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When giants converge: The role of U.S.-Japan direct investment
When Giants Converge: The Role of U.S.-Japan Direct Investment Dorothy B. Christelow. M.E. Sharpe, Armonk, NY, 1995; 240 pp.
Review by Theresa M. Greaney
Dorothy Christelow’s book, When Giants Converge: The Role of U.S.-Japan Direct Investment, presents a well-documented account of events and trends in bilateral direct investment and technology transfer between the IJnited States and Japan since World War II. By defining technotogy in broad terms and covering a variety of industries, ranging from low- to high-technology types, she is able to present a balanced account of technology transfers between the two countries. She concludes that Japan gained more from the bilateral exchange in some industries, but that the United States gained more in others. Her academic approach to the topic is a refreshing change from the methods employed in many popular books on the U.S.-Japan economic relationship that often used selected industries and events to support hypotheses involving an adversarial relationship and one-sided gains, The book is impressive for its shear volume of amassed information and data; it presents basic information on a vast array of postwar events and provides key references for readers who wish to study these events in more detail. The book is wellorganized and, as such, promises to serve the reader as a valuable reference source. The first two chapters provide au overview on foreign direct investment (FDI) and American and Japanese p~icipation in FDI. The next two chapters provide historical info~ation on bilateral technology transfers and direct investment. The following four chapters examine #he bilateral. relationship in the context of 10 specific industries. The final chapter summ~zes her findings, Chapter 1 includes an historical review of the treatment given to foreign direct investment by theories of industrial organization (IO) and economic growth. Specifically, she briefly discusses IO theories that motivate investment abroad as a means of exploiting technological advantage and growth theories that examine the role of FDI in productivity and technology convergence across countries. The theo-
589
590
JOURNAL OF ASIAN ECONOMICS
6(d), 1995
retical roles of financial incentives for direct investment (i.e., currency ove~aluation, low cost of capital) are discussed in detail. Although she states that exchange rate and cost-of-capital relationships cannot fully explain observed changes in U.S. and Japanese FDI, she judges these factors to have played a significant role (p. 33). This section provides a helpful review of the development of economic theory related to international direct investment. However, as a trade economist, I would like to have seen more updated coverage of the microeconomic foundations of the theory of FDI (Le., the theory of multinational enterprises) to complement the more thorough coverage of macroeconomic explanations for FDI. Specifically, references to work such as Krugman (1983), Helpman (1984), Markusen (1984), Helpman and Krugman (1985), Ethier and Horn (1990), Horstman and ~arkusen (1992), and Brainard (1992, 1993a, b) would provide an update on how theories of industrial organization have been combined with international trade theory to explain the investment decisions of multinationals. These authors model multinationals as oligopolistically or monopolistically competitive in markets with differentiated products and examine direct investment incentives such as factor proportions differences, proximity advantages (e.g., avoidance of transportation costs and trade barriers, ability to better serve customers or deal with local suppliers), and scale economies (e.g., at the firm or plant level). Since some of these incentives appear in the subsequent chapters on specific industries, a theoretical context would be helpful. Christelow makes an important distinction between product technology and process technology that is illustrated through examples provided in the subsequent chapters. The term “process technology” is used to describe unpatented technology, such as manufacturing methods. While the United States continues to be a world leader in product technology exports and Japan is a large importer of this technology, the latter has become a major exporter of process technology, according to Christelow. While anyone who has observed the enormous interest that developed in the 1980s around Japanese management techniques (e.g., quality control circles, bottom-up management, just-in-time delivery, and flexible manufacturing) would agree that these techniques have been important Japanese exports, how can one quantify the volume of trade in such process technology? It is relatively straightforward to quantify trade in product technology using data on international fees and royalty transactions, but what data could be used to try to measure trade in process technology? In Chapter 2, Christelow uses trade data to “offer some clues regarding the likely flow of unpatented technology” (p. 46), but trade could indicate instead a transfer of product rather than process technology, or it could indicate a transfer of both or of neither one. The same could be said of another potential indicator of trade in process technology: FDI. Nevertheless, an inability to quantify the transfer of process technology does not diminish its importance in the bilateral relationship. The author emphasizes its importance throughout the book.
BookReview
591
Chapters 3 and 4 present historical information on U.S. investments and technology transfers during the period 1948-1969 and the transition to two-way investment and technology flows in the 1970s. The 1950s and 1960s featured product technology transfers through U.S. FDI in Japan in industries such as petroleum refining, chemicals, industrial machinery, and auto parts. These investments were followed by investments in more R&D-intensive sectors such as computers, semiconductors, electronic measuring equipment, and photocopiers in the 1960s. During this time, the Japanese government limited FDI projects to those providing valuable technology that otherwise could not be obtained. In the 1970s bilateral FDI became more equal and it increasingly involved intra-industry bilateral flows in the 1980s. Japanese companies gradually shifted from investments in basic industries, such as raw materials and energy-intensive primary products, to higher-technology industries, such as photocopiers, autos, machine tools, computers, and semiconductors.’ Chapters 5-8 supply detailed information on bilateral direct investment and technology transfer in selected industries by describing the activities of the multinationals involved. Due to space limitations, my comments here are limited to brief summaries of the chapter highlights. Chapter 5 presents an analysis of the contributions Japanese technology has made to the U.S. auto industry. Attention is focused on the superior process technology of Japanese producers and the means by which various aspects of this technology were transferred to American producers. Technology transfer occurred through direct investments by Japanese auto producers and through joint ventures and other cooperative agreements between Japanese and American producers during the 1980s. The author covers other low- and medium-R&D industries, namely, steel, tires and machine tools, in Chapter 6. The details on bilateral FDI in these industries lead her to conclude that the United States probably received greater technology gains than Japan from these bilateral flows. U.S. producers in these sectors had become “technology laggards slow to adopt product and process technology developed in foreign countries” (p. 159). Japanese investments included joint ventures with all major U.S. steel companies, purchases of U.S. tire manufacturers, and greenfield investments by machine tool manufacturers. In Chapter 7, Christelow tackles the high-technology industries that have been the focus of attention in several trade disputes: computers, semiconductors, and communications equipment. The history of the bilateral competition and cooperation in these industries suggests that technology flowed in both directions between the two countries. Innovative American product technology flowed to Japan and a backflow of efficient Japanese process technology went to the United States. Chapter 8 looks into the high-R&D-intensive industries of pharmaceuticals, instruments, and semiconductor manufacturing equipment. The first two are noteworthy as the industries in which American companies invested most heavily in Japan, while Japanese firms advanced less forcefully into the United States. The history of regulation of the pharmaceuticals industry in Japan presents a case in which govemment policy (unintentionally) hindered rather than enhanced the competitive
592
JOURNAL OF ASIAN ECONOMICS
6(4), 1995
strength of Japanese manufacturers. Japanese pharmaceuticals producers have failed to match American and European firms in introducing new products. Christelow traces this failure to policies such as Japanese patent law, which until 1976 made new processes but not new products patentable, and a series of reductions in the price ceilings placed on pharmaceuticals during the 1980s. Both policies gave Japanese manufacturers the incentive to make “copycat” drugs rather than devote substantial resources to R&D for new products. A new patent law passed in 1976 and liberalization of foreign investment in Japan encouraged U.S. pharmaceuticals makers to invest in Japan. In the concluding chapter, Christelow restates the trends she has found in the selected industries’ chapters. She alludes to microeconomic explanations for FDI in stating that American firms invested in Japan more so than in other countries mainly for the purpose of exploiting superior technology. But the explanation for the reversal in bilateral FDI flows reverts back to the cost of capital and related expected rate of return on investment hypotheses.’ While certainly a contributing factor, a vast array of microeconomic considerations also played prominent roles in the industries surveyed in the book: avoidance of trade barriers and transportation costs, technology scanning and acquisition, proximity advantages of locating closer to one’s customers and suppliers, and access to cheaper inputs. Her industry analysis shows that by 1990, both countries’ multinational enterprises had staked out significant positions in the other countries’ industries where technology transfers were important: the U.S. position in Japan was stronger than Japan’s position in the U.S. in computers, pharmaceuticals, instruments, oil refining. and chemicals, while Japan’s position was stronger in semiconductors. communications equipment, steel, and tires. The countries’ positions in auto assembly and industrial machinery were judged to be about equal (p. 236). This listing implicitly indicates the importance of process technology, in addition to the more widely-recognized product technology, in evaluating international technology transfers. The author makes this point explicit by reminding the reader of the important complementarity of product technology, which mainly flowed from the U.S. to Japan. and process technology, which flowed in the opposite direction. Christelow ends the book on an optimistic note by suggesting that the U.S. government’s policies towards Japanese business activities and acquisitions in the U.S. may be softening from the confrontational stance evidenced in the passage of the Exon-Florio Amendment of 1988 and in the initial reluctance to allow Japanese participation in the Sematech consortium. Sematech’s move in the early 1990s to seek advice from a group of Japanese experts in semiconductor manufacturing processes is taken as evidence of a realization among policy officials and others of the complementarity of American product technology and Japanese process technology. In light of more recent, acrimonious events in bilateral trade negotiations over autos and auto parts and aviation flight rights, one can only hope that the warming trend Christelou identifies in FDI relations does not cool as a consequence.
593
Book Reuiew
NOTES 1. Ando and Auerbach (1990) show how the cost of capital gap between the United States and Japan may be considerably smaller than is commonly estimated once one accounts for the importance of land and cross-shareholding in explaining the rates of return in Japan.
REFERENCES Ando, A., & Auerbach, A. J. (1990). The cost of capital in Japan: Recent evidence and further results. Journal of the Japanese and Interr~ationa~ Economies, 4, 323-350. Brainard, S. L. (1992). A simple fheory of m~liinatiuna2 corporations and trade with a trade-0~ between pro~~rn~~ and concentration. MIT SIoan Working Paper No. 3492-92-EFA; also appears as NBER Working Paper No. 4269, 1993. (1993a). An empirical assessment of the proximity-concentration tradeoff between _. multinational sales and trade. NBER Working Paper No. 4580. (199313). An empirical assessment of the factor proportions explanation of multinational sales. ~-. NBER Working Paper No. 4583. Ethier, W. J., & Horn, H. (1990). Managerial control of international firms and patterns of direct invesment. .lournal of International Economics, 28,25-45. Helpman, E. (1984). A simple theory of international trade with multinational corporations. Journal of Political Economy, 92,45 l-47 1. Helpman, E., & Krugman, l? (1985). Market structure and foreign trade. Cambridge, MA: MIT Press. Horstmann, I., & Markusen, J. (1992). Endogenous market structures in intemation~ trade. fournat of international E~onorn~~s, 32, 109- 129. Krugman, P (1983). The “New Theories” of international trade and muitinational enterprise. In D. B. Audretsch & C. Kindleberger (Edsf, 7’he multinut~onal corporation in the 1980s. Cambridge, MA: MIT Press. Markusen, J. R. (1984). Multinationals, multiplant economies, and the gains from trade. Journal of international Economics, 16, 205224.
Review by Theresa M. Greaney
Dorothy Christelow’s book, When Giants Converge: The Role of U.S.-Japan Direct Investment, presents a well-documented account of events and trends in bilateral direct investment and technology transfer between the IJnited States and Japan since World War II. By defining technotogy in broad terms and covering a variety of industries, ranging from low- to high-technology types, she is able to present a balanced account of technology transfers between the two countries. She concludes that Japan gained more from the bilateral exchange in some industries, but that the United States gained more in others. Her academic approach to the topic is a refreshing change from the methods employed in many popular books on the U.S.-Japan economic relationship that often used selected industries and events to support hypotheses involving an adversarial relationship and one-sided gains, The book is impressive for its shear volume of amassed information and data; it presents basic information on a vast array of postwar events and provides key references for readers who wish to study these events in more detail. The book is wellorganized and, as such, promises to serve the reader as a valuable reference source. The first two chapters provide au overview on foreign direct investment (FDI) and American and Japanese p~icipation in FDI. The next two chapters provide historical info~ation on bilateral technology transfers and direct investment. The following four chapters examine #he bilateral. relationship in the context of 10 specific industries. The final chapter summ~zes her findings, Chapter 1 includes an historical review of the treatment given to foreign direct investment by theories of industrial organization (IO) and economic growth. Specifically, she briefly discusses IO theories that motivate investment abroad as a means of exploiting technological advantage and growth theories that examine the role of FDI in productivity and technology convergence across countries. The theo-
589
590
JOURNAL OF ASIAN ECONOMICS
6(d), 1995
retical roles of financial incentives for direct investment (i.e., currency ove~aluation, low cost of capital) are discussed in detail. Although she states that exchange rate and cost-of-capital relationships cannot fully explain observed changes in U.S. and Japanese FDI, she judges these factors to have played a significant role (p. 33). This section provides a helpful review of the development of economic theory related to international direct investment. However, as a trade economist, I would like to have seen more updated coverage of the microeconomic foundations of the theory of FDI (Le., the theory of multinational enterprises) to complement the more thorough coverage of macroeconomic explanations for FDI. Specifically, references to work such as Krugman (1983), Helpman (1984), Markusen (1984), Helpman and Krugman (1985), Ethier and Horn (1990), Horstman and ~arkusen (1992), and Brainard (1992, 1993a, b) would provide an update on how theories of industrial organization have been combined with international trade theory to explain the investment decisions of multinationals. These authors model multinationals as oligopolistically or monopolistically competitive in markets with differentiated products and examine direct investment incentives such as factor proportions differences, proximity advantages (e.g., avoidance of transportation costs and trade barriers, ability to better serve customers or deal with local suppliers), and scale economies (e.g., at the firm or plant level). Since some of these incentives appear in the subsequent chapters on specific industries, a theoretical context would be helpful. Christelow makes an important distinction between product technology and process technology that is illustrated through examples provided in the subsequent chapters. The term “process technology” is used to describe unpatented technology, such as manufacturing methods. While the United States continues to be a world leader in product technology exports and Japan is a large importer of this technology, the latter has become a major exporter of process technology, according to Christelow. While anyone who has observed the enormous interest that developed in the 1980s around Japanese management techniques (e.g., quality control circles, bottom-up management, just-in-time delivery, and flexible manufacturing) would agree that these techniques have been important Japanese exports, how can one quantify the volume of trade in such process technology? It is relatively straightforward to quantify trade in product technology using data on international fees and royalty transactions, but what data could be used to try to measure trade in process technology? In Chapter 2, Christelow uses trade data to “offer some clues regarding the likely flow of unpatented technology” (p. 46), but trade could indicate instead a transfer of product rather than process technology, or it could indicate a transfer of both or of neither one. The same could be said of another potential indicator of trade in process technology: FDI. Nevertheless, an inability to quantify the transfer of process technology does not diminish its importance in the bilateral relationship. The author emphasizes its importance throughout the book.
BookReview
591
Chapters 3 and 4 present historical information on U.S. investments and technology transfers during the period 1948-1969 and the transition to two-way investment and technology flows in the 1970s. The 1950s and 1960s featured product technology transfers through U.S. FDI in Japan in industries such as petroleum refining, chemicals, industrial machinery, and auto parts. These investments were followed by investments in more R&D-intensive sectors such as computers, semiconductors, electronic measuring equipment, and photocopiers in the 1960s. During this time, the Japanese government limited FDI projects to those providing valuable technology that otherwise could not be obtained. In the 1970s bilateral FDI became more equal and it increasingly involved intra-industry bilateral flows in the 1980s. Japanese companies gradually shifted from investments in basic industries, such as raw materials and energy-intensive primary products, to higher-technology industries, such as photocopiers, autos, machine tools, computers, and semiconductors.’ Chapters 5-8 supply detailed information on bilateral direct investment and technology transfer in selected industries by describing the activities of the multinationals involved. Due to space limitations, my comments here are limited to brief summaries of the chapter highlights. Chapter 5 presents an analysis of the contributions Japanese technology has made to the U.S. auto industry. Attention is focused on the superior process technology of Japanese producers and the means by which various aspects of this technology were transferred to American producers. Technology transfer occurred through direct investments by Japanese auto producers and through joint ventures and other cooperative agreements between Japanese and American producers during the 1980s. The author covers other low- and medium-R&D industries, namely, steel, tires and machine tools, in Chapter 6. The details on bilateral FDI in these industries lead her to conclude that the United States probably received greater technology gains than Japan from these bilateral flows. U.S. producers in these sectors had become “technology laggards slow to adopt product and process technology developed in foreign countries” (p. 159). Japanese investments included joint ventures with all major U.S. steel companies, purchases of U.S. tire manufacturers, and greenfield investments by machine tool manufacturers. In Chapter 7, Christelow tackles the high-technology industries that have been the focus of attention in several trade disputes: computers, semiconductors, and communications equipment. The history of the bilateral competition and cooperation in these industries suggests that technology flowed in both directions between the two countries. Innovative American product technology flowed to Japan and a backflow of efficient Japanese process technology went to the United States. Chapter 8 looks into the high-R&D-intensive industries of pharmaceuticals, instruments, and semiconductor manufacturing equipment. The first two are noteworthy as the industries in which American companies invested most heavily in Japan, while Japanese firms advanced less forcefully into the United States. The history of regulation of the pharmaceuticals industry in Japan presents a case in which govemment policy (unintentionally) hindered rather than enhanced the competitive
592
JOURNAL OF ASIAN ECONOMICS
6(4), 1995
strength of Japanese manufacturers. Japanese pharmaceuticals producers have failed to match American and European firms in introducing new products. Christelow traces this failure to policies such as Japanese patent law, which until 1976 made new processes but not new products patentable, and a series of reductions in the price ceilings placed on pharmaceuticals during the 1980s. Both policies gave Japanese manufacturers the incentive to make “copycat” drugs rather than devote substantial resources to R&D for new products. A new patent law passed in 1976 and liberalization of foreign investment in Japan encouraged U.S. pharmaceuticals makers to invest in Japan. In the concluding chapter, Christelow restates the trends she has found in the selected industries’ chapters. She alludes to microeconomic explanations for FDI in stating that American firms invested in Japan more so than in other countries mainly for the purpose of exploiting superior technology. But the explanation for the reversal in bilateral FDI flows reverts back to the cost of capital and related expected rate of return on investment hypotheses.’ While certainly a contributing factor, a vast array of microeconomic considerations also played prominent roles in the industries surveyed in the book: avoidance of trade barriers and transportation costs, technology scanning and acquisition, proximity advantages of locating closer to one’s customers and suppliers, and access to cheaper inputs. Her industry analysis shows that by 1990, both countries’ multinational enterprises had staked out significant positions in the other countries’ industries where technology transfers were important: the U.S. position in Japan was stronger than Japan’s position in the U.S. in computers, pharmaceuticals, instruments, oil refining. and chemicals, while Japan’s position was stronger in semiconductors. communications equipment, steel, and tires. The countries’ positions in auto assembly and industrial machinery were judged to be about equal (p. 236). This listing implicitly indicates the importance of process technology, in addition to the more widely-recognized product technology, in evaluating international technology transfers. The author makes this point explicit by reminding the reader of the important complementarity of product technology, which mainly flowed from the U.S. to Japan. and process technology, which flowed in the opposite direction. Christelow ends the book on an optimistic note by suggesting that the U.S. government’s policies towards Japanese business activities and acquisitions in the U.S. may be softening from the confrontational stance evidenced in the passage of the Exon-Florio Amendment of 1988 and in the initial reluctance to allow Japanese participation in the Sematech consortium. Sematech’s move in the early 1990s to seek advice from a group of Japanese experts in semiconductor manufacturing processes is taken as evidence of a realization among policy officials and others of the complementarity of American product technology and Japanese process technology. In light of more recent, acrimonious events in bilateral trade negotiations over autos and auto parts and aviation flight rights, one can only hope that the warming trend Christelou identifies in FDI relations does not cool as a consequence.
593
Book Reuiew
NOTES 1. Ando and Auerbach (1990) show how the cost of capital gap between the United States and Japan may be considerably smaller than is commonly estimated once one accounts for the importance of land and cross-shareholding in explaining the rates of return in Japan.
REFERENCES Ando, A., & Auerbach, A. J. (1990). The cost of capital in Japan: Recent evidence and further results. Journal of the Japanese and Interr~ationa~ Economies, 4, 323-350. Brainard, S. L. (1992). A simple fheory of m~liinatiuna2 corporations and trade with a trade-0~ between pro~~rn~~ and concentration. MIT SIoan Working Paper No. 3492-92-EFA; also appears as NBER Working Paper No. 4269, 1993. (1993a). An empirical assessment of the proximity-concentration tradeoff between _. multinational sales and trade. NBER Working Paper No. 4580. (199313). An empirical assessment of the factor proportions explanation of multinational sales. ~-. NBER Working Paper No. 4583. Ethier, W. J., & Horn, H. (1990). Managerial control of international firms and patterns of direct invesment. .lournal of International Economics, 28,25-45. Helpman, E. (1984). A simple theory of international trade with multinational corporations. Journal of Political Economy, 92,45 l-47 1. Helpman, E., & Krugman, l? (1985). Market structure and foreign trade. Cambridge, MA: MIT Press. Horstmann, I., & Markusen, J. (1992). Endogenous market structures in intemation~ trade. fournat of international E~onorn~~s, 32, 109- 129. Krugman, P (1983). The “New Theories” of international trade and muitinational enterprise. In D. B. Audretsch & C. Kindleberger (Edsf, 7’he multinut~onal corporation in the 1980s. Cambridge, MA: MIT Press. Markusen, J. R. (1984). Multinationals, multiplant economies, and the gains from trade. Journal of international Economics, 16, 205224.