Japan Promotes Growth in an Increasingly Integrated Asia

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Asia Remains Vibrant Despite Appearance of Potential Obstacles

Asia grew at an impressive 7.3% in 2004 according to the Asian Development Bank’s 2005 Outlook report. In fact, 2004 marked the region’s “best growth performance since the Asian financial crisis of 1997-98.” First quarter 2005 data supports the view the region remains on an upward trend. India grew at a 7% rate while Malaysia registered 5.7% growth over the same period. For its part, Japan registered 5.3% during the first three months of 2005. This success in part is attributable to solid growth in traditional trading partners such as the United States. At the same time the region is benefiting from rising domestic consumption and business investment, and increased intraregional trade.

Looking forward, some analysts are questioning whether this growth is sustainable. In addition to stagnant growth in Europe, Asian economies have to grapple with the potential of lower growth in China and the U.S. Robert Subbaraman, Senior Economist for Asia at Lehman Brothers, noted in a Dow Jones Newswire report that more optimistic forecasts are “conditioned partly on the electronics cycle turning up and oil prices not rising much from here.”

Although these concerns are not trivial, Asia’s fundamental strength was recently emphasized by Morgan Stanley Chief Economist Stephen Roach who noted “any hit to Asian growth seems likely to be cyclical and temporary.” Reasons for optimism were enumerated in a recent Far Eastern Economic Review article by editor-in-chief of the China Economic Quarterly, Joe Studwell, who highlighted better corporate governance, Asia’s enlarging role in global supply chains, the strong financial positions of many regional economies, its growing role as a center for innovation, and an expanding middle class. Paradoxically, portfolio investors have traditionally underweighted the region. In 2003, Marc Faber observed Asia, including Japan, accounted for only 11% of world equity market capitalization. This allows substantial room for valuation increases as this deficiency is addressed.

The Economic Potential of India is Being Increasingly Recognized

In addition, while much of the interest directed toward Asia in recent years can be attributed to rapid development in China, we are now beginning to see a similar enthusiasm emerge in regard to India. Many analysts in fact, believe India’s strong devotion to democratic rule, its emphasis on service industries, long-term familiarity with Anglo-Saxon business practices, knowledge of English and more favorable demographic structure make it an even more favorable market over the long term than China. In fact, over the last three years, the economy of India has grown at an average rate of 6.5%. According to Deputy Chairman of the Government of India’s Planning Commission, Montek Singh Ahluwalia, it is expect to average 7.5% over the next two years, with an objective of seeing it rise to an 8% growth path thereafter.

India undoubtedly still requires numerous additional structural and other reforms as well as substantial infrastructure improvements to sustain its progress. The lower baseline from which it is starting, however, allows investors and businesses a major opportunity for growth and entry into an extremely promising market as it begins to open its doors more seriously to foreign investment and participation.

Recognizing the emerging potential of the Indian economy, Japanese firms have been moving to strengthen their presence on the subcontinent. Similarly, Indian firms are increasingly looking to Japan as an export market, As a result, the Governments of Japan and India have moved to form a Joint Study Group, with the goal of establishing comprehensive economic relationship, most likely including a Free Trade Agreement (FTA) between the two nations. At the first meeting this month, it was agreed that a report to will be submitted to the two Prime Ministers by June 2006.

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Political and Social Tensions Divert Attention from Asia’s Growth Story

To some extent, investors have become more cautious toward Asia due to a myriad of political, economic, and social factors. Frictions, such as those between China and Taiwan are longstanding, while others including those between China and Japan, Muslim insurgency in Southeast Asia, and several territorial disputes -- which also have historical roots -- have only recently risen in prominence. Tensions on the Korean peninsula and Sino-American quarrels over trade, currency valuations, and intellectual property have also weighed on investors as they decide how to manage investments in the region.

These issues are very real and warrant careful attention. Even though most go back many decades, or in the case of territorial disputes, even centuries, they do have the potential to impact trade and investment flows. For example, anti-Japanese protests in China in April have made many Japanese companies wary of expanding or starting businesses in China. Hiromi Oki, Director of International Economic Research at JETRO, told Bloomberg News that “because of anti-Japanese protests earlier this year, we have seen some companies taking a more cautious view on expanding further inland” in China. The result, however, at least for now, has not been to diminish economic activity in Asia. Japanese firms – face the same structural pressures to expand offshore regardless of dynamics between Japan and China. As a result, they have now begun to seek alternatives, with India and ASEAN representing two very real and attractive options.

The intractability and conflict-potential of these frictions in any case may be exaggerated. To some extent, these tensions might be seen as the normal outcome of a region in the midst of ongoing and rapid economic, political and social change. Regional economic development has created new trade and investment patterns, with the necessary adjustments causing painful domestic and external difficulties for firms and workers. At the same time, Asian governments must justify further movement toward reform and liberalization in the face of domestic criticism. At the same time, these developments are creating newfound opportunities for nationalists, ethnic groups, an increasingly empowered middle class and a range of interest groups, who are now able, and more willing, to express sentiments they could not voice in the past.

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Asian Economic Growth Leading to Increased Regional Integration

Despite these challenges, Japan’s Ministry of Economic, Trade, and Industry (METI) estimates by 2020, Asia will have a 25.5% share of world GDP versus 19.3% in 1990. Consumption is rising, with polling firm AC Nelsen reporting Asian consumers are far more confident about 2005 than those in America and Europe.

Malaysia, Taiwan, and Vietnam all experienced growth rates exceeding 5% last year. In 2005, analysts forecast growth in India and China will exceed 6%, while Indonesia, Taiwan, and Thailand may register 4-5%. Air travel is also increasing exponentially. The Singapore-based Center for Asia Pacific Aviation concludes air traffic growth will be so strong Asia will become “a key target for major investment in service expansion and new operations.” The region’s service sector is also developing rapidly. The May 2005 issue of the Japan Entrepreneur Report predicts the privatization of up to 400,000 government-owned operations in Japan ranging from youth hostels to tourist attractions to senior centers may create a market of several hundred billion dollars. Lastly, there has been tremendous growth in Internet and telecommunications services. Technology publication Zdnet, for example, reports Asia added 4.3 million broadband lines during the first quarter of 2005 alone.

While U.S. and European managers and investors have long recognized Asia’s ability to produce cheaply manufactured export products, the region is now seen as a huge market for commodities and increasingly consumer goods. Less widely appreciated is that Asia is quickly becoming a hub for advanced R&D, as well as the design, production, and test marketing of higher-end products such as automobiles, consumer electronics and a range of technological applications and services.

Asian governments are supporting these trends by investing in education and infrastructure, offering favorable tax and regulatory treatment, and reducing tariffs and other barriers. These measures, as well as Asia’s underlying attractiveness, are helping to facilitate record numbers of cross-border transactions as well as rising trade and investment flows into the region.

The newfound appeal of Asian economies, even developing ones -- as both producers and consumers of higher-end products -- can be seen in recent comments by Intel CEO Paul Otellini. Mr. Otellini informed the Financial Times his company was considering building an assembly plant in Vietnam and that it had created a $200 million venture capital fund to invest in Chinese companies involved in mobile phone technologies, broadband and semiconductors.

Increasing economic integration is also creating exciting opportunities for companies in the region. Between 1945 and 1990, many Asian economies traded more with the U.S. and Europe than with each other. This is rapidly changing. In the post-1990 period, “Interdependence has increased rapidly” as shown in various Pacific Economic Papers published by the Australian National University. As Asia’s largest economy, Japan is playing a direct role in nurturing these linkages. Japanese imports from East Asia surged from 31 to 43% between 1992 and 2001, while exports to East Asia rose from 33 to 42% over the same period.

A number of factors make it likely this trend will continue. First, regional multilateral institutions continue to widen and deepen their activities. Jane Skanderup, a Director at the Pacific Forum of CSIS, observed last year in the PacNet Newsletter that APEC is helping to facilitate trade and to encourage further region-wide liberalization. At the November 2004 ASEAN+3 summit in Laos, economic ministers decided to set up an expert group to study an East Asian Free Trade Area. Second, the proliferation of new free-trade agreements (FTAs), highlighted in our most recent JETRO Focus newsletter , is also helping to eliminate trade barriers and force domestic restructurings. Third, regional FDI is serving to link Asian countries. Japanese firms, for example, increased investments into China by 40% in 2004/2005 over the corresponding period in 2003/2004.

Increased integration is also relieving Asia of its acute dependence on external demand. While most Asian economies remain highly sensitive to shifts in U.S. and European consumer spending, interest rates and currency values, as well as the rise and fall of protectionist sentiment, over time the region is likely to become increasingly de-linked from the U.S. and Europe. This will require that Asia be considered on its own merits.

As a result, Asia provides a way for investors to diversify their portfolios. As Mark Headley, President of Matthews International Capital Management, pointed out in the June 2005 issue of Asia Insight, carefully done, investing in Asia “seems a natural means of addressing the enormous concentration one faces in having one’s job, home, portfolio, and currency all in one place.”

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Japan Helping Drive Asia’s Attractiveness as Business and Investment Destination

Japan has been a key player in helping to promote Asian integration. This is being achieved through investments by private firms, as well as government grants to develop regional infrastructure, service operations and production capabilities. Japanese firms are also investing substantial sums in China to profit from its accelerating economic growth, manufacturing prowess and rising participation in global trade. Sharp, Panasonic, and Toshiba are just a few of many Japanese companies making major commitments to develop operations on the Chinese mainland.

Japan has also committed itself to building trade flows with Southeast Asia. It now invests approximately10% of its outbound FDI into ASEAN and Asian Newly Industrialized Economies. Individual firms such as Denso, Mazda, and Mitsubishi are all sending billions of dollars into countries such as Thailand, Malaysia, and the Philippines to produce finished goods and components for domestic, as well as external, consumption.

Japan also serves as a major customer for Asian products. ASEAN and China are major exporters of commodities and processed/assembled goods to Japan. Last year, in fact, China became Japan’s largest trade partner, supplanting the U.S. Current data also indicates that business with ASEAN represented 14.7% of total Japanese trade in 2003.

Japanese Trade with ASEAN Likely to Accelerate in Coming Years

METI’s recently released 2005 White Paper emphasizes the importance of Japanese trade with ASEAN, and encourages Japanese firms to consider basing more production in these countries as well as India. This is seen as a way to avoid the avoid the dangers of overinvestment into, and over-reliance on China and the dearth of management staff, weak IPR protection, and power outages that afflict Japanese companies currently operating on the mainland. Given this will bond a wider range of countries into regional production networks, it will serve as an additional force to deepen economic integration in Asia.

Japan’s sheer size also gives it great influence. As Fareed Zakaria, Newsweek International Editor, observed not too long ago, “Japan is still the second richest country in the world, bigger than all the rest of Asia combined.” To cite another indicator, it is estimated that 70%+ of the largest Asian companies on an annual turnover basis are Japanese. These firms play a critical role in the intertwining and expansion of Asian economies. Moreover, Japanese companies are internationalized and produce at the upper end of the value chain. They are highly advanced in terms of technological innovation, spending, and are estimated to allocate the world’s highest proportion of funds for research and development relative to GDP.

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Exposure to Asia is Essential for Internationally-Focused Firms and Investors

Despite the political, social, economic, demographic and other challenges that exist in Asia and Japan itself, it is clear the region represents an increasingly attractive and important component of global markets, which internationally-focused corporations and investors neglect at their own risk.

Those who focus solely on the risks will surely miss out on the many opportunities for enrichment afforded by Asia’s large population, its ongoing industrialization and urbanization, and its increasingly affluent middle class. India and China alone offer some of the fastest growth rates in the world, with expanding industrial and consumer markets, the ability to efficiently manufacture high quality goods, and to increasingly provide high end professional services. At the same time, Indonesia, South Korea, and Thailand are taking steps to improve corporate governance, strengthen bank regulation and supervision and to remove bad loans from state banks. Beyond this, Asian governments are pursuing other initiatives to create a fertile environment for investment such as signing on to international conventions concerning the protection of intellectual property rights.

Thinking about Asia as a whole, investors also need to keep in mind that rising regional economic integration means that investment into one country no longer is just a way to sell into single discrete markets, or to obtain an export platform, but also can serve as a springboard into one of the most dynamic, and rapidly growing, regions in the world.

Japan Offers an Entrée Into Developing Asia as Well as Significant Domestic Potential

For many years, pundits have forecast the emergence of the “Asian Century,” an era when the region would assume its rightful economic and political place alongside Europe and the U.S. While many came to discount this possibility with the advent of the Asian financial crisis in the late 1990s, the pieces now seem more in place than ever before.

While other markets in Latin America, Central and Eastern Europe, the Middle East and even parts of Africa are also showing signs of improved economic performance, few if any possess the intrinsic scale, strength and potential of Asia as both an emerging industrial and consumer market, not to mention the extensive linkages which make the region an important focal point within increasingly interdependent global supply chains.

There are undoubtedly risks, and Asian economies will continue to face many severe challenges, solid fundamentals, ongoing restructuring and reform, as well as rising regional integration, and economic, technological, political and social advancement all augur well for the future prospects of the region.

As Asia’s largest economy, Japan will continue to play a major role in the developments now taking hold. Given its importance, companies and investors looking to enter this dynamic region would be wise to pay attention to what is happening there. This is true not only in terms of the ramifications of Japanese activities in developing Asia – but also in respect to the significant opportunities now arising as a result of the restructuring, reform and changing market conditions now taking place within its domestic economy.

Data, statistics and the reference materials presented within this newsletter have been compiled by JETRO from publicly-released media and research accounts. Although these statements are believed to be reliable, JETRO does not guarantee their accuracy, and any such information should be checked independently by the reader before they are used to make any business or investment decision.

Focus: Structural Reform
Focus: Economic Recovery
Focus: Privatization
Focus: Economic Recovery
Focus: Entrepreneurship
Focus: Consumer Demand
Focus: Asia
Focus: Gross National Cool
Focus: Regional Development
Focus: New Policy Challenges
Focus: Investment Japan IV
Focus: Investment Japan III
Focus: Biotechnology
Focus: Investment Japan II
Focus: Investment Japan
Focus: Foreign Direct Investment
Focus: Mergers & Acquisitions
Focus: Entrepeneurship
Focus: Economic Revitalization 
Focus: Industrial Revitalization 
Focus: Foreign Investment 
Focus: Bush Visit
Focus: Koizumi Visit
Focus: Economic Rebirth
Focus: Hiranuma Plan
Focus: Foreign Direct Investment
Focus: Emergency Economic Package
Focus: Action Plan
Focus: Economic Reform
Focus: Okinawa Summit
Focus: Small Business Development
Focus: New Enterprise Development
Focus: Industrial Revitalization
Focus: Economic Recovery 4
Focus: Steel
Focus: Economic Recovery 3
Focus: Economic Recovery 2
Focus: Economic Recovery

Focus is published and disseminated by JETRO New York in coordination with KWR International, Inc. JETRO New York is registered as an agent of the Japan External Trade Organization, Tokyo, Japan and KWR International, Inc. is registered on behalf of JETRO New York. This material is filed with the Department of Justice where the required registration statement is available for public viewing.