Asia increased from US$2,309 million in 1986 to US$12,153
million in 1995. Even after the RER of some East Asian countries started to appreciate
against the yen from April 1995 reflecting the appreciation of the dollar against the yen(Sazanami and Yoshimura (2002)), large Japanese FDI outflow continued in 1996 andin 1997.
At the outbreak of the Asian financial crisis, some East Asian countries like Thailand,
Indonesia, Korea and the Philippines swiftly let their currencies fell and subsequently
ended their dollar pegged exchange rate regime. The adjustment in exchange rates
brought some recovery in Japanese FDI outflow to Korea, Singapore and the Philippines
in 1999, and to Thailand in 2000. However, the total Japanese FDI outflow to East Asia
in 2000 was US$5,857 million, only 51% of the corresponding outflow in 1996.
After a brief overview of Japanese FDI outflow to East Asia from 1978 to 2000 in
Section 1, the paper is organized as follows. Section 2.1 presents findings in a numberof previous studies that focus on the relationships between RER and FDI. In Section 2.2,
we discuss the role of exchange rate policies in East Asian countries before and after
the financial crisis. Our estimation results of the RER of four currencies —the rupiah,
the won, the peso and the baht —against the dollar as well as against the yen during thisperiod are presented to show how policy changes after the financial crisis have affected
their movements. In Section 2.3, we find a very high correlation in cross-correlation
matrix of four East Asian RERs from 1995 to 2000. Section 3.1 describes our research
design and data used for estimation. Results of our estimation are presented in Section
3.2. Our major findings and related policy issues on future exchange rate policies in
East Asia are summarized in Section 4.
2.

FOREIGN

DIRECTINVESTMENT,POLICYREAL EXCHANGERATES AND RELATEDISSUES2.1. Relationship between Real Exchange Rates and Foreign Direct Investment
The depreciation of the dollar from the late 1970s had generated dramatic increasein FDI inflows to the United States. During this period, U.S. assets became cheaper toforeign investors like Japanese who held the yen. Froot and Stein (1991) found that, between 1973 and 1988, a regression of de-trended FDI as a percent of U.S. GNP against
the U.S. RER indicated that a 10% depreciation induced about $5 billion additional
FDI to the United States (Froot and Stein (1991, Figure 1)). The study was based on themodel that assumed an improvement in foreign investor's wealth position to the extent
of holding more wealth in non-dollar dominated form. The depreciation of the dollar
improves the relative wealth position of the foreign investors and subsequently lowers
their relative cost of capital against the domestic investors. The total foreign capital inflows into the United States were divided into foreign official and foreign private inflowsthat were further subdivided into FDI, foreign investment in U.S. Treasury securities,
and foreign portfolio investment in corporate stocks and bonds. Each item was deflated

SAZANAMI

ET AL.: JAPANESEFOREIGN

DIRECTINVESTMENTTO EASTASIA

5

by U.S. GNP and regressed on the real value of the dollar and a time trend. The empirical results indicated that the value of the dollar present significantly negative sign only
for FDI among various types of capital inflows. When FDI inflows were subdivided
into thirteen separate industries,1 all of the thirteen coefficients on the exchange rate
were negative and five of them were statistically significant. Among the eight types of
inflows2 whose sensitivity to RERs were tested, mergers and acquisitions (M&A), newplants and joint ventures transactions were statistically significant.
Klein and Rosengren (1994) also examined whether a large increase in the foreign
ownership of land and capital in the United States from the early 1970s was caused by
the depreciation of the dollar that lowered the cost of acquisition to foreign investors(relative wealth hypothesis). In addition, the study questioned whether the depreciationof the dollar made foreign investors to choose the United States as an industrial location(relative labor cost hypothesis). In their study, FDI was divided into four subset dataon the inflowss to the United States. The correlation coefficients of RER (between thedollar and the currencies of seven industrial countries investing in the United States)and FDI indicated that a depreciation (appreciation) of the RER increased (decreased)
FDI on the period from 1979 to 1991. All estimated correlation coefficients except realestate industry were statistically significant at the 5% level. The regression results also
revealed that, in addition to the RER, a real wealth variable4 promoted FDI inflows to
the United States at 5% level of significance. Regression on foreign M&A of the U.S.
assets relative to total M&A in the United States revealed strong negative relationshipwith the RER. The relative wage cost variable, represented by the ratio of wage costs in
the United States to wage costs in the investing country, was statistically insignificant
in all four subsets data on FDI inflows to the United States.
In Japan, increased FDI outflow to ASEAN and China from the late 1980s was perceived as a threat to domestic employment and industrial competitiveness. The dangerof "hollowing out of Japan" caused by the yen appreciation became one of the important issues from the mid-lggos. Bayoumi and Lipworth (1998) tested the determinantsof FDI outflows from Japan to twenty Asian trading partners, focusing on the businessconditions of Japan and host countrys as well as the RER. The study found that the RER
and the business conditions of Japan and host country's lagged investment were statistically significant determinants of FDI for the sample period of 1982-1995. During thisperiod, the bilateral FDI flows significantly affected trade patterns between Japan and1 Thirteen industries are 1) all industries , 2) petroleum, 3) manufacturing—subdivided into 4) food, 5)chemicals, 6) fabricated metals, 7) machinery, 8) other manufacturing—, 9) trade, 10) finance, 11) insurance,12) real estate and 13) other industries.
2 Eight types of inflows are 1) mergers and acquisitions (M&A) , 2) equity increase, 3) real estate, 4) new
plant, 5) joint ventures, 6) plant expansion, 7) other expansion and 8) no type listed.
3 Four types of inflows are 1) total outlays in International Trade Administration (ITA) data , 2) total outlays
in Bureau of Economic Analysis data, 3) M&A in ITA and 4) real estate purchase subset data in ITA.
4 A real wealth variable is defined as an index of the value of the U .S. stock market relative to an index ofvalue of the stock markets in the investing countries.
5 The business condition of Japan and the host country is defined as domestic investment in Japan and thehost country, respectively.

6

KEIO

ECONOMICSTUDIESthe host countries in East Asia. While Japanese FDI outflows increased Japanese exports to the host countries in the short-run, the high stock of Japanese FDI in the hostcountries produced a long-run positive effect on Japanese imports from the host countries. One of the interesting findings of the study was that, although the depreciation of
East Asia's RERs can stimulate Japanese FDI to East Asia, poor business condition in
Japan could more than offset the stimulating effect from the fall in the RER.
Ita (2000) attributed the increased FDI outflows from Japan to Asia from the late1970s to the cost conscious behavior of Japanese manufacturing firms. The persistent
appreciation of the yen against the dollar motivated these firms to shift their production
sites to Asian countries. The study employed the yen/dollar exchange rate lagged one
year to reflect the persistency of changes in the exchange rate and the growth of the hostcountry to reflect expectation for future growth as independent variables determining
Japanese FDI to eight countries in East Asia.6 For the sample period from 1976 to
1996, only the growth rate variable was found to be statistically significant in the caseof a pooled sample of eight countries. As for individual country study, the exchange
rate variable was found statistically significant only in the case of Singapore and HongKong. The Philippines was the only country where both growth and exchange ratevariables were statistically significant. In the remaining five countries, only the growthvariable was statistically significant.
2.2. Real Exchange Rates and Exchange Rate Policies in East Asia
From early 1995, the RERs of East Asian countries that adopted a de facto dollar
pegged exchange rate regime started to appreciate against the yen reflecting the appreciation of the dollar against the yen. The appreciation weakened the price competitiveness of these East Asian countries and subsequently deteriorated their current accountbalance. The most typical case was Thailand. Between January 1995 and May 1997, theRER of the Thai baht appreciated as much as 21% against the yen while it appreciatedonly 3.3% against the dollar (Sazanami and Yoshimura 1999, Figure 4). The depreciation of the yen motivated Japanese firms to reduce the production in East Asian affiliates
and to increase their production in domestic plants. The shift decreased infra-firm imports from the East Asian affiliates to Japan. In addition, during this period, increasein imports from China was eroding the share of other Asian countries in the Japanesemarket.
The low interest rate policy in Japan aimed to recover from the recession widened
the spread among East Asian interest rates. In addition to the widening of the spreads,
Ogawa (1999) finds that the decline in the yen against the dollar that started in 1995
increased the interest rate differential between the baht and the yen to exceed those between the baht and the dollar. By the end of June 1996, total claims of Japanese banks in
Asia amounted to $115.4 billion and the claim against Thailand topped the list of Asian
countries at $37.5 billion (Sazanami and Yoshimura (1999, Table 2)). Financial institutions including non-banks in Thailand were using short-term capital inflow to invest in
6 Eight
Taiwancountries

and Thailand.

in East Asia

are Hong

Kong , Indonesia,

Korea,

Malaysia,

the Philippines,

Singapore,SAZANAMI

ET AL.: JAPANESEFOREIGN

DIRECTINVESTMENTTO EAST

ASIA

7

speculative real estate market and emerging market bonds. When the massive inflowsof short-term capital were reversed into outflow, Thailand terminated the de facto dollar
pegged exchange rate regime and let the baht to fall in July 1997. The contagion of financial crisis in Thailand triggered the currency devaluation in neighboring East Asian
countries. After the downfall of their currencies, most of the East Asian countries abandoned the de facto dollar pegged exchange rate regime and introduced more flexibility
in managing their exchange rates.
In order to examine the changes in exchange rate policies in East Asian countries
after 1997 aimed to avoid the misalignment of their RERs against the dollar and theyen which evidently was one of the causes of the financial crisis, we estimated the
RERs of the rupiah, the won, the peso and the baht against the yen and the dollar,
respectively.7 Four East Asian countries were selected because they all experienced thedownfall of their exchange rate against the dollar in 1997. Malaysia was excluded fromour estimation as Malaysia introduced the dollar pegged exchange rate regime and at
the same time controlled capital inflow from September 1998. The period covers thepie-crisis as well as the post-crisis period, from January 1995 to December 2001.
Figures 1-4 show that the monetary authorities of the Philippines, Indonesia, Korea,
and Thailand terminated the de facto pegs against the U.S. dollar in the third quarter of
1997. By the end of 1998, four countries had adjusted their over valuationof the RERs
from the long-run equilibrium rates shown in the horizontal axis against the dollar aswell as against the yen. From January 1999, we find surprisingly similar coordinatedmovements of RERs against the dollar in the four currencies.
Questions related to choosing exchange rate regime that meets their respective policy goals have attracted much interest in discussion among academics and officials inmonetary authorities and international organization. Ita, Ogawa and Sasaki (1998) advocated that pegging East Asian currencies to the optimal basket weights of the yen
and the dollar would minimize the fluctuation of economic growth rates and trade balances. They found that economic fluctuation and trade imbalance would be reduced at
the estimated optimum currency weights where the weights of the yen relative to thedollar were higher than actual weights for the sample periods of 1981 to 1996. Gan
Wee Beng (2000) pointed out that East Asian monetary authorities had assigned greater
weights to the yen at the expense of the U.S. dollar in their currency baskets from
July 1997. He concluded that East Asian currency market became more stable whenauthorities allowed their exchange rates to float more flexibly by responding to theireconomic fundamentals. Corden (2001) in a seminar at the IMF stressed that developing countries should choose their exchange rate regimes according to specific economic
circumstances.
East Asian countries have two policy objectives which are closely interrelated after
the financial crisis. The first is to regain the macro-economic stability that helps toassure foreign investors' confidence. The second objective is to maintain export competitiveness that allows continued outward-oriented growth. The World Bank (2002,
7 Model for the estimation follows Sazanami and Yoshimura (1999) .

8

KEIO ECONOMICSTUDIES

20 -----------------------------------------------------------------------------------------------------------10 -

__--•

o

I

II

I

-10
-20
-301.....

rupiah/$, ,------

rupiah/yen,

40
50
-60

-70 -----------------------------------------------------------------------------------------------------------~m~4,9>" se4~y~`~~~eQ~,~c`~~c,e4.,,z"4.4',1 4,"4.,,b,c`~;,,eQ>,b{`,4,,,i:\44 ~,~`~~%e4month/year
Figure1.

The degree of misalignment:

the rupiah against the dollar and the yen.

20 ------------------------------------------------------------------------------------------------------------..........
won/s
won/$
---------won/yen---------won/yen
10 -0 -- - I - -+-------I

I

I---------------I + --- -+--- --+--1-

the dollar

and the yen.

-20

-30

-40

-50

,,,,F)''}) c.,e,,,,,5")'"4,5)1/43_450„.,52
month/year
Figure-2.

The deg
degreeof misalignment:

the won againsti -----I9

SAZANAMIETAL.:JAPANESEFOREIGNDIRECTINVESTMENTTOEASTASIA

40

30

20

10

00

‑10

‑zo

ロ

::…一

…一一一一一… 一
一㎜ …..一一一…

試試♂試ぱぱ試♂♂ぱ劉ず試ぱノ試劉ず試試ず
month/yeazFigure3.Thedegreeofmisalignment:thepesoagainstthedollarandtheyen.
20

10

0

〇¥°‑10

‑zo

‑30

‑40

試♂ノ試劉ず試副ツ 試劉ノ試ぱノ試ぜツ 試避ズ
monthyear
Figure4.Thedegreeofmisalignment:thebahtagainstthedollarandtheyen.

10

KEIO

ECONOMICSTUDIES

p39, Box 2.2) finds that out of ten largest FDI recipient countries seven are also the developing countries with the largest exports. Nicolas (2002) recommends the East Asian
countries to have exchange rate policies that avoid both misalignment and short-term
volatility in real effective exchange rates if they wish to maintain their export competitiveness.

2.3. Regional Exchange Rate Arrangements in East Asia
The recent Asian financial turmoil taught us the lesson that the misalignment of the
RER in a single regional member currency and the subsequent instability in its exchange
rate can trigger the fall in exchange rate of other currencies. What East Asian countries
need is not only the stability of the RERs against the dollar and the yen but also between the regional members' currencies. The coordinated exchange rates movement
in four East Asian currencies—the rupiah, the won, the peso and the baht – in previous section after January 1999 suggest the possibility of having regional exchange rate
arrangements in the near future.
From the mid-lg8os, East Asian countries and Japan deepened their regional interdependence primarily without any establishment of formal regional arrangements. Urata(1998) found that, in East Asia, the share of infra-regional trade and investment in theworld total had increased primarily by market forces, namely due to the high rate of
economic growth led by liberalization of trade and FDI. In exchange rate policy field,
most of the countries in East Asia were adopting a de facto dollar-pegged exchange rate
system until the Thai government let the baht to float in July 1997 as noted earlier.
The system benefited foreign investors in assuring macro-economic policy discipline
in East Asian countries in keeping price of tradable goods in line with world price in
U.S. dollars. The system promoted Japanese multinationals in establishing their affiliates in East Asia as it reduced exchange rate risks provided that the yen/dollar rate
remained stable. The sharp appreciation of the yen against the dollar after the Plaza
Accord in 1985 had motivated Japanese multinationals to continuously shift their manufacturing affiliates to East Asian countries. When Japanese FDI outflow to East Asia
increased from $1.4 billion in 1985 to $12.2 billion in 1995, the share of manufacturing
in total FDI increased from 27.1% to 56.1%.
Mismatch between a de facto dollar-pegged exchange rate system and the growth of
East Asian countries led by trade and FDI became apparent when the dollar started toappreciate from 83.6 yen to a dollar in April 1995to 122.6 yen to a dollar in March 1997.
As noted in the previous section, the RERs of major East Asian currencies were not
only continued to be overvalued against the dollar but started to appreciate continuously
against the yen (Figuresl-4). This period coincided with the liberalization of financial
markets in the East Asian countries, Thailand and Korea in particular. Total net private
capital inflow to East Asian countries increased from $47.4 billion in 1994 to $91.2
billion in 1996 (Institute of International Finance (1998)).
Policy efforts to support a de facto dollar pegged exchange rate system by purchasing
the dollar on the one hand and trying to sterilize its impact on the money supply on theother had accelerated capital inflow. When sterilization policy was found insufficient,

SAZANAMI

ET AL.: JAPANESEFOREIGN

DIRECTINVESTMENTTO EAST

ASIA

11capital inflow increased money supply and subsequently raised price of various assets.
At the end of 1996, 61% of claims against the local East Asian banks were of maturity of one year of less. The large inflows to Thailand quickly reversed when foreignbanks withdrew such short-term loans. The downfall of the Thai baht in July 1997 wascontagious to other East Asian currencies, forcing the devaluation.
After the crisis, we find more diversity in exchange rate arrangements in the East
Asian countries. While Korea and Thailand shifted to currency basket type arrangements, increased exchange rate flexibilities were introduced in Indonesia and the Philippines (Kawai (2oo2a)). Malaysia pegged the ringgit to the dollar in September 1998 andat the same time introduced control on capital movements.
In March 1997, the currency swap arrangements were agreed by five ASEAN countries (Indonesia, Malaysia, the Philippines, Singapore and Thailand). But it did not prevent the currency attack a few months later.8 After the financial crisis, the Chiang Mal
Initiative established in May 2000 enlarged the member of currency swap arrangements
to include China, Korea and Japan. When ASEAN plus three reviewed the Chiang Mal
Initiative in April 2001, the ASEAN member countries all agreed on the importanceof strengthening the surveillance of the member countries' economies and coordinating
the dialogues with China, Korea and Japan to prevent the recurrence of financial crisis.
However, their views as well as positions differed among the ASEAN members and between the three non-ASEAN countries on specific issue as exchange rate arrangements.
In spite of their failure in launching the formal type of exchange rate arrangements
after the Asian financial crisis, Figures 1-4 in the previous section revealed surprising similarity in the movements of the RERs of Indonesian rupiah, Korean won, thePhilippine peso and Thai baht against the dollar as well as against the yen. Since East
Asian economies and ASEAN countries are so interdependent with each other as well
as closely linked to the world market, building regional exchange rate arrangementsthat contribute to assure stability of the RER among the member countries as well aswith developed countries—Japan, the United States and the EU—has become one of
the most important post-crisis policy issues.
To see if the current managed float system under different exchange rate arrangementsin the four countries—the rupiah, the won, the peso and the baht—can substitute the defacto dollar pegged system before the finance crisis, we calculated the cross-correlation
matrix of RER against the yen and against the dollar in the five East Asian countries—
Korea, Singapore, Indonesia, the Philippines and Thailand – in Table 2.9 The periods
were subdivided into three periods: pie-crisis period (January 1995–June 1997), postcrisis adjustment period (July 1997–December 1998) and the most recent post-crisis
period (January 1999–December 2001).
From Table 2, we find that pie-crisis cross-correlations of the five countries' RERs
against the yen show very high correlation ranging from 0.921 to 0.995. They are higher
8 "Regional financial cooperation in East Asia is still in its infancy stage" (Kawai (2oo2b, p. 99))
9 We eliminate other countries such as Malaysia and China since they adopt a dollar pegged exchange rate
system.

tJ

Table

2.

Cross-Correlationsof East Asianagainstthe Dollar

and the Yen.

Yen

DollarJanuary

lggs-Junelggs-June
January
1997

1997
Korea

Singapore

Indonesia

The

Philippines

Korea

1.000

Singapore

0.465

1.000

Indonesia

0.850
0.481

0.173
-0.261

0.776

1.000

0.908

0.451

0.921

0.585

Singapore

Indonesia

The

Philipp

Ines

Thailand

July

RERs

lggi-December

1.000

Korea

Philippines

1.000

Singapore

0.778

1.000

Indonesia

0.686

0.854

1.000

The

0.791

0.940

0.850

1.000

0.837

0.746

0.506

0.649

Indonesia

The

Philippines

1.000

Singapore

0.930

1.000

Indonesia

0.937

0.974

The

0.921

0.979

0.993

1.000

0.936

0.995

0.989

0.992

Singapore

Indonesia

Philippines

Thailandlggi-December

Thailand

1.000

The

Philippines

Korea

1.000

Singapore

0.376

Indonesia

0.558

1.000
-0 .097

1.000

0.719

0.616

0.614

1.000

0.762

0.442

0.180

0.492

Philipp

Ines

ThailandThailand

1.000

1998
Korea

The
1.000

Singapore

Korea

July
The

Korea

Thailand

1.000

1998
Korea

Philippines

ThailandThai land

ll
C
to
0
z0

C7
1.000

c
January

lggg-December

2001
Korea

January
Singapore

Indonesia

The

Philippines

Korea

1.000

Singapore

0.692

1.000

Indonesia

0.729

0.906

1.000

The

0.654

0.850

0.823

1.000

0.700

0.851

0.845

0.974

Philippines

ThailandFor notes

and sources,

see Table1.

lggg-December

ThailandSingapore

Indonesia

The Philippines

Korea

1.000

Singapore

0.462

1.000

Indonesia

0.270

0.110

1.000

0.513

0.428

0.727

1.000

0.659

0.659

0.619

0.925

The
1.000

2001
Korea

PhilippThailandInes

Thailand

1.000

SAZANAMI

ET AL.:

JAPANESE

FOREIGN

DIRECTINVESTMENTTO EAST

ASIA

13

than their RERs against the dollar that ranged from —0.261to 0.921. The adjustmentsof the five countries' RER during the financial crisis from July 1997 to December 1998
were evidently coordinated with the relationship with the dollar than the yen. The crosscorrelations of the five countries' RERs against the dollar ranged between 0.506 and
0.940 while against the yen ranged between —0.097and 0.762. The cross-correlationsof five countries' RERs against the dollar and the yen show that the trends in adjustment
period continued to December 2001. Namely, cross-correlations of the five countries'
RERs against the dollar ranged between 0.692 and 0.974 while those against the yen
ranged from 0.110 to 0.925.
Another interesting finding in Table 2 is that cross-correlation coefficients between
the ASEAN member countries—Singapore, Indonesia, the Philippines and Thailand—
are higher than those between the ASEAN members and Korea. Coordinated stability of RERs between ASEAN member countries will help these countries in attracting
Japanese FDI, in particular manufacturing FDI that aims to build infra-firm production
networks in ASEAN region.
These findings suggest that instead of a de facto dollar pegged exchange rate regime,
the four ASEAN countries are introducing a de facto dollar exchange rate arrangements,
or managed float system, in stabilizing currencies within the four as well as against
their trading partners. As for the Japanese yen, a de facto dollar pegged exchange rate
regime contributed to the stability of the five East Asian RERs against the yen as well
as between the five currencies in the region. Another interesting finding in Table 2 isthat cross-correlation coefficients between the ASEAN member countries—Singapore,
Indonesia, the Philippines and Thailand—are higher than those between Korea.
3.

3.1.
Research Design
Benchmarkmodel

EMPIRICALANALYSIS

and Data

Our model aims to assess the statistical significance of RERs as the determinantsof
FDI from Japan to the East Asian countries for the sample period from 1978 to 1999.
In our study, RER is defined

as:

RER
=1/P*=Sp(1)where

S is the nominal

exchange

P stands for the producer
P* denotes the wholesaleused in our analysis

rate of East Asian currencies

against the Japaneseyen,price index or wholesale price index of the host country andprice index of Japan. The benchmark
regression equationis:In~~pttal
InRER
t+a2ln
RERAt
+Et,

(2)

where superscript i refers to the country and subscripts t refers to the time. Dependent
variable, FDI tlGDP t, is the ratio of real FDI outflows from Japan to East Asian respective countries to host country's real GDP, GDP it. As the depreciation of host countries'

r

*

14

KEIO

ECONOMICSTUDIEScurrency will improve foreign investor's wealth position (Froot and Stein (1991)), thesign of a 1 is expected to be negative.
In addition to RER, as in Sazanami and Yoshimura (1999), we also include a dummy
variable to capture the effect of the Asian crisis through RER on FDI. Dummy variable,

RERAt,takesoneafter1997andzerootherwise.SazanamiandYoshimura(2002)finds
sharp fall in the RERs of the East Asian currenciesagainst the yen in 1997. As East
Asian countries abandonedde facto dollar pegs at the time of Asian crisis, the fallreflectedadjustmentof misalignmentsof East Asian RERs againstthe yen from longrun equilibriumrates. The misalignmentsagainstthe yen started from 1995when thedollar appreciatedagainst the yen. RERA tries to distinguishwhether the financial
market turmoilin 1997had statisticallysignificantinfluenceon JapaneseFDI outflow
to East Asia.
Alternativespecifications
FollowingKleinand Rosengren(1994),we includerelativelabor costvariable,RLC`t,
as an independentvariablesin the equation(2). Recent theory of internationaltrade
has emphasizedthe importance of "region" in trade (Krugman(1991)). In Europe
where national boundariesbecame less important,regional factor gained importancefor multinationalenterprisesin their choiceof productionsites (Yamawaki,Barbarito
andThiran(1998)).This "regional"or "agglomeration"effectis alsoobservedin Japanese firms. Accordingto Head, Ries and Swenson(1995), Japanesefirmspreferredto
locate their manufacturingaffiliatesin the regionwhere Japaneseproductionhas "agglomerated."In order to capture the "agglomeration"effect,equation(2) also includes
CUMFDIt_ I /GDP t _1that is definedas the one-yearlaggedcumulativetotal of Japan's
FDI

to the hostcountry

scaledby hostcountry's

GDP.
I

In FDIt =aiIn RERt+ a2 InRERAt+ a3 InRLC`t+ a4 InCUMFDIt_i+ s` (3)GDPGDPtir

The sign of a3 is expected to be positive since the rise in Japanese per capita income
relative to host country's income motivates Japanese manufacturing firms to shift theirproduction location to save the cost of production (Ita (2000)). We expect positive signs
in a4 where "agglomeration" effect in East Asia accelerates Japanese FDI.
It is important to examine whether ASEAN regionalization affects the relationshipbetween RER and FDI. To capture the regional and time-specific effects, we introduced
two types of regional dummy variables: ASEAN4 and ASEAN4St

To capturethe ASEAN-specificregionalization
effects,ASEAN4`ttakes one for
ASEAN4 countries—Indonesia, Malaysia, the Philippines and Thailand—and zero forotherwise. ASEAN4St takes one for ASEAN4 plus Singapore and zero for otherwise.
ASEAN4`. is introduced in our study for two reasons. Firstly, we found very high crosscountry correlations in Japanese outward FDI to ASEAN countries for sample periodof 1979-2000 (Appendix Table 1). Cross-country correlation coefficients ranged from
0.504 in case of Malaysia and Indonesia, and to 0.871 in case of Thailand and Singapore. Such close link between Japanese FDI and the member countries reflects JapaneseSAZANAMI

ET AL.:

JAPANESE

FOREIGN

DIRECTINVESTMENTTO EAST

ASIA

15

firms' preference to locate affiliates in the ASEAN where they have built production
network generating the strong "agglomeration" effects.
Secondly, the recent emergence of China as a major industrial center in East Asia
is threatening ASEAN member countries' vested advantage in attracting Japanese FDI(Kuroda (2001)). China's joining the WTO can provide an opportunity for opening up
its potential domestic market to ASEAN countries. However, at the same time, ASEAN
countries must strengthen regional co-operation to compete with China in attracting
Japanese FDI. In our study, we try to investigate the level of statistical significancein the ASEAN dummy for different manufacturing industries—food industry, textile
industry, wood and pulp industry, chemical industry, precision machinery, general machinery, electrical machinery and transportation machinery—to assess the importanceof "regional" factor as a determinant of Japanese FDI outflow to the East Asian countries:i

InFDIr = a InRER, + az InRERAt+ a3 InRLCr
GDPi(4) CUMFDI+a4ln----------------t~~asASEAN4t
GDP'
+ et
t-l
and

InFDIr = al InRERt + a2 In RERAt+ a3 InRLCr
GDP `r
CUMFDI _(5)-}-a4ln-----------GDP
ittIasASEAN4St
+ et.
t–I

Data
The nominal exchange rates are annual averages expressed in local currency units
against the U.S. dollar (IMF (2001, line if)). Exchange rates of the East Asian currencies against the yen are obtained by applying the U.S. dollar against the Japanese yen.
For the tradable price-based deflator, we used producer price index or wholesale priceindex data, reported in IMF (2001, line 63). The Indonesian producer price index data
excludes petroleum products (IMF (2001, line 63a)). The Malaysian producer price index data are missing for number of years. The RER is computed based on equation (1)and normalized assuming the value in 1990 as 100.
Nominal FDI data is obtained from the website of the Japanese Ministry of Finance(http://www.mol.go.jp), and converted into dollars by applying annual average nominal
exchange rates in the respective years. In our regression analysis, we follow Bayoumi
and Lipworth (1998) in deflating real FDI by the GDP deflator. The nominal exchange
rate is based on IMF (2001, line if), except for Taiwan. For Taiwan, it is based on
the Taiwan Statistical Databook published by the Council for Economic Planning andDevelopment, Republic of China (2000). The GDP deflators are taken from the WorldBank (2001) except for Taiwan where the GDP deflator was from the Council for Economic Planning and Development, Republic of China (2000).

16

KEIO

ECONOMICSTUDIES

Relative labor cost is measured by taking the ratio between Japanese per capita GDP
to the host country's per capita GDP in 1995 prices. Per capita GDP in host countries
are from World Bank (2001). Taiwan's per capita GDP is taken from the Council for
Economic Planning and Development, Republic of China (2000). Although the International Labour Office (ILO) wage index is a more desirable wage index for our analysis,
the limited availability of data on East Asia made it difficult to use ILO wage index
in our estimation. FDI t, RLC`t, GDP it and CUMFDI `r are in 1995 prices. The basic
statistics of variables are summarized in Appendix Table 2.
3.2. Estimation results
Table 3, Table 4 and Table 5 show the estimated relationship between the RER andJapanese FDI outflows to East Asia (FDI/GDP) as in our benchmark model and alternative specifications. Feasible generalized least square estimation method was applied
to assess the statistical significance in all three tables.10 Table 3 includes dummy variable (RERA) which takes one for years after 1997 and zero otherwise to assess if policychange before and after Asian financial crisis had statistically significant influence on
the relationship between the RER and FDI/GDP. Table 4 introduces two independent
variables, relative labor cost (RLC) and the "agglomeration" variable (CUMFDI/GDP)in addition to RER. Table 5 aims to assess ASEAN regional effects dummy (ASEAN4
or ASEAN4S)in addition to RER, RERA, RLC and CUMFDI/GDP in attracting Japan's
FDI. Regressions in each table are applied to total FDI outflows, FDI in all industry,
manufacturing total and in manufacturing subsectors such as food, textile, wood andpulp, chemical, precision machinery, general machinery, electrical machinery and transportation machinery in Table 3, Table 4 and Table 5.
Estimation results of equation (2) are presented in Table 3. In Table 3, the coefficientsof RER are negative and statistically significant at 1% level in total FDI outflows as wellin total manufacturing FDI and FDI in manufacturing subsectors. These results are
consistent with the findings of Froot and Stein (1991). It is interesting to note that thecoefficients of RERA were found statistically significant only in precision machineryand electrical machinery at 1% level of significance. This result implies that the decline
in the RER attracts Japanese FDI to East Asia but the policy changes after the Asianfinancial crisis of 1997 did not have statistically significant effect on the relationshipbetween the two.
Table 4 shows the estimation results of equation (3). All the coefficients of RER
show the expected negative signs and are statistically significant. Similarly, the coefficients of CUMFDI/GDP are positive and statistically significant at 1% level in all the
10 Feasible generalized least squares (FGLS) are used when elements of the variance-covariance matrix ofthe disturbances are unknowns in a nonspherical disturbance model. FGLS estimator is obtained as follows.
Suppose that the generalized linear regression model is: y = X,3 + s, [Elx] = 0, E[ss'IX] = o-2S2, where
0 is a positive definite matrix but it contains unknown parameters. Let small set of unknown parameters,
0, satisfy S2 = Q(9). Suppose that 6 is a consistent estimator of 0. If we use 0 = (6) instead of Q, S2
is asymptotically equivalent to S2 because of plim6 = 0. Therefore, FGL estimator,
is obtained from= (X' Q —1x)— X' SI—ly. For more details, see Greene (2000).

TableAll industry (total FDI outflows)
In RER

3.

Regressions

Manufacturing

total

0.003

0.000

0.009

0.019

0.015

[0.68][0.10][0.02][0.42]-0 .063[0.87][0.57]

0.088[0.86][0.81][0.77][0.24]-0 .0392.71.307***[0.68]
161

161
.73

-230

115
-205

.5

2.89

2.71

.86

2.90

140

140

140

-235.81-235.48-267

machinery

.45
3.86

Precision

Transportation

machinery-1.683***-1 .936***-1 .958***-1 .808***-1 .862***-1 .884***-1 .858***[39.15][36.44][33.97]-0 .068***[35.52]-0 .009[36.18][34.66]0.010[37.10]-0 .057***[33.41]

0.008

0.004

0.034**[34.35]-0 .011[32.06]-0 .027[0.48][0.46]-0 .011[3.56][3.44][0.53][1.991[0.54][1.15]

n

0.079[0.17]-0 .075

0.152

Hz[ 1.04][1.05]-287.7-287.68

AIC

3.64

157
-267

3.66

157
.08

-266

3.43

1)

Feasible2)*** , **, * indicate

3)

AIC means

4

In RERA:In RER5)

For othernotes and sources,

generalized

leastsquaresstatistically

Akaike'ssignificant

Informationx Afterare used

the AsianCriteria
financial

see Appendix

156
-278

.98
3.44

156
.77

-278

3.60

for estimation.

Figuresin brackets

3.61

0.063***[3.08]-0.166**[2.23]

160.25

machinery

3.85-1.696***

159

Electrical-267

industry159

machinery

3.41

140
.47

-1 .921***[0.13]

General

3.40

4
rm
H

0.025

115

3.63

z

[0.28]-205.47

3.61

N-1 .919***

Trend

Notes:

0.015[1.73]-0 .080

In RERA

Log-L[28.92][1.02]

ChemicalN[31.32]0.024*AIC

In RER[39.11]

0.012

-230

and pulp in dustry[41.28][35.52]-0 .004.87

Wood[35.29][37.87]-0 .010161

industry[38.09][34.77]-214

Textile-2 .152***[36.62].1

industry-2.159***

-2

161

FDI.

-2.130***-1 .351***-216

Outward-2 .115***-1 .341***[1.52]

Rate on Japan's-2 .289***-1 .213***

Trend

Log-L

Food

-1 .194***

In RERAN

of Real Exchange

-279

160
.24

-277

3.52

means

crisis dummies,
Table

2.

142
.35

3.50

-256

142
.46

3.64

-255

Y
rri z to c to O z
H4
to z

.21
3.64

H
HO
mY

are t-values.

Hat the 1%, 5% and 10% level, respectively.
and Log-L[1.51]

log-likelihood.
whichtakes one if year > 1997and zero otherwise.

YTableIn RER

4.

Regressionsof Real Exchange

Rate on Japan's Outward

FDI with

Food

Relativeindustry

All industry (total FDI outflows)-0 .339***-0 .351***-0 .558***-0 .569***-1.044***-1 .051***[6.91][8.67][8.79]-0 .031[5.53][5.57]-0 .061

In RERA[7.00]-0.030

Manufacturing

total

Wag es and Afflomeration

00

Effects.
Wood

and pulp

industry

Textile industry-1 .323***-1 .320***-0 .983***-0 .983***[8.15][5.23][5.22]
0.024[8.08]-0.007In RLC

0.179***[0.90]
0.178***

0.238***[0.80]
0.236***

0.249***[0.81]
0.246***

0.362***[0.08]
0.359***

0.192**[0.29]
0.192*

In(CUMFDI/CDP)[4.18]
0.935***[4.16]
0.929***[5.00]
0.833***[4.98]
0.829***[2.94]
0.636***[2.90]
0.638***[4.38]
0.563***[4.31]
0.565***[ 1.96]
0.693***[ 1.96]0.690***

Trend[19.21]-0 .087***[19.01]-0 .083***[ 14.77]-0 .055***[ 14.76]-0 .050***[6.04]-0.061***[6.06]-0.053**[7.34]-0 .022[7.33]-0 .021[9.23]-0 .035*[9.15]-0 .038*[10.96]
Log-L

161-137 .92

AIC

1.76

N

[8.63]
161-137.51
1.77

Chemical industry-0 .988***-0 .987***

In RER[11.02]In RERA[ 10.99]
0.007[6.29]
161-166 .35
2.12
Precision[4.77]
161-166 .04[3.26]
140-221 .85

2.12

3.23

machinery

General[2.48]
140
-221

.51
3.24

machinery[ 1.07][0.88][ 1.82]

140

140

113

-243.68-243.71-172.81

3.54
Electrical

-172

.77

3.13

3.15

Oz

machineryO-0 .927***-0 .923***-0.578***-0.598***-0 .579***-0 .608***-1 .459***-1 .441***[9.78][9.50]
0.071[5.71][5.83]-0.061[7.48][7.60]-0 .077[ 10.48][ 10.24]
0.142*n

C7m

In RLC

0.235***[0.11]
0.235***

0.155**[1.14]
0.156**

0.339***[0.99]
0.340***

0.281***[ 1.46]
0.271***

0.485***[1.68]
0.489***

In(CUMFDI/GDP)[2.92]
0.738***[2.92]
0.737***[2.51]
0.597***[2.52]
0.591***[4.21]
0.920***[4.29]
0.918***[4.16]
0.853***[4.04]
0.839***[4.79]
0.431***[4.82]
0.426***

Trend[10.68]-0 .001[ 10.63]-0 .002[9.96]-0 .062***[9.76]-0 .071***[12.96]-0.067***[12.91]-0.057***[ 15.08]-0 .056***[14.70]-0 .044***[6.09]-0 .042**[6.03]-0 .059***

N

159

159

-252.41-252.4[0.06]
Log-L
AIC
Notes:

3.23

1)
2)
3)
4)

[0.11]

3.24

Ch
O
to

Transportation

3.55
machinery[ 1.72]113[4.44]
157-237 .45[4.23]
157-237 .29[5.05]
156-227 .59

3.08

3.09

2.97

Feasible generalized least squares are used for estimation. Figures in brackets are t-values.
*** ** , * indicate statistically significant at the 1%, 5% and 10% level, respectively.
AIC means Akaikc's Information Criteria and Log-L means log-likelihood.
For other notes and sources, see Appendix Table 2.

[3.54]-227[4.94]
160

156
.17
2.98

-213.39
2.72[3.13]
160-212 .69
2.72[2.31].92[2.80]
142-232 .55

3.35

3.35

142
-233

SAZANAMI

ET AL.: JAPANESEFOREIGN

DIRECTINVESTMENTTO EAST

ASIA

19

estimations. Such results suggest that Japanese firms try to locate affiliates in East Asia
to enjoy the advantages of "agglomeration". All coefficients of RLC are positive andstatistically significant except in wood and pulp and in precision machinery industries.
The result supports previous study as Ita (2000), namely a rise in Japanese labor costs
relative to East Asian labor costs promotes Japanese FDI from cost conscious Japanesemanufacturing firms.
As for the coefficients of RERA, we found statistical significance only in the transportation machinery industry at the 10% level of significance. After controlling the effects of relative labor costs and agglomeration, the impacts of Asian Crisis are vanishedin precision and electrical machinery industries. This result implies that the impacts of
the Asian financial crisis on Japan's FDI are negligibly small in almost all the industries.
Estimation results of equations (3) and (4) are shown in Table 5. From this table,
we find that the coefficients of RER are negative and their level of significance range
between 1% and 5% in total FDI and in total manufacturing FDI as well as in its subsectors. Among the variables included in the regression, the coefficients of CUMFDI/GDP
are positive and show 1% level of significance in all the estimations. The coefficients of
RLC are positive and show 1% level of significance in total manufacturing, food, textile,
general machinery, electrical machinery and transportation machinery.
Regional effects by industries are estimated by adding ASEAN4S and ASEAN4 to theregressions. Regional dummies are positive and have statistically significant influence
on increasing Japanese FDI in manufacturing total, food and general machinery industries. In precision machinery, and wood and pulp industries, the coefficients of ASEAN4and ASEAN4S show statistical significant positive signs. In all industry, chemical industry and electrical machinery industry, the coefficients of ASEAN4S are positive andstatistically significant. On the other hand, the coefficients of ASEAN4 are positive andstatistically significant in transportation machinery while negative and statistically significant in textile industry.
The coefficients of RERA are statistically significant only in transportation at 10%
level of significance. Such results suggest policy changes at the time of the Asian financial crisis did not give statistically significant influence on Japanese FDI to East Asian
industrial subsectors except for transportation industry at a low significant level.

4.

SUMMARY

OF OUR FINDINGSAND RELATEDPOLICYISSUES

Our estimation results on Japanese FDI to East Asia for total FDI, total manufacturing
FDI and FDI in manufacturing subsectors are consistent with previous studies that find a
decline in the RER increase FDI. In addition, accumulated total of Japanese FDI relative
GDP of East Asian countries (CUMFDI/GDP) reflecting so-called "agglomeration effect" have statistically significant positive effect on Japanese FDI in all the estimation.
The finding implies that while the high rates of growth in Japanese FDI to East Asia
as experienced in the early 1990s to build Asian production networks promoted further increase in annual outflow from Japan, any downturn can lead to slowdown in theTableIn RER

5.

Regressionsof Real Exchange

Rate

on Japan's

Manufacturing

Outward

FDI: Regional

Effects.

total

Food industry

All industry (total FDI outflows)-0 .468***-0.347***-0.360***-0.454***-0 .543***-0 .553***-0 .620***-0 .628***-0 .940***-0.948***-0.909***-0.921***[6.94][8.04][8.13]-0 .032[6.97][7.05]-0.028[4.27][4.30]-0.059[3.34][3.37]-0 .059

In RERA[7.03]-0 .030[7.67][7.83]-0 .033

In RLC

0.143**[0.91]
0.143**

0.084*

In(CUMFDI/GDP)[2.28]
0.915***[2.28]
0.908***[ 1.65]0.809***[1.03]
0.081[1.59]
0.802***[16.79]0.106[16.61]
0.106[13.19][13.12]ASEAN4[0.80][0.81]

0.270***[0.83]
0.269***[4.31]
0.856***[4.33]
0.853***[13.19]-0 .108[13.17]-0 .111[0.74][0.76]

0.209***[0.71]
0.207***[3.72]
0.779***[9.90][3.71]
0.776***[9.88]

0.306***[0.80]
0.302***[3.20]
0.695***[5.73]-0.246[3.15]
0.698***[5.75]-0 .239[1.04][1.01]

ASEAN4S

0.375***

0.376***

0.140

0.138

Trend

[3.26]-0.078***[3.32]-0.072***[0.92]-0 .051***[0.91]-0 .046***-0 .067***

N
Log-L
AIC
In RER-0 .087***-0.082***[ 10.82]161[8.51]
161
137.241.78

1.77-1 .003***[9.07][9.14]
161-133 .74
1.72

Chemical industry-1 .002***-1 .331***

1.73[6.41]
161
166.022.12-0 .051***[4.85]
161-165.69[5.45]
161-166.58[4.18]
161[3.27]
140

2.13

2.13

2.14

3.23

Precision-1 .055***-1 .051***-1 .179***-1.193***-0.579***[8.34][8.28]
0.093[7.48][7.45]
0.090[5.75]In RLC0.229***[0.12]
0.229***

0.167*[9.68]
0.022[0.34]
0.168*

In(CUMFDI/GDP)[2.59]
0.729***[2.59]
0.728***[ 1.80]0.555***[1.81]
0.552***[0.79]
0.509***[8.86]
0.042[8.79]
0.043[0.20][5.80][5.76]

ASEAN4[6.26]
0.453*[0.73]
0.501***[6.20]
0.491 *

[ 1.77][1.89]

0.696***

0.702***[0.20]

N
Log-L
AIC

0.000

-0.001[0.00]
159[0.07]
159-252 .41
3.25

3.24

machinery-1 .330***[9.07]
0.007

ASEAN4S[9.69][7.17]
161-0 .056***

In RERA

Trend

N
O

0.065

[2.90]
0.015[2.92]
0.011-0 .056***[0.96]
159-252.04[0.62]
159[3.86]
157

3.23

3.25

3.08

[ 1.46]0.061-0 .068***[3.95]
157-236 .07
3.08-0 .059**[2.57]
140-220 .66
3.24[2.91]
0.703***[0.79]
0.277***[2.86]
0.703***[4.89][4.89]-0 .188[0.69]-0.070***-0 .1810.282***[3.09]
140-221 .58
3.24

General machinery-0 .547***-0.598***[5.86]-0 .063[4.55][0.66]-0.061**[2.46]
140
3.25[4.70]-0 .063[1.02]
0.361***[2.40]
0.484***[5.78][5.49]

0.500**

0.537**-0.106-0 .114[2.20]-0 .061***[0.55]-0 .068***[0.60]-0 .058***

0.417***[4.53]
0.929***[ 13.09]-0 .306[ 1.48][2.07]-0 .051***[3.46]
157-235 .73
3.07[3.55]
157-235 .26
3.07

0z
O

-0 .566***[ 1.43]0.151**[2.39]
0.467***

0.152**

tri0
tri[1.04]
0.415***

0.359***[4.65]
0.927***[4.06]
0.938***[13.05]-0 .305[1.51][11.60][4.17]
0.937***[11.67]-0.067***-0 .057***[5.03]
156[3.52]
156[5.01]
156-227.45[3.53]
156-226.99

2.97

2.98

2.98

2.99

C7
to

Y

Textile-1 .159***

in RER[6.42]In RERAIn RLCl n(CUMFDI/GDP)
ASEAN40.436***[5.30]
0.636***[7.64]-0 .568**[2.14]-1 .159***[6.40]-0 .032[0.40]
0.431***[5.17]
0.639***[7.62]-0 .569**[2.13]

ASEAN4S
Trend-0.035-0.030N[1 .62]140[1.23]
140-241 .21
3.53-241.28

Log-L

industry-1 .189***[5.82]-1 .188***-1 .175***[5.35]

0.386***[4.52]
0.617***[6.76][5.80]-0 .009[0.11]
0.383***[4.44]
0.618***[6.74]-0.307-0.306[1.08]-0 .032[1 .43]
140
243.1
3.54

[1.07]-0 .031[1.21]
140-243.14
3.56

0.123[1.19]
0.610***[6.81]
0.450*[1.65]-0 .028[1.44]
113-171.53
3.12

Wood and pulp industry-1 .174***-1 .266***-1 .264***[5.47][5.34][5.46]
0.020
0.026[0.24][0.32]
0.123
0.153
0.152
[1 .18][1.60][1.58]
0.608***
0.581***
0.579***[6.78][6.34][6.30]
0.449*[1 .65]0.553**
0.553**[2.06][2.06]-0 .031-0 .029-0 .032[ 1.38][ 1.50][1.46]
113
113
113-170 .87-170 .82-171 .49
3.14
3.11
3.13

AIC

3.52

In RER-0.566***-0.599***-0.650***-0.681***-1.580***-1.574***-1.527***-1.524***[7.25][7.43]-0.075[7.83][7.86]-0 .076[ 1.45]0.251***[3.73]
0.809***[13 .84][10.25][9.14]

0.354***[2.82]
0.353***[4.22]
0.505*[1.68][10.20]0.149*[1.80]
0.347***[2.75]
0.339***[4.06]
0.539*[1.81][9.10]
0.147*[1.75]
0.438***[3.76]
0.380***[4.36]-0.032*-0.049**0.208[0.72]-0.037**0.253[0.88]-0.054**[ 1.73]142-232 .83
3.35[2.34]
142-231 .27
3.34[1.97]
142-233.69
3.36[2.51 ]
142
-232.2
3.35

Electrical

In RERAIn RLCl n(CUMFDI/GDP)
ASEAN40.237***[2.94]
0.853***[ 1 .43]0.235***[2.98]
0.840***[15.18]0.192[1.08][14 .78]
0.168[0.95]-0 .058***-0 .046***

ASEAN4S
Trend[5.04]
160

N

-212

Log-L
AIC

Notes:

.85
2.72

1)
2)

[3.21 ]
160
-212

.26
2.73

machineryTransportation

0.261***[3.86]
0.822***[14 .24]

0.329**[2.40]-0 .054***[4.75 ]
160
-210 .64
2.70

0.326**[2.31]-0.042***[2.93]
160-210 .09
2.70

N
z
4
Ch H

z to
v, m
C
to

machinery

0.444***[3.83]
0.393***[4.52]

z
C7
7d Ch
C] H
z
m JD
H
4
to
zH
0
hi Y
H

Feasible generalized least squares are used for estimation. Figures in brackets are t-values.
*** , **, * indicate statistically significant at the 1%, 5% and 10% level, respectively.
3) AIC means Akaike's Information
4) ASEAN indicates ASEAN-4

Criteria and Log-L means log-likelihood.

(Indonesia,

Malaysia,

5) For other notes and sources, see Appendix Table 2.

the Philippines and Thailand) dummy variable while ASEANS indicates ASEAN-4

plus Singapore dummy variable.
lv

22

KEIO

ECONOMICSTUDIESfollowing years. Hence the slow recovery of Japanese FDI to ASEAN after the financial crisis may be due to this negative "accumulative effect". Dummy variable (RERA)
introduced to distinguish policy changes before and after the financial crisis was notstatistically significant in FDI in all industry, in total manufacturing as well as in mostof FDI in manufacturing subsectors. Theses findings are consistent with the stability wefind in FDI inflow to East Asian countries at the time of the financial crisis. Indeed, FDI
was the only item in private capital flows to the East Asian that was positive in 1997
(Institute of International Finance (1998)).
As noted earlier, the World Bank (2002, p. 39, Box 2.2) finds that out of the ten largest
FDI recipients, seven are also developing countries with the largest exports. Based on
our findings in the previous sections, we highlight a number of policy issues related
to the re establishment of trade and exchange rate regimes that will help to attract FDI
and promote export-oriented growth in the East Asian countries, and in ASEAN in
particular.
The recent surge of Japanese FDI to China and Hong Kong motivated the ASEAN
member countries to strengthen their industrial ties by accelerating the formation of theASEAN Free Trade Area (AFTA).11 They try to lower infra-regional trade barrier byreducing tariffs to 5% for the initial ASEAN member countries by 2002, for Vietnam by
2003, for Laos and Myanmar by 2005 and for Cambodia by 2006. The tariff reduction
will help to rationalize productions fragmented within the ASEAN members. In order toassess the regional effect in attracting Japanese FDI, we introduce the ASEAN4 dummythat includes Indonesia, Malaysia, the Philippines and Thailand and the ASEAN4 plus
Singapore dummy to capture the "entrepot center" effects of Singapore in the ASEAN
region. The ASEAN4 plus Singapore dummy gave better results than the ASEAN
dummy showing a positive and statistically significant influence in attracting Japanese FDI to East Asia. The ASEAN4 plus Singapore dummy is positive and statisticallysignificant at 1-5% level in total FDI and in chemical, precision and electrical machinery industries. On the other hand, ASEAN4 dummy is statistically significant in textile
industry at 5% level, but statistically significant in wood and pulp, precision machineryand transportation machinery industries only at 10% level of significance. Our estimation results show the importance of regionalization in East Asia in terms of reducing
infra-regional trade barriers in helping to increase Japanese FDI inflows.
The financial crisis of 1997 taught us the lesson, that the other important regional
policy to attract Japanese FDI to AFTA is regional exchange rate arrangements thatwill jointly avoid misalignment and excessive volatility of their currencies against both
the dollar and the yen. If AFTA aims to promote infra-ASEAN trade and to build
united regional market with 500 million inhabitants, exchange rate arrangements thatto stabilize exchange rate movements within the region will become necessary. Our
study finds that the ASEAN member countries' officials may be fully aware of theimportance of managing exchange rates after the financial crisis. In spite of the diversity
See, Box.2.3 Round-tripping
41)).

of capital flows between China and Hong Kong (World Bank (2002, p.

Cl)
>
N
YZ
a4
CTI
H
Appendix

China

Table

Korea

1.

Cross-country

Hong

Kong

Correlations

Taiwanof Japan's

OutwardSingapore

FDI between

1979 F/Y and 2000

Indonesia

Malaysiar"

F/Y.

The Philippines

1.000

Korea

0.339

1.000

Hong Kong

0.395

0.530

1.000

Taiwan

0.456

0.726

0.646

1.000

Singapore

0.567

0.503

0.650

0.538

1.000

Indonesia

0.571

0.037

0.223

0.216

0.529

1.000

Malaysia

0.546

0.352

0.660

0.572

0.717

0.504

1.000

The Philippines

0.830

0.487

0.417

0.421

0.684

0.616

0.627

1.000

0.416

0.635

0.565

0.871

0.600

0.790

0.734

0.600

Thailandand sources,

see Table

YY
zm

China

For notes

Thailand

m
~n
0 X)
CV
0Z
C'
n
H

1.000

zC
m
H4

1.

z
H0
rrl
H
a
a

N
Cl)

Appendix
Basic

Table

2.

Basic Indicators

and Correlation

Matrixof Variables.

indicators

l n(FDI/GDP)=1 n(FDI/GDP)
In(real exchange rate)=lnRERInRERxCrisis
Dummy=In RERA
In(relative labor cost)=lnRLCIn(cumlative FDI/FGDP)=In(CUMFDI/GDP)
ASEAN4N
189

Mean-5 .515

1.247

Min.
-11 .251Max.
-2 .773

161

4.601

0.200

4.047

5.232

161

0.640

1.575

0.000

4.741

189

2.489

1.324

0.470

5.132

188

-3 .665

1.427-9 .473-1 .542

189

0.444

0.498

0.000

1.000

ASEAN4S

189

0.556

0.498

0.000

1.000

Trend

189

11.000

6.071

1.000

21.000In RERIn RERAIn RLC1.000-0 .230

1.000

Correlation

Sources:

S.D.

O
m

matrixl n(FDI/GDP)In RERIn RERAIn RLCIn(CUMFDI/GDP)
Trend
ASEAN4ASEAN4S
Notes:t^.)

In(FDIGDP)
1.000
0.069
0.030
0.179
0.708
0.160
0.519
0.134

0.200
-0 .274
0.209
0.231-0.705l n(CUMFDI/GDP)

Trend

ASEAN4ASEAN4S0z
0(')-0 .1270.249-0 .066-0 .068
0.580

1.000
-0 .4240.601
0.240-0 .171

17

1.000
0.010

1.000

0.342

0.768
-0 .085

0.558

1.000
-0 .118

FDI: Japanese outward FDI to each country (1995 prices).
GDP: Foreign partner country's GDP (at 1995 prices).
RER: real exchange rate.
RLC: Japanese per capita GDP relative to each country's per capita GDP (at 1995 prices).
CUMFDI: cumulative value of Japan's outward FDI (1995 prices).
ASEAN4: ASEAN-4 (Indonesia, Malaysia, the Philippines and Thailand) dummy variable that takes one if host country and zero otherwise.
ASEAN4S:ASEAN-4 plus Singapore dummy variable that takes one if host country belongs to ASEAN-4 or Singapore zero otherwise.
World Bank (2001) WorldDevelopment Indicators [CD-ROM], Washington D.C.: World Bank.
Council for Economic Planning and Development (2000) Taiwan Statistical Databook, Council for Economic Plannning and Development, Republic of China.
International Monetary Fund (2000) International Financial Statistics [CD-ROM], Washington, D.C.: IMF.
Ministry of Finance (2000) http://www.mol.go.jp/Icoo8.him (accessed date 12/24/00)

1.000

SAZANAMI

ET AL.: JAPANESEFOREIGN

DIRECTINVESTMENTTO EAST

ASIA

25

in the ASEAN member countries' exchange rate regimes introduced after the Asiancrisis, our study finds that while the exchange rate regime for the rupiah, the won,
the peso and the baht have become more flexible after the financial crisis, they are
managed to avoid the over valuationof their RERs against both the dollar the yen after
they have adjusted their exchange rates between July 1997 and December 1998. In
addition, the cross-correlation coefficients of East Asian RER against the dollar areeven higher after the financial crisis than before. We also found that the correlation
coefficients of RER against the dollar between Singapore and other ASEAN members
are higher than those between Korea and ASEAN members. Such findings suggestthat the East Asian countries are substituting a de facto dollar pegged exchange rate
regime before the financial crisis to what can be named as "a de facto dollar coordinatedexchange rate regime" with "managed flexibility" as advocated in Nicolas (2002). Thechange helps to achieve the stability of the RER of the East Asian countries not only
against the dollar but also between the regional currencies, which in turn help to promote
Japanese FDI outflows to East Asia.
REFERENCES

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Beng, Gan-Wee (2000) "Exchange-rate Policy in East Asia after the Fall: How Much Have Things Changed?"
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Corden, W. Max (2001) " 'Developing Countries' Choice of Exchange Rate Regimes," IMF Survey, 30(3):44-46.
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Froot, Kenneth A and Jeremy C. Stein (1991) "Exchange Rates and Foreign Direct Investment: An Imperfect
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Lessons from the East Asian Crisis," International Economy, Screening Series 7: 65-108.
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Krugman, Paul R. (1991) Geography and Trade, Cambridge, MA: MIT Press.

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ECONOMICSTUDIES

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