An Empirical Analysis of Outward Foreign Direct Investment of Korea and Japan

By Bae, Sung C.; Hwang, Sungoh | Multinational Business Review, Fall 1997 | Go to article overview
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An Empirical Analysis of Outward Foreign Direct Investment of Korea and Japan


Bae, Sung C., Hwang, Sungoh, Multinational Business Review


This paper examines the empirical relationship between Korean and Japanese outward foreign direct investment (FDI). Considering the heavy dependence of Korean firms on Japanese technology and the intensive competition of Korean firms against Japanese firms, it is argued that Korean firms' FDI is affected by Japanese movement for outward FDL The results of this paper provide evidence supporting the significant positive relationship between Korean FDI and Japanese FDL Specifically, current year's Korean FDI is significantly positively related with previous year's Japanese FDI even after the effects of other macroeconomics variables on the Korean FDI are controlled. This paper also offers interesting findings on the relationships between macroeconomic variables and Korean FDL In particular, greater Korean FDI is found to be associated with an increase in Korean wages relative to Japanese wages and with an appreciation of Japanese yen against Korean won.

INTRODUCTION

This paper focuses on foreign direct investment (hereafter, FDI) activities of the two more advanced economics in Pacific-Basin countries, Japan and Korea. Japan and Korea exhibit some similarities in their FDI activities during the past decade. During the 1980s, Japanese exporting industries were expanding globally to remain competitive with both foreign and domestic companies. During the late 1980s and early 1990s, however, Japanese firms experienced severe economic downturns and restructurings following the so-called "bubble economy." Combined with these economic conditions domestically, according to Komiya (1991), deregulation of financial sectors in Japan and increased import barriers by major trading partners have contributed to the increase in Japan's FDI.

During the 1980s, Korean industries faced similar economic hardships. Along with increased pressure from major trade partners, including the U.S. and Western Europe, to open its economy, domestic problems such as wage hikes, labor shortage, frequent labor disputes and appreciation of Korean won= have led Korean firms to invest abroad. The increase in outward FDI by Korean firms could also be attributed to changes in global markets including intensifying protectionism in trade and technology, formation of economic blocs, and incentives offered by many overseas countries (e.g., China, Indonesia and Mexico). For the first time, FDI by Korean Firms exceeded foreign investment in Korea in 1990 [Kim 1993]. While previous literature has identified several important determinants of a country's outward FDI, this paper investigates the empirical relationship in outward FDI activities between Korea and Japan. In particular, it is argued in this paper that Korean FDI is further influenced by Japanese FDI in addition to the macoeconomic variables documented as determinants of outward FDI by previous studies. Traditionally, Korean and Japanese firms have not only worked as partners but also competed against each other in the world markets. For example, Korean firms have competed with Japanese firms in the U.S. markets mainly for automobiles, electronics, and computer products. Firms in both countries also compete against each other in other lessdeveloped Asian countries including China, mainly to take advantage of cheap labor and local production costs. Considering the heavy dpendence of Korean firms on Japanese technology and the intensive competition of Korean firms against Japanese firms, it is expected that Korean firms' FDI is strongly positively related to Japanese to Japanese firms' FDI.

In order to investigate the empirical relationship between Korean and Japanese FDI, regression analysis is performed on FDI data for 1977-92. As a country's outward FDI is supposedly influenced by macroeconomic variables, such as GDP growth rate, interest rate, trade balance, exchange rate, and wage growth [United Nations 1992], these variables are used as control variables in regressions of Korean FDI, with Japanese FDI as the test variable.

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