Foreign Direct Investment in East Asia

Abstract

This paper surveys research on foreign direct investment (FDI) in East Asia. The pattern of FDI in the region has changed over time. Outward FDI from Asia began in earnest when Japanese multinational corporations (MNCs) shifted production to other Asian economies following the 60% appreciation of the yen that started in 1985. The major destinations for Japanese FDI initially were South Korea and Taiwan. However, as labor cost in these economies rose, Japanese FDI shifted to Association of Southeast Asian Nations (ASEAN) economies. MNCs from South Korea and Taiwan responded to the increase in labor costs by also investing in other Asian economies. Following the 1997-98 Asian financial crisis, China became a favored destination for FDI. As Kojima (1973) noted, one of the striking features of East Asian FDI is its complementary relationship with trade. The complementary nature of trade and FDI in Asia is partly due to the rise of regional production networks. Parts and components rather than final products are traded between fragmented production blocks. To understand the slicing up of the value chain, it is helpful to compare the production cost saving arising from fragmentation with the service cost of linking geographically separated production modules (Kimura and Ando, 2005). This has been called "networked FDI" by Baldwin and Okubo (2012). It is a complex form of FDI in which horizontal, vertical, and export platform FDI take place to differing degrees at the same time. The fragmentation strategy adopted especially by Japanese MNCs is to allocate production blocks across countries based on differences in factor endowments and other locational advantages. The paradigm example of this type of production fragmentation is the electronics sector, where parts and components are small and light and can easily be shipped from country to country for processing and assembly. In this sector, the quality of a country's infrastructure plays an important role in its ability to attract FDI.