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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings Asymmetries in National Patterns of Foreign Direct Investment: Consequences for Trade and Technology Development1 Simon Reich University of Pittsburgh This paper addresses the plausibility of an argument concerning the increasingly complex relationship that is emerging among trade, investment, finance, and the development of new high-technology in today's global economy. Specifically, my purpose is to consider firm behavior and public policy in the context of encouraging the emergence of a strategic understanding of how these components work in conjunction with each other. INTRODUCTION In a Newsweek article, Robert J. Samuelson (1986:59) wrote, The trade surpluses create a huge imbalance in foreign-exchange markets that inevitably raises the Yen's value and subverts the competitiveness of Japanese industry. . . . The message is that unless Japan acts effectively to reduce its trade surpluses, economic forces will ultimately act for it. . . . The surpluses can't last indefinitely and no one should want them cured by a slump in Japan's export industries. At the date of publication of this article in 1986, the yen value then stood at approximately 170 to the dollar. The yen's exchange rate had risen from 238 to 1 This paper relies on work prepared for two studies for the Office of Technology Assessment published under the titles of Multinationals and the National Interest: Playing by Different Rules (Office of Technology Assessment, 1993) and Multinationals and the U.S. Technology Base (Office of Technology Assessment, 1994). The results of this study will be published in a forthcoming volume entitled Globalization and Convergence in the 1990s? The Comparative Political Economy of Multinational Corporations (Reich et al., forthcoming).
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings the dollar the prior year, when Japan earned a $50 billion current account surplus, the overwhelming proportion in manufacturing trade exports. In May of 1986, the bilateral trade deficit stood at $4.7 billion, the bilateral annual merchandise trade deficit for that year being $54.4 billion. Samuelson's prescription was for Japan to grow faster at home, cut domestic interest rates, and to import more. In a Los Angeles Times article nearly a decade later, relatively soon after an announcement that Japan's January bilateral trade surplus with the United States had reached over $14.7 billion, Samuelson (1995) wrote, ''Japan's huge trade surpluses are unsustainable. If they aren't corrected, the cycle of stagnation may continue, and the Japanese will have only themselves to blame." Within weeks, the yen exchange rate grew to 80 to the dollar. By then Japan's monthly surplus with the United States had grown by an order of magnitude. For 1993, the latest available figures, the annual U.S. trade deficit with Japan had reached $60.5 billion. In the time between these two comments, Japan had earned billions of U.S. dollars, and the deficit grew despite the best-devised policies of successive Republican and Democratic administrations in raising and then lowering interest rates, despite strengthening the dollar's value and then letting it weaken, despite introducing and then discarding protectionist trade measures, and, of course, despite seemingly innumerable rounds of bilateral negotiations between successive U.S. administrations and their Japanese counterparts. And in contrast to the public warnings of the imminent "hollowing out" of the Japanese economy as the high value of the yen drives Japanese firms off shore, recent and forthcoming studies indicate quite clearly that the economic structure of Japan's most strategically important industries remain firmly intact. Although assembly facilities have moved off shore as part of an ongoing process for the last two decades, the heart of Japan's manufacturing capability and its industrial basis remains firmly entrenched in its traditional domestic centers.2 In June of 1995, Samsung, a Korean firm, announced that it had "beaten" both its American and Japanese rivals "to the punch" by being the first to develop a fully functional "next-generation" 256-k semiconductor DRAM chip. But such a development marks a startling change from a decade ago, just as Japanese firms confounded their American critics by first developing computer components, then full hardware systems, and subsequently software. In this paper I argue that these facts are not altogether unrelated. Indeed, in stronger terms, I suggest that patterns of trade, strategies of investment, and the development of the next generation of technology share an intrinsic relationship 2 For an extensive, critical assessment of the rectitude of the claim of the "hollowing out" of the Japanese economy, see Tilton (1995). On page 14, Tilton suggests that, "Although the Japanese talked about hollowing out as domestic production was replaced by imports, it never happened, except in aluminum smelting, in apparel, and to a very limited degree, lumber and furniture."
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings as we enter the new millennium that both American firms and the U.S. government cannot afford to ignore. I contend that direct investment is often a supplement to trade, and the inability to invest therefore creates sanctuary markets for the protected producers that not only provide them with the money to fund subsidized exports, but also the essential cash needed to fund the development of new technologies whose costs are growing at an exponential rate. ANALYSIS A recent study conducted by the Office of Technology Assessment (1994), entitled Multinationals and the U.S. Technology Base, entailed an extensive empirical assessment of the behavior of the world' s leading multinationals, combining aggregate statistical analysis with interviews with senior corporate executives from many of the Fortune 500 companies in the United States, Japan, and Europe. The findings of that study provide strong evidence of at least two distinct patterns of behavior among the world's leading multinational corporations in regard to how they link their trade and overseas investment policies—and a plenitude of anecdotal evidence that such strategic choices by the world's largest firms have an impact on their capacity to design and manufacture the next generation of technology, whether a billion-dollar fabrication plant that will be redundant within six years, or a new software program whose life expectancy will be considerably shorter. Prevalent View of Investment Patterns: Product Cycle Theory Traditional patterns of behavior have often meant policies designed to substitute foreign trade for foreign direct investment (FDI). The export of finished products has therefore eventually been replaced by the formation of overseas affiliates and the building of fully integrated overseas plants. The manufacturing process subsequently has been shipped abroad by firms—first, the final assembly process but eventually the entire process—as they seek, characteristically, to take advantage of lower overseas labor costs and avoid protectionist trade barriers. Economists, studying this pattern of corporate behavior, claim to have identified a routine pattern that they label "product cycle theory." Certainly, the function of FDI really defines the multinational corporation. It is what distinguishes a multinational firm from a national one, whether that investment is in the form of acquiring either wholesale or manufacturing facilities. Of course, the first wave of multinationals (Dutch and British) were largely trading companies who invested in extractive plants for natural resources and in wholesale and service facilities. Subsequent theories, however, about multinational corporate behavior focused increasingly on the patterns of corporate investment in manufacturing facilities with an emphasis on the transplant of manufacturing facilities abroad, notably to what was alternatively described as the third
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings world, the underdeveloped world, the lesser developed countries, the periphery or—in contemporary parlance—the "emerging markets." John Hobson's, Karl Kautsky's and Vladimir Lenin's early debates were focused on the distributional consequences of such development—primarily whether the investing country of the first world or the recipient third world country benefited more, and secondarily, what the distributional consequences of investment were within the first world between classes (Kautsky, 1915; Hobson, 1938; Lenin, 1977). The belated liberal response was encapsulated in the theory of the product cycle that, in contrast to these earlier formulations that stressed the divisive and zero-sum effects of FDI, emphasized the mutually beneficial, cyclical, and routinized pattern of foreign investment. In theory, the product cycle is quite straightforward. When multinational corporations establish affiliates in a foreign country, these new firms tend to pursue a familiar, consistently replicated strategy. Initially firms, located in their home countries, tend to export finished products to foreign markets. These are produced in the first world and sold in (successively) other markets of the advanced industrialized world and then, as economies of scale bring the product price down, limited third world markets. As competition emerges from other firms in advanced industrial countries, producers have to cut prices and thus seek to reduce costs by developing production facilities off shore. Initially, the aspects of the manufacturing process that are relocated to foreign plants are the most simple assembly jobs, with more sophisticated production processes that require intensive capitalization remaining within, broadly speaking, the advanced industrialized world. As a result, multinationals heavily import intermediate goods early in the foreign direct investment cycle, because they have more developed business relations, established standards and certification procedures, and secure sources in the home market. Critically, however, foreign affiliates can be expected to increase their local sourcing over time, as they become more deeply integrated into the local economy and consequently can realize the efficiencies of local sourcing. Eventually, product sales will service both local markets and export markets, with the production plants of the affiliate serving as the primary manufacturing base of individual products, as the home plants of the multinational corporation move on to the production of new, more technologically sophisticated goods. The development of the consumer electronics industry provides an example of this pattern, as production shifted from within the Triad to facilities in Southeast Asia. Problems with the Functioning of Product Cycle Theory There are, however, problems with the product cycle theory popularized in recent decades by the work of liberal political economists who have continued to focus on patterns of investment between the advanced industrialized and third world countries. The most vocal and eloquent proponents of this theory have
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings been Raymond Vernon and, in continuing work that builds on these basic assumptions to form more sophisticated formulations, John Dunning. 3 These problems become evident in trying to observe or operationalize the theory. First, there is no standard expectation regarding the amount of time that firms need to operate in local markets before it is reasonable to expect high degrees of local content. By this explanation, Japanese affiliates in the United States have different sourcing patterns than their European counterparts because Japanese investment in the United States is relatively new. Over time, the theory predicts, the volume of Japanese intra-firm trade will decrease and local content will increase as Japanese affiliates become more deeply embedded in the U.S. economy. Furthermore, the theory predicts that foreign affiliates will shift over time from purely domestic to more internationally diversified sales. Yet there often appear to be important exceptions to this apparent rule. In the case of Japanese manufacturing affiliates in North America, for example, while exports have increased as a percentage of all sales since the late 1980s, they were the highest in 1983 at 12.8 percent and actually decreased from then until 1988, when they hit a low of 6.2 percent. The issue of timing—of growing domestic local manufacturing content and diversified sales—is therefore underspecified in the theory. This proves problematic in the theory's utilization. Second, data limitations make it very difficult to measure local content, particularly in industries that produce goods with large numbers of complex manufactured parts and components. Further complications arise when it proves unwieldy to define local content in industries that include a large number of foreign affiliates that produce intermediate goods locally. The arrival of a "second wave" of affiliates of traditional suppliers to the parent of the multinational corporation in the country of origin therefore presents all types of problems for evaluating local production. For example, the formation of affiliates of Japanese auto firms in the United States has been accompanied by the formation of affiliates of traditional keiretsu (trading group) members, leading to all types of complications in measuring local content. As these affiliates have increased U.S. production capacity, they have also increased the volume of purchases from domestic parts suppliers. Toyota Motor Corporation's own data, for example, indicate that it increased its local purchases in the United States from $800 million in 1988 to a projected $3.8 billion in 1994, as its U.S. production grew from 164,500 to 600,000 vehicles—a rate of increase in Toyota's U.S. sourcing that was somewhat faster than that anticipated by product cycle theory (Toyota Motor Corporation, 1994). 3 One of the early, most comprehensive formulations of the FDI life-cycle theory by an economist was offered by Dunning as the "eclectic theory" of FDI (see Dunning, 1977, 1986, 1993). Vernon's major contributions include Sovereignty at Bay (1971) and The Storm Over the Multinationals: The Real Issues (1977). But Vernon's most succinct and perhaps widest read analysis of this issue is in an article entitled "International Investment and International Trade in the Product Cycle. Other notable contributions on this issue are to be found in work by Hennert (1985) and Barnet and Müller (1974).
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings Yet a definitional issue remains unresolved. Much of what constitutes domestic production, for example, remains contested, as critics contend that a substantial portion of the purchases of the U.S. affiliates of Japanese auto firms (to continue the example) are merely imports of components that have been redirected through affiliates. Evidence in support of that critical view is anecdotal and uneven. Yet work by Howes (1993) has suggested that most U.S. purchases by transplants are either by import from traditional Japanese suppliers or purchases from their subsidiaries in new greenfield plants. Support for Howes' position is provided by another study (Newman, 1990) whose author notes that the formation of affiliates of Japanese assemblers has been accompanied by the formation of affiliates of their traditional suppliers. And a further study documents that 115 traditional Japanese automobile suppliers have established U.S. subsidiaries, constituting more than 20 percent of the total number of Japanese manufacturing subsidiaries in the United States. In addition, 66 Japanese firms in the potentially allied area of electrical components have established U.S. subsidiaries, along with a number of firms that are involved in the manufacture of paints and ink, plastic products, and electric wire and cable. These latter firms are likely to supply their products as inputs to automobile production (Yamawaki, 1994). Thus, without proving definitive on the issue, this example demonstrates that local content is often a complicated and even impossible element to measure. Third, much of product cycle theory work (although by no means all, as Dunning's work attests) has either a theoretical or empirical focus which assumes the investing firm is based in the advanced industrialized world and the recipient in the third world, with remarkably little consideration given to the differing factors that might apply when investment remains within the Triad or, more broadly, the Organization of Economic Cooperation and Development (OECD). Even in the context of the globalization of investment and deregulation of markets in the 1980s and early 1990s, however, Europe generally accounted for approximately 37 percent of inward investment and Japan for less than 1 percent in this period, while the U.S. percentage grew from 16.4 to 22 percent (Organization for Economic Cooperation and Development, 1993). Therefore, even as the world's stock of FDI grew precipitously in the 1980s and early 1990s, increasing from $491 billion in 1980 to nearly $2.0 trillion by 1992, and as it became fashionable to focus on emerging markets as a location for FDI, the proportion of global FDI accounted for by intra-Triadic investment also grew.4 Given this fact, the renewed attention to the importance of "emergent 4 Inward investment refers to the flows of FDI into a given country. Outward investment refers to the flows of direct investment abroad from a given country. In principle, world inflows and outflows should balance. In practice, however, they often do not (as is the case with other balance-of-payments items). Reasons for the discrepancy between total inflows and outflows of investment include cross-national differences in accounting for unremitted branch profits, capital gains and losses, reinvested earnings, real estate and construction investment, and the transactions of offshore enterprises.
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings market" investment as important in the formulation of policy appeared to be a case of the "tail wagging the dog." Such discussion about investments in the third world shifted focus away from considering whether any contrasting dynamic conditions apply in the case of intra-Triadic investment. Finally, structural, if not necessarily regulatory, barriers to investment remained in effect in some (if not all) OECD countries despite the institution of the OECD's "code of conduct." Barriers greatly vary, both in form and by degree, among different countries. Although U.S. policy was officially neutral but, in fact, informally encouraged the growth of FDI, the same was not true of some of its major economic competitors in Europe and East Asia. Sustained barriers are important because product cycle theory is reliant on the assumption of investment access. If this assumption is unjustified, the theory cannot possibly provide a description of actual investment behavior.5 These structural impediments may constitute the largest and most effective barriers to the effective functioning of product cycle theory. Among the problems I have identified, such barriers may also have the greatest practical policy implication for my argument that sanctuary markets exist which generate artificial profits for investment. Certainly, among Triadic countries, the most significant problematic case concerning market access continues to be Japan—as recent discussions between the United States and Japanese governments over the auto industry and the accusations made by Kodak seem to indicate. So what are these apparent barriers to investment? Private Sector Impediments Despite the trend toward liberalization and the pressures exerted on Japan by the sustained national recession, many analysts and managers of U.S.-based multinationals argue that official government restrictions haye been supplanted by "private sector impediments" emanating from an "interior layer of business practices" (Johnson, 1982:200). One report published by the Office of the United States Trade Representative (1993:143) suggested that access is still limited by ingrained structural factors that "stem from particular features of the Japanese economic structure, business organizations, and relations between the Japanese private sector and the government."6 What form do these constraints take? The claim that some are the product of cultural factors and others stem from an arcane distribution system imply that they are not accessible to reform.7 Yet, in contrast, some analysts highlight both private and public sector policies that they say are amenable to reform. 5 This point is discussed at greater length below; but for a discussion of this point elsewhere, see, for example, Office of Technology Assessment (1993:68-79). 6 These constraints are systematically outlined in detail in The Second Annual Working Report of the U.S. Japan Working Group on the Structural Impediments Initiative (Department of Commerce, 1992). 7 These are discussed in U.S. Department of the Treasury (1988:2), and U.S. Congress (1993:6).
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings First, in contrast to most countries, new FDI in Japan occurs primarily through greenfield establishments and/or joint ventures (Lawrence, 1992:47). This pattern can be explained by Japanese attitudes toward mergers and acquisitions. Many companies in Japan are hostile to unsolicited takeovers, and the private sector in Japan instituted a system of "stable shareholders" as part of the liberalization of investment rules by the Japanese government. According to this view, the Ministry of International Trade and Industry (MITI) encourages companies to exchange shares and thus make acquisitions by foreign investors more difficult. Dating from General Motors' attempt to purchase shares of Isuzu in 1969: MITI finally announced that it would accept up to 35 percent foreign capital participation, on the condition that a substantial portion of the shares be held by stable shareholders. The term was used to indicate shareholders of Japanese nationality who could be counted on to retain their shares, even if the stock declined in market value and favorable prices were offered by foreign interests. . . . A feasible means of finding stable shareholders would be for companies in a group or industry to hold each other's shares Ballon and Tomita, 1988:50-51). Since then, companies have sought stable shareholders, who must obtain approval of the issuing company if they wish to sell their stock, but who are also explicitly not interested in participating in the management of said company. The maximum shareholding for financial institutions was reduced to 5 percent in 1987, apparently encouraging the wider distribution of company shares. But, in practice, members of the same keiretsu commonly exchange shares, binding their business relationships together more tightly and making foreign acquisition of their respective companies correspondingly more difficult. It has been suggested that firms such as Toyota, as well as broader business groups such as Mitsubishi, Mitsui, and Sumitomo, consciously pursued stable shareholding acquisitions designed to achieve the "keiretsu-ization" (Keiretsuka) of their firms Mason, 1992a:205-204. 8 Keiretsu members and their related companies account for approximately 34 percent of all corporate assets in Japan (Ballon and Tomita, 1988:42). And despite much discussion of the apparently imminent disintegration of the keiretsu system, Table 1, reflecting calculations of cross-shareholdings within Japan's leading bank-centered keiretsu, provides an example of how remarkably little change there has been in cross-shareholdings between the end of the 1970s and the most recent figures available for the 1990s. In practice, hostile takeovers are rare, and foreign takeovers usually occur only after all domestic possibilities have been exhausted U.S. Department of the Treasury, 1988:2). Consistent with these claims, common to recent foreign acquisitions of Japanese companies in the early 1990s, was the belief that the domestic firms procured were generally described as economically "distressed" or "unprofitable" (Friedland, 1993). 8 See cite in Mason (1992a:207) Nakashima Shuzo Kabushiki no mochiai to kigyo ho (p. 46).
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings TABLE 1 Cross-Shareholdings Within Bank-Centered Japanese Keiretsu Year Mitsui Mitsubishi Sumitomo Fuyo Sanwa DKB 1980 17.62 29.26 26.74 16.26 16.78 14.12 1985 17.87 25.18 25.01 15.79 16.84 13.33 1988 17.09 26.87 24.42 15.29 16.38 12.24 1991 16.58 26.37 24.67 15.62 16.67 12.16 1992 16.58 26.33 24.65 15.62 16.72 12.19 NOTE: Cross-shareholdings are the average of the ratios of stocks in one member company owned by other companies within the group. SOURCE: Adapted from Kigyou Krietsu Soran (1987, 1990, and 1993). Determined foreign investors may turn to greenfield site construction or licensing. But the high cost of land renders the greenfield option available to only a few companies, encouraging U.S. firms to settle for licensing agreements, which save them the costs of manufacturing and market entry (Lawrence, 1992:47, 51–52, 63). Indeed, despite the liberalization of formal Japanese rules regarding inward FDI, in 1990 the $1.2 billion earned by U.S. companies from royalties and licensing fees from Japan accounted for 35 percent of worldwide U.S. receipts from unaffiliated foreigners (Lawrence, 1992).9 This figure of $1.2 billion was 61 percent of the figure for U.S. direct investment abroad (DIA) in Japan in the same year (a percentage wildly out of line with both the ratio between U.S. licenses and U.S. DIA in other countries and with the ratio between Japanese licenses and FDI in the United States). This proportion of fees to U.S. DIA in Japan has grown over the prior ten years when liberalization of the rules for FDI in Japan suggests that it should have decreased. According to product cycle theory, with liberalization, U.S. firms would expect to invest more and license less Lawrence, 1992:52-53). These figures indicate that the constraints on mergers and acquisitions, which many believe are caused by keiretsu behavior, push U.S. firms into business arrangements that effectively limit their market access and thus their capacity to compete in Japan. In joint ventures, U.S. firms often take a minority share. As compared with Europe, U.S. shareholders in Japan are more likely to be the minority partner. 10 At the same time, licensing ensures that Japanese firms gain 9 Lawrence (p. 50) notes that Japanese firms earned only $185 million in royalties and license fees from U.S. firms. 10 "In 1990, majority-owned companies accounted for about 78 per cent of the FDI assets of United States firms. By contrast, only 34 per cent of the FDI assets in Japan and only 26 per cent of the assets in manufacturing were in majority-owned companies. Indeed, there is a relationship between countries that have generally discriminated against FDI and the share of majority-owned firms in FDI assets. While in developed countries that ratio averaged 76 per cent, the conspicuous outliers are the Republic of Korea (18 per cent), India (14 per cent), and Japan (34 per cent)" (Lawrence, 1992:53).
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings access to U.S. technology, leading to widescale, nonreciprocated technology transfer from the United States to Japan. As Lawrence (1992:55), an advocate of this position, states: In sum, the continued dependence on licensing, the heavy reliance on minority-interest ventures and the relatively large investments in majority-owned wholesale trade ventures support the argument that the marketing and distribution of foreign products in Japan is unusually difficult, or that current inflows have been too small to offset the impact of earlier policies. Merger and acquisition activity among domestic Japanese firms is vibrant and unhindered, in contrast to that by foreign investors in Japan, suggesting that no systemwide limit on activity exists. Figures provided by Japan's Fair Trade Commission (FTC) (1990:32) for 1990 note that 1,532 mergers and 969 acquisitions occurred. Another source indicates that, of 584 mergers and acquisitions involving Japanese firms in 1992, 387 involved Japanese firms acquiring other Japanese firms, and 165 were Japanese firms acquiring foreign firms. In only 32 cases did foreign firms acquire Japanese firms Bergsten and Noland (1993:81).11 Consistent with this view of Japan as providing limited access, an American Chamber of Commerce in Japan (ACCJ) (1993) report stressed the exclusionary business relationships that continually hinder the capacity of its members to trade in Japan. The report noted that the keiretsu arrangements "have affected the ability of certain American industries, such as the automotive, flat glass, insurance, and semiconductor industries, to take full advantage of market opportunities in Japan, even when the product is highly competitive."12 A final effective impediment to FDI instituted by the private sector in Japan has been the adoption of articles in company charters that preclude any form of foreign participation in the running of the companies, such as excluding non-Japanese citizens from their boards. Toyota, for example, wrote this provision into its charter in the 1960s Mason, 1992a:207). The combined effect of these private sector limitations was to reduce new FDI in Japan in the 1980s to a nominal sum while it was growing rapidly on a global basis. As a result, the greatest source of new FDI in Japan came primarily from the reinvested earnings of existing firms there (Lawrence, 1992:70). Foreign firms that are able to establish a presence in Japan often face supply and distribution problems when one or a few firms control the supply of essential products in Japan. For example, efforts by Toys "R" Us to establish itself in 11 The large discrepancy in the total number of mergers and acquisitions between this source and the Japan FTC (cited in the text) may result from different counting rules. Bergsten and Noland give the following statistics for 1990: total mergers and acquisitions, 801; Japanese firms acquiring Japanese firms, 341; Japanese acquiring foreign firms, 450; foreign firms acquiring Japanese firms, 10. 12 The details of these limits are offered in American Chamber of Commerce in Japan (1993:30-34, 49-50, 64-68, 90-92). For an academic study noting similar problems, see Gerlach (1992:36-37, 262-268).
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings Japan as a low-cost toy retailer often have been impeded by a few supplier firms trying to ensure that other retailers are not damaged by the entry of a new competitor (for details, see Mason, 1992b). The recent case of Kodak provides a comparable example of this tendency, as does that of the automobile industry. Certainly foreign automobile firms suffer from restricted market access in Japan, a problem that the Clinton administration sought to address by attempting to ensure U.S. producers of a guaranteed minimum share of the components market as had (proponents claim) successfully worked in the case of the semiconductor agreement of the 1980s. European auto firms complain about the collusion and exclusivity of the distribution system in Japan as well as unfair taxation, administrative guidance, inadequate protection of intellectual property rights, and the cost of land (see International Trade Reporter, 1993). Indeed, confidential interviews with European component suppliers revealed that some Japanese firms demanded licensing agreements with the parent company in Japan before allowing European firms to sell to the affiliates of Japanese companies in the United States. And the perennial problem of access to dealership networks has been raised but remains largely unresolved by recent negotiations. Automobile companies in Japan have much greater control of their dealership network than do their counterparts in the United States, through both direct ownership and individually negotiated contracts between the independent dealerships and the automobile manufacturers. In the absence of the active encouragement of the auto company that controls the dealership, penetration of the market through dual dealerships is exceptionally difficult, making the creation of an effective dealership network in Japan extremely time-consuming and expensive. Estimates suggest that establishing a new distribution network in Japan, with sales outlets equal in number to Mazda or Honda (about 2,500) could be expected to cost in excess of $1 billion, not including the recruiting and training of staff.13 Public Sector Impediments to Investment To these private sector constraints must be added the sustained public sector ones.14 As a 1992 Keidanren report stated: Japan has considerably more regulations on business than most other countries, and this undoubtedly obstructs the entry of new firms, both domestic and foreign, into the market. Many foreign firms, which are able to enter other markets, 13 This estimate is based on a 10 percent share of Autorama, which cost Ford $10 million in 1992. Autorama had 328 sales outlets. Honda and Mazda each had approximately 2,500 sales outlets in 1990. Indirect investments by Mazda (currently 25 percent owned by Ford) to support Autorama, in which it has presently a 41 percent stake, probably exceeds $100 million (Ford Motor Co. and Japan Automobile Manufacturers Association (1990:3). 14 For a proponent of the view that the Japanese government has indeed liberalized FDI access, see, for example, Julius (1990:33).
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings controlled by small cabals of like-minded industrialists and financiers who are not minded to give up control (Commission of the European Communities, 1993:51).21 The study found structural barriers in the major European economies to be strongest in France, Germany, Italy, and Switzerland. The second impediment to acquisitions identified by the report was a series of technical barriers that inhibit or prevent the transfer of control by contested takeover. For example, in Germany, Switzerland, and The Netherlands, companies often restrict the voting rights of ordinary shareholders and instead concentrate voting power in the hands of shareholder groups that are friendly to management. Among European Union members, the United Kingdom has relatively weak structural and technical barriers. As a result, management in the United Kingdom is much more likely to be responsive to shareholders' short-term interests. In addition, the value and number of cross-border acquisitions in the United Kingdom often exceed those found in the rest of the European Union Commission of the European Communities, 1993:51-52). Despite the sustained claims of deregulation and liberalization voiced by proponents of the process of globalization, the eradication of impediments to investment appears at best partial, at worst, grounds for sustained concern. Combined, the relatively recent presence of much of the world's FDI, the complexity and uncertain origin of manufactured inputs, the increasingly nuanced patterns of national affiliation among producers and their suppliers as strategic alliances weave companies together in new and unusual configurations, and the continued importance of government and corporate sector inhibitions on foreign investment all make the utility of product cycle theory inherently problematic. It remains difficult to confirm by analyzing the sourcing behavior of foreign affiliates. And indicators that focus on the output of affiliates also provide important but often stubbornly inconclusive evidence. In addition, sustained barriers to investment complicated the situation by generating conditions under which the theory was not likely to work.22 As a consequence, the problems in the formulation and operationalization of the product cycle theory—concerns about whether the same conditions apply in the case of intra-Triadic FDI as apply to outward investment in the rest of the world's 21 This image of Italy is consistent with broader data on inward FDI flows, which remain small and relatively volatile. Although the stock of investment grew in the late 1980s and early 1990s, the flow was uneven, peaking in 1988 and 1990 and dropping substantially in subsequent years. For further discussion and data on FDI flows in and out of Italy, see Commission of the European Communities (1993:61). 22 This paper does not provide a comprehensive comparison of multinational behavior with the Triad by nationality or sector. Such an analysis, consistent with these claims is, however, available in Office of Technology Assessment (1994).
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings economies by the Triadic countries, a series of empirical anomalies, and the durability of barriers to entry—all therefore raise a series of theoretical and empirical challenges to the generalizability of product cycle theory. AN ALTERNATIVE FORMULATION An abiding question, however, concerns the issue of what happens in the absence of impediments to market access of the type outlined above. Product cycle theory would expect convergence toward the type of investment behavior outlined by the theory. In the product cycle formulation, investment and trade are interchangeable, with investment replacing trade over time, substituting for it. Yet empirical data suggest that behavior need not conform to the expectations generated by the theory. To be more specific, substitutability between trade and investment need not be guaranteed. Nearly three decades ago, Japanese economists, notably Kiyoshi Kojima, wrote about a differing form of relationship between trade and investment. Kojima, in his study of the investment behavior of Japanese multinational corporations abroad, concluded that at least two forms of relationship existed between trade and investment. The first, implicit in traditional product cycle theory as described in the prior section, concluded that investment was "trade-destroying," meaning that, over time, investment abroad would result in a reduction in exported goods; first finished goods, then intermediate goods. The process would gradually extend from the firm level to a macroeconomic one. Thus "when FDI in manufacturing replaces domestic production followed by export to a foreign market, it substitutes for trade, and could be termed 'trade-destroying"' (Gilpin, 1989:337). In his study of the behavior of Japanese firms, however, Kojima concluded that a second pattern of FDI existed that was "trade-creating," rather than destroying. In this context, he suggested that multinational corporations used their FDIs as a conduit, if not for the creation of more exports, then certainly the maintenance of those exports. In this formulation, therefore, investment was not a substitute for trade but a supplement to trade. Anglo-American critics of Kojima initially ignored his work, adjudging it simply as a vestige of a mercantilist approach that an evolving Japanese economy would have to discard. But underlying this criticism of Kojima' s approach was a strikingly important point: That because the product cycle theory was (perhaps unkindly but accurately stated) written by Anglo-Americans, developed in the study of Anglo-American firms, primarily for an Anglo-American audience, then it promulgated the view that everybody would come to behave the way Anglo-American firms did. When Kojima's work simply could not be dismissed, western critics noted that his analysis was focused empirically on the behavior of Japanese multinationals in the context of their accumulation of extractive resources in (mostly
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings Southeast) Asia. Accordingly, they largely dismissed the applicability of this alternative trade-creating model to the behavior of Japanese (or any other) multinational corporations within the advanced industrialized world. But while resisting the temptation to label this a "Japanese model," unlike Gilpin who does so in interpreting Kojima' s analysis,23 what appears clear is that this model has been adapted for application in the context of the 1980s and 1990s. And Japanese firms have been the most common practitioners of this approach. The key additional component to that model, the element that distinguishes it from product cycle theory, is the use of intrafirm trade as the mechanism for a trade-creating strategy. This may have been, in part, what Akio Morita, the famous, late President of the Sony Corporation may have meant in observing that Japanese multinationals have institutional characteristics that encourage them to behave differently than their European and U.S.-based counterparts (see Morita, 1992). For as international trade and investment expanded throughout the 1970s and 1980s, intrafirm trade increased in tandem (albeit unevenly) across the Triad. Indeed, by the early 1990s, intrafirm trade within multinational corporations accounted for more trade within the Triad than did interfirm trade. At its most extreme, this reached startling proportions. For example, U.S. intrafirm trade with Japan makes up a much larger proportion of all U.S.-Japan merchandise trade than does inter-firm trade, at an average of 71 percent of the total of all trade between 1983-1992 U.S. Department of Commerce, 1983-1991a,b, 1993). Furthermore, over the same period Japanese multinationals and their affiliates conducted an average of 92 percent of all U.S.-Japan intrafirm trade. This asymmetry is even more pronounced than that associated with the bilateral U.S.-Japan imbalances in direct investment and merchandise trade. Taken together, these two statistics indicate that most U.S. trade with Japan takes place within and is dominated by affiliated networks of Japanese multinationals. The ability to pursue strategies with high levels of intrafirm trade is, of course, contingent on the capacity to invest freely, as is the traditional form of FDI. Thus, both are circumscribed when direct investment is limited or heavily regulated. But, in practice, this "trade-creating" form of FDI may require a greater degree of freedom—notably from domestic content or market-access prohibiting forms of regulations. Thus, although firms that advocate this strategy may seek to adopt this approach in differing markets, they are as limited by governmental regulation 23 Gilpin reflects this sentiment in citing the work of Kojima. Gilpin states that "[c]ontrasting Japan's foreign direct investment with that of the United States, Kojima argues that Japanese foreign direct investment attempts to be 'trade-creating,' whereas American foreign direct investment has been 'trade-destroying.' Japanese foreign direct investment has sought to increase, or at least maintain, Japanese exports; U.S. foreign direct investment, on the other hand, has tended to replace U.S. exports by establishing production facilities abroad to serve the U.S. or world markets. Although Kojima was referring specifically to direct investment by Japanese corporations, his characterization is applicable to almost all Japanese foreign investment" (Gilpin, 1989:337).
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings as by the peculiarities of sectoral requirements. Where none of the regulations outlined above in the case of Japan exists, multinational corporations have a greater latitude to act. Certainly recent extensive empirical work I conducted under the auspices of the Office of Technology Assessment adds support to the notion that a second, alternative corporate strategy exists (Office of Technology Assessment, 1993, 1994). Instead of replacing domestic production with production at the manufacturing plants of their foreign affiliates, some multinational corporations focus their direct investment policy on efforts to increase domestic exports. This trade-promoting corporate strategy places a premium on intrafirm trade or, more broadly, trade within traditional parent-supplier networks as a conduit for increased exports. To achieve this goal, FDI focuses on the development of wholesale and manufacturing assembly facilities rather than fully integrated plants. The optimal goal of such an investment strategy is to increase domestic exports, not to substitute domestic production for foreign production. Minimally, although the overall volume of exports might nevertheless fall as a result of overseas investment, it will not fall as precipitously as would normally be expected. Crucially, the high value-added end of the production process will be retained at home. This "trade-promoting" approach to investment by corporations challenges the traditional FDI pattern of behavior because it is designed to sustain the firm's domestic manufacturing base and shift as little of the production process off shore as possible. Evidence suggests that such a pattern of trade-promoting behavior by multinational corporations is systematic, widespread, and, where appropriate, effective in sustaining a vibrant domestic manufacturing base while increasing foreign sales. The capacity to pursue this strategy is, however, curtailed by three factors: the limits of host government regulation, the exogenous effects of macroeconomic forces, and requisites of sectoral constraints. Nevertheless, a major bifurcation in the preferred patterns of direct investment behavior among the world's leading firms is becoming readily evident—not the converging pattern that product cycle theory would predict. The preference in corporate behavior appears strongly correlated with the country of origin of the foreign direct investor. Japanese firms appear to be the leading exponents of this alternative, trade-promoting strategy, as measured by the concentration of their investments and consistently high levels of intra-firm trade. This observation is evident both in data concerning their global patterns of investment as well as their investments within the United States, where they enjoy sustained free market access within a market characterized by minimally intrusive regulations. Likewise, other, new investments by some German and Korean firms show preliminary evidence that they too are or will be engaging in similar patterns of behavior. The capacity of these firms to invest in ways that maximize exports to the United States, for example, is in part a product of the American policy of national
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings treatment. This approach minimizes government regulation in the hope of maximizing the volume and gains of FDI. National treatment articulates the principle that foreign investors, whatever form their investment takes, should be treated as if they were domestic investors and encourages the influx of FDI, as was clearly articulated in 1991 by the Bush administration: The Administration supports maintaining an open foreign investment policy, with limited exceptions related to national security. This policy produces the greatest possible national benefits from all investments made in the U.S. economy. The United States has long recognized that unhindered international investment is beneficial to all nations, that it is a "positive sum" game (White House, 1991:262). Anglo-American firms have often encountered a different pattern of regulation when investing abroad. They have often been forced by host governments to invest in fully integrated production facilities, exchange market access for patents, or have often been denied any investment access at all. Recent evidence suggests, for example, that a series of "structural barriers" continue to deny U.S. firms the kind of reciprocal access to some foreign markets that their rivals enjoy in the United States—as was outlined in the case of Japan. Indeed, the denial of such access has become so routine that both government and corporate officials have confidentially concurred that it may be better to avoid trying to enter such markets at all, and to move on to other, less regulated or "structurally impeded" investment markets. This approach has become an implicit part of government policy, with the decision to focus on "emergent markets" for both trade and investment, and to turn away from some mature markets. THE CONSEQUENCES OF A STRATEGY OF AVOIDANCE In tandem, the asymmetry in market access and the decision to focus on alternative markets rather than to persist in breaking down the barriers of protected ones, and the "avoidance strategy" it has spawned, bears a potentially heavy cost for both corporate America and the national competitiveness of the U.S. economy for at least three reasons. First, if the analysis suggesting that FDI has taken on increased importance in enhancing the significance of intrafirm trade is indeed correct, then the persistent inability of U.S. firms to invest in the economies of major competitors such as Japan naturally curtails the capacity of U.S. firms to export to those same countries. With the majority of U.S.-Japanese trade, for example, accounted for by intrafirm trade, and the overwhelming proportion of that trade being among and within Japanese firms, the inability of U.S. firms to invest in Japan and thus sell goods there has major implications for the recent, present, and future size of the U.S.-Japan bilateral trade deficit. Indeed, this phenomenon may indeed go a
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings long way toward explaining the relatively inelastic response of the trade deficit in the face of volatile currency fluctuations. In contrast, where the United States has a relatively balanced investment situation, and lower ratios of intrafirm trade as a percentage of all trade, it tends toward balanced trade accounts. The bilateral U.S. trade surpluses and deficits with Europe, for example, have proved to be far more cyclical and responsive to macroeconomic forces over the last decade than has been the case with Japan (for figures, see Office of Technology Assessment, 1994:14-15). This evidence suggests that investment access is therefore key to generating trade surpluses in the 1990s. Second, constraints on the ability of foreign firms to invest in another country afford the firms that do compete in that country a sanctuary home market. Although competition between domestic firms may exist, it is, nonetheless, limited. The cumulative effect of this limited competition is the creation of a sanctuary market and, in some cases, this generates cartelistic arrangements.24 Here, artificial profits are often generated as domestic consumers are forced to pay artificially high prices. This is undoubtedly the case in many sectors in Japan, where a variety of goods—from agricultural to consumer products—cost more than identical goods sold overseas by those same firms. Thus, the inability to invest thwarts competition and awards domestic firms artificial profits to subsidize exports. Although there is no doubt that competition may exist—and, indeed, may be fierce—in some sectors in Japan, that competition may not exist at all or may not be price-based competition. The cost of automobiles in Japan represents an interesting example of an industry in which competition does exist, yet the cost of purchasing an automobile far exceeds that for identical products in the United States. In other cases, such as that of the Japanese film market, Fuji exerts the type of monopolistic production position that would not be tolerated under U.S. antitrust law. And, in some cases, Japanese governmental procurement practices have subsidized domestic firms in niche markets—such as the case of supercomputers. Finally, how does this argument about trade and investment relate to the development of new technology? Well, preliminary—albeit extensive anecdotal, if often undocumented—evidence drawn from interviews suggests that these same artificial profits serve domestic firms in a new, irreplaceable manner. Formerly, the focus on artificially high prices in domestic markets lay in the issue of how these extra profits subsidized export prices. But these profits now serve an additional and perhaps even more important purpose. 24 For a most recent example, see the case involving Japanese electrical machinery makers, in which they prearranged "winners of 84 contracts worth about 17.27 billion yet, or $196 million, for local water supply and sewerage systems in 1992 and 1993." Those found guilty include Toshiba Corporation, Hitachi, Mitsubishi Electric, Fuji Electric, and Meidensha—some of Japan's most notable producers of new technologies (New York Times, 1995).
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings Returning to the much-publicized case of Kodak proves instructive on this point. Kodak is presently developing a system of optical imaging that could one day make conventional cameras obsolete. To finance the cost of such development requires relying on ''cash cows" such as sales of conventional film. If Kodak cannot sell in the Japanese market, it then loses a valuable source of revenue to finance the development of this revolutionary new technology. As the cost of successive rounds of development of new high-technology grows at exponential rates, firms are therefore increasingly pressed as to how to successfully finance the research, development, engineering, marketing, and distribution of innovative products. Even the largest computer companies, for example, have had to enter into strategic alliances so as to raise the necessary capital to develop the next round of semiconductor chips. Sanctuary markets are therefore crucial in that they provide firms with artificial profits that prove to be an effective source of capital in financing these efforts. In interviews, firms of all sizes and nationalities repeatedly stressed that the cost of developing new technologies was growing exponentially. American firms, it should be noted, were generally persuaded to enter into joint ventures with Japanese and European counterparts not because they were confounded by ideas about how to generate new technologies, but by the lack of the funds necessary to develop them. It was repeatedly the case that Japanese or European partners were providing the funding rather than the ideas. That funding was often (although, it is crucial to add, not always) generated by a pool of profits that had come from domestic sales. In the case of many small U.S. firms, such agreements began as joint ventures and ended with those firms being affiliates of the foreign producer with whom they had originally entered into a joint partnership. In the case of large firms, the terms of the deal often included provisions that limited the partners in terms of the markets in which they could sell their new technologies. Confidential interviews reveal once again that, American firms, for example, have repeatedly found themselves prohibited from competing in the Japanese markets in the case of the new technologies that they jointly developed with Japanese partners. We therefore should not be deceived into thinking that this age of globalization has created a financial environment in which it is easy for firms to roam the globe and garner the capital necessary to finance these projects. Far from the oft-cited stereotype, the world's largest firms continue to get an overwhelming percentage of their capital from their home market. With three very different forms of capital markets operating across the United States, Japan, and Europe, access to capital remains constrained and the importance of earnings to finance new projects has become greater than ever. When IBM has to enter into joint development agreements with some of its biggest Japanese and European competitors so as to finance the development of a new semiconductor chip, and the terms of that agreement include proprietary access to sales by region, then it appears that trade, investment, technology development, and financing have become indelibly and inseparably linked.
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings POLICY IMPLICATIONS The policy implications of major constraints on investment access are not without major significance. I focus here on three. First, how have government and corporate officials reacted? Faced with this problem in the case of Japan, administration officials have tended to advocate the pursuit of economic possibilities in large, untapped potential markets such as the People's Republic of China, Brazil, Southeast Asia, and Eastern Europe. Although making some efforts to break down investment barriers in recalcitrant OECD partners, they (similarly to corporate officials) have privately confided that the low possibilities for successful market entry, coupled with the high cost of business in Japan as a result of the yen's appreciation, have pushed them to pursue, more aggressively, entry into what they perceive to be easier and more promising markets. The potential flaw in this approach is that it is a shrinking world, and American firms often face competition from the very same firms in these third markets that benefit from the privileges of sanctuary markets. Armed with artificial profits that subsidize sales and finance new technological development, American firms face the short-and long-term prospect of being out-competed in their efforts to attract new customers. Second, the investment access problem may not be confined to Japan. It may prove to be a growing problem, even in the age of apparent growing liberalization, globalization, and deregulation. A variety of regional requisites and agreements, nontariff (such as technical) barriers and the consolidation of private sector access barriers have compounded a tendency by some countries to use Japan's traditional public sector regulatory behavior as a model for development. Although this tendency has been most avidly discussed in the behavior of South Korea, the newly industrializing countries, and NIEs, recent evidence points to the use of discriminatory trade barriers in the Vizegrad countries of Eastern Europe against American products, as well as the denial of trade and investment access in select cases in other OECD countries—such as Westinghouse's recent experience in Germany. Finally, it appears increasingly likely that such issues as the linkages between trade, investment, and high-technology will have to be managed in the context of multilateral, regional, and bilateral cooperative frameworks if policy friction is to be avoided. Anecdotal evidence suggests that the onus of responsibility increasingly lies with those critics of negotiated agreements to justify their claim that a laissez-faire approach yields an optimal outcome for all parties. Left alone, the international economic system appears under too much stress to hope for satisfactory, non-negotiated outcomes. In sum, FDI access appears key to the realization of global and regional liberalization, to mutually beneficial and balanced trade, and to the capacity to fund the next generation of technological development. In turn, the failure to
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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings secure satisfactory access among the home of the world's largest multinational corporations does not augur well—for global free trade, for the future competitiveness of America' s largest and most prosperous firms, or for the vitality of the U.S. economy. REFERENCES Department of Commerce. 1994. Survey of Current Business, December. Department of Commerce. 1992. The Second Annual Working Report of the U.S.-Japan Working Group on the Structural Impediments Initiative. Tokyo. American Chamber of Commerce in Japan. 1993. The United States-Japan White Paper 1993. Tokyo: American Chamber of Commerce in Japan. Ballon, R.J., and I. Tomita. 1988. The Financial Behavior of Japanese Corporations. Tokyo: Kodasha International. Barnet, R.J., and R.E. Müller. 1974. Global Reach: The Power of the Multinational Corporations. New York: Simon and Schuster. Bergsten, C.F., and M. Noland. 1993. Reconcilable Differences? United States-Japan Economic Conflict. Washington, D.C.: Institute for International Economics. Commission of the European Communities. 1993. Panorama of EC Industry 1993. Brussels: Office for Official Publications of the European Communities. Committee on Foreign Affiliated Corporations. 1992. Improvement of the Investment Climate and Promotion of Foreign Direct Investment into Japan. The Report of the Ad-Hoc Committee on Foreign Direct Investment in Japan, Keidanren Committee on International Industrial Cooperation. Tokyo: Committee on Foreign Affiliated Corporations. Dunning, J. 1977. Trade, location of economic activity and MNE: a search for an eclectic approach. Pp. 395-418 in O.P. Hesselborn and P. Wilkman, eds., The International Allocation of Economic Activity. London: Macmillan. Dunning, J.H. 1986. Japanese Participation in British Industry. London: Croom Helm. Dunning, J.H. 1993. Multinational Enterprises and the Global Economy. Reading, Mass.: Addison-Wesley. Ford Motor Co. and Japan Automobile Manufacturers Association, Inc. 1990. Automotive Distribution in Japan. Washington, D.C.: Japan Automobile Manufacturers Associations, Inc. Friedland, J. 1993. The urge to merge. Far Eastern Economic Review. Gerlach, M.L. 1992. Alliance Capitalism: The Social Organization of Japanese Business. Berkeley: University of California Press. Gilpin, R. 1989. Where does Japan fit in? Millennium: Journal of International Studies 18(3):337. Hennert, J. 1985. A Theory of Multinational Enterprise. Ann Arbor: University of Michigan Press. Hobson, J.A. 1938. Imperialism: A Study. London: George Allen and Unwin. Howes, C. 1993. Transplants and the U.S. Automobile Industry. Washington, D.C.: Economic Policy Institute. International Trade Reporter. 1993. European auto industry proposes "Joint Sectoral Initiative" with Japan. International Trade Reporter, May 19, pp. 830-831. Japan Fair Trade Commission. 1990. Annual Report to the Committee on Competition Law and Policy, OECD, on Developments in Japan. Tokyo: Japan Fair Trade Commission. Johnson, C. 1982. MITI and the Japanese Miracle: The Growth of Industrial Policy, 1925-1975. Stanford, Calif.: Stanford University Press. Julius, D. 1990. Global Companies and Public Policy: The Growing Challenge of Foreign Direct Investment. London: Royal Institute of International Affairs. Kautsky, K. 1915. Nationalstaat, Imperialistischer Staat und Staatenbund. Nuremberg, Germany: Fränkische Verlagsanstalt.
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Representative terms from entire chapter: