Will Foreign Direct Investment Accelerate the Economic Integration of East Asia?

The amount of foreign direct investment (FDI) flowing into advanced economies began to take a noticeable downturn since the dawn of the new millennium. By contrast, the amount of FDI flowing into East Asia has been steadily growing as East Asian economies began to emerge as the most appealing and important objects of investment to multinational corporations (MNCs). Between 2000 and 2012, the amounts of FDI directed toward the member states of the North American Free Trade Agreement (NAFTA) and the European Union (EU) have been on a constant decline, while the share of the overall FDI made in East Asia in the worldwide total grew from 7.2% to 24.4%. Also, East Asia is now recognized as a significant investor overall, as South Korea, China, and Japan, along with the member states of the Association of the Southeast Asian Nations (ASEAN) are increasingly becoming important sources of FDI. These nations of East Asia have been steadily climbing up the FDI trustworthiness rankings as well as the list on the FDI Performance Index, which measures the FDI each country makes against its gross domestic product (GDP). FDI indeed makes up significant parts of these East Asian economies’ GDPs and gross fixed capital, while the shares of FDI in their respective GDPs also continue to grow.

There are a number of reasons why East Asia is emerging as the most appealing target of FDI, including East Asian economies’ rising profiles around the world in general and the improvement in international opinions regarding the investment conditions in the region. As of 2012, East Asia accounted for 29.5% of the worldwide GDP, 29.0% of worldwide trade, 24.4% of FDI received, and 48.7% of the world population. East Asia therefore represents a bigger market than either the EU or the NAFTA bloc. Because of the region’s rapid economic growth, East Asia is also raising its profile and influence worldwide. The aggregate foreign reserves of the East Asian governments have significantly increased their share in the world total from 27.3% in 2000 to 43.8% in 2012. Of the 3.4 billion people inhabiting the region, at least 69% are capable of working. With their income levels rising, East Asians are also becoming able to spend more and more, thus contributing to the enlargement of their respective domestic markets.

Furthermore, East Asia attracts investors with the various improvements it is making to the investment environment, including the lowering of trade barriers and the formation of FTA networks. Numerous states in the region strive to minimize the setup costs for investors looking to establish local offices or companies and to reinforce investor protection while reducing the tax rates on earnings. East Asian governments also actively invest in the development of highly skilled and well-educated workforces. As all the states in East Asia are now members of the World Trade Organization (WTO), they have set out to reduce tariffs across the board and enter an increasing number of FTAs with major markets worldwide.

Since the onset of the latest global financial crisis, the appeal of the ASEAN member states as recipients of FDI has been on rise. In the meantime, the FDI in manufacturing began to drop, while that in the service sector began to grow. The most popular form of FDI in the region is the greenfield investment, which goes toward establishing production bases. The greenfield investment has been occupying an increasing weight in total investment that East Asia has been receiving over the last five years, thus strengthening the region’s production network. Whereas Korea and China’s shares of greenfield FDI in the ASEAN member states grew smaller between 2008 and 2012, Japan’s significantly grew by contrast with its share of the outward direct investment (ODI) in the region growing by 13.4% age points from 48.6% to 62.0%. While the volume of intraregional trade among all East Asian states except Japan grew dramatically from 2008 to 2012, it took an abrupt downturn in 2012 as Japan decreased the volume of its intraregional exports, and together with Korea and China, it also decreased its volume of intraregional imports. The territorial dispute between Japan and China and the dramatic appreciation of the yen (JPY), in particular, were the main causes of the shrinking intraregional trade, cutting Japan and China’s shares in it from 42.2% to 29.7% and from 31.2% to 25.8%, respectively.

In the meantime, South Korea has been consolidating its position as a main producer of intermediate goods, increasing the share of intermediate goods in its exports from 58.9% to 66.1% between 2002 and 2011. Exports to fellow East Asian countries account for more than half of all the exports made from South Korea, amounting to USD 274.9 billion. The share of intermediate goods in Korea’s exports to East Asia amounted to 74.7% in 2011, far higher than either China’s (49.3%) or Japan’s (65.8%). East Asia is therefore the most important market for Korea. The Korean government therefore needs to develop an FDI strategy, focusing on exporting more intermediate goods for industrial processing as well as processed food and beverages (for industries) and transport equipment, parts and accessories thereof, which are the main best sellers among the intermediate goods that Korea exports.

FDI has contributed significantly to the development and growth of not only the manufacturing sector but also the related services industries in East Asia by allowing East Asian businesses to adopt advanced technology and develop and export their own patents and intellectual properties worldwide in consequence. Because of the greenfield investment in East Asia, 1.83 million new jobs have been created over the last five years. As more and more investment goes to benefit small-to-medium projects in the service sector, the employment effect of FDI has also increased significantly. The increase in the FDI in East Asia has prompted the development and expansion of the region’s production network, the growth of intraregional trade, the creation of new jobs, and technological progress. With East Asia becoming increasingly integrated on the economic plane, these positive effects of FDI will grow even more. Nevertheless, East Asia took only 22.6% of all FDI flowing from Korea in 2012. The Korean government therefore needs to employ a negotiation strategy vis-a-vis other East Asian countries so as to allow Korean businesses to make maximum use of the burgeoning intraregional production network.