Japan - In the steps of the foreign investor

Branson's Virgin Cinemas have caught a shifting consumer mood in Japan

For those hopeful that Japanese leaders had finally grasped the importance of liberalizing markets and encouraging competition and foreign participation in the economy, the report made depressing reading. The OECD concluded that these reform efforts had been largely ineffective. Excessive state intervention still distorts markets in many sectors. Though foreign strategic and portfolio investors in theory have easy access to Japan, once there they still face the danger that opaque and sometimes arbitrarily enforced regulatory procedures will restrict their activities. Regulatory reform has been too slow and too episodic to deliver sustainable economic growth.

So although the Japanese government has vowed to reduce government ministries and agencies from 22 in 1998 to 13 by later this year and to cut public non-defence employees by 25% over 10 years, it has resorted to massive intervention through public spending to boost the economy.

There was much excitement worldwide in early 1999 when Japanese growth resumed. Moreover the Japanese stock market boomed last year, responding to signs of more modern management thinking, better financial discipline and corporate restructuring at such companies as Sony, Fujitsu and NTT. However, growth has remained weak because Japanese investors have continued to salt away gains from public spending in savings rather than consuming. Low interest rates have not reversed this tendency. And while government investment grew massively in 1999, business investment fell sharply for the second straight year. It fell 6% in 1999, having fallen by 11.3% in 1998. Japan is not an export-led economy. Net exports declined slightly in 1999 by 0.2%.

An economy that isn't growing, with a population that isn't spending, where regulations are often onerous and arbitrary and where the cost of employing workers remains high, would not seem a particularly attractive destination for foreign companies to set up operations. So it's surprising to note that foreign direct investment into Japan has been growing at a healthy rate in recent years, doubling from ¥3.7 trillion ($33 billion) in 1995 to ¥7.7 trillion in 1996 and rising to ¥13.4 trillion in 1998, the most recent year for which figures are available from the Development Bank of Japan, which promotes and supports foreign companies investing in the country.

The Development Bank of Japan (DBJ) was launched in October 1999, taking over the functions of the old Japan Development Bank and the Hokkaido-Tohoku Development Finance Public Corp, with the aim of promoting sustainable development of the Japanese economy. Since 1983 the Japan Development Bank had been providing long-term loans and other types of funding, often at low fixed interest rates, to support foreign investment projects that private-sector lenders might be reluctant to fund because of perceived high risk or long time-lags between initial investment and eventual profit.

FDI catches on

Encouraging foreign direct investment has become a growing priority as Japan has grasped its potential role in stemming unemployment as established corporations begin to restructure, and as a means of learning new management styles. DBJ lends at subsidized rates to all manner of capital investment in Japan, including in land, factories, office buildings, warehouses, machinery, when those investments are expected to contribute to the Japanese economy through the import of new know-how. Its loans are often structured with lengthy grace periods, so that companies are not burdened with repayments in the early cash-consuming years of a project development. Maturities may be from 10 to 25 years with one to five years' grace, with the interest rate fixed at disbursement and based on the 10-year JGB coupon. DBJ loans and guarantees rarely exceed more than 40% to 50% of project cost, but its support often encourages private-sector lenders to provide funding.

For all the gloom about Japan, the officers of DBJ believe it has many selling points. "Japan offers investors the world's second-largest market, one in which firms excel in new product development, production technology and others aspects of industrial technology," says Takashi Yamamoto, assistant director in the international department of DBJ. "Foreign firms set up plants in Japan in order to be near their customers and get a better grasp of their needs." Although certain factors may deter foreign investors, namely "insufficient English-language ability, expensive land and high personnel costs," he claims that excessive and impenetrable regulation is diminishing. "The Japanese business environment has been deregulated to such an extent that government regulations no longer present a significant obstacle to investment."

A shift to service industries

Over the years, US, French and Dutch companies have been among the biggest investors, many being attracted by Japan's track record in new product development and production technology. Now, despite the cautious spending habits of Japanese consumers, investment is shifting to service industries, notably financial services, where foreign firms have been attracted to pick up the remnants of failing Japanese companies. "We are seeing a shift these days from the manufacturing to the non-manufacturing sector, as the cost of producing goods in Japan tends to limit profitability," says Yamamoto. For the same reason, Japanese companies massively shifted production overseas into Asia and even Europe in the 1980s and 1990s and foreign manufacturers will never move into the country on a scale to take up the slackening in employment.

Financial services is one of the sectors in Japan where deregulation has been most obvious. But there are other sectors now attracting foreign companies, including retailing. The opening of new retail stores in Japan has traditionally been heavily restricted. Existing stores in a given location had a right of veto over new openings, a system of regulation that protected the rights of often inefficient incumbents and kept newcomers out.

But this has been changing over the years. Toy-store chain Toys "R" US, set up its first Japanese store in 1991, with financial assistance from JDB to help it with the huge rental deposits required to secure prime retail space. By mid-1999, it had 83 stores, and there should be 100 this year. Similarly Starbucks found that Japanese consumers are willing to pay a slight premium for higher-quality expresso coffee. With DBJ's help it opened its first shop in Ginza in 1996 and had more than 50 by the middle of last year.

Yamamoto says: "Japan does have a large retail store law which regulates the opening of new supermarkets and other large stores, but this is expected to be abolished in the near future." And the famous thriftiness of the Japanese consumer is not always such an obstacle. He adds: "The Japanese do indeed have a high rate of savings and tend to spend their money on high-quality goods. Toys "R" US is a good example of a retail firm that has succeeded in Japan, while cinema complexes such as Virgin Cinemas are also doing well".

The entry of Virgin Cinemas into Japan is an example of a foreign entrant catching a shifting consumer mood. Cinema audiences in Japan have been in steady decline since the 1960s, falling from 1.12 billion in 1965 to 120 million by the mid 1990s. But the introduction of the multiplex cinema complex, typically combining 20 screens, also providing other retail services and often located in modern suburban malls, may be reversing this trend. Admissions grew in 1997 by 20% over the previous year. Virgin Group entered the multiplex business in the UK in 1995 and after carefully studying the Japanese market obtained a loan from DBJ to expand in Japan. Virgin Cinemas Japan opened its first multiplex last April and plans to open two more.

Helping the little guys

DBJ focuses most of its energies on mid-size and smaller foreign companies. For example, DBJ recently provided support to a JPK Technology, a new Japanese subsidiary of Malaysian company JPKM, in setting up a research and development and technical support centre in Tokyo. The fast-growing Malaysian company carries out precision injection and moulding assembly for the audio and video equipment industry. By setting up in Japan it hopes to pursue joint R&D agreements with Japanese companies in the same sector, develop new technology and also improve relations with Japanese multinationals that are among its customers.

Even in Japan's agriculture sector - where notorious protectionism against foreign rice imports bedevilled trade relations with the US in the 1980s and early 1990s - cross-fertilization of ideas with foreign firms is selectively encouraged. An example is Swedish company Swedeponic, set up in the 1980s with a new technique for low-cost continuous production of potted lettuce and herbs. In 1997, Swedeponic Kuju was established between the company and farmers in Kuju, Oita. The 10,000 square metre facility has established year-round production and Swedeponic has been encouraged to plan 10 more such plants with local partners around Japan.

Encouraging more such ventures, as well as financing them, is DBJ's role. According to Yamamoto the banks is "trying to close the information gap between foreign and Japanese firms."

Accumulated DBJ financing to foreign-affiliated companies

Source: Development Bank of Japan

Foreign direct investment

Source: Development Bank of Japan