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FRBSF

WEEKLY LETTER

July 1, 1988

Foreign Investment in the Pacific Basin
Private foreign investment activity recently has
experienced atremendous upsurge among the
economies in the Pacific Basin, a region which
comprises North America (the United States and
Canada), East Asia (Japan, China, South Korea,
Taiwan, and Hong Kong), ASEAN (Brunei, Indonesia, Malaysia, Philippines, Singapore, and
Thailand), and Oceania (Australia, New Zealand,
and South Pacific nations). Foreign trade already
is a strong link among these economies. Now,
the growth in both direct investment (that is, investment for the purpose of setting up production
facilities and operations) and in portfolio investment (that is, the purchase of financial assets in
securities markets) among these economies suggests that foreign investment also is beginning to
play an important role in binding these economies together.
Coupled with the rapid growth in foreign investment, new trends in the direction and nature of
investment flows also are emerging. Foreign investment in the Pacific Basin now is more diversified across industries and more multidirectional
across economies than was the case in the past.
This Letter discusses these trends, their impact on
the Pacific Basin economies, and the policy issues they raise.

Foreign investment boom
The growth in private foreign investment, particularly in the more developed Pacific Basin economies, has been spectacular in the last few years.
In 1986 and 1987, for example, analysts estimate
that private foreign investment grew 50 percent.
In the newly-industrialized East Asian economies
of South Korea, Taiwan, and Hong Kong, as well
as in the ASEAN economies, foreign investment
growth was much higher; some countries even
reported growth rates in excess of 100 percent.
In addition to its booming rate of growth, foreign
investment in the Pacific Basin region also has
been remarkable for its new, multidirectional
flow. In the past, American 'and Japanese companies were the primary investors in the region,
and although American investment was somewhat diversified geographically, Japanese in-

vestment tended to concentrate on portfol io
investment in North America.
Today, in contrast, the East Asian, ASEAN, and
Oceanian economies no longer are merely recipients of foreign investment funds, but also are
engaged in foreign investment themselves. The
newly industrialized economies of East Asia, for
example, now have direct investment in North
America, ASEAN, and Oceania, while Australia
and New Zealand have direct investment in
ASEAN and China.
Similarly, the nature of Japanese and North
American foreign investments also has changed.
Japanese investment now encompasses. both
direct and portfolio investment in North America,
as well as direct investment in the whole region.
North American foreign investment now includes
portfolio investment in some countries as well as
direct investment in the whole region.
Another distinction between the type of foreign
investment that is taking place now as opposed
to that which took place in the past is that foreign
investment now is more diversified across industries in the region. In the past, foreign investment
concentrated in the manufacturing and goodsproducing sectors. Today, in addition to manufacturing, North American direct investment encompasses petroleum and services, including
finance and insurance. Similarly, Japanese direct
investment encompasses manufacturing, resource development, real estate, and services.
Oceanian and East Asian foreign investment is in
manufacturing.

Why the upsurge?
A number of developments in the last few years
have contributed to the favorable climate for
private foreign investment in the Pacific. First, all
the Pacific Basin economies have experienced
strong economic growth, especially in 1986 and
1987. For example, China, South Korea, Taiwan,
and Hong Kong all reported double-digit or near
double-digit growth in 1987. The ASEAN
economies recovered in 1986, and in 1987,
growth ranged from 3.5 percent for Indonesia

FRBSF
and 8.6 percent for Singapore. Japan, Australia,
and Canada reported growth in the four to five
percent range for the year. The U.S. reported
somewhat slower though still respectable,
growth. The fairly optimistic medium-term ouF
look for growth. These growth rates have stimulated demand for foreign investment in the
region, particularly, among the East Asian and
ASEAN countries, likewise has made foreign
investment in the Pacific Basin more attractive.

Trade imbalances
A second reason for the upsurge in foreign investment has been the emergence of substantial
trade imbalances among countries in the region.
For example, in 1986 and 1987, Japan recorded
current account surpluses of about $80 to $90
billion a year, and Taiwan recorded surpluses of
$15 to $20 billion a year. These surpluses generated substantial foreign exchange reserves for
some countries that were best recycled through
investment in foreign assets. High domestic saving in Japan, in particular, provided funds for
foreign investment.
The currency realignments that took placeafter
September 1985 also contributed to the rapid
growth in foreign investment. The fall of the U.s.
dollar and the rise in the value of the Japanese
yen, coupled with the internationalization and
liberalization of financial services in major markets, have made direct foreign investment in financial companies attractive. Moreover, the rises
in the yen, the Taiwan NT dollar, and the Korean
won (to a lesser extent) have forced firms in these
countries to establish production facilities in
other countries with weaker currencies as away
ofremaining competitive internationally.
Trade barriers, or threatened trade barriers, also
have played a role in encouraging direct investment. Japanese and East Asian newly industrialized countries have invested in production
facilities in the u.s. partly in response to rising
protectionist sentiment here.
New technology and attitudes
New production technology and improvements
in telecommunications and transportation systems also have encouraged foreign investment.
These technological advances have made it less
expensive for firms to assemble parts manufactured in many different countries and produce
goods that are truly international in origin.

Investment in the electronics and automotive
industries, in particular, has become internationalized, allowing firms to exploit the comparative advantages of many different countries.
Finally, foreign investment has boomed lately
because the countries in the Pacific Basin have
adopted much more liberal attitudes towards private foreign investment. The governments of
these countries have changed rules and regulations governing foreign investment, making it
easier and more attractive for foreign firms to
operate. This is especially true in the case of the
ASEAN countries.
Impact of investment
The upsurge in private foreign investment is having a profound impact on Pacific Basin economies. Economic and technological integration
within the region is occurring at an accelerated
pace partly because of foreign investment. Increasingly, it makes sense to view the Pacific
Basin region as one economy.

Since most foreign direct investment in manufacturing has been related to international trade,
trade naturally has increased among the countries in the region. This, in turn, has made each
economy more open, and more subject to the
fluctuations in international trade and finance.
Similarly, new trends in foreign portfolio investment are leading to increased internationalization of securities markets and improved
access for domestic firms to international capital
markets.
Direct investment in the ASEAN and East Asian
newly industrialized countries also is helping to
accelerate the process of industrialization. Increasingly, the industrial sectors of all of East Asia
and ASEANare becoming integrated, with different countries specializing in different stages of
production in the same industry. Moreover, because.firms are choosing to invest in production
facilities where the needed supplies are available,
process and product technologies are being diffused at a faster rate than in the past.
Finally, the sudden rise in foreign investment is
intensifying competition for local resources, including labor, and leading to rising land prices
and wages in some countries. Reduced disparities among countries in these fa<::tor costs is further evidence of increasing integration within the
Pacific Basin region.

Policy issues
The boom in foreign investment also highlights
the need for domestic economic reforms and, as
a consequence, sometimes fosters controversy. In
the United States, American companies investing
overseas are accused of exporting jobs, while foreign companies investing in the U.S. are accused of buying up America. New Zealand is
wrestling with a conflict between the need to
push forward with the liberalization and internationalization of its economy, on the one hand,
and the resistance of domestic businesses to international competition, on the other hand.
ASEAN countries, likewise, are attempting to balance the political implications of both the need
to promote foreign investment and the consequences of the rapid growth in such investment.
japan has had to introduce additional measures
to encourage more overseas private investment as
a means of reducing its current account surplus.
These measures include liberalization of the japanese capital market. Programs to insure overseas investments from fluctuations in value also
are under consideration.
The newly industrialized Asian countries are
finding for the first time that they must encourage
domestic firms to go overseas to retain international competitiveness. Rules and regulations
regarding foreign exchange transactions may
need to be changed in the process.

Regional coordination
In addition to the policy dilemmas that each
country faces domestically, there are issues raised
by the multidirectional and diverse nature of
foreign investment that are best resolved on a
region-wide basis. First, trade barriers, or
threatened barriers, distort investment flows.
japanese investment in the U.S. would have
been lower and, according to business persons

close to the situation, investment elsewhere in
the region higher, if the U.S. had not threatened
higher trade barriers.
In addition to trade barriers, foreign exchange
fluctuations can deter investment in many instances. Since exchange rate instabilities largely
are the result of imbalances in international
payments, greater policy coordination in this
regard might create a more favorable environment for investment in the ASEAN region.
Third, the internationalization of production
requires cooperation in the standardization of
components and the quality of products. Also,
rules regarding immigration and emigration need
to be simplified to facilitate investment and economic integration.
In ASEAN and China, the physical and institutional infrastructure, including their tax codes
and systems, needs further development. Cooperation with the more highly industrialized
countries is essential in this regard to assure
greater uniformity in the tax treatment of foreign
investment.
Finally, assistance in the development of the securities markets of developing economies in the
region would help to facilitate the flow of portfolio investment in these economies and make
international capital markets more accessible.
The economic integration that has taken place to
date in the Pacific Basin region is indeed remarkable. Trade and foreign investment flows among
all the economies in the region are increasing in
size and diversity. It is no wonder, then, that the
Pacific Basin is one of the most dynamic regions
in the world.

Narongchai Akrasanee

Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of
San Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Barbara Bennett) or to the author.•.. Free copies of Federal Reserve
publications can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702,
San Francisco 94120. Phone (415) 974-2246.

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