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Japan Capital Flows
Capital movements offset the surpluses or deficits in
the
current account. A current account surplus, for example,
implies
that rather than using all the foreign currency earned by
selling
exports to buy imports, corporations and individuals
choose to
invest the money in foreign-currency-denominated assets
instead. As
measured in Japan's balance of payments data, capital
movements
consist of long- and short-term investments and movements
in
official foreign-exchange reserves and private bank
accounts.
Capital movements include loans, portfolio investments in
corporate
stock, and direct investment (establishment or purchase of
subsidiaries abroad). A capital outflow occurs when a
Japanese
individual or corporation makes a loan, buys foreign
stock, or
establishes a subsidiary abroad. A capital inflow occurs
when
foreigners engage in these operations in Japan.
After World War II, Japan's return to world capital
markets as
a borrower was slow and deliberate. Even before the war,
Japan did
not participate in world capital markets to the same
extent as did
the United States or West European countries. Caution and
control
remained strong until well into the 1970s, when Japan was
no longer
a net debtor nation. Since that time, deregulation has
proceeded
steadily, and capital flows have grown rapidly. The rapid
growth of
investment abroad in the 1980s had made Japan the largest
net
investor in the world by the end of the decade.
As might be expected of a country recovering from a
major
wartime defeat, Japan remained a net debtor nation until
the mid-
1960s, although it was never as far in debt as many of the
more
recently developing countries. By 1967, however, Japanese
investments overseas had begun to exceed foreign
investments in
Japan, changing Japan from a net debtor to a net creditor
nation.
The country remained a modest net creditor until the
1980s, when
its creditor position expanded explosively, altering
Japan's
relationship to the rest of the world.
In Japan's balance of payments data, these changes are
most
readily seen in the long-term capital account. During the
first
half of the 1960s, this account generally showed small net
inflows
of capital (as did the short-term capital account). From
1965 on,
however, the long-term capital account consistently showed
an
outflow, ranging from US$1 billion to US$12 billion during
the
1970s. The sharp shift in the balance of payments brought
about by
the oil price hike at the decade's end produced an unusual
net
inflow of long-term capital in 1980 of US$2.3 billion, but
thereafter the outflow resumed and grew enormously. From
nearly
US$10 billion in 1981, the annual net outflow of long-term
capital
reached nearly US$137 billion in 1987 and then dropped
slightly, to
just over US$130 billion, in 1988 (see
table 30,
Appendix).
Short-term capital flows in the balance of payments do
not show
so clear a picture. These more volatile flows have
generally added
to the net capital outflow, but in some years movements in
international differentials in interest rates or other
factors led
to a net inflow of short-term capital.
The other significant part of capital flows in the
balance of
payments is the movement in gold and foreign-exchange
reserves held
by the government, which represent the funds held by the
Bank of
Japan to intervene in foreign-exchange markets to affect
the value
of the yen. In the 1970s, the size of these markets became
so large
that any government intervention was only a small share of
total
transactions, but Japan and other governments used their
reserves
to influence exchange rates when necessary. In the second
half of
the 1970s, for example, foreign-exchange reserves rose
rapidly,
from a total of US$12.8 billion in 1975 to US$33 billion
by 1978,
as the Bank of Japan sold yen to buy dollars in
foreign-exchange
markets to slow or stop the rise in the yen's value,
fearful that
such a rise would adversely affect Japanese exports. The
same
operation occurred on a much larger scale after 1985. From
US$26.5
billion in 1985 (a level little changed from the decade's
beginning), exchange reserves had climbed to almost US$98
billion
by 1988 before declining to US$84.8 in 1989 and US$77
billion in
1990. This intervention was similarly inspired by concern
about the
yen's high value.
The combination of net outflows of long- and short-term
capital
and rising holdings of foreign exchange by the central
government
produced enormous change in Japan's accumulated holdings
of foreign
assets, compared with foreigners' holdings of assets in
Japan. As
a result, from a net asset position of US$11.5 billion in
1980
(meaning that Japanese investors held US$11.5 billion more
in
foreign assets than foreigners held in Japan), Japan's
international net assets had grown to more than US$383
billion by
1991 (see
table 31, Appendix). Japanese assets abroad grew
from
nearly US$160 billion in 1980 to over US$2 trillion by
1991, a more
than twelvefold increase. Liabilities--investments by
foreigners in
Japan--expanded somewhat more slowly, about elevenfold,
from US$148
billion in 1980 to US$1.6 trillion in 1991. Dramatic
shifts were
seen in portfolio securities purchases--stocks and
bonds--in both
directions. Japanese purchases of foreign securities went
from only
US$4.2 billion in 1976 to over US$21 billion in 1980 and
to
US$632.1 billion by 1991. Although foreign purchases of
Japanese
securities also expanded, the growth was slower and was
approximately US$444 billion in 1988.
Capital flows have been heavily affected by government
policy.
During the 1950s and the first half of the 1960s, when
Japan faced
chronic current account deficits, concern over maintaining
a high
credit rating in international capital markets and fear of
having
to devalue the currency and of foreign ownership of
Japanese
companies all led to tight controls over both inflow and
outflow of
capital. As part of these controls, for example,
government
severely restricted foreign direct investment in Japan,
but it
encouraged licensing agreements with foreign firms to
obtain access
to their technology. As Japan's current account position
strengthened in the 1960s, however, the nation came under
increasing pressure to liberalize its tight controls.
When Japan became a member of the OECD in 1966, it
agreed to
liberalize its capital markets. This process began in 1967
and
continues. Decontrol of international capital flows was
aided in
1980, when the new Foreign Exchange and Foreign Control
Law went
into effect. In principle, all external economic
transactions were
free of control, unless specified otherwise. In practice,
a wide
range of transactions continued to be subject to some form
of
formal or informal control by the government.
In an effort to reduce capital controls, negotiations
between
Japan and the United States were held, producing an
agreement in
1984, the Yen-Dollar Accord. This agreement led to
additional
liberalizing measures that were implemented over the next
several
years. Many of these changes concerned the establishment
and
functioning of markets for financial instruments in Japan
(such as
a short-term treasury bill market) rather than the removal
of
international capital controls per se. This approach was
taken
because of United States concerns that foreign investment
in Japan
was impeded by a lack of various financial instruments in
the
country and by the government's continued control of
interest rates
for many of those instruments that did exist. As a result
of the
agreement, for example, interest rates on large bank
deposits were
decontrolled, and the minimum denomination for
certificates of
deposit was lowered.
By the end of the 1980s, barriers to capital flow were
no
longer a major issue in Japan-United States relations.
However,
imbalances in the flows and in accumulated totals of
capital
investment, with Japan becoming a large world creditor,
were
emerging as new areas of tension. This tension was
exacerbated by
the fact that the United States became the world's largest
net
debtor at the same time that Japan became its largest net
creditor.
Nevertheless, no policy decisions have been made that
would
restrict the flow of Japanese capital to the United
States.
One important area of capital flows is direct
investment--
outright ownership or control (as opposed to portfolio
investment).
Japan's direct foreign investment has grown rapidly,
although not
as dramatically as its portfolio investment. Data
collected by its
Ministry of Finance show the accumulated value of Japanese
foreign
direct investment growing from under US$3.6 billion in
1970 to
US$36.5 billion in 1980 and to nearly US$353 billion by
1991 (see
table 32, Appendix). Direct investment tends to be very
visible,
and the rapid increase of Japan's direct investments in
countries
such as the United States, combined with the large
imbalance
between Japan's overseas investment and foreign investment
in
Japan, was a primary cause of tension at the end of the
1980s.
The location of Japan's direct investments abroad has
been
shifting. In 1970, 21 percent of its investments were in
Asia, and
nearly 22 percent in the United States. By 1991 the share
of
investments in Asia had dropped to 15 percent, while that
in the
United States had risen sharply, to over 42 percent of the
total.
During this period, Japan's share of investments decreased
in Latin
America (from nearly 16 percent in 1970 to less than 13
percent in
1988), decreased in Africa (down slightly from 3 percent
to under
2 percent), and held rather steady in Europe (up slightly
from
nearly 18 percent to over 19 percent). Both the Middle
East (down
from over 9 percent to under 1 percent) and the Pacific
(down from
roughly 8 percent to 6 percent) became relatively less
important
locations for Japanese investments. However, because of
the rapid
growth in the dollar amounts of the investments, these
shifts were
all relative. Even in the Middle East, the dollar value of
Japanese
investments had grown.
The drive to invest overseas stemmed from several
motives. A
major reason for many early investments was to obtain
access to raw
materials. As Japan became more dependent on imported raw
materials, energy, and food during the 1960s and 1970s,
direct
investments were one way of ensuring supply. The Middle
East,
Australia, and some Asian countries (such as Indonesia)
were major
locations for such investments by 1970. Second, rising
labor costs
during the 1960s and 1970s led certain labor-intensive
industries,
especially textiles, to move abroad.
Investment in other industrial countries, such as the
United
States, was often motivated by barriers to exports from
Japan. The
restrictions on automobile exports to the United States,
which went
into effect in 1981, became a primary motivation for
Japanese
automakers to establish assembly plants in the United
States. The
same situation had occurred earlier, in the 1970s, for
plants
manufacturing television sets. Japanese firms exporting
from
developing countries, moreover, often received
preferential tariff
treatment in developed countries (under the Generalized
System of
Preferences). In short, protectionism in developed
countries often
motivated Japanese foreign direct investment.
After 1985, a new and important incentive materialized
for such
investments. The rapid rise in the value of the yen
seriously
undermined the international competitiveness of many
products
manufactured in Japan. While this situation had been true
for
textiles in the 1960s, after 1985 it also affected a much
wider
range of more sophisticated products. Japanese
manufacturers began
actively seeking lower cost production bases. This factor,
rather
than any increase in foreign protectionism, appeared to
lie behind
the acceleration of overseas investments after 1985.
This cost disadvantage also led more Japanese firms to
think of
their overseas factories as a source of products for the
Japanese
market itself. Except for the basic processing of raw
materials,
manufacturers had previously regarded foreign investments
as a
substitute for exports rather than as an overseas base for
home
markets. The share of output from Japanese factories in
the lower-
wage-cost countries of Asia that was destined for the
Japanese
market (rather than for local markets or for export) rose
from 10
percent in 1980 to 16 percent in 1987, but had returned to
11.8
percent in 1990.
Data as of January 1994
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