The Effect of Outward Foreign Direct Investment on Exports in Japan during The Lost Decade, 1985-2005

Abstract

This study will utilize an OLS analysis of the panel data coming from various databases such as the World Bank, Federal Reserve and etc. to determine if there exists a significant correlation between the exports of Japan and its foreign direct investment (FDI) in the period of 1985-2005 with nearby trading partners of which include the countries of ASEAN, China and South Korea. In addition, a selection of supplemental factors will be used to determine if they also possess any significance with exports. These factors include: the exchange rate of the Japanese yen with the currency of the trading partner in relation to the US Dollar, the magnitude of trade between Japan and the trading partner (YA * YB), and GDP growth. The signing of the Plaza Accord in 1985 caused the appreciation of the Japanese yen that inflated the economy to a substantial growth period that rivalled post-war revival. Japan’s transition to becoming the leading economy in East Asia enabled itself to become a provider of capital by initiating outward FDI in less developed countries to penetrate into those foreign markets. This study analyzes Japan’s trade relations with the Association of Southeast Asian Nations (ASEAN), South Korea, Taiwan and China by testing empirically how Japan’s FDI in those host countries spur its export growth in those countries. Japan pursued an export-led growth strategy in its economic development in the post-World War II period, which led to an insurmountable trade surplus from 1960 to the mid 1980’s. Applying trade theories such as the border effect and the gravity model, this study will evaluate what prompted Japan’s export growth in those host countries in the region after currency appreciation under the Plaza Accord. This paper proposes that Japan’s exports are indeed significantly correlated with FDI, relative exchange rate, trade intensity and GDP growth. It is concluded that Japan’s outward FDI contributes to its export growth during the period under study