China does it, to the tune of $70bn-$80bn a year. The US does it ($175bn in 2006). Even India, a country better known for its rolls of red tape than receptiveness to foreign investors, pulled in $19bn of foreign direct investment in the first five months of this year. So how come the world’s second biggest economy actually racked up net outflows in 2006?
Japan’s politicians are on the case. Junichiro Koizumi, former prime minister, succeeded in doubling Japan’s cumulative stock of FDI from 1.2 per cent of national output to 2.4 per cent in the five years to 2006.
Now comes the more ambitious part: Yasuo Fukuda, the prime minister who quit all of a sudden last week, this year confirmed a goal of 5 per cent of gross domestic product by the end of 2010.
Even at 5 per cent, Japan would be behind India and South Korea on current rankings. It is a minnow compared with the UK, at 48 per cent, or France at 35 per cent.
Shiro Akiyama, deputy director of the Invest Japan division of the Japan External Trade Organisation, a government agency, attributes the yawning gap in part to historical and geographic causes. “We did not need foreign capital when we developed our economy after World War II,” he says. “And geographically we did not have competitive markets around Japan at that time – for example, half the UK’s FDI comes from other European countries.”
Robert Feldman, who heads the economic research department for Morgan Stanley, Japan, lists three more modern impediments: taxes, regulations and language. “Because of the way the rules work, it’s difficult to do an outright acquisition,” he says.
New laws enabling so-called triangular mergers, whereby foreign companies can acquire Japanese companies through a locally-incorporated subsidiary, were introduced last year, but take-up is light. So far, just one deal, Citigroup’s acquisition of Nikko Cordial, a securities house, has made use of the structure.
Although officials say there will be some flexibility on tax deferral, it will be decided on a case-by-case basis, creating unpredictability for buyers.
“The persistence of such barriers has given many international investors and observers the impression that the government of Japan has lost the political will to follow through on its stated goal to increase FDI flows ... and is sending mixed signals to the world about its commitment to FDI, despite what the prime minister and others have said publicly,” the American Chamber of Commerce in Japan said in a paper published last March.
Jetro, however, attributes such views to misperceptions. “Even though the corporate tax rate (about 40 per cent) might be a little high, when you look at the facts the point is that foreign companies operating here are profitable,” says Kazuo Nakamura, director in charge of investment promotion at Jetro.
The latest survey carried out by foreign chambers of commerce, in March, shows that roughly half the respondents saw an increase in profits in the previous six months; more than half expect to increase profitability over the following six months.
As for regulations, Mr Nakamura says that countries everywhere are battling to find a balance between welcoming foreign investors and ensuring national security. “Japan is making efforts to ease regulations and make the environment comfortable for both domestic and foreign players. I don’t think it’s going to be a big problem for foreign companies to enter the Japanese market,” he says.
Instead, he sees the fact that Japanese companies offer strong competition in certain industries as the bigger deterrent. On manufacturing, meanwhile, cost-conscious foreign companies are more likely to choose developing markets such as China or Vietnam – although Japan still pulls in research and development investments, he says.
Bankers reckon there is a far simpler reason: a dearth of interest among foreign buyers. Bankers report that Japan desks in the US and Europe have basically been shuttered, or wrapped into broader Asian desks.
Jiro Seguchi, head of Japan origination at Merrill Lynch, says “Japan passing” pessimists are the cause. “This has become a common misunderstanding,” he says. “People are not paying close enough attention to Japan … because population growth is in decline, foreign investors are beginning to look elsewhere when making investment choices. For the time being, people think Japan is not as sexy as countries such as China and India.”
Yuichi Jimbo, head of investment banking at JP Morgan in Japan, adds that overseas interest in Japan has not been that strong among strategic buyers because there is rather less growth and Japanese companies in general have lower profit margins than their global peers.
“It’s going to be tough for foreign buyers, even if they succeed in buying a company in Japan, to carry out a major overhaul to improve margins. So people generally are not that enthusiastic about investing in Japanese companies.”
Instead, “the big losers in this are the Japanese, particularly Japanese investors”, says Mr Feldman. “By not letting foreigners in to stir things up and bring in new ideas, the net result is that the average productivity of Japanese companies is lower than it would otherwise be.”