Academic journal article Atlantic Economic Journal

"Following" or "Attracting" the Customer? Japanese Banking FDI in Europe

Academic journal article Atlantic Economic Journal

"Following" or "Attracting" the Customer? Japanese Banking FDI in Europe

Article excerpt

Introduction

Much of the recent expansion of global foreign direct investment (FDI) flows is the result of an increase in services--rather than manufacturing-related investment. As a result, a growing literature has arisen investigating the characteristics, causes, and determinants of such service-related FDI. Many studies point to the strong link that exists between manufacturing firms and service (primarily financial and banking) firms. In describing the location choice of these banks, many studies find support for the hypothesis that service firms "follow the customer" (FTC) abroad; that is "the larger the home-based business (manufacturing) presence in the host (FDI-recipient country), the more the service provider should invest in that country." This suggests that service-FDI flows are tied to manufacturing FDI flows as service providers, either seeking to maintain home-based business relationships with their customers in foreign countries or searching for a means to enter foreign markets, choose to locate where manufacturing has previously invested. From a policy perspective, this may then suggest that the more non-banking FDI a country can attract, the more banking FDI that country may later host.

The empirical literature on the FTC hypothesis faces several challenges in accurately testing whether service providers do follow their customers abroad. Among these challenges is that much of the data employed by previous research were at a level of aggregation (industry- or national-level) that failed to characterize the investment activities of individual service firms. (1) As a result, precise determination of who the service firm's customers are is not possible. Further, the actual investment patterns of specific service firms cannot be discerned. In fact, the actual bank-firm link, on which the FTC hypothesis is based, cannot be examined. Thus, as the FTC hypothesis is based on firm-level business relationships, testing such relationships with aggregated data cannot lead to accurate determination of whether service firms actually followed customers abroad.

The purpose of this study is test the FTC hypothesis using firm-level data on Japanese banking FDI into Europe during the period 1970-2000. In contrast to earlier studies that typically apply ordinary least squares estimation to study the aggregated FDI and/or banking asset data, this study applies the logit estimation technique to firm-level banking FDI decisions to examine the individual investment patterns of Japanese banks into Europe. By employing firm-level data, this study addresses two important aspects of the FTC debate: first, the paper examines whether the FTC hypothesis holds at the firm level; and second, if the FTC hypothesis does not hold, the paper suggests alternative explanations to explain the investment pattern.

Examining Japanese banking FDI at the firm level may be particularly useful to testing the FTC hypothesis since Japanese firms, like British and German firms, use bank finance much more than market finance to fund their business [Daniels and VanHoose, 2002, p. 202]. Bank-client relationships in Japanese FDI are quite strong, and banks remain the preferred source of investment credit, especially since securities markets are not as developed as in the U.S. [Yamori and Murakami, 1999]. For instance, at the height of Japanese global outward FDI in the late 1980s, Japanese banks provided two-thirds of the external funds raised by Japanese corporations. (2) In addition, the downgrade of a bank's long-term credit ranking by a single step resulted in an approximately 30% decrease in the total amount of Japanese FDI into the US by the bank's clients between 1987 and 1994, suggesting the prominent role that Japanese banks play in Japanese outward FDI [Klein et al., 2002]. Finally, a recent study found that nearly 50% of Japanese manufacturing affiliates in Europe financed their operations through European-based, Japanese-affiliated banks [Japanese External Trade Organization (JETRO), 1999]. …

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