The Determinants of the Location of Foreign Direct Investment by Japanese Small and Medium-sized Enterprises

Japanese manufacturing small and medium enterprises (SMEs) have actively undertaken Foreign Direct Investment (FDI) in Asia since the mid-1980s. FDI contributes to economic growth of the FDI recipient countries, as it brings in not only financial resources for investment but also technologies and managerial know-how, which are important factors for promoting economic growth. Recognizing these benefits of receiving FDI, policy makers in developing countries have formulated various strategies to attract FDI. This paper examines the factors in the host countries that would attract FDI by Japanese SMEs. Our results show the importance of both supply-side and demand-side factors in the recipient countries for attracting FDI by Japanese SMEs. Supply-side factors include abundance of low-wage labor, availability of well-developed infrastructure, and good governance of the host government, while an important demand-side factor is the presence of sizable local market. In addition, Japanese SMEs regard industrial agglomeration, which has a element of both supply and demand factors, as an important factors making FDI decision. Supply-side factors are found to be important for attracting Japanese FDI in developing countries, while demand-factors play a role in attracting Japanese FDI in developed countries. A comparison of the results for SMEs to those for large firms reveals that SMEs are more sensitive to the conditions in the host countries in making their FDI decision. In particular, SMEs regard the availability of low-wage labor, well-developed infrastructure, and industrial agglomeration as important elements much more than large firms. High sensitivity of SMEs to local economic conditions in their decision on FDI location may be explained by their limited availability of financial and human resources and high dependence on overseas production in their business. In light of these findings, we conclude that countries interested in hosting FDI have to provide a very attractive business environment.