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REGIONAL ECO N O M IC ISSU ES
W o r k in g P a p e r S e r ie s
The Opening of Midwest Manufacturing
to Foreign Companies:
The Influx of Foreign Direct Investment
Alenka S. Giese
FEDERAL RESERVE BANK
OF CHICAGO
WP- 1989/5
Table of Contents
List of Tables and Graphs
Introduction
I.
What is Foreign Direct Investment?
II.
The Nature o f F D I in Manufacturing
III.
Major Source Countries of Manufacturing F D I
IV.
Factors that Motivate F D I in Manufacturing
V.
VI.
The Surge in F D I in Manufacturing— 1978-1986
The Geographical Dispersion of Manufacturing F D I
VII.
An Overview o f the Pros and Cons Swirling Around F D I
VIII.
A Case Study of F D I in the Auto and Autoparts Industries
Conclusion
Footnotes
References
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List of Tables
1.
F D I by Industry in the U.S. and the Seventh District, F D I Transactions:
1986
2.
F D I by Source Country in the Seventh District:
3.
Growth in Manufacturing F D I in the U.S. and Seventh District:
1978-1986
4.
Regional F D I Employment in Manufacturing:
5.
Three Measurements o f Manufacturing F D I in the Seventh District:
1986
6.
Shifts in Regional Shares o f Manufacturing FDI:
7.
F D I by Japanese Automakers
8.
U.S. Big Three Automakers and their Ties to Japanese Automakers:
1988
9.
Foreign Autoparts Manufacturers in the U.S.:
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1978 and 1986
1986
1978-1986
1988
The Opening o f Seventh D istrict M anufacturing to
Foreign Companies: the In flu x o f Foreign D irect
Investment
By Alenka S. Giese*
Introduction
The 1980s have heralded in dramatic changes in the Seventh District’s
manufacturing sector (the Seventh District comprises Illinois, Indiana,
Iowa, Michigan, and Wisconsin). One of the many dimensions of the re
structuring of District manufacturing is the increasingly prominent role
played by foreign direct investment (FDI). Although F D I has received less
attention than other aspects of the transformation of District manufactur
ing, its analysis is warranted given its exceptional growth, its role in the
globalization of the District’s manufacturing sector, and the controversy it
has stirred. In a nutshell, F D I in the U.S. overall and in the District spe
cifically has increased dramatically over the past decade. Foreign compe
tition in the District has evolved from being primarily in the form of
imports to being in the form of F D I (e.g., acquisitions, joint ventures, and
new plants). Since 1978, both employment and total real sales of U.S. af
filiates o f foreign investors have more than doubled. Although Western
European countries and Canada are still the dominant sources of FD I, the
trend in F D I reveals a wave of Japanese investment.
This paper focuses on F D I in manufacturing in the Seventh District. Its
objective is to analyze the nature and extent of F D I in District manufac
turing and the implications of its strong growth. The paper is divided into
eight sections. The first section provides a definition of F D I and describes
the three measures used to quantify it. The second section examines the
forms of F D I in manufacturing and discusses their advantages and disad
vantages. The third section covers the major source countries of F D I and
their preferred forms of FD I. The fourth section highlights the factors that
motivate F D I and have fueled its extraordinary growth in the 1980s.
Sections five and six review the growth and geographic dispersion trends
of FD I. The seventh section provides an overview of the polemical nature
of F D I and outlines the views of F D I advocates and opponents. The
*Alenka S. Giese is an associate economist at the Federal Reserve Bank of Chicago. The au
thor thanks David Allardice, Eleanor Erdevig, Robert Schnorbus, and William Testa for
helpful comments and suggestions.
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3
purpose o f this section is not to settle the dispute over the costs and benefits
of FD I, but rather it is to present contrasting arguments along with their
assumptions and conjectures. In order to place F D I in an industry context
and examine more closely its complex nature, the last section undertakes a
case study o f F D I in the auto and autoparts industries.
I. W h a t is foreign direct investment?
Before undertaking an analysis of FD I, it is useful to clarify its definition.
The definition of F D I used by the Bureau of Economic Analysis (BEA) and
the International Trade Administration (ITA) is direct or indirect foreign
ownership of 10 percent or more of the voting securities o f a corporation
or equivalent interest in an unincorporated business. While ten percent
foreign ownership is sufficient to call the U.S. corporation a U.S. affiliate,
most U.S. affiliates have a much higher percent o f foreign ownership.1 Be
cause F D I involves voting securities, it should not be confused with foreign
portfolio investment in bank deposits, non-voting securities, and U.S.
Treasury issues.
This study focuses on three measures o f F D I in manufacturing: employ
ment at U.S. affiliates, gross book value of property, plant, and .equipment
o f U.S. affiliates, and number o f F D I transactions (unless otherwise noted,
data cover manufacturing only).2 The reason for the choice of these meas
ures is that they provide complementary data on F D I that can be used to
calculate regional levels, shares, and growth rates. F D I employment and
gross book value (GBV) can be used as a proxy for the “ stock” of FD I, that
is, the cumulative value of FD I. In addition, F D I employment data are a
good proxy to measure growth in F D I activity. Gross book value data
cannot be used to measure growth because they are in historical dollars
(i.e., assets are valued at acquisition cost), and there are no G B V deflators
available to convert them to constant dollars. Nevertheless, G B V data are
useful to measure regional shares of F D I and probably provide more ac
curate share measures than employment data which could underestimate
the level of F D I activity in capital-intensive industries and industries in
which capital is being substituted for labor. The number o f F D I trans
actions is a good proxy for annual F D I and is the only source that provides
regional F D I data by form o f F D I and by industry, at the three and four
digit SIC (Standard Industrial Classification) code level.3
II. T h e nature of F D I in manufacturing
Foreign direct investment in manufacturing takes on four basic forms:
acquisition/merger, new plant, joint venture, and plant expansion.4 The
most
common
form
of
FD I
is
the
acquisition/merger.5 An
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acquisition/merger offers several advantages over the other forms of FDI.
Firstly, it provides the foreign buyer with an on-going business that already
has a foothold in the U.S. market and thus allows the buyer to avoid po
tentially high start-up costs, which include building or acquiring a plant,
interviewing and staffing, and establishing networks upstream to suppliers
and downstream to distributors. Secondly, an acquisition/merger often
provides established and extensive marketing and distribution channels.
This advantage may be paramount because it facilitates one of the most
difficult tasks o f a foreign company’s attempt to capture U.S. market share.
The establishment of an adequate distribution system often entails high
costs and much trial and error because of the cultural and logistical differ
ences between our distribution and transportation systems and those of
other countries.6 A third advantage of an acquisition/merger is that it al
lows the foreign firm to have autonomy over managing the company.
Through an acquisition (as opposed to a joint venture) the foreign firm has
relatively greater leeway in any changes it wishes to undertake.
The second form of FD I, establishing a new plant, may be optimal in some
instances even though it entails start-up costs and possibly higher risks.
The decision of whether to establish a company as opposed to acquiring
one is often dependent upon market opportunities which differ across in
dustries. For the nonelectrical and electrical machinery and auto industries,
there appears to be room for new entrants, that is, new plants (LTCB of
Japan 1987). In contrast, in the primary metals industries, the markets of
fer smaller opportunities to a new entrant, and thus F D I is usually in the
form of an acquisition. Outside of market opportunities, F D I in the form
of a new plant could be the best choice if the foreign company has extensive
experience selling and producing in the U.S., wants to maintain proprietary
rights over its technology, or cannot find a suitable company to form a joint
venture with or to buy.
Many foreign firms view the third form of FD I, the joint venture, as the
preferable means for entry into the U.S. market. There are several reasons
behind their preference. Firstly, if the foreign company has little experience
in producing and marketing in the U.S., major barriers must be overcome
to successfully enter the U.S. market alone through a new plant. Secondly,
if the company’s industry entails taking high risks (e.g., production of high
tech products with relatively short product life cycles), the company may
want to share the risk with a U.S. company.
Thirdly, if the foreign
company’s business involves high capital requirements and it does not have
sufficient funds or the ability to raise such funds, it can spread out the
capital costs by undertaking a cost-sharing joint venture with a U.S. firm.
The most common form of F D I in both the nation and the District is the
acquisition/merger. In 1986, acquisition/mergers accounted for 42 percent
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5
of the F D I transactions in the District. New plants ranked second with 26
percent. The rise in prominence of F D I in the form of new plants is strik
ing. Since 1978, the share held by new plants has jumped from only 6
percent to 26 percent. Although joint ventures rank a far third with 10
percent of total F D I transactions, their presence has grown also since 1978
when they accounted for only 6 percent. Within the District, the dominant
form of F D I in 1986 differed in only one state, Indiana, where new plants
outnumbered acquisitions over two to one.
In order to better understand the nature of FD I, it is useful to overview the
industries that have attracted a significant amount of FD I. An interesting
aspect of F D I in the U.S. is that it often flows into the same industries that
U.S. F D I has traditionally favored abroad. Exemplary of this phenomenon
is the extraordinary expansion of Japanese F D I in the auto industry. Who
would have expected that Japan would build cars in the U.S. and export
them back to Japan? For example, Honda plans to export one-third of its
production of 350,000 vehicles from its new plant in Marysville, Ohio (A u
tom otive N e w s 9/21/87).
Table 1 ranks two-digit SIC code industries by their share of F D I in the
U.S. and the District. The table reveals that F D I is not distributed equally
across industries but rather displays certain preferences. The dominance
of the chemical, electrical and electronic machinery, and nonelectrical ma
chinery industries suggests that much F D I flows into technology-intensive
industries.7 Following the tech-intensive industries are the resource
intensive industries such as food and kindred products and paper and allied
products. Third in attracting F D I are the capital-intensive industries such
as primary and fabricated metals. The reason for their lower ranking is
probably that these industries are hobbled by overcapacity in the U.S. (e.g.
steel) and thus offer little market expansion opportunity. All the laborintensive industries accounted for less than 4 percent of the F D I trans
actions. The relatively weak flow o f F D I into labor-intensive industries is
explainable by the combination of relatively high cost of labor in the U.S.
and the reluctance of foreign investors to deal with organized labor.
III. M a j o r source countries of manufacturing F D I
Western European countries and Canada have traditionally been the dom
inant source countries of FD I. Their status, however, has been eroded by
the dramatic rise in Japanese FDI. Since 1978, expansion in Japanese FD I
has been occurring at an above average pace. In 1978, the top five source
countries in terms of national F D I transactions were in rank order:
Canada, United Kingdom, West Germany, Japan, and France. The rank
ing of these countries in the District was slightly different with Canada’s
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6
Table 1
F D I b y in d u s tr y in t h e U .S . a n d t h e S e v e n t h D is t r ic t
F D I T r a n s a c tio n s : 1 9 8 6
Seventh District
United States
Industries
Number
(in the U.S.)
Share of Total
Industries
(percent)
(in the District)
Number
Share of Total
(percent)
Electrical and Electronic
Machinery
75
16.6
Chemicals
15
22.7
Chemicals
69
15.3
Electrical and Electronic
Machinery
11
16.7
Nonelectrical Machinery
66
14.6
Nonelectrical Machinery
9
13.6
Food and Kindred Products
39
8.6
Transportation Equipment
7
10.6
Paper and Allied Products
38
8.4
Fabricated Metals
5
7.6
Primary Metals
29
6.4
Primary Metals
4
6.1
Instruments and Related
Products
24
5.3
Food and Kindred Products
3
4.5
Transportation Equipment
24
5.3
Paper and Allied Products
3
4.5
Fabricated Metals
19
4.2
Rubber and Miscellaneous
Plastic Products
3
4.5
SOURCE: International Trade Administration (U.S. Department of Commerce) Foreign Direct Investments in the U.S.: 1986 Transactions
September 1987.
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Table 2
F D I b y s o u r c e c o u n t r y in t h e S e v e n t h D is t r ic t : 1 9 7 8 a n d 1 9 8 6
FDI Transactions in Manufacturing
Number
Country12
1978
Total FDI Employment and GBV2
Share of Total
1986
1978
Share of Gross
Book Value
Share of Employment
1986
1978
(percent)
1986
1978
(percent)
1986
(percent)
Canada
6
11
10
11
21
22
31
24
France
1
2
2
2
10
9
8
7
Japan
5
37
8
37
5
9
3
15
United Kingdom
11
13
18
12
21
21
13
12
West Germany
23
6
38
5
14
13
20
10
1 Another country that ranks in the top five in terms of "stock" of FDI is the Netherlands with 12 percent of the gross book value of U.S. affiliates in
the nation. The Netherlands is excluded here because there were no transactions with it in 1986.
2 Total U.S. Affiliates (i.e., all sectors) data used because no separate data on manufacturing are available.
SOURCE: Bureau of Economic Analysis (U.S. Department of Commerce), F o r e ig n D ir e c t In v e s tm e n t in th e U .S .: O p e ra tio n s o f U .S . A ffilia tes,
1 9 7 7 - 1 9 8 0 , 1985 and
1 9 8 6 , 1988; and International Trade Administration (U.S. Department of Commerce) F o r e ig n D ir e c t In v e s tm e n t in th e
U .S .: C o m p le te d T ra n sa ctio n s, 1 9 7 4 - 1 9 8 3 , June 1985 and
1 9 8 6 , September 1987.
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and West Germany’s position switched (Table 2). By 1986, Japan’s posi
tion had risen to number one in both the U.S. and the District.
Despite Japan’s recent investment spurt in the U.S., it has yet to build a
“stock” of F D I comparable to that of Canada or the United Kingdom.
Among the top five source countries, Japan still holds the smallest share
o f F D I employment across all sectors (no separate data for 1978 on man
ufacturing available). Nevertheless, a rise in Japan’s status in the District
is visible. Between 1978 and 1986, the share of total F D I employment held
by Western European countries began to fall off (approximately 1 percent
age point) whereas Japan’s share grew from 5 to 9 percent while that of
Canada rose from 21 to 22 percent (Table 2). In terms of F D I gross book
value, Japan’s rising presence and West Germany’s declining presence are
more pronounced. Between 1978 and 1986, Japan’s share of total FD I
gross book value increased five-fold, placing it as the second largest source
country.
It is interesting to note that the preferred form of F D I differs notably across
source countries.
Western European countries and Canada favor
acquisition/mergers heavily over joint ventures and new plants. In 1986,
over 50 percent o f Canada’s and the United Kingdom’s F D I transactions
across all sectors was concentrated in acquisition/mergers (no separate data
on manufacturing available). In contrast, Japan has a more equal balance
of F D I in acquisition/mergers (23 percent of total F D I transactions) and
new plants (20 percent) and has a greater propensity to form joint ventures
(11 percent) than the Canadians or Europeans.
Although there are no clear-cut reasons for these differing tendencies across
source countries, there are some hypotheses. One hypothesis is that Japan
has a greater propensity to undertake joint ventures because of the rela
tively greater distance between itself and the U.S.— both in geographical and
cultural terms. In contrast, Canada and Western European countries with
relatively more experience in and similarities with the U.S. are better
adapted to undertake acquisitions and new plants. Although the part of
the hypothesis regarding European and Canadian F D I is substantiated by
F D I data on acquisitions, the part regarding Japanese investment, however,
does not hold.
IV. Factors that motivate F D I in manufacturing
What are the factors that have propelled the surge in F D I in manufactur
ing? How do they differ from those that act as an incentive to export?
Although trade barriers and exchange rate movements are the factors most
often cited, the answer to the first question is more complex because there
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are a host o f other factors that have been shown to influence FD I. The
factors affecting the F D I decision can be categorized under three broad
headings: economic and strategic factors, transactional factors and intan
gible assets, and political factors.
A t the top o f the hierarchy of the motivators of F D I are economic factors
such as the minimization of cost of production and materials and the ex
pansion of foreign market share. These factors are often coupled with
saturated domestic markets and surpluses of savings and dollars (due to
trade surpluses with the U.S.) Trade barriers (e.g. tariffs, restrictive import
quotas, and domestic content legislation), which could be placed under ei
ther the economic or political rubric, are included with the economic factors
because they play a prominent role in the price competitiveness and market
share of foreign goods.
In order to explain the economic factors that motivate F D I in the U.S.,
traditional international economic theory has to be expanded. The reason
is that the economic factors that drive F D I in the U.S. extend beyond those
included in traditional theories such as Heckscher-Ohlin’s (which focuses
on comparative-cost advantages and factor endowments) and Vernon’s
product cycle theory (which emphasizes the role of phases of production,
innovation, scale economies, and imperfect knowledge).8
Before expanding beyond these theories, it is necessary to describe how they
partially explain the factors behind FDI. The basic foundation o f the
Heckscher-Ohlin theory is the concept of comparative-cost differences
across nations. Although this model was constructed to predict trade flows,
it can be used to partially explain the behavior of FD I. The HeckscherOhlin theory states that a country’s comparative advantages in production
vis-a-vis those of other countries is a function of its endowment of three
factors o f production: labor, capital, and natural resources. In terms of
explaining F D I flows, the theory predicts that F D I will go to countries
whose factor endowments allow the source country to minimize its labor,
capital, and/or input costs and maximize its return on capital. A t the firm
level, F D I becomes lucrative when a firm can transfer its comparative
advantage(s) in production activities to another country and thus is able to
successfully compete against domestic firms.
The Heckscher-Ohlin theory does not, however, adequately explain FD I
flows because it focuses on only three factors and makes assumptions that
are unrealistic in the context of F D I such as perfect markets, free trade, and
knowledge as a free universal good. Some of the important factors that
Heckscher-Ohlin does not take into consideration include trade barriers,
differences in economies of scale, and differences in technological know
how.
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In order to supplement the Heckscher-Ohlin theory and better explain the
impetus behind F D I in the U.S., additional factors (aside from labor, cap
ital, and natural resources) must be included. Other factors that should be
examined include trade barriers, exchange rates, and market expansion
opportunities in both the source country and the recipient country (i.e., the
U.S.). These additional factors can be incorporated into a broader theory
on F D I by drawing from Vernon’s product cycle theory. The product cycle
theory holds that F D I as opposed to exports becomes optimal when the
marginal production cost of exporting to the U.S. plus transportation costs
exceeds the average production cost of producing in the U.S. (Vernon
1966). Vernon does not limit the factors that enter into the cost equations
and includes differing economies of scale. In addition, he considers non
economic factors such as patent protection and communication between the
firm and its customers and suppliers. He does not, however, directly in
clude political factors.
Among the additional factors that Vernon takes into consideration are
those that threaten a company’s position in a foreign market. He states
that “any threat...is a powerful galvanizing force to action; in fact, if I in
terpret the empirical work correctly, threat in general is a more reliable
stimulus to action than opportunity is likely to be” (Vernon 1966, p. 200).
His theory on threats provides an explanation as to why trade barriers are
a key factor in a foreign firm’s decision to produce in the U.S. as opposed
to export to the U.S. Trade barriers are a clearcut example of a threat to
a foreign firm’s share of the U.S. market.
Regarding the connection between trade barriers and FD I, Richard Caves
cites over a half a dozen studies that have found a close positive relation
ship between the raising of trade barriers and the change in F D I across all
sectors (Caves 1981). A case in point is the influx of Japanese F D I into the
U.S. auto industry that coincides with the looming threat of increased
protectionism. A study by the Industrial Bank of Japan (IBJ) found that
the primary motive in the move to the U.S. by Japanese original equipment
manufacturers (OEMs) was the expectation of continued and stiffer re
strictions on Japanese auto exports to the U.S. Another example o f how
the threat of protectionism spurs F D I is seen in the recent acceleration of
U.S. F D I in Europe which is primarily attributable to fears that a “ Fortress
Europe” will emerge in 1992.
In addition to tariffs and restrictive import quotas, the threat of
protectionism comes in the form of domestic content legislation.9 Unlike
tariffs which are implemented in reaction to a strong inflow of imports,
domestic content legislation is usually proposed in reaction to an influx of
FD I. The primary objective of the legislation is to expand the economic
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11
benefits of F D I by requiring foreigners operating in the U.S. to buy their
inputs from domestic firms as opposed to favoring firms in their own
country. This goal may be circumvented, however, because foreign firms
may choose to procure their materials from another U.S. affiliate. For
example, many o f the Japanese O EM s in the U.S. have encouraged strongly
(some critics say coerced) their Japanese autoparts suppliers to locate in the
U.S. It has been estimated that 90 to 95 percent of the local content of
Japanese U.S.-built autos is supplied by Japanese U.S. plants (Iannone
1988).
Another economic factor related to foreign trade that has a similar effect
as tariffs do on the price competitiveness of foreign goods is the dollar ex
change rate. A significant depreciation in the dollar against the currency
of its trading partners has two effects, both of which make F D I more at
tractive than exporting. Firstly, the price competitiveness of exports to the
U.S. is adversely affected. Secondly, the cost to foreigners o f acquiring or
establishing companies in the U.S. falls. Although the negative relationship
between the dollar exchange rate and F D I is theoretically clear, empirically
it turns out to be significantly weaker than the positive relationship between
trade barriers and FD I. For example, the depreciation of the dollar was
not cited as a significant factor in several surveys of the Japanese F D I de
cision (L T C B of Japan 1987).
There are a couple of reasons why fluctuations in the value of the dollar
are not as influential in the F D I decision as trade barriers are. Firstly, the
decision to invest in the U.S. takes time to plan and implement, particularly
if a new plant is being built. Thus, F D I cannot be undertaken simply as a
short-term reaction to a declining dollar. A foreign firm may, however,
have an F D I plan already prepared and may wait for an anticipated decline
in the dollar to carry it out. Secondly, there often is large uncertainty sur
rounding the duration of a fall in the dollar exchange rate. The dollar may
reappreciate just as a foreign firm begins producing in the U.S., which
could make the firm’s products less price competitive than imports of sub
stitutes. Thirdly, the benefits of producing in the U.S. may be diminished
if the dollar profits are repatriated when the value of the dollar is relatively
low.
Although comparative advantages in production and trade barriers are of
ten important factors in the final decision to produce in the U.S., market
factors and surpluses in savings and dollars often play an important role
too. Market factors include limited domestic market expansion and short
age of domestic investment opportunities. Shrinking domestic market op
portunities have been important motivators in Japanese and European F D I
in the U.S. In addition, over the past decade, savings in Japan and West
Germany have surpassed domestic investment needs and thus have flowed
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abroad, primarily to the U.S. whose savings/investment situation is the
converse and whose market, being one of the largest and richest in the
world, offers relatively strong growth opportunities. Another factor that
has facilitated FD I has been surplus dollars resulting from positive trade
balances with the U.S. For example, Japan, in particular, has a large stock
of dollars that it can draw upon to Finance its FDI.
An industry example of how domestic market saturation and surplus dol
lars promote F D I is provided by the Japanese auto industry. Since their
early development, Japanese OEM s recognized the limited domestic market
opportunities in Japan and have consequently focused on expanding their
share of lucrative foreign auto markets. The IBJ study (mentioned above)
found that the second most important factor in Japanese FD I in the U.S.
auto industry is that the U.S. market is the largest in the world with about
10 million cars sold per year.
In contrast to the first category of FD I motivators which focuses on tan
gible assets and production activities, the second category deals with com
parative advantages in intangible assets and nonproduction activities. The
paper draws upon the transactional approach theory to explain why the
optimization of the benefits of intangible assets is achieved through FD I
as opposed to exporting or licensing. Intangible assets include technology,
skilled labor, and extensive transportation and communication systems and
nonproduction activities include R & D , advertising, and marketing. The
U.S. market is particularly attractive to FD I motivated by qualitative fac
tors because it offers the resources necessary to optimize the use of intan
gible assets.
F D I whose purpose is to maximize the use of intangible assets differs from
F D I spurred by economic and political concerns in that it tends to be
driven more by long-term goals than by short-term financial performance.
The objectives of this type of F D I emphasize developing and expanding a
firm’s internal strength rather than overcoming external problems such as
trade barriers and exchange rates that are unfavorable to exporting.
The transactional approach theory outlined by Caves explains why a for
eign firm would prefer to optimize the benefits of its intangible assets
abroad by retaining exclusive rights over them and exploiting them
internally through F D I (Caves 1982).
According to the theory, firms
choose to establish their own multinational plants because the other options
to optimize their intangible assets are often impossible to undertake due to
market imperfections and transaction impediments.10 Moreover, even when
these other options are feasible, they may diminish the benefits to the for
eign firm of having an edge in a particular nonproduction activity, partic
ularly if the activity is R & D or technology related.
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Although Caves provides a sound argument in favor o f maximizing com
parative advantages in intangible assets through F D I in the form of a new
plant or acquisition, it may not be economically or technically possible to
undertake these types of FD I. If not, an alternative way for a foreign firm
to use its intangible assets in the U.S. is to form a joint venture and share
its intangible assets with a U.S. company. Exemplary of this type of ven
ture is G M -Fan uc’s cooperative effort to produce robotics. Their goal is
to benefit from the synergies and complementarities between their R & D ,
marketing, and technological resources (to name only a few).
The third category of factors in the F D I decision are political. Among the
primary political factors that attract F D I are a stable government and
laissez-faire attitude. In terms of these two factors, the U.S. has historically
been a safe haven for FD I. Foreign investors do not have to worry about
their U.S. assets being expropriated by the government or their U.S. profits
and capital being burdened with repatriation restrictions. In addition,
foreign-owned companies benefit from the American free enterprise doc
trine. Over the past decade, the U.S. has appeared even more attractive to
F D I than developing countries because the political situation of many of
these latter countries has become more tenuous while their economic situ
ation has become more depressed, mainly due to a growing and yet unre
solved external debt problem and soaring inflation. In contrast, domestic
demand in the U.S., fueled in part by an expansionary fiscal policy, has
been growing at a faster pace than G N P while inflation has been held in
check.
A secondary political factor that influences F D I is state efforts to attract
it. As mentioned above, F D I has been attracting a lot o f attention from
state and local politicians who see it as a means of creating jobs in and
supplying capital to their community. Although local efforts to attract F D I
may have little bearing on the level of F D I flowing into the U.S., they ap
pear to have some influence over its final location and thus merit attention
(Kahley 1986; L T C B of Japan). A survey by the U.S. Government A c
counting Office on state government policy toward F D I revealed that 35
states strongly encourage F D I overall and have budgeted state funds to
attract it (all 50 states were surveyed; U S G A O 1980). A t the same time 45
states were strongly promoting F D I in the form of new manufacturing fa
cilities and joint ventures. Their efforts range from investment missions to
industrial incentives (e.g., subsidization of job training programs, bond fi
nancing, and tax incentives). In order to establish closer ties with foreign
investors, 33 states have established offices overseas. Illustrative of these
efforts within the District is the effort of the State of Illinois to attract the
Chrysler/Mitsubishi joint venture.
FRB CH ICAGO W orking Paper
February 7989, W P -1 9 8 9 -5
14
Now that the three categories of influential factors in the F D I decision have
been outlined, it is interesting to note how their influence varies across in
dustries. Economic factors seem to dominate F D I flowing into durable
goods industries while transactional factors appear to have the most influ
ence in F D I targeted at nondurable goods industries.
In many of the durable goods industries, rising trade barriers appear to
have triggered FD I. For example, in the steel industry, strong protectionist
sentiment that began in the 1950s has spurred the Japanese to buy out or
to buy into U.S. steelmakers (e.g., National Steel). Other examples include
color T V ’s, semiconductors, and autos. In these industries, foreign com
panies have set up operations in the U.S. either through acquisitions or new
plants in order to hurdle trade barriers and mitigate trade friction.
For the nondurable goods industries and a minority of durable goods in
dustries, there is a relatively greater tendency for F D I to be motivated by
transactional factors. The enhancement of technological strengths either
through access to high skilled labor or synergistic joint ventures (e.g.,
knowledge acquisition) is often the objective of F D I in the chemicals and
instruments industries, though trade barrier considerations also play a role.
Comparative advantages in intangible assets such as advertising and R & D
play a role in F D I in the chemicals industry as well as the food industry
(Goedde 1978).
V. T h e surge in F D I in manufacturing— 1978-1986
Over the past decade, F D I in manufacturing has been attracting increas
ingly more attention on the part of economic developers and researchers
because of its extraordinary growth. This growth has been contributing to
the globalization of the U.S. economy and its mainstay industries. Exam
ination of the 1978-1986 growth of the three selected measures of FD I
reveals that F D I has soared, both at the national level and in the
District.11 Between 1978 and 1986, national F D I employment nearly dou
bled from 798,100 to 1,391,100 (Table 3). Similarly, total assets, sales, and
G B V of U.S. affiliates showed strong growth. Total sales of U.S. affiliates
more than doubled from $87.4 to $192.7 billion (1982 dollars), while G B V
jumped from $29.4 to $113.0 billion (historical dollars). National FD I
transactions grew from 270 to 452, or 67 percent.
As a result of the surge in FD I, the U.S. role in F D I has evolved from being
primarily the largest source to being both the largest source and the largest
recipient. The growing importance of the U.S. as recipient is reflected in
total asset data. Between 1977 and 1985, the ratio of the value of total
FRB CH ICAGO W orking Paper
February 1 989, W P -1989-5
15
Table 3
G r o w t h in M a n u f a c t u r i n g F D I in t h e U .S . a n d S e v e n t h D is t r ic t : 1 9 7 8 -1 9 8 6
FDI Employment
1978
1986
(thousands)
FDI Transactions
1978-1986 Growth
1978
1986
(percent)
1978-1986 Growth
(percent)
UNITED STATES1
798.1
1,391.1
74
270
452
67
SEVENTH DISTRICT
138.5
204.0
47
34
69
103
Illinois
44.6
69.7
56
10
29
190
Indiana
28.8
37.0
28
2
11
450
8.1
10.9
35
1
3
200
Michigan
33.0
53.0
61
11
20
82
Wisconsin
21.4
33.4
56
10
5
-50
Iowa
1 United States = 50 states and the District of Columbia.
SOURCE: Bureau of Economic Analysis (U.S. Department of Commerce), F o r e ig n D ire c t In v e s tm e n t in th e U .S .: O p e ra tio n s o f U .S . A ffilia tes,
1 9 7 7 - 1 9 8 0 , 1985 and - - - ,1 9 8 6 , 1988; and International Trade Administration (U.S. Department of Commerce) F o r e ig n D ire c t In v e s tm e n t in the
U .S .: C o m p le te d T ra n sa ctio n s, 1 9 7 4 - 1 9 8 3 , June 1985 and
1 9 8 6 , September 1987.
FRB CH ICAGO W orking Paper
February 1989, W P -1989-5
16
assets o f U.S. affiliates to the value of total assets of American-owned for
eign affiliates rose substantially from .16 to .56 (BEA data).
Similar to the U.S., the District has experienced strong growth in FD I,
though its strength varies depending on which measure is used (Table 3).
Between 1978 and 1986, F D I transactions in the District more than doubled
from 34 to 69, a 103 percent increase which surpassed the national average
growth of 67 percent. Exceptional F D I growth in the District is not,
however, visible in the growth of F D I employment. Over the same period,
F D I employment growth in the District fell notably below national growth.
In the District, employment grew 47 percent compared to the national
growth o f 74 percent. Reasons for the District’s lagging F D I employment
growth are presented in a broader geographical context in Section VI. The
contrasting pictures of growth presented by these two measures demon
strates the importance of examining several measures of FD I and inter
preting each one vis-a-vis the others.
The growth in Japanese F D I has been even more astounding than FD I
growth across all countries. Between 1978 and 1986, Japanese F D I trans
actions across all sectors increased over 500 percent in the nation and over
600 percent in the District (no separate data for F D I in manufacturing by
country available for 1978). A similar surge in Japan’s presence is seen in
the growth in employment of Japanese-owned U.S. affiliates. Between 1978
and 1986, Japanese F D I employment grew 141 percent in the nation and
200 percent in the District.
Within the District, varying growth trends are visible with a couple of states
having relatively greater F D I magnetism (Table 3). In terms of F D I em
ployment, Michigan showed the strongest 1978-1986 growth (61 percent
compared to the District average of 47 percent). Also above the District
norm in second and third place were Illinois and Wisconsin. Weak FD I
employment growth was experienced by Indiana and Iowa. That Iowa’s
growth is below average is easily explained by its industry mix which is
dominated by agriculture and has a relatively low concentration of manu
facturing industries. This low manufacturing concentration has translated
into a relatively low propensity to attract FDI.
A slightly different picture of F D I growth across District states emerges
when transactions are examined. Although Indiana ranked last in terms
of F D I employment growth, it ranked first in terms o f transactions. The
reason is that there was strong influx of Japanese investment in 1986 (eight
of the eleven transactions) that had not occurred in 1978. Iowa showed
strong growth because of the relatively small number of transactions during
the base year. Illinois came in third, showing an above average growth of
190 percent while Michigan ranked fourth with below average growth.
FRB CH ICAGO W orking Paper
February 1989, W P -1 9 8 9 -5
17
Illinois’ edge was due to the greater amount o f F D I it attracted from the
United Kingdom and Canada. Wisconsin’s decline is attributable to the
lack of Japanese investment in the state and declining European investment.
VI. T h e geographical dispersion of manufacturing F D I
With the boom o f F D I in the U.S., several questions have arisen regarding
F D I in the Seventh District: has the District been fully benefitting vis-a-vis
other regions from the strong influx o f FDI? Has its historical comparative
advantage in manufacturing been an attractor or detractor of FDI? O f
particular interest is whether the recent decline in the District’s manufac
turing sector overall has had negative repercussions on F D I in District
manufacturing. If so, this could explain why the District’s share of F D I
employment has been falling off. In order to determine the share of FD I
garnered by the District, this section examines the regional dispersion of
F D I and the shifts in its location since 1978.
Regardless of which measure of F D I in manufacturing is used, the East
Coast is shown to have historically attracted the most FD I. In terms of
F D I employment, the South Atlantic region holds the largest share (20.6
percent of the national total) followed by the Mid-Atlantic region (19.1
percent) and the East North Central region (19.0 percent) (Table 4). The
first two regions, South and Mid-Atlantic, hold a disproportionate share
of national F D I employment compared to their share of national manu
facturing employment of 16.2 percent (compared to 20.6 percent) and of
15.8 percent (compared to 19.1), respectively. In addition, these two re
gions have the highest share of F D I employment to total manufacturing
employment (9.3 and 8.9 percent, respectively). The Pacific region, though
closest to the economically expanding Pacific Basin, has not yet attracted
an exceptional amount of FD I. It ranks fifth in terms of share of national
F D I employment and eighth in terms of F D I’s share of total manufacturing
employment. The dominance by the East Coast is probably due to its rel
atively close proximity to Europe which has historically been the strongest
investor in the U.S.
The geographical distribution o f 1986 F D I gross book value diverges
slightly from that o f F D I employment. The South Atlantic region ranks
first again with 18.9 percent of the national total. A switch in the second
rank occurs with the West South Central region replacing the Mid-Atlantic
region. The West South Central region holds 18.7 percent of the total,
followed by the East North Central (15.0 percent) and Mid-Atlantic (14.2
percent) regions. The probable reason for the shift in rank is that F D I in
the West South Central region is concentrated in the chemical industry
which tends to be more capital-intensive versus labor-intensive.
FRB CH ICAGO W orking Paper
February 1989, W P -1989-5
18
Table 4
Regional FDI Employment in Manufacturing: 1986
Region1
Number of
Employees
Region's Share
of U.S. FDI
Manufacturing
Employment
(thousands)
<
FDI Share
of Region's
Manufacturing
Employment
------ percent...............--- -------------------- )
Region's
Share of U.S.
Manufacturing
Employment
New England
85.5
6.1
7.4
6.0
Mid-Atlantic
265.2
19.1
15.8
8.9
South Atlantic
286.2
20.6
16.2
9.3
East North Central
263.9
19.0
21.8
6.4
SEVENTH DISTRICT
204.0
14.7
17.1
6.3
East South Central
101.9
7.3
7.0
7.7
West North Central
66.3
4.8
6.8
5.1
West South Central
111.3
8.0
7.9
7.4
48.6
3.5
3.2
8.1
Pacific
152.5
11.0
13.7
5.9
California
127.3
9.1
10.9
6.2
Mountain
1Census regions are used: New England = CT, ME, MA, NH, Rl, and VT; Mid-Atlantic = NJ, NY, and PA; South Atlantic - DE, DC,
FL, GA, MD, NC, SC, VA, and WV; East North Central = IL, IN, Ml, OH, and Wl; East South Central = AL, KY, MS, and TN; West
North Central = IA, KS, MN, MO, NE, ND, and SD; West South Central = AR, LA, OK, and TX; Mountain = AZ, CO, ID, MT, NV,
NM , UT, and WY; Pacific = AK, CA, HI, OR, and WA.
NOTE: Percent figures sum to greater than 100% because the District states are included in the East and West North Central regions.
SOURCE: Bureau of Economic Analysis (U.S. Department of Commerce), Foreign Direct Investment in the U.S.: Operations of
U.S. Affiliates, 1986, 1988.
FRB CH ICAGO W orking Paper
February 1989 , W P -1 9 8 9 -5
19
As evidenced by East North Central’s (ENC) stock o f FD I, F D I has flowed
beyond the East Coast into the manufacturing heartland. The District,
however, has not attracted a significant amount o f F D I compared to the
E N C region. The probable reason is that its boundaries include Iowa
which has a relatively small manufacturing sector and exclude Ohio which
has a dominant manufacturing sector. Thus, it is not surprising that the
District’ s share o f national F D I employment falls several percentage points
below E N C ’s. This share comparison, however, belies the size o f F D I in
the District. When F D I employment’s share o f total regional manufactur
ing employment is examined, its share in the District is only a tenth of a
percentage point below E N C ’s (6.3 percent compared to 6.4 percent).
Within the District, the leading recipients o f F D I have been Illinois and
Michigan which is not surprising given the relatively large size of their
manufacturing sectors and the strong growth exhibited in their F D I stock
in Table 3. F D I manufacturing employment in Illinois accounts for 5 per
cent of the national total, slightly higher than its share of national manu
facturing employment of 4.9 percent (Table 5). Illinois’ locational appeal
to F D I is more pronounced when the number of transactions is examined.
In 1986, Illinois was the location of 29 transactions which ranked it third
among the 50 states (behind California and New York). Illinois’ attrac
tiveness to F D I will probably be fortified by the presence of the
Chrysler/Mitsubishi plant in Bloomington-Normal. Michigan’s share of
F D I manufacturing employment, 3.8 percent, is less than would be ex
pected given its share of national manufacturing employment of 5.3 per
cent.
Michigan has, however, attracted a substantial number o f F D I
transactions, 20, which ranked it sixth, behind the top three states men
tioned above and Texas and North Carolina. The ranking o f F D I em
ployment in Indiana, Wisconsin, and Iowa corresponds roughly to their
share of national manufacturing employment. As mentioned above, Iowa
has a small manufacturing sector, accounting for only .8 percent of national
F D I employment in manufacturing and 1.1 percent of national manufac
turing employment.
Although a snapshot of the geographical dispersion of manufacturing F D I
provides an understanding of the present status of FD I, it does not offer
any information on the geographical dynamics of F D I or conjectures on
F D I’s future locations. An examination o f the shift in regional shares of
F D I reveals that the South has been gaining a larger share of the F D I pie
while the North has been losing ground. Evidence of this shift is visible in
the change in regional shares of F D I transactions, employment, and gross
book value.
In terms of number of transactions, over the past decade F D I has become
more geographically dispersed, spreading beyond the coastal states towards
FRB CH ICAGO W orking Paper
February 7959, W P -1 9 8 9 -5
20
Table 5
Three Measurements of Manufacturing FDI in the Seventh District: 1986
FDI Gross Book Value
FDI Employment
Number
Share of
United States
Value
FDI Transactions
Share of
United States
Number
Share of
United States
(thousands)
(percent)
(million
historical)
204.0
14.7
13,108
11.8
69
15.3
Illinois
69.7
5.0
4,848
4.4
29
6.4
Indiana
37.0
2.7
2,046
1.8
12
2.6
Iowa
10.9
.8
826
.7
3
.7
Michigan
53.0
3.8
3,630
3.3
20
4.4
Wisconsin
33.4
2.4
1,758
1.6
5
1.1
SEVENTH DISTRICT
(percent)
(percent)
SOURCE: Bureau of Economic Analysis (U.S. Department of Commerce), F o r e ig n D ir e c t In v e s tm e n t in th e U .S .: O p e ra tio n s o f U .S . A ffiliates,
1 9 8 6 , 1988; and International Trade Administration (U.S. Department of Commerce) F o r e ig n D ir e c t In v e s tm e n ts in th e U .S .: 1 9 8 6 T ra n sa ctio n s,
September 1987.
FRB CH ICAGO W orking Paper
February 1 989, W P -1 9 8 9 -5
21
the heartland, including the District.
Evidence of the District’s F D I
locational appeal is seen in the District’s rising share of total F D I trans
actions.
In 1978, the District’s share was 12.6 percent while that in
California alone was 13.7 percent. By 1986, the District’s share was up to
15.3 percent, above California’s share of 14.8 percent.
Changes in the regional distribution of manufacturing F D I employment
reveals a different picture (Table 6). The share o f F D I employment held
by older manufacturing regions such as New England, Mid-Atlantic, East
North Central, and the District has been declining whereas the share held
by southern regions such as East and West South Central has been rising.
Between 1978 and 1986, the District’s share of F D I employment shrunk
from 17.4 percent in 1978 to 14.7 percent in 1986. Similarly, M id-Atlantic’s
share fell from 21.4 percent to 19.1 percent over the same period. In con
trast, South Atlantic’s share jumped to first place from 17.5 to 20.6 percent.
There are several possible reasons for the different trends in F D I reflected
by transactions and employment. Firstly, the northern manufacturing belt,
especially the District, has been beleaguered by a declining manufacturing
sector.
Between 1978 and 1986, District manufacturing employment
dropped a dramatic 19.4 percent whereas South Atlantic’s manufacturing
employment expanded 2.9 percent. The precipitous decline in the District’s
manufacturing sector has undoubtedly had negative repercussions on the
flow of F D I into the District. As highlighted in Section V, growth in FD I
employment in the District has been lagging national growth. This lag ex
plains why its share of F D I employment has been shrinking. Secondly,
South Atlantic’s strength in F D I employment could be explained by the
high probability that F D I in the relatively more labor-intensive industries
is going to southern regions, which offer lower labor costs and less
unionization than northern regions. Conversely, the North may be at
tracting relatively more F D I transactions in the capital and tech-intensive
industries. Evidence of the District’s tendency to attract F D I into these
kind of industries is the above average number of 1986 transactions in two
tech-intensive industries, chemicals and electrical and electronic machinery.
When gross book value data are examined, their pattern reveals similar
shifts in regional shares, but there are some caveats in interpreting them
(Table 6). The main problem is that they are in historical dollars. Thus,
they tend to underestimate the share of F D I held by regions with a rela
tively older capital stock and tend to overestimate the share held by regions
with relatively younger capital stock and strong influxes of FD I. For ex
ample, for the District, a relatively older manufacturing region, the share
of G B V in both 1978 and 1986 is several percentage points below its share
of F D I employment (same case for the Mid-Atlantic and New England re
gions). In contrast, the share of G B V of the West South Central region, a
FRB CH ICAGO W orking Paper
February 1989 , W P -1 9 8 9 -5
22
Table 6
Shifts in Regional Shares of Manufacturing FDI: 1978-1986
1978 Share of U.S.
Regions1
frankarl K\/
employment
share)
FDI
FDI Gross
Book Value
Employment
(\__________
-----— nprrpnt__________
— ---------/\
1986 Share of U S.
Regions
/rank
^Iai us. h\/
uy
employment
share)
FDI
FDI Gross
Employment
Book Value
(\---------__________ ptJl
nprront_______
toi 11 -------
Mid-Atlantic
21.4
17.1
South Atlantic
20.6
18.9
East North Central
20.9
15.3
Mid-Atlantic
19.1
14.2
South Atlantic
17.5
22.2
East North Central
19.0
15.0
SEVENTH DISTRICT
17.4
12.2
SEVENTH DISTRICT
14.7
11.8
Pacific
12.4
9.8
Pacific
11.0
10.3
West South Central
6.8
12.4
West South Central
8.0
18.7
New England
6.7
4.6
East South Central
7.3
6.6
East South Central
6.3
10.0
New England
6.1
4.1
West North Central
5.5
5.6
West North Central
4.8
4.7
Mountain
2.4
2.0
Mountain
3.5
2.4
1See T ab le 4 fo r d e fin itio n o f regions.
NO TE:
Percent figu res sum to greater th a n 1 0 0 % because th e D istrict states are in c lu d e d in th e East and W e s t N o rth C entral regions.
SOURCE:
B ureau of E conom ic A n aly sis (U .S . D e p a rtm e n t o f C o m m e rc e ), F o r e ig n D i r e c t I n v e s t m e n t in th e U . S .: O p e r a tio n s o f U .S . A f filia te s ,
1986, 1988.
1 9 7 7 - 8 0 , 1 9 8 5 and
FRB CH ICAGO W orking Paper
February 1989, W P -1989-5
23
younger manufacturing region is substantially larger than its share of F D I
employment. Despite the problems with G B V data, shifts in the regional
shares o f G B V mirror the decline of F D I in northern regions that was vis
ible in the shifts in regional shares of F D I employment. There is one di
vergence, however.
G B V data show that South Atlantic’s share has
declined as well. Unfortunately, because of data limitations, the reason for
this cannot be discerned.
VII. A n overview of the pros a n d cons swirling a r o u n d F D I
The surge in F D I has been met with contrasting reactions from people
within the business community, academia, and public sector. Embraced
by most state and local public figures, particularly economic developers,
F D I is known as reverse investment and is touted as a source of capital and
jobs to rejuvenate a sagging manufacturing sector. Decried by others, FD I
is viewed as the gradual selling of America and loss of control over our
mainstay industries.
Much of the divisiveness has been regarding F D I’s
employment repercussions.
For example, most state governments are
steadfast in their belief that F D I creates jobs and promotes economic
growth. In contrast, certain special interest groups such as the U A W and
various trade organizations have warned that F D I will lead to net job
losses.
In order to sift through the myriad of opinions about the effects of F D I
on the U.S. economy, competitiveness, and employment, they are divided
along the straightforward lines of pro and con. The discussion tries to be
impartial and presents evidence both supporting and/or disproving each
argument. A conclusion either way is not offered because it would be based
on too many uncertainties and conjectures.
The proponents of F D I argue that it can help boost our economy, the
competitiveness of U.S. industries, and thereby create jobs and increase
welfare. As a N e w Y ork T im es headline reads: “Japan’s Money Helps Build
America” (N Y T 6/5/88). In answer to the question of how does F D I build
America, there are five broad responses: F D I increases national wealth,
offers competitive advantages, transfers technological know-how, stimu
lates investment, and generates jobs. According to F D I advocates, F D I
not only builds America but also represents a long-term commitment to do
business in the U.S. because the majority o f foreigners are acquiring real
assets that are less liquid than non-voting security ownership.
The first response to how F D I builds America (i.e., increases national
wealth) is based on free trade theory. It argues that just as free trade is
beneficial to all countries involved and increases national welfare, so is
FRB CH ICAGO W orking Paper
February 1989 , W P -1 989-5
24
“ free F D I.” The chain of events is as follows: FD 1 promotes greater
competition because it increases the number of new entrants in an industry.
Faced with more vigorous competition and in search of a competitive edge,
industry participants implement cost-reducing, efficiency and quality im
proving methods. Those who hesitate usually do not survive the ensuing
industry shakeout. The implementation of new methods usually translates
into lower prices and increased quality and service. The ultimate benefici
ary is the consumer. Along a related vein is the viewpoint that in order to
excel in global competititon, the U.S. must open its doors to foreign pro
duction on its own soil.
The view that F D I is only a source of competition is lopsided. F D I can
also be source of cooperation in the form of joint ventures. It is the benefits
of joint ventures that is the focus of the second pro-FDI response. In their
article “Cooperate to Compete Globally,” Perlmutter and Heenan tout the
advantages of cooperative efforts across borders (Perlmutter and Heenan
1986). The general advantages of a joint venture include risk diversifica
tion, capital requirement reductions, established marketing and sales net
works and thus relatively low start-up costs. Those industries that benefit
the most from sharing capital requirements tend to be those in R & D and
tech-intensive industries such as pharmaceuticals and high tech equipment.
Perlmutter and Heenan cite several examples such as the alliance between
General Electric and S N E C M A (a French state-owned company) to
produce a low pollution high-performance aircraft engine whose high R & D
costs would have prevented either company from producing the engine on
their own. An example of marketing and sales synergies is the union be
tween A T & T and Olivetti (an Italian firm). Through this union, A T & T
gains access to the European market and Olivetti gets a foothold in the U.S.
market.
Another pro-argument that is derived from the “cooperate to compete”
view focuses on the technological transfer benefits that arise from F D I ei
ther through joint ventures or spill-over and spin-offs. As explained in
Section IV, one of the motives to invest in the U.S. is to optimize the use
of an intangible asset such as technological know-how. One avenue of
technology transfer is a joint venture between a U.S. firm and a foreign firm
in which one or both of the firms possess a technological edge in their in
dustry. Examples of such a marriage are the G M -Toyota (N U M M I) and
the Chrysler-Mitsubishi (Diamond-Star) joint ventures.
Both G M and
Chrysler hope to learn the sophisticated production technologies of
Japanese OEMs. The use of Japanese technology has also facilitated the
technological catch-up of U.S. firms that have fallen behind in the tech
race. For example, Westinghouse who missed the technological leap from
vacuum tubes to semiconductors has been able to shake off the moth balls
from its plant in upstate New York thanks to a joint venture with Toshiba.
FRB CH ICAGO W orking Paper
February 1989, W P -1989-5
25
Toshiba will transfer crucial technological know-how to Westinghouse en
gineers that will allow them to develop tech-advanced color television tubes.
A fourth benefit of F D I offered by its proponents is that it stimulates in
vestment which often has a multiplier effect. This argument is, obviously,
stronger for F D I in the form o f new plant and plant expansion than it is
for F D I in the form of an acquisition. For example, when a Japanese O E M
builds a plant in the U.S., its F D I represents an infusion of new capital
whose benefits accrue in part to sectors outside o f manufacturing such as
construction and services. Similarly, when a foreign firm forms a cost
sharing joint venture, the foreign firm often provides crucial capital. A c
quisitions are also a source o f capital, though the multiplier effect is
probably weaker.
The impact o f F D I in the form of an acquisition has been studied exten
sively by Jane Sneddon Little (Little 1981 and 1982). Her findings suggest
that in the long-run, F D I has a positive impact on the U.S. firms acquired.
Among her important findings are the following. Foreign buyers do not
focus solely on acquiring healthy strong growth companies, that is, com
panies that do not have dire capital needs. In fact, the 78 publicly-owned
firms in her survey acquired by foreigners tended to be less profitable than
the average firm in their industry and thus may have been facing difficulties
raising capital. Another finding is that there were regional variations in the
acquired firms profitability which suggest that acquisitions in the belea
guered northern manufacturing belt (e.g., the District) had relatively
stronger potential in generating financial benefits. She noted an apparent
acceleration in sales and asset growth of the acquired firm which could be
attributable to the foreigners’ contribution of capital, technology, and/or
management skills.
Little concludes that “foreign acquisitions of U.S.
companies confer some benefits on the U.S. economy,” and that “foreign
ownership...appears to strengthen the competitive position of the acquired
firm and allow them to expand their market share” (Little 1981 p.17 and
1982 p.53, respectively). A specific example of the financial benefits that
result from foreign acquisition is the Renault-AM C deal. When Renault
acquired nearly half of A M C in 1979, it gave A M C desperately needed
capital that allowed it to maintain production and to modernize in the early
1980s (the deal did not endure, however, with Renault selling A M C to
Chrysler).
A fifth reason given to promote FD I, one popular among economic devel
opers, is that it generates jobs. This argument has been challenged by
people who believe that the opposite is or will be the case. The contrasting
views stem from different assumptions about the factors included in the net
employment change calculations. F D I proponents claim that there is a net
employment gain because products produced by foreign firms on U.S. soil
FRB CH ICAGO W orking Paper
February 1989, W P -1 9 8 9 -5
26
primarily replace imports. This replacement translates into a shift in jobs
from the foreign country to the U.S. F D I opponents counter that replace
ment, if it occurs at all, is only partial and that the foreign firms’ products
compete directly with domestic firms’ products and thus there is no net job
gain. Some argue that there is even a net job loss because foreign firms
tend to substitute more capital for labor than domestic firms and have rel
atively higher productivity rates.
Few studies have been undertaken to gauge the employment impact of FD I.
The probable reasons for this are that there are little data available and that
insufficient time has passed to determine the impact of the influx of FDI.
Nevertheless, for certain industries in which the employment impact has
raised exceptional concern, studies have been attempted. For example, the
impact of F D I on employment in the autoparts industry has been examined
by the U.S. International Trade Commission (U SITC 1987). Based on ev
idence that Japanese autopart producers in the U.S. primarily supply the
Japanese O EM s in the U.S., the IT C concluded that presently there has
been a net gain in autoparts employment. There is, however, uncertainty
about the future job impact. If the Japanese producers expand their market
to include the U.S. Big Three (i.e., General Motors, Chrysler, and Ford)
and the aftermarket, U.S. autoparts producers will feel the pinch and may
have to cut production and consequently reduce their labor force.
The employment impact o f F D I in the auto industry has been estimated
by the U.S. G A O for the years 1987 and 1990 under various scenarios. The
scenarios are based on different displacement ratios (i.e., the percentage of
sales by U.S. automakers that is displaced by Japanese auto production in
the U.S.). Because there is great uncertainty surrounding what the actual
displacement ratio is or will be, the argument that there is a positive or
negative net employment impact is futile. Only time and an ex-post anal
ysis will tell which way the impact falls. The U.S. G A O findings in terms
of employment changes under three displacement scenarios are as follows:
Net employment change due to Japanese auto production in the U.S.
Displacement ratios
Year
85%
1987
-39,000
1990
-45,000
60%
0%
33,000
0
112,000
Note: Zero displacement means that only imports are displaced.
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27
Although there are many convincing arguments in favor o f FD I, there are
several sound arguments against it and many articles critizing it. Reich and
Mankin titled their article on the topic: “Joint Ventures with Japan Give
Away our Future” (Reich and Mankin 1986). The E co n o m ist described the
long term effect of Japanese F D I in the auto industry as “creeping
colonisation” (March 2, 1985). The con arguments can be divided into two
categories. Firstly, there are the con opinions highlighting what are per
ceived to be F D I’s near-term adverse effects. These include overcapacity
and unfair competition. Secondly, there are the negative views that cover
F D I’s long-term repercussions. These comprise the loss o f economic and
technological control and the prediction that F D I will cause a transforma
tion o f U.S. manufacturers into hollow corporations or, in other words, a
corporation that is less a manufacturer and more an assembler and/or a
marketing organization. Because the argument of employment loss has al
ready been detailed above under the pro section, it will not be duplicated
here.
One o f the immediate concerns regarding F D I is that it will exacerbate
domestic overcapacity problems. Stagnant or declining demand and surg
ing foreign competition have resulted in overcapacity problems in many of
our mature industries such as steel and autos. As a result, these industries
have had to retrench and reduce capacity. F D I investment in these indus
tries, assuming that it results in a competitive enterprise, will lead to further
retrenchment on the part of U.S. producers.
The concern over additions to domestic capacity due to F D I is most pro
nounced in the auto and autoparts industries. The W E F A Group/Ward’s
Automotive Research has estimated that excess auto supply based on cur
rent production capacity will grow from 1,269,000 in 1988 to 1,515,000 by
1992 (includes Big Three, Japanese production in the U.S., and imports).
Because the demand for autos is predicted to grow relatively slowly, any
increases in domestic capacity due to F D I will probably lead to capacity
reductions on the part of U.S. producers. U.S. autoparts producers face a
similar situation. Although Japanese autoparts firms have located in the
U.S. to supply Japanese automakers operating in the U.S., it is likely that
they will try to gain market share in the aftermarket (i.e., replacement sales)
and acquire contracts with the Big Three. Their incentive to pursue these
markets is very strong because they need to increase their production runs
in order to benefit from economies of scale and reduce their costs to com
petitive levels. If they succeed, they will be cutting into the market share
held by U.S. companies.
The second concern is that of unfair competition. U.S. producers have
complained that they face an unlevel playing field vis-a-vis foreign com
petitors on U.S. soil because of direct or indirect subsidies funneled to for
FRB CH ICAGO W orking Paper
February 1989, W P -1 9 8 9 -5
28
eign producers (primarily Japanese). These advantages include tie-ins with
other foreign producers in the U.S. and state and local government incen
tives to attract foreign producers. One domestic industry that has been
outspoken on this topic is the autoparts industry. U.S. autoparts producers
claim with convincing evidence that Japanese autoparts suppliers enjoy high
barriers to entry to supplying Japanese OEMs. The relationship between
supplier and O E M in Japan appears to much tighter and more long-term
than the relationship between U.S. suppliers and the Big Three. For ex
ample, a few Japanese suppliers were directly encouraged by a Japanese
O E M to establish operations in the U.S., and several have organizational
and/or financial ties with Japanese OEMs. In addition, those that do not
have direct ties still have an edge over U.S. suppliers because they are more
familiar with the demands of Japanese OEM s and more capable to meet
their quality specifications.12
Another argument regarding an unlevel playing field is that foreign com
panies are given unfair advantages through state and local government in
centives. Incentives include reduced taxes, low interest loans, assistance in
site acquisition, and infrastructure improvements (e.g., roads and utilities).
Charges o f biases in favor of Japanese producers over U.S. producers have
been leveled against these types of state incentives. The incentive packages
that have drawn the most attention and criticism have been those used to
attract Japanese OEMs. Two examples include: Kentucky’s $125 million
support package to Toyota (15 percent of Toyota’s planned investment)
and Michigan’s $52 million support package to Mazda (12 percent of
M azda’s planned investment) (U SITC 1987). Several Japanese autoparts
suppliers have also been courted by local economic development organiza
tions near the auto plants.
In addition to the bias charge, the overall benefits of such incentives have
been challenged. There is some validity in the arguments that state incen
tives are a zero-sum game in terms of national economic growth and a
negative-sum game for U.S. producers. In regards to the negative-sum
game, for example, when incentives are given to foreign producers in in
dustries facing overcapacity, it is likely that U.S. producers will be forced
to cutback capacity. In regards to the zero-sum game, when states are
vying for the same FD I project, one state’s gain is another’s loss.
In terms of the long-term repercussions of FD I, concerns have been raised
over the potential loss of economic control and technological edge. The
loss of economic control argument is based on the conjecture that F D I will
expand infinitely and dominate certain industries. The chemical industry,
in which F D I accounts for around a third of total employment, is often
highlighted as a case in point. The loss of technological edge is predicated
on the belief that U.S. companies will fall technologically behind their for
FRB CH ICAGO W orking Paper
February 1989 ,, W P -1989-5
29
eign competitors as the U.S. firms are bought out by their competitors or
form joint ventures with them. The culmination o f F D I’s adverse effects
is claimed to be the hollow U.S. corporation that is more a marketing or
ganization and assembler than a producer or value-added generator.
The loss o f economic control argument does not have a strong foundation
because of three major flaws. Firstly, it does not take into consideration
that F D I is often in the form of a joint venture with a U.S. company who
shares production and managerial responsibility. Secondly, it does not
recognize that U.S. companies have been undertaking their own F D I and
thus have been expanding their production and marketing base in a similar
fashion. Thirdly, it assumes that F D I is not regulated. To the contrary,
F D I has been under surveillance in industries tied to national security (e.g.,
defense, nuclear and hydroelectric power, semiconductors, and broadcast
ing). A case in point is the blockage of Fujitsu’s (of Japan) attempt to ac
quire an 80 percent share of Fairchild Semiconductor Corp.
Fujitsu’s
announcement of its intentions stirred up such controversy and negative
responses from the Secretaries of Commerce and Defense that Fujitsu de
cided to withdraw its offer. The controversy revolved around the deal’s
potentially adverse impacts on national security and stemmed from the
perception that the Pentagon was becoming uncomfortably dependent upon
foreign suppliers. The irony o f this case is that Fairchild was at that time
owned by a French company, Schlumberger.
A stronger argument against F D I is that it has the potential to lead to a
gradual loss o f our technological edge. Reich and Mankin in their article
against joint ventures with Japan present their case o f technological de
generation (Reich and Mankin 1986). They argue that the implicit strategy
of the Japanese that are investing in the U.S. is to keep the frontend activ
ities (e.g., R & D and prototype development) and high value-adding activ
ities in Japan, leaving the more routinized activities to their U.S. plants
(e.g., assembly operations). In order to substantiate their view, they cite
three deals between U.S. and Japanese OEMs: G M -Toyota, ChryslerMitsubishi, and Ford-Mazda. They state that in each case, the Big Three
delegated most of the responsibility of the plant design and engineering
tasks to the Japanese.
Articles in A u to m o tiv e N e w s have reflected a similar view. The concern of
the U.S. auto and autoparts industries is that the Japanese O E M s will
probably have a cost advantage due to the fact that they import a greater
percent of their inputs. The negative impact of this on U.S. producers and
their technological edge is twofold. Firstly, if there is significant displace
ment o f U.S. auto sales by Japanese auto sales, U.S. autoparts producers
could be faced with a shrinking market and could be closed out of the
high-tech niche of the market in which the Japanese have a competitive
FRB CH ICAGO W orking Paper
February 1989, W P -1 9 8 9 -5
30
advantage.
Secondly, in order to maintain their cost and quality
competitiveness vis-a-vis the Japanese OEM s, the Big Three may be forced
to purchase more parts from Japanese suppliers and thereby contribute to
the erosion of the U.S. autoparts producers’ market share and their ability
to invest in cutting-edge technology.
In addition to the U.S. producers’ being relegated to the less tech-intensive
activities, Reich and Mankin see another threat. They contend that the
flow of technological learning will be from the U.S. to Japan. They focus
on the skills gained by Japanese workers in the areas of applications engi
neering, fabrication, and complex manufacturing. They do not prove de
finitively, however, that the learning is only unilateral. They omit the fact
that U.S. workers can gain similar skills when they work for a joint venture.
As demonstrated by the exceptional quality improvements at G M -Toyota’s
N U M M I plant, U.S. workers can gain invaluable quality control experi
ences and learn how to boost productivity from the Japanese.
Another argument against F D I in the form of a joint venture is that the
U.S. company is less a full participant in the value-adding activities of
manufacturing and more a marketing arm for the venture. This argument
provides the underpinnings o f the fear that U.S. manufacturers are vulner
able to becoming hollow corporations. Reich and Mankin state that most
of the high-tech joint ventures that they examined involved the Japanese
company as producer and the U.S. company as marketer and distributor
(70 percent of the 33 companies). They studied the machine tools and
semiconductors industries in which this phenomenon was prevalent. With
regards to the machine tools industry, they found that more than 75 percent
of all machining centers sold in the U.S. were made in Japan, though many
of them were sold with U.S. brand plates. Although they do not provide
any statistics for Japan’s presence in the U.S. semiconductor industry, they
predict that the Japanese edge in state-of-the-art chip production and rela
tively low production costs, particularly that of Hitachi, will trigger sales
and distribution agreements between U.S. and Japanese producers. A study
by the Commerce Department substantiates in part the findings of Reich
and Mankin. The report states that Japanese are pursuing joint ventures
with U.S. companies in order to gain quick market access and distribution
channels {A u tom otiv e N e w s 5/25/87).
After reviewing the pro and con arguments surrounding FD I, it is hard to
determine which way the scale tips. There are too many uncertainties, as
pointed out in the discussion regarding the adverse effects of F D I on em
ployment. M any of the viewpoints are only conjectures and predictions.
Thus, only time will tell whether or not they are valid.
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February 1989 , W P -1 9 8 9 -5
31
V III.
A
c a s e s t u d y o f F D I in th e a u t o a n d a u t o p a r t s in d u s tr ie s
The choice o f the auto and autoparts industries for a case study o f F D I
was based on several factors. Firstly, F D I in the auto and autoparts in
dustries has been attracting a lot of attention, including both positive and
negative reactions from the media and government organizations (partic
ularly state governments that are scrambling to attract auto plants). Thus,
there are ample data on auto and autoparts FD I. Secondly, auto and
autoparts F D I have been growing at above average rates. For example, in
the District, the number o f transactions in the transportation equipment
industry (over 80 percent was in the auto industry) jumped from two in
1978 to seven in 1986, a 350 percent rise compared to the average increase
across all industries of 136 percent. Thirdly, F D I in the auto and autoparts
industries provides an excellent example of the complexities of F D I and of
the globalization of U.S. industries.
Because there are differences in the composition and magnitude of F D I in
the auto and autoparts industries, they are discussed separately.
One
striking difference between F D I in the two industries is that it is composed
of different source countries. In auto FD I, the Japanese are the sole players
whereas in autoparts FD I, the Europeans and Canadians have a foothold
as well.13 Another difference is found in the reasons that underlie the for
eign firms’ move to the U.S. The Japanese O EM s began production in the
U.S. in order to hurdle existing and potential trade barriers whereas the
Japanese autoparts producers followed suit in order to best meet the needs
of the Japanese OEM s. In other words, their move was precipitated by the
move of their primary customers. In contrast, the move to the U.S. by
Canadian and West German autoparts producers was independent o f any
direct ties with U.S. located customers. In a sense, they started from
scratch while the Japanese producers already had some guaranteed market
share in the U.S. F D I in the auto industry will be discussed first.
Seven of the nine Japanese O E M s have established new plants and/or
formed joint ventures in the U.S. (Table 7; Suzucki and Daihatsu M otor
Co. have not). Japanese presence on U.S. soil is a phenomenon of the
1980s with the pioneer being Honda who built a plant in Ohio in 1982.
Over the past few years, other Japanese OEM s have been fast to follow
Honda’s initiative. In terms of the location of the Japanese O E M s’ trans
plants, they have tended to favor locations in the District or neighboring
states, that is, in or nearby the U.S. auto industry hub. The only location
outside of this area is the N U M M I plant in Fremont, California.
The preferred type of entry has been sole entry, accounting for four of the
Japanese entries into U.S. production. The joint venture, however, has
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32
T a b le 7
FDI by Jap an ese A utom akers1
Company
Type of Entry
Location
Date Open
Annual Capacity
No. of Employees
(full)
(estimates)
Unionized
Local Content2
(percent)
Honda of America
Mfg., Inc.
Sole entry
Marysville, OH
(an additional
plant planned)
1982
360,000
(an additional
150,000 projected
by 1991)
4,200
No
60
(75 projected)
Nissan Motor
Mfg., Corp. USA
Sole entry
Smyrna, TN
1983
240,000
3,250
No
50 -60
New United
Motor Mfg., Inc.
(N U M M I)
Joint venture
Toyota-50%
GM -50%
Fremont, CA
1984
250,000
2,500
Yes
50
Mazda Motor
Mfg. Corp. USA
Sole entry
Flat Rock, Ml
1987
240,000
3,500
Yes
50
(75 projected)
Diamond-Star
Motors Corp.
Joint Venture
BloomingtonChrysler-50%
Normal, IL
Mitsubishi-50%
1988
240,000
2,900
No
60
Toyota Motor
Mfg. USA Inc.
Sole entry
Georgetown, KY
1988
200,000
3,000
Yes
65
(75 projected)
Subaru-lsuzu
Automotive, Inc.
Joint venture
Fuji-51%
lsuzu-49%
Lafayette, IN
1989
120,000
1,700
undecided
55
1,650,000
21,050
TOTAL U.S.A.
1There are no other foreign automakers (including trucks) operating assembly plants in the U.S. Volkswagen of America, Inc. closed its U.S. plant in
1988.
2lt has been estimated that 90 -95 percent of the local content of Japanese U.S.-built autos is supplied by Japanese U.S. plants (lannone 1988).
SOURCE: The Motor Industry of Japan, Japan Automobile Manufacturers Assoc., Inc. 1987; Automotive Industries, June 1987; Automotive News
articles on Japanese plants in the U.S. 1986-1988.
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February 1989 , W P -1 9 8 9 -5
33
been nearly as popular, accounting for the three remaining entries. Two
of the joint ventures follow the expected pattern: a Japanese O E M forms
a venture with a U.S. O EM . There is, however, one aberration: a joint
venture between two Japanese OEM s (Fuji and Isuzu). The sole entries and
the Japan-Japan joint venture suggest that a majority o f the Japanese
O E M s have become confident enough with their knowledge o f the U.S.
auto market and have the needed capital to establish U.S. operations on
their own. In regards to their reaction to unions—which do not exist in the
Japanese auto industry—half of them have accepted union representation
and half have not. Nissan was adamently against it. Local content will
be discussed along with the autoparts industry.
The Japanese O E M s’ motives to move to the U.S. fit right into the frame
work outlined in Section IV. The Industrial Bank of Japan’s (IBJ) study
of Japanese auto industry participation in the U.S. market found four main
motives. The first two are economic and the second two are strategic.
Firstly, the Japanese O E M s feel that the threat of protectionism is rising.
They expect that the voluntary export restrictions (VER) will be main
tained. Secondly, there is the potential o f relatively high profits from pro
duction in the U.S. Contributing to the high profitability are relatively
lower corporate taxes (at all three government levels) and the strong de
mand for Japanese cars. Thirdly, the Japanese O E M s view the U.S. market
as the most lucrative in terms of expansion. Because car production in
Japan is expected to plateau or decline, it is only through further expansion
into foreign markets that they will be able to increase production.
Fourthly, they want to strengthen their sales network through a more reli
able supply of cars. That the IBJ did not mention the appreciation o f the
yen as a factor supports the point mentioned above that changes in ex
change rates are usually not a decisive factor in FD I.
It is interesting to examine the reactions of the Big Three to the Japanese
invasion o f their turf. G M , Ford, and Chrysler have not been sitting idly
by as the Japanese O EM s make greater inroads into the U.S. market. Their
initial reaction, in the late 1970s, was to lobby for more rigorous import
restrictions. They appear to have been playing for time in order to boost
their competitiveness through an overhaul of their operations and model
designs (Chrysler epitomizes the transformation). As they revamped their
organization, they began attempts to recoup their U.S. market share by
offering better quality and service, plus smaller models.
Although the Big Three have primarily undertaken an offensive/defensive
strategy, they have also recognized the benefits o f “if you can’t beat them,
join them.” All three have security interests in a Japanese O E M (Table 8).
G M leads the pack in terms of ownership with 41.6 percent of Isuzu, fol
lowed by Ford with 25 percent of Mazda and Chrysler with 24 percent of
FRB CH ICAGO W orking Paper
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34
Mitsubishi.
In addition, they have formed joint ventures with their
Japanese counterparts. G M has successfully teamed-up with Toyota and
established N U M M I. Chrysler is nearing the finishing touches o f its joint
venture with Mitsubishi. Although Ford has yet to consumate a joint
venture, it is discussing just such a deal with Nissan. In addition to joining
leagues directly, G M and Chrysler have also been importing cars from
Japan. Nineteen percent of G M ’s captive imports come from Japan while
36 percent of Chrysler’s originate from there.
As the Japanese O E M ’s have set up shop in the U.S., Japanese autoparts
suppliers have followed suit. Over the past decade, they have become the
dominant source of F D I in the autoparts industry, numbering 126 and ac
counting for nearly 40 percent of all foreign autoparts firms in the U.S.
(Table 9). Their strong presence is only a recent phenomenon compared
to that of European and Canadian firms. Prior to the influx of Japanese
autoparts firms, West German firms had made the deepest inroads into the
U.S. market (67 firms).
The location of these firms tends to be concentrated in or near the District.
Proximity to customer tends to be especially important to the Japanese
autoparts suppliers, though some distance is necessary in order to not bid
up labor rates. The importance of proximity is due to the “just-in-time”
(JIT) inventory demands of the Japanese OEMs. JIT translates into deliv
ering the exact volume and quality needed when needed.
Similar to the Japanese OEM s, the Japanese autoparts firms have opted for
sole entry with most being wholly-owned by Japanese. Joint ventures,
however, have not been shunned because they provide some important
benefits. Most of the autoparts joint ventures were motivated by the need
to improve technological and manufacturing capabilities and attain higher
production levels in order to benefit from economies of scale. For example,
many of the joint ventures have involved cooperative agreements covering
robotics, machine vision, and artificial intelligence. In addition, because
most Japanese autoparts suppliers have weak links to the Big Three, a joint
venture with a U.S. firm offers access to the Big Three as well as the
aftermarket.
As mentioned above, the move by Japanese autoparts producers to the U.S.
was in large part triggered by the move of Japanese OEMs. There are se
veral economic factors that were catalysts in the Japanese O E M ’s move and
the subsequent move of their suppliers. The IBJ study highlights three
primary factors. Firstly, there has been a fear of declining domestic sales.
The expected decline in auto production in Japan translates into sales de
cline for Japanese-based autoparts producers. Secondly, it is predicted that
the O E M s will produce more parts in-house. Thirdly, there is the percep-
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35
Table 8
U .S . B ig T h r e e A u t o m a k e r s a n d t h e i r T ie s t o J a p a n e s e A u t o m a k e r s :
1988
Ties with Japanese Automakers
Company
General Motors Corp.
—
—
—
—
—
—
—
owns 41.6% of Isuzu.
imports Isuzu car sold as Chevrolet Spectrum (90,000 autos imported in 1985).
expected to be a supplier of major components for the Subaru-Isuzu plant.
joint venture with Toyota (NUMMI).
owns 5.3% of Suzuki and imports a Suzuki car sold as Chevrolet Sprint.
joint venture with Suzuki in Ingersoll, Ontario.
total imported autos and trucks in 1987 from Japan = 140,000 (19% of total captive imports).
Ford Motors Corp.
—
—
—
—
—
owns 25% of Mazda.
Mazda plant in Flat Rock produces Ford Probe (60% of production).
Mazda supplies Ford's foreign affiliates.
discussing a joint venture with Nissan to produce a new auto in North America.
no autos or trucks imported from Japan.
Chrysler Motors Corp.
—
—
—
—
—
owns 24% of Mitsubishi.
joint venture with Mitsubishi (Diamond-Star).
imports cars and trucks from Mitsubishi sold as Plymouths and Dodges.
Mitsubishi supplies engines for various Chrysler models.
total imported autos and trucks in 1987 from Japan = 235,000 (36% of total captive imports).
SOURCE: John Holusha, "Mixing Cultures on the Assembly Line," N e w Y o rk Tim es. June 5, 1988; U.S. International Trade Commission, U .S . G lo b a l
C o m p e titiv e n e ss : T h e U .S . A u to m o tiv e P a rts In d u stry , December 1987; and A u to m o tiv e N e w s articles on automakers in the U.S. 1986-1988.
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Table 9
F o r e ig n A u t o p a r t s M a n u f a c t u r e r s in t h e U .S .:
Country
No. of firms
1988
No. of employees
(estimates)
TOTAL
324
Japan
1261
100,000
n.a.
West Germany
67
22,000
Canada
17
3,0002
France
13
12,000
7
2,200
United Kingdom
10wned or partly owned by Japanese companies projected to 1,990.
2Canadian plants tend to be relatively small.
SOURCE: Motor and Equipment Manufacturers Assoc.; Automotive Parts International, Feb. 12, 1988 and March 25, 1988.
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37
tion o f “first come first serve.” The Japanese autoparts producers fear that
if they do not follow their O E M customers to the U.S., they will be ex
cluded from supplying not only the Japanese O E M s but also the Big Three
and the burgeoning Japanese aftermarket market in the U.S. The latter two
markets have yet to be fully tapped by the Japanese and offer important
market expansion opportunities.
Another threat that has motivated the Japanese autoparts suppliers to move
to the U.S. is more restrictive domestic content legislation. The U.S. G A O
estimates that in 1985 Japanese O E M s in the U.S. had 54.5 percent do
mestic content while U.S. automakers had 93.5 percent (U S G A O 1988).
They predicted that by 1990, domestic content will be 67.5 and 89.0 per
cent, respectively. To reduce the disparity between the Japanese and U.S.
rates, certain special interest groups such as the U A W have been lobbying
for domestic content legislation which would require upwards to 75 percent
domestic content.
Similar to the Japanese OEM s, the Japanese autoparts producers’ decision
to move was not based upon a stronger yen, even though this has lessened
the financing required to move. The yen has, however, played a role in
increasing the domestic content of Japanese autos made in the U.S. As the
value of the yen vis-a-vis the dollar increases, Japanese O E M s in the U.S.
are increasing their purchases of parts and materials from U.S. based firms,
though these firms are predominately Japanese-owned.
Unlike the Japanese OEM s, the Japanese autoparts producers were not at
tracted to the U.S. by strong profit potential. To the contrary, profitability
has been low (IBJ 1986). The Japanese autoparts producers face a difficult
situation. On the one hand, they have yet to reach production levels high
enough to benefit from economies o f scale. On the other hand, they have
to price their parts to compete with imports produced in greater volume in
order to gain orders from the Japanese OEMs. According to IBJ, they are
struggling to beat the price o f imports and have been only gradually bene
fiting from the appreciation of the yen. In order to improve their price
competitiveness, several have been forming joint ventures with U.S.
autoparts producers which allow them to hurdle high start-up costs and
benefit from economies of scale.
In sum, the overview of F D I in the auto and autoparts industries has re
vealed several interesting features of FD I. Firstly, much of the F D I in the
auto industry was precipitated by concern over increasing protectionist
sentiment in the U.S. In a sense, there is irony in the chain of events that
triggered the inflow of FD I. In trying to protect certain U.S. industries
from foreign competition by building trade barriers, the U.S. Federal
Government has indirectly and probably unintentionally brought the for-
FRB C H IC AG O W orking Paper
February 1989, W P -1 9 8 9 -5
38
eign competitors to U.S. soil. The initial move by the Japanese O EM s
triggered a second wave o f moves by Japanese autoparts producers. This
second wave may accelerate if stronger domestic content legislation is en
acted. The Big Three, realizing that they cannot stem the tide of FD I, have
joined forces with the Japanese either through part-ownership of a Japanese
O E M or a joint venture. These types o f cross-cultural interactions have
raised some thought-provoking questions regarding the costs and benefits
of F D I to U.S. manufacturers overall.
C o n c lu s io n
This analysis o f F D I was motivated primarily by F D I’s expanding presence
in the Seventh District and the growing attention that it has been drawing.
A diverse array of organizations and individuals such as economic devel
opers and domestic producers have become interested in F D I and have
formed contrasting opinions regarding its costs and benefits. Part of the
limelight has resulted from the controversies that F D I has stirred up re
garding its impact on the U.S. economy, domestic employment, and pro
ducers. In trying to determine the implications and repercussions of F D I
on District manufacturing, this paper has covered its many dimensions
from its various forms and its accelerating growth to its geographic dis
tribution and industry preferences.
In addition, the paper showed how the growing presence of F D I in the
District has been transforming the competitive landscape. As the threat
of protectionism looms larger, foreign firms have been altering their U.S.
expansion strategies and have hurdled the threat through FD I. As a result,
domestic producers are confronted with not only foreign competition in its
traditional form of imports but also face to face competition with foreign
firms producing on U.S. soil. In addition to reacting to existing or poten
tial trade barriers, foreign firms have moved to the U.S. in order to opti
mize the use of their tangible assets (e.g. production expertise) and their
intangible assets (e.g. R&D).
In order to examine more closely the nature of F D I and the attendant re
action o f U.S. producers, the auto and autoparts industries were high
lighted. The case study revealed that the Big Three have pursued a blend
of strategies to retain their competitiveness vis-a-vis their Japanese
counterparts. They initially took a defensive stance and then progressed to
an offense approach mixed with a “join ’em” strategy. The reaction of the
Big Three may have important implications for other domestic producers
who face direct foreign competition. Domestic producers must adapt to the
presence o f F D I because it shows no signs of fading.
FRB CH ICAGO W orking Paper
February 1989 , W P -1 9 8 9 -5
39
The restructuring o f District manufacturing will most likely continue to be
influenced by the presence of foreign firms. Their presence is a doubleedged sword in terms o f economic impact. On the upside, their presence
can contribute to boosting the competitiveness o f domestic producers
through, for example, technological transfer or synergistic joint ventures.
On the downside, their U.S. production may lead to overcapacity problems
in certain industries and thus trigger retrenchment on the part o f domestic
producers. Economic developers who promote F D I must take into con
sideration its potentially dichotomous economic impact. Because it is im
possible to currently predict with any accuracy the net cost/benefit of FD I,
the best that can be done to understand its implications and impacts is to
examine what motivates it, which industries and geographical areas attract
a disproportionate amount of it, and how domestic producers are reacting
to it.
FRB CH ICAGO W orking Paper
February 1989, W P -1 9 8 9 -5
40
F o o tn o te s
1 See Ned G. Howenstine, “U.S. Affiliates of Foreign Companies: Operations in
1986,” Survey o f Current Business, May 1988, pp. 59-75.
2 In choosing a means to measure the status and dynamics of FDI in the U.S. and
the District, this study examined over six datasets on FDI available from various
U.S. Federal Government sources. BEA statistics on FDI at the state level in
clude total assets and gross book value of property, plant and equipment of U.S.
affiliates and employment at U.S. affiliates. At the national level, BEA collects
data on investment outlays also. IT A collects data on FDI transactions and when
possible, their value. ITA has also compiled a list of Japanese autoparts manu
facturing facilities in the U.S. The U.S. International Trade Commission (USITC)
has collected similar data on FDI in the U.S. autoparts industry.
In addition to government compiled data, FDI data are collected by private or
ganizations such as the Japan Economic Institute which collects data on Japanese
investments in U.S. production facilities (similar to the ITA data) and Automotive
Parts International which focuses on FDI in the autoparts industry.
3 Total value of FDI transactions is probably a better measure of the magnitude
of FDI than number of transactions, but it cannot be used because the*e is only
partial data available.
4 Real estate acquisitions related to manufacturing are not included in this study
because separate data are not available. Data on real estate are aggregated across
all sectors and placed under the real estate sector.
5 Acquisition is a generic term that covers several types of stock and asset pur
chases. A merger is the most common type of acquisition and involves the
transferral of the selling company’s assets and liabilities to the buying company
and the end of the selling company’s existence as a separate entity. Payment is
made to the firm because actual property rather than shareholders’ interest in
property is being exchanged. A second type is acquisition of stock (e.g., tender
offer) which differs from the merger in that it entails purchasing the seller’s stock
(vs. assets and liabilities) and involves a transfer from shareholders (vs. firm) to
buyer. The third type of acquisition is the acquisition of specific assets (and
sometimes liabilities) for which the payment is made to the firm and not to the
shareholders.
6 The fact that foreign companies are in part seeking marketing and distribution
networks when they acquire a U.S. company or form a joint venture has raised
concern that U.S. companies are being used as^ marketing arms as opposed to
production arms (discussed in Section VII).
7 Manufacturing industries can be classified under four different headings:
1. Tech-intensive: chemicals, nonelectrical, electronic and electrical machinery,
transportation equipment, and controlling instruments.
2. Capital-intensive: textiles, printing and publishing, rubber, primary metals,
and fabricated metals.
3. Labor-intensive: apparel, furniture, leather products, and miscellanea.
FRB CH ICAGO W orking Paper
February 7989, W P -1 9 8 9 -5
41
4. Resource-intensive: food, lumber, paper products, petrolium refining, and
stone, clay, and glass products.
8 For a detailed description of the Heckscher-Ohlin theory see Baldwin 1971 and
for Vernon’s theory see Vernon 1966.
9 Domestic content, as defined by the U.S. General Accounting Office (USGAO),
is the value of parts and materials purchased from U.S. sources (both American
and foreign-owned) plus the value of domestic labor, overhead, and markups.
10 Caves states that “intangible assets are subject to a daunting list of infirmities
for being put to efficient use by conventional markets: l. they are, at least to
some degree, public goods... 2. Transactions in intangibles suffer from
impactedness combined with opportunism [i.e., pricing is difficult because it is in
the best interest of the seller not to reveal all the details about the intangible asset
and it is in the best interest of the buyer to be wary of exaggerated claims about
the intangible asset by the seller]... 3. An element amplifying the problem of
impactedness is uncertainty revolving around whether or not the buyer will be able
to successfully use the seller’s intangible asset.” (Caves 1981 pp. 4-5).
11 To analyze the growth in FDI in manufacturing, this paper uses the years 1978
and 1986 as end points. The choice was based on several factors. Firstly, rela
tively little FDI occurred prior to the late 1970’s, especially in the District. Thus,
using a beginning year of 1972, for example, would have resulted in extremely
large growth rates that would have been biased towards regions which had rela
tively little FDI in the 1970’s. Secondly, the paper’s focus is on the striking evo
lution of manufacturing FDI that has occurred over the past decade, a period
when the District’s manufacturing sector was hobbled by a double-dip recession.
Thirdly, the dollar exchange rate was following the same trend in both 1978 and
1986. During both years, the trade-weighted dollar was declining, nearing a
trough point (Federal Reserve Board’s trade-weighted dollar used). Thus, the
dollar exchange rate should have had the same influence on FDI in both years
and should not have resulted in any distortions in the growth rate of FDI.
12 A qualification regarding the unlevel playing field argument of the U.S.
autoparts producers is necessary. Japanese OEMs claim that they do not prefer
Japanese suppliers because of nationalistic reasons but because Japanese suppliers
are better capable at meeting their quality and price demands than U.S. suppliers
are.
13 There are no other foreign automakers (or truck manufacturers) operating as
sembly plants in the U.S. Volkswagen of America, Inc. closed its U.S. plant in
1988.
FRB CH ICAGO W orking Paper
February 7989, W P -1 9 8 9 -5
42
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February 1989, W P -1 989-5
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@FedFRASER