Protectionism and Japanese direct investment in the United States

NORTH- HOLLAND

P ~ t e e ~ o ~ m and Japanese Direct Investment in the United States Paul Azrak, Queensborough Community College, CUNY Kevin Wynne, Pace University This paper generates predicted probabilities of the International Trade Commission's affirmative decisions in Japanese dumping cases to determine its influence on the level of direct investment in the United States. The empirical results suggest that Japanese direct investment in the United States is influenced by the state of the economy and the likelihood of protectionist action. These results lend credence to the internalization theory of direct foreign investment and have direct implications for U.S. commercial policy.

1. INTRODUCTION "The company [Brother Industries Ltd.] admits that it moved to Tennessee chiefly to avoid dumping charges" (Sanger, 1991). This commentary provided the impetus for the central inquiry of this empirical study. That is, has U.S. antidumping policy with respect to Japan created a direct correlation between protectionism and direct foreign investment? One of the traditional explanations for a firm's willingness to produce abroad is the avoidance of trade barriers erected in the foreign nation. Japanese direct foreign investment (JDFI) in the United States increased from the insignificant levels of the early 19708 to a cumulative $97 billion by the end of 1992. In recent years approximately half of the annual inflow of direct investment from Japan has gone into the U.S. manufacturing sector. 1 While a wide range of factors have contributed to this increase, the principal query of this paper is whether the avoidance ~Although overall JDFI as reported by the Department of Commerce (DOC) includes direct investment in areas as diverse as banking, real estate, and mining, this paper will concern itself solely with the Japanese presence in the area of manufacturing. Address correspondence to Prof. Paul Azrak, Queensborough Community College, City University of New York, Department of Social Sciences, 222-05 56th A venue, Bayside, N Y 11364. Received June 1994; final draft accepted December 1994.

Journal of Policy Modeling 17(3):293-305 (1995) © Society for Policy Modeling, 1995

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of U.S. protectionist measures from 1976 to 1992 played a role in the decision of Japanese manufacturing firms to invest in the United States. The difficulty of quantifying protectionism has been the subject of much research in recent years. The replacement of tariffs and quotas with non-tariff barriers to trade (NTBs) during the era of the new protectionism led American firms to utilize escape-clause, countervailing-duty, and antidumping statutes to gain protection from the perceived unfair trade practices of its foreign rivals. Over the long run, U.S. firms have principally chosen to employ antidumping laws as a means of obtaining protection from alleged unfair Japanese competition. More antidumping petitions have been filed and antidumping duties imposed against Japanese firms over the past 17 years than against any of America's other trading partners. The purpose of this paper is to ascertain whether or not requests for protection and/or the subsequent granting of protection from dumping have influenced the level of JDFI in the U.S. Lee (1984) presents a survey of macroeconomic theories used to explain recent Japanese direct investment. The debate over causation generally centers around whether Japanese investment is triggered by microeconomic or macroeconomic factors. Because much of Japan's early Asian investment pointed to its comparative disadvantage in the area of natural resources, the macroeconomic (or location-specific) approach seems an appropriate explanation. However, more recent North American investment appears to have been motivated by firm-specific factors. Kim and Lyn (1990) find that Japanese multinational corporations (MNCs) tend to be more research-and-development and advertising intensive than their Canadian and European counterparts that invest in the United States. This would be in keeping with the internalization theory of direct foreign investment, which states that MNCs often attempt to internalize a firm-specific advantage or overcome market imperfections by establishing a subsidiary abroad. This view is supported in empirical studies by Horst (1972) and Grubaugh (1987). Rugman (1985) has argued that all other theories of direct investment are simply subsets of internalization theory. For instance, the intangible capital hypothesis (Caves, 1974) claims that firms often possess some intangible advantage, be it managerial, marketing, or production related, that aids them in overcoming market imperfections. Rugman claims that this is just another aspect of internalizationinstead of licensing or selling this advantage, they keep it within the firm's subsidiary. In the current case, Japanese firms would be

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internalizing the market imperfection created by existing or perceived protectionist sentiment. The Japanese MNC would, therefore, circumvent and internalize this imperfection through direct investment. It is not our intention in the empirical portion of the study to address firm-specific variables, but rather to take an aggregate approach to JDFI. The previously mentioned difficulty of quantifying protectionism and its causes has been the subject of empirical studies that take diverse paths to identify the factors that produce protectionist activities. Once again, the literature is divided between microeconomic and macroeconomic perspectives. Herander and Schwartz (1984) and Hartigan, Kamma and Perry (1989) took a firm-specific track toward the causes and effects of antidumping policies, while Takacs (1981) and Salvatore (1987) took a macroeconomic approach to the subject of escape-clause cases. Herander and Schwartz examined the impact of industry-specific factors on the filing of antidumping petitions and the affirmative material-injury decision by the International Trade Commission (ITC). Takacs chose to test the influence of aggregate cyclical activity and U.S. trade competitiveness on the frequency of escape-clause petitions and the granting of import relief by the president. Heitger and Stehn (1990) addressed the influence of tariffs on Japanese direct investment in Europe and found a significant positive relationship. This paper departs from previous studies of protectionist action and direct investment because of its measurement of the effect of antidumping policy on the decision to invest. Specifically, the probability that an antidumping tariff will be imposed on a Japanese industry is used to measure the impact of U.S. commercial policy on JDFI in the manufacturing sector. Over the 17-year period under investigation in this study, U.S. firms have filed an average of five petitions per year complaining of Japanese dumping. These requests for protection have led to protectionist action in 63 percent of the cases. While voluntary export restraints have been important in American and Japanese managed trade in autos, steel, and machine tools, antidumping duties have been imposed on a major cross-section of manufacturing industries. At the two-digit Standard Industry Classification Level, 14 of 20 manufacturing industries have been affected by antidumping duties. Currently, there are approximately 50 antidumping duties affecting the flow of Japanese goods into the U.S. 2 2Calculations are based on data received from the ITC.

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It would seem consistent with internalization theory that the sheer magnitude of antidumping activity would create an incentive for Japanese MNCs to bypass these obstacles and directly invest in the United States. In the following section we present the methodology used to investigate the impact of U.S. antidumping activity on JDFI from 1976 to 1992.

2. M E T H O D O L O G Y In order to test the central hypothesis that JDFI has been responsive to U.S. protectionist pressure, a two-step approach is utilized. The first equation portrays the decision by the ITC in cases involving alleged Japanese dumping in the United States. This is a logit estimation with a binary dependent variable, AFFIRM, representing whether or not the commission reached a final affirmative material injury decision in a given quarter. AFFIRM will assume the value one in those quarters where a petition that was filed led to an affirmative decision and zero in quarters where either no petition was filed or a petition filed led to a negative decision. The date that a petition was filed was used for the data on the dependent variable. This is in keeping with the work of Takacs (1981) and Harris and Wynne (1989). Once a petition complaining of dumping is filed, this triggers a simultaneous investigation by the DOC and the ITC. The DOC decides whether dumping is indeed taking place while the ITC determines whether a domestic industry has been injured or threatened with injury because of the d u m p e d goods. This paper is principally concerned with the ITC's final decision and the subsequent imposition of an antidumping duty. The use of ordinary least squares (OLS) with a limited dependent variable leads to the twofold problem of heteroskedastieity and estimated probabilities that lie outside the zero to one range. 3 In order to overcome the shortcomings of the OLS estimator, the logistic distribution is assumed and the m a x i m u m likelihood estimator is employed. The logistic distribution is an exponential function given as: p/--.-- 1 1 + e-zi

3For a detailed discussion of the properties of qualitative response models, see Amemiya (1981).

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where P~ is the probability of the ith observation and zi = ao + [3~'i. The estimated probabilities will, therefore, be obtained from: log IP l _ ~ p ~ ] = a 0 + ~ l ~ ( , +

e,

where ¢to is a constant, [3i are the u n k n o w n parameters, X~ are the independent variables, and ei is the error term. The above formulation will yield predicted probabilities that lie between zero and one and avoid the problem of heteroskedasticity inherent in the OLS estimator. The ITC's affirmative decision can then be modeled as a function of aggregate determinants and written as: AFFIRM~ = f(D,, M~, U~)

(1)

where Of /OD~ < O, Of /c~M~> O, Of /OUi > 0, and the independent variables are defined as: • D, = the growth rate of the real Gross Domestic Product from one quarter prior to one quarter after a petition is filed • M~ = the growth in the dollar value of Japanese imports into the United States over the four quarters prior to a petition being filed • U, = the unemployment rate in Japan at the time a petition is filed The above function is a logit estimation where the results represent the predicted probability that the ITC reaches an affirmative material injury decision? The predicted probabilities will be used to determine whether or not the possibility of the ITC reaching an affirmative decision will have an effect on the level of Japanese direct investment in the United States. Measures of cyclical activity and international competitiveness in the United States were tested to ascertain their influence on the decision-making process. The growth of the real gross domestic product (D) in the period encompassing the time that an investigation takes place captures the effect of the state of the U.S. economy. It should be inversely related to the probability of a positive decision. Japanese import penetration, M, should impart a positive 4It should be noted that while technically the estimation will yield the log of the odds that the dependent variable takes its higher value (1), the computer program used for this paper (Statistical Software Tools, 1992) computed the probability that the dependent variable takes the higher value. This makes for a straightforward interpretation of the estimated probabilities-that is, the probability of an affirmative ITC decision.

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influence on AFFIRM; that is, as the ITC witnesses a relatively rapid influx of imports from Japan, the greater the probability that a U.S. industry has been or will be injured. In addition to these domestic influences, published reports of ITC investigations indicate that the commission implicitly considers economic conditions in the country of origin to see if conditions may be conducive to dumping. Thus, this led to the inclusion of the unemployment rate in Japan (U) as an explanatory variable. It is assumed that the higher the unemployment rate in Japan, the greater would be the probability of an affirmative decision. 5 This would be indicative of the theoretical notion of persistent dumping that takes place in order to maintain domestic production and employment levels. The dependent variable of the second equation represents the natural log of quarterly inflows of JDFI (lnJDFl) exclusively in manufacturing. 6 The predicted probabilities generated in the first equation (PR) are used as an explanatory variable to determine their influence on Japanese investment in the U.S. manufacturing sector. Japanese direct investment in the United States is modeled as a function of: lnJDFIi = f(UNi, P . P R . EXi)

(2)

where, Of/OUNi < 0, Of/OPi > O, Of/OPRi > 0, Of/OEX~ < 0, and the independent variables are defined as:

• UN~ = the unemployment rate in the U.S. in the current quarter • Pi = the number of antidumping petitions filed against Japanese firms in the year preceding the current quarter • PRi = the predicted probability of an affirmative ITC decision • EX~ = the real yen to dollar exchange rate The unemployment rate, UN, is used as an indicator of cyclical economic activity. It is hypothesized that Japanese MNCs would be more willing to acquire, build, or otherwise invest in manufacturing facilities and firms during a period of expected economic expansion. 5There is a fine line between analyzing the decision of the ITC and the decision of Japanese firms to dump. This model specification is established to examine the ITC's decision-making process and not that of Japanese firms. The factors influencing these decisions, however, are clearly related. A linear transformation of the capital flow data obtained from the Bureau of Economic Analysis of the DOC was performed because of an exponential increase in JDFI during the 1980s. In addition, some of the quarterly data represented capital outflows. It was never the intention of the paper to explain these outflows, just the capital inflows.

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Two measures of protectionist sentiment are included to determine the influence of both the demand for and the supply of protection. As outlined above, P is the number of antidumping petitions filed with the ITC for the year preceding the quarter in which a case is initiated. As such, this variable represents to Japanese firms an indication of protectionist activity in the United States. The greater the demand for protection, the more likely Japanese MNCs may decide to produce in the United States rather than risk a hostile response to their exports. The estimated probabilities of an affirmative decision, PR, is an alternative indicator of protectionist sentiment. While P represents protectionist pressure, PR represents the probability that protection will be granted. A Japanese firm contemplating direct investment in the United States would surely be cognizant of this expectation when analyzing their investment decision. In times of a high probability, the Japanese firm may decide to internalize this market imperfection through the establishment of a U.S. subsidiary. This is one of the major thrusts of the paper, and it is expected that PR will have a positive effect on JDFI. Foreign firms making a long-term commitment to direct investment must also consider the cost-effectiveness of producing abroad. The expected yen-to-dollar exchange rate will shed some light on the future buyin~ power of the yen. 7 While the inclusion of an exchange-rate variable may seem more appropriate in a portfolio investment model, the long-term appreciation of the yen has certainly reduced the cost of dollar-denominated real investments. This appreciation has also created an expectation of continued increases in purchasing power for Japanese MNCs. As presented in this model, the real exchange rate in the current quarter represents an expectation by Japanese firms at the time the decision was made to directly invest in the United States. As the yen appreciates against the dollar (fewer yen to the dollar), this should spur more investment and a negative relationship with JDFI. The inclusion of the real exchange rate variable (EX) causes econometric problems because of its collinearity with other independent variables. To correct this problem, the real exchange-rate variable was purged of its shared information with the other independent variables. Following an approach used in asset pricing models to isolate industry effects from market effects, we regress 7The real exchange rate is defined here as the nominal yen-to-dollar exchange rate times relative consumer price indexes.

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the independent variables on the real exchange rate. Allowing Zi = [UN. P~, PRi}, we can generate the residual of the exchange rate, EX~*, from the equation: E X , ~ = EX~ = (a + ~[~iZt)

where, under normal conditions the correlation coefficient, P
where 1 is the first eigenvalue and p is the last eigenvalue in the data series. K = 1 implies orthogonality, and as K approaches infinity, exact multicollinearity exists. K is equal to 1.450 for Equation 1 and 1.751 for Equation 2. These results show nonorthogonality, but do not suggest that a problem of collinearity exists. A parallel test is to determine if the last eigenvalue of a series exceeds 1/6, where 8 is the number of regressors. Both models exceed this critical value and support the results that were obtained by the condition number K.

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Table 1: Principal Component Analysis Eigenvalue

Proportion

Cumulative

Equation

1

1.396 0.940 0.664

0.465 0.313 0.221

0.465 0.779 1.000

Equation

2

1.716 1.015 0.709 0.560

0.429 0.254 0.177 0.140

0.429 0.683 0.860 1.000

3. EMPIRICAL RESULTS The regression results from the first equation are presented in Table 2. All the independent variables are of the hypothesized sign and all are significant explanatory variables. The general state of the economy (D) proved to be a meaningful influence on the probability of an affirmative decision. The growth rate of Japanese imports (M), while not as strong, also impacts the ITC's decision. Likewise, the unemployment rate (U) also has an affect on AFFIRM. It will be recalled that the ITC implicitly considers conditions in the foreign nation accused of dumping. The degree to which U is significant - at the 99-percent l e v e l - suggests a positive influence on the decision-making process. As for the overall predictive strength of the regression, two measures of goodness of fit are often applied to logit models: the percentage correctly predicted and the likelihood ratio test (LRT). Table 2: Regression Results Equation 1, Dependent Variable: AFFIRM Independent variable Constant Db U~ Mc

Estimated coefficient

Standard error

t-Statistic

- 4.835 - 0.448 2.244 0.028

2.169 0.208 0.940 0.018

- 2.229 - 2.152 2.386 1.516

Number of observations Log likelihood Percent correctly predicted Chi-squared

68 - 41.75 72.06 9.82 b

adenotes 99% significance, bdenotes 95% significance, Cdenotes 90% significance (onetailed test).

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Table 3: Regression Results Equation 2, Dependent Variable: Independent variable Constant UN~ /x PR b

E X TM

lnJDFI

Estimated coefficient

Standard error

t-Statistic

5.640 -0.410 0.121 1.967 -0.014

1.149 0.136 0.076 0.861 0.003

4.910 -3.004 1.586 2.285 -4.550

Number of observations R-squared Adjusted R-squared Durbin-Watson statistic F-statistic

58 0.53 0.49 1.87 14.88 a

adenotes 99070 significance, bdenotes 95°70 significance, Cdenotes 90% significance (onetailed test).

Because the actual share of observations on the dependent variable that were equal to one (an affirmative decision) was 56 percent, the 72 percent correctly predicted indicates that the model has predictive power. This is supported by the LRT, which approximates a chi-squared distribution. The LRT that was used here is: - 2[in(MLc)

-

ln(MLu)l

where ln(MLc) is the maximum of the log-likelihood function in the constrained version, and ln(MLu) is the maximum of the loglikelihood function in the unconstrained version) The chi-squared statistic, evaluated at k-1 degrees of freedom, where k equals the number of independent variables, is significant at the 95-percent confidence level. Table 3 contains the results of the second regression. All the estimated coefficients are the correct sign. The measure of cyclical activity, the exchange rate, the number of petitions filed, and the predicted probabilities all played a significant role in determining JDFI. Two explanatory variables, UN and EX*, were significant at the 99-percent level. Clearly, a growing U.S. economy and the long-term appreciation of the yen encouraged greater Japanese direct investment. To a lesser degree, P also influenced the Japanese SThe constrained version is computed by setting the independent variables equal to zero and maximizing the log-fikelihood function.

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firm's decision-making process. Although the number of requests for protection (P) was not as strong an influence as the predicted probabilities (PR), the dual impact of these variables supports the contention that Japanese firms respond to expectations of protectionist action. The F-statistic t.99,4,53) in Equation 2 illustrates that this set of independent variables has explanatory power. In addition, the Durbin-Watson statistic leads to an acceptance of the null hypothesis (H0) that there is no autocorrelation in the disturbances. 4. CONCLUSIONS This paper tested the traditional concept that direct foreign investment is, in part, responsive to protectionism in the foreign nation. The empirical results presented also add support to the internalization hypothesis of direct investment. While other empirical studies have found Japanese MNCs internalize their intangible assets (Kim and Lyn, 1990), it also appears that Japanese firms internalize the market imperfections generated by U.S. trade barriers. In a dual test of the influence of the threat of protection and the influence of enacted protectionist measures, the statistical evidence points to Japanese firms responding to both the probability that an antidumping duty will be imposed and to the magnitude of complaints lodged by U.S. firms. Overall, the Japanese appear to view the expected state of the economy, the expected purchasing power of the yen, and the perception of trade barriers being erected when determining to invest directly in the United States. This last finding indicates that Japanese MNCs establish subsidiaries in order to avoid the market distortions created by U.S. trade policy. In an attempt to protect U.S. firms from alleged unfair Japanese competition, American antidumping laws have provided an unintentional incentive to invest directly in the U.S. manufacturing sector. APPENDIX: D A T A SOURCES

The quarterly data on Japanese direct foreign investment in the United States (JDFI), in the area of manufacturing, was provided to the authors by the Bureau of Economic Analysis of the Department of Commerce. The U.S. Gross Domestic Product (D) and

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unemployment rate (U), as well as the Japanese unemployment rate (UN), were obtained from various editions of the Economic Report of the President. The yen-to-dollar exchange rate (EX) came from the International Financial Statistics of the International Monetary Fund. The International Trade Commission furnished the data for both the number of dumping petitions filed (P) and the positive decisions (AFFIRM). Lastly, Japanese merchandise import figures are published in the Survey of Current Business. REFERENCES Amemiya, T. (1981) Qualitative Response Models: A Survey, Journal o f Economic Literature December: X1X:1483-1536. Baldwin, R.E. (1985) The Political Economy o f U.S. Import Policy. Cambridge, MA: The MIT Press. Caves, R.E. (1974) Causes of Direct Investment: Foreign Firms' Shares in Canadian and United Kingdom Manufacturing Industries, The Review o f Economics and Statistics August: 56(8):279-293. Grubangh, S.G. (1987) Determinants of Direct Foreign Investment, TheReview o f Economics and Statistics February: 69(2): 149-152. Harris, M.C., and Wynne, K.J. (1989) Explaining the Decline of Nuclear Power in the United States: Evidence from Plant Cancellation Decisions, The Journal o f Energy and Development Spring: 14(2):253-267. Hartigan, J.C., Kamma, S. and Perry, S. (1989) The Injury Determination Category and the Value of Relief from Dumping, The Review o f Economics and Statistics February: 71(2):183-186. Heitger, B., and Stehn, J. (1990) Japanese Direct Investments in the E C - Response to the Internal Market 19937 Journal o f Common Market Studies September: 29(9): 1-15. Herander, M.G., and Schwartz, B.J. (1984) An Empirical Test of the Impact of the Threat of U.S. Trade Policy: The Case of Antidumping Duties, Southern Economic Journal July: 51(7):59-79. Horst, T. (1972) Firm and Industry Determinants of the Decision to Invest Abroad: An Empirical Study, The Review o f Economics and Statistics August: 54(8):258-266. Kim, W.S., and Lyn, E. (1990) FDI Theories and the Performance of Foreign Multinationals Operating in the U.S., Journal o f InternationaIBusiness Studies First Quarter: 20(1): 41-53. Lee, C.H. (1984) On Japanese Macroeconomic Theories of Direct Foreign Investment, Economic Development and Cultural Change July: 33(7):714-723. Pindyck, R.S., and Rubinfeld, D.L. (1981), Econometric Models and Economic Forecasts. New York: McGraw Hill. Rugman, A.M. (1985) Internalization as a General Theory of Foreign Direct Investment: A Re-Appraisal of the Literature, Weltwirtschaftliches Archives: CXIV:356-379. Salvatore, D. (1987) Import Penetration, Exchange Rates, and Protectionism in the United States, Journal o f Policy Modeling Spring: 9(1):125-141. Sanger, D. (1991) A Twist in Fair-Trade Case: Japanese Charge U.S. Rival, The New York Times. August 12: D5.

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Takacs, W.E. (1981) Pressures for Protectionism: An Empirical Analy.sis, Economiclnquiry October: XIX:687-693. U.S. International Trade Commission (various years) Annual Report. Washington: USITC Publications. Vinod, H.D., and Ullah, A. (1981) Recent Advances in Regression Methods. New York: Marcel Dekker, Inc.