Japanese Investment and Technology Transfer: Report of a Workshop (1992)

The aggregate and industry-specific evidence concerning the impact of Japanese investment on technology transfer between Japan and the United States presents a mixed picture; while technology clearly is being transferred to the United States, information on a number of relevant issues is lacking or incomplete. Future study will hopefully shed more light on the industries examined here and others in which Japanese investment is significant.⁶¹ The situation is still evolving, as Japanese companies assimilate their American acquisitions and a wider range of Japanese firms establish U.S. manufacturing and technology development capabilities. The discussion that follows outlines key issues for policy discussion related to Japanese investment and technology transfer to the United States. Clearly, a large part of the current policy debate revolves around the concerns expressed about foreign investment and outward technology transfer. An evaluation of the situation and policy implications of inward technology transfer and Japanese investment must take this context into account.

A basic question is whether lack of information about foreign investment and the activities of foreign firms in the United States hobbles policymakers. How to balance the benefit of timely and complete information about FDI from Japanese and other foreign companies with the tradition of national treatment is another important question.

Data collected and published by the Department of Commerce's Bureau of Economic Analysis could be augmented and provided on a more timely basis to policymakers.⁶² Some of the obstacles to enacting and implementing proposed changes can be traced to a reluctance to expend resources on data collection in the current atmosphere of Federal budget constraints. Others relate to differences of view about whether changing the reporting requirements would disadvantage foreign firms doing business in the United States.

A number of benefits might be realized from more disaggregated and complete data. For example, figures on trends in productivity, R &D spending and technology licensing at Japanese-owned subsidiaries would be invaluable to a deeper understanding of the actual situation in specific industries with regards to technology transfer. Information on the technological aspects of Japanese and other foreign MNC behavior may also be useful to U.S. government policymakers seeking to promote commercial technology development. While academic analyses and news reports on industry-specific aspects of the technology transfer issue are valuable and not necessarily inaccurate, the evidence remains incomplete and impressionistic. More detailed information would aid the CFIUS process of reviews of investments that raise potential national security problems.

The goal of the Foreign Direct Investment and International Financial Data Improvements Act of 1990 was to provide better data without damaging the confidentiality underlying current reporting practices, and with-

out violating principles of national treatment.⁶³ Some say that there should be more data collection and reporting on the activities of U.S.-owned companies as well as on foreign-owned enterprises, and that better information correlates with better policymaking. ⁶⁴

But taking action to address these issues could require a commitment of additional resources in order to generate more complete, accurate and timely data. In August 1991, the Commerce Department submitted its first report to Congress under the provisions of the 1990 legislation. ⁶⁵

While the United States has followed an open investment policy, the Committee on Foreign Investment in the United States (CFIUS) was established to review foreign investments with national security ramifica-

tions. The Exon-Florio amendment, which was made permanent in August 1991, provides the President with the power to block foreign investments that are deemed to have a potentially negative impact on national security. A number of questions pertain to the CFIUS process: Should changes be made that provide clearer criteria for evaluating potentially negative impacts? Should mandatory reporting requirements be introduced or are other changes in the CFIUS process necessary? Broader concerns are related to the impact of cumulative investments on the defense technology base and what policy instruments should be used to ensure the viability of the industrial base that supports defense needs.

The fundamental anxiety raised by dependence on any foreign source is that access to critical products or components may be delayed or denied in a crisis. Anxiety often focuses on Japan because of the strength of Japanese firms in industries such as electronics, machine tools, robotics and others with clear present and future military applications.⁶⁶ The notion that Japan's dual-use high technology could be a potent weapon in global geopolitics has become part of the public debate in both countries.⁶⁷ In the wake of the Persian Gulf War concerns about U.S. dependence on Japan for key components in military systems have been raised. ⁶⁸

Countries dependent on foreign sources for key components of weapons systems are not only vulnerable to clear threats of technology denial, but can be manipulated in more subtle ways.⁶⁹ The experiences of countries dependent on foreign sources of technology or goods indicate that there is

a security threat inherent in the globalization process. The United States has long used technology as a tool in its defense policy. In the view of some analysts, formulating policies aimed at ensuring that the United States will not be sitting on the other side of the table in the future is a worthwhile goal. According to others, however, Japanese investment in troubled U.S. companies in critical industries helps to maintain U.S. defense technology capabilities and is much preferable to letting the U.S. firm in question go out of business.

Concretely, military security becomes entangled with technology and Japanese FDI when a Japanese company proposes to purchase a U.S. manufacturer of a product that has an important military application. Concerns can be divided into two basic types. The first is fairly straightforward. The firm being acquired may possess a technology or manufacture a product that represents a “unique capability” or may be part of an industry that is critical to defense needs, small and very concentrated. Under these conditions, the supplier could theoretically delay or deny access during a crisis or transfer the capability to an adversary, impairing U.S. national security in the process. If a foreign company maintains manufacturing capability in the United States, however, the U.S. government could force the subsidiary to supply the product during a crisis. In practice, however, the U.S. government may have little knowledge or control over the level of production or product development a foreign firm maintains in the United States, particularly in the case of subcontracted components.

The second issue is broader in nature and more difficult to assess — so much so that some observers assert that no problem exists. A pattern of setbacks in global competition and direct investment by foreign companies may weaken U.S.-owned companies in an industry important to the defense industrial base. Over time, if U.S. technology development and production capabilities in the industry are reduced or eliminated, the capability to respond to a military crisis could be impaired.

The continuing debate over the CFIUS process is relevant to both of the national security concerns raised by FDI.⁷⁰ Although CFIUS has made only one recommendation to block a sale, there have been several other cases in which Congressional opposition or informal signals sent by the executive

branch have caused foreign firms to refrain from corporate acquisitions or takeovers of sensitive operations of U.S. companies.⁷¹

Some analysts argue that U.S. policy on foreign investment and the defense technology base may be inadequate to protect against technological vulnerability in the long-term. Theodore Moran proposes a comprehensive set of policy changes to address perceived shortcomings. These proposals are based on the assumption that the primary threat of technological manipulation arises when particular component or product markets are concentrated. If no country or group of companies can exercise market power, the threat of denial or delay is not credible. While it is not necessary that every critical component of every weapons system be made in the United States by an American-owned company, it is necessary to carefully guard against vulnerabilities in products where external suppliers are concentrated. A “4-4-50 rule” could be introduced as a basis for decision-making: If fewer than four companies located in less than four countries control more than fifty percent of the market for the product in question, it may be possible for suppliers to coordinate their actions and deny access.

Moran proposes that this “4-4-50” criterion be used by CFIUS to decide whether or not to recommend blocking a foreign acquisition. If the product in question is critical to the defense industrial base and suppliers are concentrated to the extent that four companies or four countries control fifty percent of the world market, then CFIUS should recommend blocking the sale.

But what if the acquisition target is the last U.S. company making the product in question and is unprofitable as a result of fierce competition with foreign firms? How will the firm stay in business without Japanese investment? One possible solution would be to link trade protection with the CFIUS review and recommendation process. If U.S. firms come under pressure in a critical industry where external suppliers are concentrated, a “national security tariff” could be introduced. Proponents say that a tariff is more advantageous to the United States than the quotas or voluntary restraints that have been imposed on imports in a number of industries

because the extra charge for the imported good goes to the U.S. Treasury rather than to the foreign firms.

How would this system work in practice? In some cases, the “4-4-50” rule would allow more scope for foreign acquisition than there is today, because there would be no grounds to block the sale of even the last U.S. company in a given market if the concentration criterion is not met. One possible benefit would be to reduce the uncertainty that potential foreign investors encounter under the present system.

A counter example is the case of photo lithography equipment for the semiconductor manufacturing — an industry which is concentrated and critical. Several years ago, after months of uncertainty, a consortium of U.S. companies agreed to acquire Perkin-Elmer's photo lithography business in order to prevent Nikon from doing so.⁷² If the “4-4-50” rule had been in effect, it would not only have eliminated the uncertainty over whether Nikon would be allowed to acquire the Perkin-Elmer division, but application of a “national security tariff” to lithography equipment would have either allowed Perkin-Elmer to continue operating the division profitably, or would have made it an attractive acquisition for a U.S. company. A compromise position between unconditional approval and blocking a sale might be to allow a foreign acquisition in a globally concentrated industry to proceed in return for imposing stiff “performance requirements ” on the purchaser, mandating continued R&D and production in the United States.

These proposals raise several issues. Economic efficiency arguments favor direct subsidies to domestic firms over tariffs on imports. But it may be easier to exert political control over the imposition of national security tariffs than it would be to regulate the award of large subsidies. Another argument states that protection awarded under these criteria may conflict with the interests of industries for which the protected product is an input. For example, tariffs on semiconductors would hurt U.S. computer companies by making them pay higher prices for chips. Despite these problems, the “4-4-50” rule does have the twin virtues of clarity and coherence.

While much of the debate over foreign investment has focused on national security concerns in the traditional sense, there are a number of issues related to foreign government promotion of high technology indus-

tries and contrasts in antitrust policy and implementation. One set of concerns relate to the question of whether Japanese investments in small, high technology U.S. companies reflect a conscious strategy of global domination. Will the United States need to adopt more activist policies to promote high technology industry, including restrictions on Japanese investment? Should policies be instituted to promote technology transfer from Japanese investment even if requirements run counter to the open investment approach taken by the United States in the multilateral arena for many years?

Some observers worry that our open investment environment leaves U.S. high technology industries vulnerable to targeting strategies of foreign governments or “business-financial combines.”⁷³ Much of this concern is related to the possibility that U.S. industry could fall prey to anticompetitive practices by Japanese companies. ⁷⁴ Differences in antitrust law and practice are the basis for these concerns.

Anticompetitive behavior by Japanese or other foreign companies could theoretically harm U.S. industries in two ways. First, an oligopoly may restrict access to its domestic market or use government subsidies to underprice U.S. companies and drive them from the market. After eliminating the competition, the oligopoly could charge exorbitant prices. Second, a group of companies that are vertically linked in supplier-manufacturer relationships or horizontally linked through financial ties may favor group members over U.S. firms and other outsiders.⁷⁵ In small or concentrated markets, the result may be to exclude the outsiders altogether or severely reduce their ability to compete.

Many assert that Japanese success in the consumer electronics and semiconductor industries can be traced in part to anticompetitive behavior.⁷⁶ While charges leveled at the Japanese electronics industry have targeted the practices of firms that were ostensible competitors, U.S. negotiators have focused on the practices of Japanese horizontal and vertical business groups, or keiretsu, in the Structural Impediments Initiative (SII) talks. Recent research by Robert Lawrence of the Brookings Institution on the import behavior of keiretsu provides a basis for substan-

tiating the collusive behavior of keiretsu, though Lawrence finds no basis for the charge that keiretsu ties lead to collusive export behavior.⁷⁷

In contrast to the current U.S. approach of multilateral and bilateral efforts aimed at an international harmonization of national competition policies, there are some who argue that a tougher stance is required. The specific recommendations center on revamping Exon-Florio so that the CFIUS process considers “economic security” as well as “defense security.” The Technology Preservation Act of 1991 was introduced in the 102nd Congress by Representative Cardiss Collins (D-Ill.) to address “the failure of Exon-Florio to stop the transfer of technology and production out of our country due to foreign investment.”⁷⁸

The permanent renewal of the Exon-Florio provision in August 1991, which was favored by the Bush Administration, marked the establishment of a consensus on the issue of review on national security grounds. While there was a lull in Japanese investment activity during 1991, Japanese high technology acquisitions continue to be a matter of serious public debate. Whether review should be extended to include “economic” security and the adequacy of data to assess impacts are the subjects of this debate.

A final concern is the widespread perception that U.S. and other foreign firms do not have the same opportunities to invest in Japan that Japanese

firms enjoy in the United States. Since investment can be a mechanism for technology acquisition as well as transfer, the result may well be to limit the scope of technology transfer from Japan to U.S. firms. Asymmetries in the industrial and R&D structures of the two countries present a context that facilitates the flow of technology from the United States to Japan, and investment policies are part of that context.

Over the past several years, a number of large American companies have opened R&D facilities in Japan, and have had some success in gaining access to Japanese technology as a result.⁷⁹ Japan has somewhat relaxed its traditional restrictive stance toward inward FDI, which was designed to obtain foreign technology yet discourage foreign ownership of business enterprise in the domestic market. ⁸⁰ At the same time, private arrangements and business practices continue to act as important barriers to foreign acquisition, including, notably, acquisition of Japanese firms that possess significant technologies. ⁸¹

Limitations on foreign access to Japanese technology can result in a long-term competitive advantage for Japanese companies. Sony and Matsushita were able to purchase American motion picture studios and thereby gain “software leverage” for future consumer electronics products. But Compaq, the U.S. computer company, would find it impossible to acquire a Japanese company such as Citizen Watch in order to gain access to the precision component technology that it needs to be competitive in the long run. Some believe that if Japanese firms have access to all of the world's technology while U.S. companies only have access to two-thirds, the American firms will lose in the end.⁸²

In certain respects, the policy implications and alternatives are similar to those raised in relation to antitrust considerations. Indeed, reciprocal opportunities for U.S. firms to access technology and vulnerability to possible anticompetitive practices by Japanese companies are closely linked. Policies toward one might imply complementary approaches toward the other.

Some argue for a more restrictive U.S. stance on foreign investment as part of a larger shift toward more active government involvement in promoting technology development and competitiveness in U.S. industry. It is argued that continuing traditional U.S. policies toward FDI and relying on multilateral and bilateral solutions will not bring reciprocal opportunities for U.S. firms in Japan.

Obviously, the adoption of a more restrictive approach to FDI by the United States would signal a major shift in U.S. approaches to international trade and investment. Proponents of the present approach argue that U.S. companies own many assets abroad and that these “hostages” in practice constrain the use of more restrictive practices here. ⁸³ Further, restrictions on inward FDI — by themselves — may be counterproductive if the ultimate goal is strengthening the technical base of U.S. industry. But if Japanese companies continue to gain strength across the range of high technology industries and the perception of a lack of reciprocity remains, public support for more restrictive investment policies — which is already significant according to polls — will continue to escalate.

The demonstration that Japanese investment leads to significant technology transfer to the United States is relevant here. To the extent that proponents of an open investment and trade environment can point to benefits of Japanese FDI, it will certainly strengthen their case. However, “good citizenship” cannot replace reciprocal access in the long run.

The discussion of policy options illustrates the close linkage between technology transfer concerns and many of the broad issues influencing U.S.-Japan relations. The evaluation of Japanese investment and technology transfer at the NRC workshop illustrates how much we need to learn about impacts as a prerequisite for developing effective policies. Some general points are worth reiterating:

1. The workshop uncovered evidence that in some industries Japanese foreign direct investment has led to a net positive flow of technology to the United States.

2. It appears that the technology transfer impact of Japanese investment differs widely among industries and these differences should be taken into account by policymakers and business people. Of the three industries examined, the most technology transfer to the U.S. appeared to be in automobiles, the least in consumer electronics.

3. The discussions at the workshop did not uncover evidence of major outward technology flow resulting from Japanese investment in small, high technology companies. However, analysis of the technology transfer effects of Japanese investment in the U.S. semiconductor, semiconductor manufacturing, software and other industries has not been as extensive as analysis of the automobile industry. In a number of industries, particularly high technology industries, the net impact cannot be assessed. This lack of knowledge hinders informed discussion and policymaking.

4. Although encouraging technology transfer from Japan to the United States is important, technology transfer by itself will not solve the technological aspects of America's competitiveness problems. By any measure, the U.S. automobile industry is much more efficient than it was ten years ago. But it has not regained world leadership; the Japanese industry has made great strides as well. Many problems remain for the U.S. industry and technology transfer from Japan is only one lever among many approaches that must be considered.

5. Concern over Japanese investment is often a proxy for other issues. Policy prescriptions concerning technology transfer are a part of the larger “competitiveness debate.” In this context, it will be important to consider when and why U.S. capital opts out of technology development and commercialization here in the United States.

6. In considering differences in the opportunities that Japanese and U.S. firms possess to invest in and acquire technology in the respective foreign setting, it is important to determine whether the problems are due to Japan being closed or to a lack of effort on the part of U.S. companies.