Investigation of the “China effect” on crowding out of Japanese FDI: An industry-level analysis (1990-2004)

This paper applies a dynamic panel model to investigate whether China is crowding out Japanese foreign direct investment (FDI) from other economies of Asia. We examined this with industry-level data on Japanese FDI flows into Asian economies. In order to deal with possible problems of serial correlation and endogeneity, we estimated coefficients using a difference and system generalized method of moments to examine the “China effect” on industries. We found a significantly high degree of crowding out effect by China on its Asian counterparts. Among twelve industries, a crowding out effect was found in nine industries, including electrical & electronics-the biggest industry for Japanese FDI. However, a complementary effect was found in two industries, one of them being transport, which is the second biggest industry for Japanese FDI. We conclude that while China's rise is a prominent threat for the region, it could be transformed into an opportunity in vertically fragmented industries.

Research Highlights►There is a high degree of crowding out effect by China on Japanese FDI. ►Among 12 industries investigated, 9 had crowding out, 2 had complementary and 1 had no effect. ►The largest industry − “electrical and electronics” experienced the crowding out effect. ►The second largest industry − “transport” had complementary effect. ►Chinaˈs rise could be transformed into an opportunity in the vertically fragmented industries.