The policy orientations of East Asian governments, discussed in the previous chapter, are based on assumptions that recognize important linkages between trade and FDI. By encouraging foreign firms' investment in key industries such as autos and electronics, comparative advantages in industrial production have been created. With these industries, opportunities for product differentiation have also grown, contributing, in turn, to the growth of intra-industry trade and the horizontal division of labour. In this chapter, patterns of inter-industry and intra-industry trade are first examined and the reasons for intra-industry trade (IIT) are then studied. Determinants of IIT include converging income differentials, economic structures and geographic proximity. FDI should also be a significant explanatory variable because of its role in the evolution of domestic industrial structures beyond reliance on natural resource and labour endowments.

Beginning with inter-industry trade, also referred to as the “vertical division of labour”, trade patterns are established by differences in endowments of land, labour, capital and technology, and by countries specializing in things they do well. A simple gravity analysis in Table 3 of the intensity of bilateral trade ties in 1988 suggests that Japanese and U.S. trade with the East Asian economies is still characterized by inter-industry trade. Gravity coefficients compare the bilateral export shares of each pair of economies with the export shares they have with all the others in order to measure the relative strength of each bilateral trade tie. The close ties between Singapore and Malaysia are evident in coefficients of greater than 5; ties between Singapore and Hong Kong and their immediate neighbours come next with values greater than 2. Japan's strongest ties are with Indonesia (because of raw materials) and the United States; while U.S. ties are strongest with Taiwan and Korea (because of exports by the latter of capital and labour-intensive consumer goods, respectively). Beyond that, coefficients around 1 indicate bilateral trade ties no stronger than the average, while coefficients less than 1 indicate low levels of integration.

There are two national sources of data on Japanese FDI: the balance of payment statistics of the Bank of Japan (BOJ) and notification data collected by the Ministry of Finance (MOF). BOJ statistics are compiled on actual investment transactions by Japanese residents, on a calendar year basis, in overseas branches, subsidiaries or associated companies in which Japanese parents' ownership exceeds 10 per cent. These data are available only in aggregate form, with no national or industrial breakdowns. MOF statistics, which do provide such breakdowns, are anticipatory, compiled at the time the Ministry is notified by firms of their intentions to invest, subject to approval of the host government. Because these data are collected before the transaction occurs, they overstate actual investment. U.S. Department of Commerce (U.S. DOC) data measures actual capital flows by U.S. firms that own at least 10 per cent of the voting equity of a foreign enterprise. This measure of FDI includes retained earnings.

Comparisons between Japanese and American foreign direct investment must, therefore, be made with caution and are best confined to general ratios and trends rather than to levels. Data from host governments also vary considerably because of the variety of methods used to track investment inflows. They are, therefore, of limited assistance in reconciling differences in home country data.

To evaluate and apply the distinctions implied by the introductory discussion, it is important to be aware of certain characteristics of the post-war Japanese economy and to make some comparisons with those in the U.S. economy. For purposes of this study, the comparison is organized around Dunning's framework to address differences in ownership factors including country-and firm-specific characteristics and advantages; differences in internalization and locational advantages, such as the evolution of relative factor endowments, relative costs, barriers to trade and inducements to invest. The areas of contrast include differences in resource endowments and economic frameworks; policy goals and government and industrial responses to rapid economic change and to outward FDI.

Economic Environments

Japan

Japan is a small crowded island, poor in natural resources, and – until less than two decades ago – preoccupied with creating employment for a growing labour force and achieving rapid economic modernization and growth in per capita incomes. In the post-war period, in contrast, the United States has been the world's hegemonic leader, supported in no small measure by the power, dynamism and natural resource riches of its huge economy. Where Japan's economic development has involved protection of infant industries, economic planning and close business-government co-operation, economic development in the United States has, like in other Anglo-Saxon countries, emphasized laissez-faire behaviour in an independent private sector, and the private sector as the engine of growth. The public sector provides public goods, corrects market failure and fights concentration of economic power.

Japan's economic growth in the immediate post-war period was fuelled by procurement requirements for the Korean and Vietnam wars. Its industrial base was provided by labour-intensive light manufacturing and heavy and chemical industries that produced substitutes for imports. Heavy dependence on energy and natural resource imports changed rapidly after the first oil shock, world recession and collapse of the Bretton Woods system of fixed exchange rates in the 1973-74 period.

This study has examined why and how Japanese manufacturing firms have located production in the East Asian economies; it has also assessed the strategic role of government policies in this investment and the implications for global welfare. The conclusions from this study are organized into two parts: conclusions about public policies of home and host governments as factors affecting firms' decisions to invest abroad; and conclusions about firms’ behaviour and the implications of this behaviour.

First, Japanese public policy, although it has become more neutral towards exporting with such changes as deregulation of Japanese capital markets since the late 1970s, still encourages outward FDI. ODA activity in Asia has lowered the cost to MNEs of investment by providing essential infrastructure in host economies. One reason for this positive stance is Japan's labour shortage; while automation is one possible response, moving labour-intensive manufacturing abroad has also been a way to release the labour constraint. A second reason for continued Japanese policy activism towards FDI is the perceived need to deflect pressures from the U.S. congress and administration for reduction of the persistent large bilateral trade surplus. By moving goods production offshore, Japanese firms can maintain export market shares.

Another major policy change that influenced outward FDI, though not in an overtly intentional way, was the decision in 1985 (as in 1971) to allow yen/dollar realignment. Although firms failed to anticipate the realignment, once exchange rate expectations had adjusted to a stronger yen and related increases in production costs, FDI became a channel of real-side adjustment. Location by international businesses of production in economies on both sides of major exchange rate relationships is increasingly employed as a way to manage around exchange rate uncertainties as well as trade barriers.

At the same time, host governments have liberalized their policies towards foreign investors to create comparative advantage in manufacturing activities. For host governments, one of the desirable outcomes of these policies is the introduction of knowledge and creation of skills and employment that would be longer coming in the absence of access to foreign savings and know-how.

In Chapter 1 to Chapter 5 of this study, we analysed the economic factors likely to have an impact on the structure of financial intermediation activity in a particular domestic financial system and in the global financial markets as a whole. We also discussed the principal aspects of strategic positioning and performance of firms engaged in this activity.

The financial flows which are the basis of the preceding discussion are affected dramatically by regulatory factors. Financial services comprise an industry that has usually been, and will inevitably continue to be, subject to significant public authority regulation due to its fiduciary nature and the possibility of social costs associated with institutional failure. Indeed, small changes in financial regulation can bring about truly massive changes in financial activity—such as, for example, significant capital requirements associated with counterparty exposures in swaps and derivatives contracts.

When analysing the effects of regulation on the level of activity in a nation's financial system, it is useful to think of regulation as imposing a set of “taxes” and “subsidies” on the operations of financial firms. On the one hand, the imposition of reserve requirements, interest/usury ceilings and certain forms of financial disclosure requirements, for example, can be viewed as imposing additional implicit “taxes” on a financial firm's activities in the sense that they increase its costs of financial intermediation. On the other hand, regulator-supplied deposit insurance and lender of last resort facilities serve to stabilize financial markets and reduce the risk of systemic failure, thereby lowering the costs of financial intermediation. They can therefore be viewed as implicit “subsidies”.

The difference between these “tax” and “subsidy” elements of regulation can be viewed as the net regulatory burden (NRB) faced by a bank or other financial firm in any given jurisdiction. Private, profit maximizing financial firms tend to migrate towards those financial centres where the NRB is lowest— assuming all other economic factors are the same.

OVERVIEW

Relatively Benign Environment

The prospects for peace and stability in Southeast Asia appear to be good in the short to medium term, that is, up to about five years. During this period the overall Asia-Pacific security environment is expected to stay relatively benign. A credible U.S. military presence will probably remain; Japan will still be enmeshed in the security alliance with the United States; China will be more preoccupied with domestic problems and still without a significant long distance power projection capability; and Russia will be largely absorbed with keeping its own house in order.

With the signing of the Cambodian peace agreements, political and economic relations between the ASEAN countries and the Indochina states have improved further. Vietnam and Laos have acceded to ASEAN's Treaty of Amity and Co-operation and have been admitted as observers to the annual ASEAN Ministerial Meeting. Similar links between ASEAN and Cambodia can be expected once a new government, elected according to the terms of the peace accords, comes to power in Phnom Penh.

The ASEAN countries are stepping up their efforts at co-operation. The Singapore Summit in January 1992 decided to form an ASEAN Free Trade Area (AFTA) in fifteen years. It also agreed to strengthen the ASEAN Secretariat, and the powers of the new Secretary-General. There is also a desire for new modes of co-operation and confidence-building in the Asia-Pacific region. This is in response to the new situation which has arisen from the end of Soviet-U.S. confrontation in the region and the U.S. military withdrawal from bases in the Philippines. The ASEAN post-Ministerial Conference has become a forum for discussions on Asian-Pacific security. The Asia-Pacific Economic Conference (APEC), established in 1989, is strengthening its organizational machinery and embarking on new projects. While its immediate rationale is economic co-operation, over the longer-term, there are likely to be political and confidence-building yields as well.

In this study, we have considered a basic model of financial intermediation, the static and dynamic efficiency and stability attributes that define its value in the context of economic development and the national interest, and the implications for the financial firm in terms of strategic positioning and performance. We have also considered the relationships that appear to exist between the banking and financial structure and the process of corporate governance and control, including their implications for economic performance. And we have considered some of the difficult issues and tradeoffs facing regulators as they strive to maximize the efficiency, competitiveness and stability of the national financial systems in a global environment where not only financial firms compete with one another, but regulators do so as well.

Prospective developments in global financial markets carry serious implications for both national financial systems and for the various strategic groups of firms competing for business, and much reshuffling of clients and suppliers can be expected as traditional relationships are gradually eroded by pressure for access to creative financing structures, capable and efficient execution, and performance orientation. Over time, firms and national financial systems capable of offering integrated financial services of various types and with substantial execution and trading capabilities will emerge among the market leaders.

Countries should certainly make it a primary goal to evolve towards a financial system that optimizes static efficiency, dynamic efficiency and stability via vigorous competition across and between channels of financial intermediation and the firms operating in those channels. They should also provide national treatment of foreign-based financial institutions, which often are the source of intense competition and financial innovations transferred from abroad. Countries should work to minimize functional and geographic barriers to activities in all types of financial and allied non-financial businesses, including elimination of barriers between banking and insurance. And the regulatory environment should be as competitive as possible—within the bounds of reasonable prudence—with the major financial centres abroad in order to retain as much domestic financial value-added as possible and maximize the prospects of providing them for others as well.

The C-A-P model discussed in the previous section can be used in several ways:

1. 1. Given adequate data availability it can be used to analyse the size and durability of excess returns associated with individual segments of domestic and international financial markets by applying conventional market-structure analysis. In the case of imperfect competition, it can be used to identify the importance of scale economies in the financial services industry.

2. 2. It can aid understanding of the linkages that exist between different types of financial services, and help to identify the importance of economies of scope in this industry.

3. 3. It can be used to explain industry internationalization both through the value coefficients embedded in individual C-A-P cells and by superimposing on the basic structure economies of both scale and scope.

4. 4. It can be used to identify appropriate public policies towards the financial services industry in a competitive structure-conduct-performance context.

5. 5. It can serve a normative function by identifying coherent firm strategies that combine correctly-identified market characteristics and firm-specific advantages.

In the latter context, a firm in the financial services industry faces a given C-A-P cell configuration and linkages at a point in time, alongside a particular institutional capability profile. Some of the cells have already been accessed, and some form a feasibility-set for possible further development. The firm's expansion path—and the desired cell-configuration of its business—depends on the level of perceived risk-adjusted economic returns associated with the feasibility-set of cells, resistance lines impeding access to those cells, and the assessed value of inter-cell linkages. Successful players must therefore identify (1) the specific sources of their competitive advantage; (2) those cells where this competitive advantage can be applied, adds value, and is sustainable; and (3) the competitive potential inherent in the cell-linkages. Application of a competitivestructure framework, such as the one presented here, will help identify the cells and cell-clusters where significant returns based on market power are likely to exist, and (equally important) where they are likely to be durable.

In recent years Islamic internationalism (Schulze 1983, Siddique 1985) has become a subject for analysis. There has also been much discussion about how Islam has been reshaped by local culture. In fact, it is generally understood that the elements of unity in Islam have come to be mediated by the differences and controversies between regions and various ethnic and cultural entities. Indeed, within the framework of homogeneity in orthodoxy, one is tempted to forget that there exist variations in Muslim social life which are experienced alongside regional, cultural and linguistic differences. The tendency to view homogeneity in terms of Islamic orthodoxy, and variety in terms of geographical differences leads us to forget that there have always been generational differences in the nature or character of ideal scholars and types of Islamic intellectualism. Such variations, one might argue, perhaps have denominators which lie beyond the rigid borderlines of religious beliefs and scholarly learning in Islam. We will argue here, however, that these variations result from broader societal change. Colonial rule and the introduction of capitalist relations in the late nineteenth and early twentieth centuries, the bureaucratic rule of new nation-states and their ideologies in the 1950s and 1960s, and access to the global media and information networks from the 1980s might also be considered as factors influencing the physical, psychological and spiritual attitudes of religious scholars and intellectuals. This study explores how these societal factors have shaped the variations in Islamic ideals which are to be found at the generational level.

The focus will be on three different generations of Indonesian scholars and ‘Ulama who have studied in Cairo, and in al-Azhar in particular. This form of religious exchange no doubt has been established through the cross-regional networks of “high culture” in Islam, implying an element of unity in this educational pursuit across generations. A closer look at these different generations would reveal, however, that although an ‘Atim from Morocco can understand his Indonesian colleague perfectly, ideological differences can be observed between various generations of ‘Ulama from the same country.

Global Overview

The global economy continued to be anaemic in 1992, with a flagging recovery in the United States and Japan slipping into a recession in the first quarter of the year. Other major industrial economies are in no better shape, but economic reforms for market-led growth are occurring speedily, from the former Soviet Union and Eastern Europe to China and Mexico. The world has also seen much economic pluralism with the loss of political and economic hegemony of the United States, leading to the emergence of a multipolar global trading system.

The new paradigm in international trade looks at shifts in the composition and direction of direct foreign investment in tandem with new patterns of locations of multinational corporations (MNCs). This has been prompted by industrial restructuring, changes in technology, and supply and demand in an increasingly borderless world There is also a decline in effectiveness of the traditional gatekeepers of international trade (General Agreement on Tariffs and Trade, GATT) and the international financial system (International Monetary Fund, IMF).

Regionalism has grown apace, coexisting under a framework of globalism. Whether in response to moves in Western Europe and North America or out of its own accord, the Asia-Pacific region has also embarked on various concepts and configurations of an economic community. Fifteen economies in the Asia-Pacific Economic Co-operation (APEC) forum and twenty in the Pacific Economic Co-operation Council (PECC) currently constitute the more active Asian-Pacific groupings, apart from other efforts.

Within the Association of Southeast Asian Nations (ASEAN), more innovative ideas have emerged, based on private initiative as the locomotive of growth. An APEC-like proposal for the East Asian Economic Caucus (EAEC), including the six ASEAN states, Japan, South Korea, Taiwan, Hong Kong, China and even the Indochinese states, was mooted by Malaysia.