Directory UMM :Data Elmu:jurnal:UVW:World Development:Vol29.Issue1.2001:
World Development Vol. 29, No. 1, pp. 189±208, 2001
Ó 2000 Elsevier Science Ltd. All rights reserved
Printed in Great Britain
0305-750X/00/$ - see front matter
www.elsevier.com/locate/worlddev
PII: S0305-750X(00)00086-3
Backward Vertical Linkages of Foreign
Manufacturing Aliates: Evidence from Japanese
Multinationals
BELDERBOS
RENE
Maastricht University, Maastricht, The Netherlands
GIOVANNI CAPANNELLI
University of Malaya, Kuala Lumpur, Malaysia
and
KYOJI FUKAO *
Hitotsubashi University, Tokyo, Japan
Summary. Ð We examine the determinants of backward vertical linkages established by
multinational ®rms in host economies through an analysis of the local content ratio of 272
Japanese electronics manufacturing aliates in 24 countries. Host country factors promoting
vertical linkages are the quality of infrastructure and the size of the local components supply
industry, while restrictive trade policies have a detrimental eect. Local content regulations have a
positive impact but do not stimulate procurement from locally owned suppliers. Experienced
aliates, joint ventures and acquired aliates, andÐin less-developed economiesÐaliates of less
R&D-intensive ®rms exhibit more extensive vertical linkages. Firms belonging to Japanese vertical
industrial groups (keiretsu) show higher procurement from local clusters of aliated Japanese
suppliers. Ó 2000 Elsevier Science Ltd. All rights reserved.
Key words Ð Japan, world, vertical linkages, foreign direct investment, subcontracting, electronics
industry
1. INTRODUCTION
The extent to which foreign direct investors
establish backward vertical linkages with host
country suppliers has been a focus of policy
concern in both less-developed and industrialized countries. Several less-developed and
* This
research was conducted as part of the project
``Economic Analysis Based on MITI Survey Data'' in
liaison with the Institute of International Trade and
Industry (ITI) and sponsored by the Japanese Ministry of
International Trade and Industry (MITI). We are grateful
to the ITI for the data compilations. We are also grateful
to Ashoka Mody, David Wheeler, and Krishna Srinivasan for providing the Business International data. Helpful
comments were received from two anonymous referees,
189
newly industrializing countries in Asia and
Latin America have instituted formal local
content requirements for foreign investors,
while others have made preferential investment
status conditional on local content, or have put
informal pressure on foreign investors to
extend their vertical linkages (Japan Machinery
Robert Pitkethly, Alexander Roy and participants at the
1999 CEPR Japan Network Conference at Oxford
University. Ren
e Belderbos' research was funded by a
fellowship from the Royal Netherlands Academy of Arts
and Sciences. Part of this research was conducted while
Giovanni Capannelli and Ren
e Belderbos were aliated
to Hitotsubashi University, and Hitotsubashi University
and the Science Policy Research Unit at the University of
Sussex, respectively. Final revision accepted: 8 July 2000.
190
WORLD DEVELOPMENT
Center for the Trade & Investment, 1997;
Commission of the European Communities,
1998). Although the use of local content rules
in industrialized countries has ocially been
banned after conclusion of the Uruguay Round
of the GATT, in practice local content rules for
foreign investors are present in several guises.
In the European Union, local content rules are
embedded in anti-dumping law and aect
foreign investors whose exports to the EU have
previously have been targeted by EU antidumping actions (e.g., Belderbos & Sleuwaegen, 1997). In the United States, local content
rules embedded in rules of origin regulated with
the establishment of the North American Free
Trade Association (NAFTA) have aected the
less integrated manufacturing operations of
foreign-owned ®rms. 1 In both the United
States and the European Union, subsidies
granted by regional governments to (foreign)
investors are often made conditional on direct
and indirect employment generation. Implicitly
or explicitly these conditions establish required
local content levels.
The concern about backward vertical linkages arises because the potential bene®ts of
foreign direct investment (FDI) in terms of
technology transfer and spillovers to the host
economy 2 can be enhanced considerably
through extended vertical linkages (e.g., Brannon, Dilmus, & Lucker, 1994; Lall, 1995;
Turok, 1993). If increased backward vertical
linkages, as measured by the local content of
manufacturing operations, are achieved by
sourcing materials and components from local
suppliers, this may involve transfer of knowhow to, and promote growth of, the local
supplying industry. 3 If backward vertical
linkages are extended, on the other hand,
through increased vertical integration of
manufacturing operations (by sourcing more
components from in-house plants or from
related component suppliers established
locally), it may be associated with an upgrading
of employee skills, in particular if the production of components is more technology and
know-how intensive. In either case, increased
vertical linkages are likely to enhance the local
employment and trade balance eects of the
investment project. A potential additional
advantage may stem from the fact that vertical
linkages are achieved through country-speci®c
investments in building up relationships with
the local economy. This makes it more costly
for highly integrated foreign ®rms to divest in
the future and increases the long-term viability
of FDI. In a recent paper, Schmitz and Nadvi
(1999) conclude that backward vertical linkages
and supplier±buyer cooperative relationships
are of increasing importance in the formation
and growth of industrial clusters in developing
countries. Such relationships are associated
with frequent information ¯ows, which allow
for quality improvements, reduced delivery
times, and fast upgrading of designs in response
to changing demand conditions for ®nal products. Cooperative supplier±buyer interaction is
one of the major forces behind sustained
competitive advantages of a regional or
national cluster of ®rms (e.g., Porter, 1990).
Given the importance of backward vertical
linkages, there is relatively little empirical evidence on the factors determining their establishment. A number of studies have examined
the extent and characteristics of backward
vertical linkages in the context of speci®c
industries and countries (e.g., Lim & Fong,
1982; Kelegama & Foley, 1999; Brannon et al.,
1994; Turok, 1993). O'Farrell and O'Loughlin
(1981) and Reid (1994) statistically examined
the determinants of local procurement levels
for cross-sections of foreign-owned plants in
Ireland and the United States, respectively. The
focus of all these studies on a single country
has, however, precluded a more comparative
analysis of the establishment of backward
vertical linkages in response to dierences in
host country environments and policies.
This paper contributes a systematic analysis
of the determinants of backward vertical linkages established by foreign-owned manufacturers across a variety of less developed as well
as industrialized countries. We analyze the
determinants of the local content ratio (the
ratio of the value of local procurement plus
intra-aliate value added over sales) of 272
Japanese electronics manufacturing aliates
operating in 24 countries. The local content
ratio captures both the value of vertical linkages established through arm's length transactions (procurement from unrelated local
suppliers) and vertical linkages established
through intra-®rm transactions (procurement
from related local suppliers or intra-aliate
vertical integration into component production). We use a detailed dataset derived from
the 1992±93 survey by Japan's Ministry of
International Trade and Industry (MITI)
among Japanese multinational ®rms. The micro
(aliate) level analysis allows for measurement
of the impact of host country factors such as
the imposition of local content rules, while at
BACKWARD VERTICAL LINKAGES
the same time controlling for the impact of
aliate and parent ®rm characteristics such as
research and development (R&D) intensity,
establishment mode and investment motives. 4
The focus on Japanese ®rms is an interesting
one since Japanese ®rms are often found to be
less inclined to establish such vertical linkages
but to rely on imports of components and
materials from Japan (Capannelli, 1997; Froot,
1991; Graham & Krugman, 1990; Murray,
Wildt, & Kotabe, 1995). A number of explanations have been put forward to account for
this pattern. It has been argued that Japanese
®rms' lower local procurement may be caused
by the relatively recent establishment of their
manufacturing plants, in comparison with
European or US ®rms (e.g., Graham & Krugman, 1990; Westney, 1996). Since it takes time
to establish relationships with local suppliers
and to secure reliable delivery of components,
the later ``vintage'' of Japanese aliates may
leave them still more dependent on existing
suppliers in Japan. Another explanation relates
to a more idiosyncratic practice of Japanese
®rms: the reliance on long-term relationships
with suppliers in Japanese vertical industrial
groups (or keiretsu) (e.g., Mason & Encarnation, 1994). 5 Hackett and Srinivasan (1998)
argue that Japanese ®rms face higher supplier
switching costs because of their relationshipspeci®c investments associated with the intensive
use of cooperative subcontractor relationships
with established Japanese suppliers, in particular suppliers within vertical keiretsu. These
tangible and intangible investments include
cooperation on, and transfer of, new product
and component designs, the use of specialized
machinery, and the organization of just-in-time
(JIT) delivery systems and components quality
control. The sunk character of these investments imply substantial costs of switching
procurement from these longstanding suppliers
in Japan to suppliers in host countries. A third
possible explanation relates to the motivation
for the rapid increase in Japanese overseas
investments in the late 1980s and early 1990s.
In industries responsible for a major share of
Japanese foreign investment, such as electronics, machine tools, and automobiles, an
important motive has been to ``jump'' trade
barriers erected against Japanese exports.
There is convincing evidence that voluntary
export restraints and quota, high taris, and
antidumping measures have induced investments substantially over and above levels that
would have been reached in the absence of such
191
trade policies (Belderbos, 1997b; Blonigen,
1998). If investments are merely a response to
trade barriers, they are not a ®rst-best managerial decision based on manufacturing cost
and eciency. Limiting investment to relatively
simple assembly tasks while sourcing components from abroad may be the most cost-eective response. Hence, the role of restrictive
trade policies in motivating Japanese investments may also contribute to the explanation of
the observed lower level of backward vertical
linkages (Belderbos, 1997a). Our dataset on
Japanese electronics aliates is well suited to
test the validity of these hypotheses. The electronics industry is the largest Japanese investor
abroad and has been an important target of
restrictive trade policies, electronics ®rms make
extensive use of subcontracting relationships
within vertical keiretsu, and electronics aliates
show a large variety in establishment dates
(ranging from the late 1950s until the early
1990s).
The remainder of this paper is organized as
follows. The next section reviews the previous
literature on backward vertical linkages, international sourcing, and local content. Section 3
develops hypotheses concerning the determinants of the local content of aliates' manufacturing operations and describes the
empirical model. Section 4 presents the empirical results and Section 5 concludes the paper.
2. BACKWARD VERTICAL LINKAGES,
INTERNATIONAL SOURCING,
JAPANESE SUPPLIER NETWORKS,
AND LOCAL CONTENT RULES
Since there is no well-de®ned theory of local
procurement, we develop our empirical model
after reviewing previous studies in a number of
related ®elds including the literatures on backward vertical linkages, strategic (international)
sourcing, Japanese subcontracting relationships
and keiretsu ties, local content rules, and
Japanese FDI.
The research tradition on backward vertical
linkages of foreign ®rms in the economic
geography literature had produced a limited
number of papers analyzing local procurement
levels of foreign-owned aliates. An early
paper by O'Farrell and O'Loughlin (1981)
examined a sample of foreign manufacturing
aliates in Ireland and found support for the
``vintage'' eect hypothesis: earlier established
plants showed signi®cantly higher procurement
192
WORLD DEVELOPMENT
levels. The only recent attempt to provide a
more comprehensive explanation of local
sourcing decisions in this tradition is Reid
(1994), but this study is primarily concerned
with the eect of JIT delivery systems on the
spatial clustering of suppliers. Reid found that
the use of JIT systems by Japanese-owned
manufacturing plants in the United States was
positively associated with the proportion of
material inputs procured at the county level,
but not at the state or national levels.
Other evidence concerning the extent of
vertical linkages by (Japanese) investors and
factors having an impact on these linkages is
provided by a variety of case studies. In an
early study, Lim and Fong (1982) interviewed
three foreign electronics producers in Singapore, one of which was Japanese-owned. They
found that while the Japanese ®rm used
subcontractors in Singapore most extensively,
these linkages were predominantly with Japanese-owned ®rms established there. The
authors argued that technology transfer and
stimulation of local entrepreneurship would
bene®t more from the establishment of supply
linkages with locally owned suppliers. A more
recent study by Capannelli (1993, 1997) examining sourcing practices of Japanese electronics
manufacturers in Malaysia found that the role
of locally owned ®rms in the supply chain was
still limited. A study of the subcontracting and
sourcing relationships of a number of Japanese
television and VCR assemblers in Asia and
Europe by Hiramoto (1992) also found that
Japanese assemblers have often failed in their
attempts to establish long-lasting subcontracting relationships with local parts suppliers.
Major obstacles were the suppliers' lack of a
strong attitude toward continuous improvement, the buyer's emphasis on quality and
reliability, the dominant position of the buyer,
and the buyer's preference for the use of relatively ambiguous contracts. Turok (1993)
investigated local sourcing by foreign-owned
®rms in the Scottish electronics industry (``Silicon Glenn'') in 1992 and generally found low
levels of vertical linkages. He suggested that
sourcing rates would have been even lower in
the absence of EU local content requirements.
Kelegama and Foley (1999) examined the
impediments for backward linkages in the
garment industry in Sri Lanka. Their analysis
suggested that the capital intensity and scale
economies of upstream fabric and accessory
production impeded entry by local ®rms, while
FDI in upstream manufacturing was rendered
unattractive given the poor quality of the local
(energy) infrastructure. They also found that
existing international supplier linkages of
multinational ®rms in some cases discouraged
procurement from local suppliers. Brannon et
al. (1994) and Lowe and Kenney (1999) looked
at supplier linkages of the ``maquiladora''
plants set up by foreign multinationals in
Northern Mexico. One impediment to the
development of backward vertical linkages with
Mexican suppliers were US and Mexican tari
(exemption) policies, which gave US investors
important incentives to import components
from the United States. Other major impediments were the export orientation of the foreign
plants, which was incompatible with the traditional domestic market orientation of suppliers,
the lack of proximity of Mexican suppliers to
the clusters of foreign investors at the Northern
border, and a lack of plant-level autonomy
concerning purchasing decisions.
Studies in the strategic management literature have also examined local and international
procurement strategies of multinational ®rms
but have focused primarily on the relationship
between sourcing strategies and ®rm performance. In general, this literature has stressed
the positive eect on performance of the use of
proprietary components developed in-house or
in close cooperation with longstanding suppliers and subcontractors. Kotabe and Omura
(1989) examined sourcing strategies of a
number of foreign-owned manufacturing ®rms
in the United States and found that the extent
of internal sourcing of major components was
positively related to US market performance of
the product. Murray et al. (1995) surveyed 104
foreign-aliated manufacturing aliates in the
United States in 1993 and found weak evidence
that reliance on nonstandardized components
and internal sourcing was related to better
market performance as measured by sales
growth. They also reported signi®cant dierences in procurement behavior between European- and Japanese-owned aliates in the
United States in 1991. Japanese aliates
sourced a signi®cantly smaller share of the
value of components in the United States and
combined a greater reliance on nonstandardized components with signi®cantly higher levels
of intra-®rm sourcing. Dyer (1996) found evidence that automobile assemblers are more
pro®table the greater the proximity (spatial
clustering) of their suppliers. Proximity was
associated with suppliers' dedicated investments in production facilities, greater sharing
BACKWARD VERTICAL LINKAGES
of know-how and more intense communication. These were found to be correlated with
faster design changes, improved quality, and
increased return on investment. Asanuma and
Kikutani (1992) and Okamuro (1995) emphasized the risk-sharing function of subcontracting relationships in the Japanese automobile
industry and found evidence that the intensity
of long-term supply relationships was positively
correlated with the stability of performance.
The role of Japanese supplier and subcontractor linkages has also been studied in the
context of Japanese ®rms' decision to invest
abroad and the location of these investments.
Belderbos and Sleuwaegen (1996) found that
vertical linkages between ®rms were an important factor in the decision to invest in Asia:
subcontractor ®rms within vertical keiretsu
were more likely to invest in Asia if the parent
®rm operated a large number of plants in the
region. Using location data on Japanese
manufacturing aliates in the United States,
Head, Ries, and Swenson, 1995 found that
Japanese plants were more likely to be set up in
a state, the greater the number of existing
Japanese plants in that state in the same
industry. The existence of plants set up by
parent ®rms or suppliers in the same vertical
automobile keiretsu exerted an additional
positive eect on the location decisions by ®rms
in the keiretsu. There is also evidence that
Japanese automobile manufacturers have
actively assisted their keiretsu component
suppliers to set up plants near their assembly
operations abroad (Cusumano & Takeishi,
1991). A recent study by Hackett and Srinivasan (1998) found that the strictness of local
content regulations in host economies exerted a
stronger negative eect on Japanese FDI than
on US FDI. They posited that the close
supplier±buyer relationships (in particular
within vertical keiretsu) characterizing Japanese
procurement practices imply greater costs of
switching to host country suppliers. The
necessity to increase local sourcing in case of
strict local content requirements pushes up the
cost of local manufacturing relatively much and
this discourages Japanese investment. On the
other hand, the Japanese investments that do
occur are also more likely to induce existing
suppliers in Japan to follow suit and invest in
local component plants in order to replicate
existing supplier relationships abroad. Hackett
and Srinivasan also found a positive and
signi®cant eect of the existing stock of Japanese FDI on new Japanese investments, which
193
is consistent with the ®nding of strong clustering eects in Japanese FDI reported by
Belderbos and Sleuwaegen (1996) and Head et
al. (1995). The net eect of local content rules
on inward Japanese FDI depends on these two
opposing forces but is dicult to sign.
Finally, the popularity of local content rules
among policy makers has in¯uenced a now
substantial body of literature analyzing the
welfare eects of local content rules under
various market structures (e.g., Richardson,
1993; Belderbos & Sleuwaegen, 1997; Lopezde-Silanes et al., 1996). The eect of local
content requirements is found to depend,
among others, on the market power of local
parts suppliers, the cost competitiveness and
level of vertical integration of local competitors
in the assembly industry, and on whether the
requirements induce FDI in component
production. With the exception of Hackett and
Srinivasan (1998), however, there has been no
empirical investigation of the actual impact of
such rules.
The literature reviewed above suggests that a
variety of factors are important for the creation
of backward vertical linkages by Japanese
investors. At the country level, characteristics
such as local content rules, infrastructure, and
the availability of and proximity to local
suppliers are important. In addition, aliate
characteristics such as the ``vintage'' eect and
the market orientation of investment aect
backward vertical linkages. Finally, parent ®rm
characteristics such as the strength of existing
long-term supplier linkages within vertical
keiretsu and the possibility of induced clustering eects through investments by keiretsu
suppliers are also expected to in¯uence vertical
linkages. We incorporate these factors in the
empirical model described below.
3. HYPOTHESES, EMPIRICAL MODEL
AND DATA
In this section we develop an empirical model
explaining the extent of backward vertical
linkages of Japanese manufacturing aliates.
Backward vertical linkages in the host economy
can be established through intra-®rm transactions (procurement from related local suppliers
or intra-aliate vertical integration into
component production) or through arm's
length transactions (procurement from unrelated local suppliers). Both types of transactions are expected to provide a number of
194
WORLD DEVELOPMENT
particular bene®ts to the host economy, and
our main analysis therefore focuses on the local
(host country) content of the electronics
manufacturing aliates, rather than on local
procurement alone. 6 On the other hand, it
would be of interest to make a distinction
between procurement from locally owned
unrelated suppliers and related suppliers, since
the former is likely to be associated with greater
technology transfer and the stimulation of local
entrepreneurship (e.g., Lim & Fong, 1982).
Unfortunately, our data do not allow us to
measure the importance of procurement from
locally owned ®rms. 7 As a second-best option,
we do report robustness tests of the empirical
model in Section 4 with the local procurement
to sales ratio substituted as the dependent
variable.
The local content ratio is measured as sales
of the aliate minus components and materials
imported from abroad, divided by aliate
sales. 8 This ratio encompasses value added
created by the aliate, a measure of in-house
vertical integration, and the value of local
procurement of components and materials. 9
Since the dependent variable is restricted within
the interval 0,1] two-limit Tobit analysis is used
to relate the local content ratio to a set of
explanatory variables. Below we will discuss the
hypotheses and corresponding explanatory
variables. The section concludes with a brief
description of the data set.
(a) Hypotheses and explanatory variables
A Japanese ®rm's decision concerning the
sourcing of components and materials for its
foreign manufacturing operations can be
subdivided into two decision problems: (i)
whether to procure components in-house (or
intra-keiretsu), and (ii) whether to procure the
components in Japan or abroad (e.g., Cavusgil,
Yaprak, & Yeoh, 1996). The ``internalization''
decision of (i) re¯ects the tradeo between
quality and reliability bene®ts of in-house
production of components of proprietary
design versus cost-reducing sourcing of standard components. If a ®rm chooses external
sourcing of components to maintain a
competitive cost structure, it will be more likely
to choose components produced in low-cost
locations abroad (produced by locally owned
®rms or independent Japanese transplants). If a
®rm chooses proprietary components manufacturing, it is still possible that overseas
manufacturing activities reach high local
content levels. A condition is that the overseas
manufacturing location allows for cost eective
production of the components within the
assembly plant or in a dedicated components
manufacturing aliate established by the
assembler or its related component suppliers.
Factors aecting local content levels will
therefore be related to both the importance of
transaction costs associated with arm's length
trade and the attractiveness of foreign locations
for components manufacturing. For convenience, we distinguish between determinants at
the parent ®rm, aliate, and country level in
the remainder of this section.
(i) Parent ®rm level determinants
Japanese ®rms dier in the intensity of longterm cooperative subcontracting and supplier±
assembler relationships (e.g., Sako, 1992; Dyer,
1996). Firms that are members of a large
vertical keiretsu with a substantial number of
related component manufacturers will make
particularly intensive use of these relationships.
Intra-keiretsu procurement is based on longterm relationships characterized by intensive
interaction between supplier and assembler
involving dedicated investments in equipment
and human resources and requiring the implementation of just in time delivery and total
quality control systems. There is evidence that
these relationships enhance performance and
reduce risk (Dyer, 1996; Asanuma & Kikutani,
1992; Okamuro, 1995). Since the assemblersupplier system is one of the bases for
competitiveness of Japanese ®rms, they have
followed a strategy to emulate it abroad. In
practice, however, it has proven dicult to
involve locally owned suppliers in such relationships (Hiramoto, 1992). The supplier
switching costs are higher for keiretsu ®rms
given the sunk investments in existing relationships with Japanese suppliers (Hackett &
Srinivasan, 1998). Supplier networks have
therefore often been replicated abroad through
the establishment of overseas manufacturing
plants by existing Japanese manufacturers of
parts and components, in which they were often
assisted by the ``core'' ®rm of the keiretsu
(Belderbos & Sleuwaegen, 1996). The consequences of keiretsu membership for the local
content of overseas operations are not unambiguous. On the one hand, keiretsu members
®rms' higher switching costs may lead to a
greater continuing reliance on supplies of
inputs from long-standing suppliers located in
Japan. On the other hand, if the suppliers
BACKWARD VERTICAL LINKAGES
follow the assembler abroad, keiretsu ®rms may
be able to reach higher local content than
independent ®rms. Hence, we are not able to
sign the eect of keiretsu membership a priori.
Since there are substantial dierences in the
importance of supplier networks within dierent vertical keiretsu, membership of a vertical
keiretsu as such is not a very distinctive characteristic. Instead, we devised a measure of the
intensity of supplier±assembler relationships
within keiretsu. We used Toyo Keizai's publication ``Nihon no Kigyou Guruupu'' (Japanese
corporate groups), to establish for each Japanese investor whether it belonged to a vertical
keiretsu. Then we proxied the intensity of
supplier±assembler relationships for keiretsu
members by taking the ratio of the size
(measured by paid-in capital) of all keiretsualiated manufacturing ®rms to the size of the
``core'' ®rm of the keiretsu in Japan. We call
this variable keiretsu intensity (KEIRINT).
KEIRINT reaches higher values the more the
``core'' ®rm relies on components sourcing
from other manufacturers within its keiretsu.
The values for KEIRINT corresponded well to
our intuition concerning the strength of
supplier networks, with, for example, the
highest ratios for Matsushita and Fujitsu and
the lowest for Sharp.
We posit that the R&D intensity of the
parent ®rm (R&DINT) has an impact on the
local content of its foreign aliates. R&D-intensive ®rms make greater use of proprietary
designs and in-house know-how. They possess
more intangible assets related to manufacturing
capabilities of nonstandardized high-technology components. They are less likely to transfer
component production to external suppliers.
Since production of components developed inhouse is generally human capital and technology-intensive, it is less likely that foreign
manufacturing locations provide substantial
cost advantages over production in Japan,
which is relatively abundant in these factors.
The attractiveness of foreign investment in
technology-intensive component production
positively depends on the technological capabilities and human resources, or the ``absorptive capacity'' (Cohen & Levinthal, 1990), of
host countries. 10 Hence, the greater these
capabilities and resources, the less we expect a
negative impact of the ®rm's R&D intensity on
local content. We therefore not only include the
variable R&DINT, but also a cross-eect with
a measure of economic and technological
development of the host country. As an
195
imperfect proxy for the latter we include GDP
per capita (GDPCAP). We expect a negative
sign of R&DINT and a positive eect of
R&DINT*GDPCAP.
(ii) Aliate-level determinants
At the aliate level, the experience in
manufacturing in a country is likely to be an
important determinant of the extent of vertical
linkages. Finding suitable local suppliers and
establishing links with these ®rms is a timeconsuming process, in particular if the suppliers
have to adapt to the demands of the Japanese
assemblers in terms of quality and delivery
schedules. In other cases, redesign of the
product is necessary to allow for the use of
locally made standardized components. As
foreign ®rms learn through time how to
develop relationships with local suppliers and
how to adapt products to local markets, local
procurement is expected to increase. O'Farrell
and O'Loughlin (1981) found a positive eect
of operating experience on the level of local
procurement by foreign-owned aliates in
Ireland, but Reid (1994) could not establish a
similar eect for Japanese ®rms in the United
States. One reason for the latter result may be
that no distinction was made between green®eld establishments and acquisitions. In case
the Japanese investor acquired the local aliate, it is natural to assume that the aliate is
relatively deeply embedded in the local economy at the time of the acquisition. Hence, the
number of years of operation under Japanese
ownership is not likely to have an important
additional impact on local content. 11 We
include two experience variables, EXPER_
GRE and EXPER_ACQ. EXPER_GRE
measures the number of years since operations
started in newly established (green®eld) manufacturing aliates; EXPER_ACQ measures the
number of years since acquired aliates came
under Japanese control. Because we expect a
relatively strong increase in local content in the
®rst few years of operating in the host country
and a smaller eect of additional years of
experience for older aliates, we include
EXPER_GRE and EXPER_ACQ in logarithmic form. We hypothesize a positive eect of
EXPER_GRE but no eect of EXPER_ACQ.
The entry mode is likely to have an impact on
vertical linkages in the host economy. Acquired
aliates are likely to have higher local content
given their pre-acquisition embeddedness in the
local economy as locally owned ®rms. We also
expect that joint ventures facilitate higher levels
196
WORLD DEVELOPMENT
of local content than wholly owned aliates.
This is because the local joint venture partner
or its related ®rms may have accumulated
expertise in either electronics components
manufacturing or components procurement
from local suppliers. Taking the wholly owned
green®eld aliate as the base case, we include
two dummy variables in the model, ACQUIS in
case the aliate was acquired, and JV in case
the aliate was established as a joint venture
with a local partner. We hypothesize positive
signs for both variables.
A feature of the overseas operations of
Japanese electronics ®rms is a certain dichotomy between the main motivation for the
establishment of the aliates (e.g., Ernst,
1997). One group of aliates is established to
access available pools of low-cost labor and is
export oriented, while another group of aliates is primarily established to improve access
to local customers and sells predominantly on
the host country market. The motivation for
investment and the associated market orientation may have an impact on vertical linkages of
the aliate in a number of ways (e.g., Lowe &
Kenney, 1999; Kelegama & Foley, 1999). If the
aliate's primary markets are local, it is more
likely to adapt products to local tastes and
circumstances, which involves local procurement or local development of components.
Second, competitive price pressures may be
lower on the local market compared with
export markets, in particular if the local market
receives some form of protection through tari
or nontari barriers. This may allow local
market-oriented producers to use local
components even if these come at higher costs.
Third, aliates selling on the local market have
an incentive to reduce reliance on imports from
Japan given the associated vulnerability of
pro®tability to an appreciation of the Yen.
Fourth, if the aliate is located in less-developed countries and sells locally, it will produce
and sell relatively mature and low-priced
products. In that case, it is of greater importance to use the low-cost standardized components that are more likely to be available
locally. In sum, we expect that aliates with
higher local sales ratios have higher local
content. LOCSALES measures the percentage
of aliate turnover destined for the local
market. We expect this positive eect to be
smaller the more developed the host economy.
We therefore include the cross-eect of
LOCSALES and GDPCAP and expect a
negative sign.
There is evidence that the establishment of a
substantial number of Japanese aliates has
been speci®cally motivated by the need to
circumvent trade barriers, such as antidumping
duties, targeting Japanese ®rms' exports to the
host economy (Belderbos, 1997b). If the main
motivation for setting up the manufacturing
aliate was to circumvent trade barriers, the
investment was not a ®rst-best managerial
decision based on manufacturing cost and eciency. Limiting investment to relatively simple
assembly tasks while sourcing components
from abroad may be the most cost-eective
response. In particular when trade policy
measures are seen as temporary (e.g., given the
®ve-year duration limit for antidumping
measures or the prospects of tari reductions
due to GATT negotiations or regional integration initiatives), ®rms may also wish to limit
their resource commitment, facilitating the
relocation of investment when measures have
expired. Hence we expect less extensive vertical
linkages if manufacturing investments were
primarily induced by trade barriers. The level
of trade barriers varies substantially across
products (e.g., taris) and trade protection is
often targeted at speci®c products (e.g.,
through VERs and antidumping measures).
The role of trade barriers is therefore preferably
measured at the product or aliate level.
Although we could not obtain detailed product
information for the aliates, we could measure
the ``tari jumping'' motivation directly, by
utilizing a question in the MITI survey
concerning the motivation for the aliate's
establishment. If the aliate chose ``trade friction'' from among the alternatives, the dummy
variable TARJUMP takes on the value 1. A
negative sign is expected. 12
Industry characteristics will have an eect on
the extent of vertical linkages. High local
content ratios may be more dicult to achieve
in high technology industries such as in telecommunications than in the more mature
consumer goods sector. Aliates manufacturing products that use components with a low
value to weight ratio will be more inclined to
use local components since transportation costs
associated with imports are relatively high. The
industry classi®cation of the MITI survey
distinguishes four subclasses in the electronics
industry: consumer goods, semiconductors
and electronics parts, telecommunication and
computer equipment, and other electronics and
electrical equipment. We attempt to control for
systematic dierences in local content across
BACKWARD VERTICAL LINKAGES
these industries by including three industry
dummies: TELCOMP, PARTS, and CONSUMER, and taking other electronics (OTHERIND) as the reference case.
(iii) Country-level determinants
The most obvious country characteristic
determining backward vertical linkages is the
availability of locally established component
suppliers. We include the variable SUPPLIERS, which measures the dollar value of electronic parts and components production in
each country in 1992. The variable SUPPLIERS measures the availability of locally
produced components and will also generally
re¯ect the attractiveness of a country to establish components manufacturing operations.
From both perspectives we hypothesize a
positive eect on local content. 13
The extent to which Japanese suppliers play a
role in the local components industry is also
expected to aect vertical linkages. By using
longstanding suppliers from Japan established
near the overseas manufacturing base, ®rms
can avoid switching costs and emulate best
practice in Japan. There may also be important
economies of agglomeration once a substantial
number of Japanese suppliers have set up local
manufacturing aliates. For instance, reduced
input costs can result from increased specialization and training of local personnel. We
include the variable JSUPPLIERS, which is a
measure of the role of Japanese ®rms in the
local components industry, and expect a positive sign. Since the presence of Japanese
suppliers is most likely to allow keiretsu ®rms
to avoid switching costs, keiretsu members are
expected to increase their local content most.
We include the cross eect of JSUPPLIERS
and KEIRINT and expect a positive sign.
JSUPPLIERS is de®ned as the number of
Japanese plants producing electronic components and materials in the country, divided by
SUPPLIERS. A comprehensive data source on
Japanese electronics production abroad
(Denshi Keizai Kenkyujo, 1994) was used to
calculate plant counts. To incorporate dierences in plant scale, we counted each component manufactured in multicomponent plants
separately.
The cost advantage of using a local network
of suppliers also depends on the quality of the
infrastructure. A good infrastructure facilitates physical transport of components within
the country and communication between
assembler and suppliers (Lowe & Kenney,
197
1999). The quality of infrastructure has also
been found to exert a signi®cantly positive
impact on inward investment (Hackett &
Srinivasan, 1998). As a proxy for the quality
of infrastructure we include the variable
INFRA, which measures the number of telephone lines per capita (International Telecommunication Union, 1995). We expect a
positive sign.
An important issue is to what extent local
content rules directed at increasing the local
content of (foreign-owned) manufacturing
operations are successful in increasing backward vertical linkages. We include a country
variable, LCR, which measures the severity of
local content regulations in host countries.
LCR is taken from a survey among US multinational ®rms conducted by Business International Corporation (1989) and measures the
severity of such regulations on a scale between
0 and 10. We expect a positive sign. As noted
before, a certain level of local content is often
required if investing ®rms wish to bene®t from
tax grants and other incentives schemes oered
by national and regional authorities in the
United States and Europe. In less developed
countries there often is a similar preferential
treatment to foreign investment projects
contingent on local content (among other
requirements). Malaysia, for instance, grants
``Pioneer status'' (entitling to tax exemptions)
to investments which meet a number of conditions, among which local content requirements
(Commission of the European Communities,
1998). These incentive schemes and their
conditions vary per investment project, introducing a degree of discretion in the application
of local content rules. This implies that there
could be an important ®rm-speci®c element in
local content regulations. We therefore also
include a measure of local content requirements
at the level of the individual aliate in addition
to the country variable LCR. LCR_AFF is a
dummy variable taking the value one if the
aliate indicated in the MITI survey that local
content rules are aecting its manufacturing
operations.
(b) The data set
The data on Japanese aliates are drawn
from MITI's 1992 Basic Survey among Japanese multinational enterprises and report on
operations in the ®scal year through March
1993. A representative number of 272 aliates
198
WORLD DEVELOPMENT
in the electronics industry had sucient information on the local content ratio and the
explanatory variables. 14
Table 1 shows the distribution of aliates
over countries and the average (unweighted)
local content ratio of the aliates. The local
content ratio is relatively high at 80% in the
largest developed economy, the United States.
Local content in European countries is lower
in general. The lowest ratios are recorded in
ASEAN countries (with the exception of
Singapore), China, and Ireland. In India and
Brazil, two countries known for strict regulations on multinational ®rms, local content is
relatively high, which appears to provide some
indication of the role of local content regulations. Caution should be exercised, however,
in drawing conclusions from simple tables
such as Table 1. Characteristics of aliates,
such as whether they are acquired or not,
vary across countries and have an important
impact on local content. More accurate
insight into the role of country, aliate, and
parent ®rm characteristics is provided by the
multivariate empirical analysis reported in the
next section.
Table 1. Number of Japanese manufacturing aliates
and average local content ratio by country
United States
Canada
United Kingdom
Germany
France
Spain
Belgium
Netherlands
Ireland
Hong Kong
South Korea
Singapore
Taiwan
Indonesia
Malaysia
Philippines
Thailand
India
China
Mexico
Brazil
Venezuela
Australia
Israel
# Aliates
Local content
ratio
44
5
19
7
5
4
2
2
2
6
20
24
34
5
36
4
27
4
7
2
10
1
1
1
0.81
0.71
0.66
0.57
0.50
0.73
0.80
0.65
0.49
0.63
0.63
0.68
0.74
0.72
0.56
0.54
0.53
0.87
0.54
0.95
0.86
0.60
1.00
0.88
4. EMPIRICAL RESULTS
The results of ®ve models explaining the local
content ratio of Japanese aliates are presented in Table 2. Model 1 ®rst tests the explanatory power of the independent variables if
Japanese supplier linkages and keiretsu
membership are not taken into account. The
model generally performs well. All explanatory
variables with the exception of LCR_AFF have
the expected sign and most variables reach
conventional signi®cance levels. In addition,
robustness tests showed no evidence of heteroskedasticity or correlated error terms. 15
As hypothesized, R&DINT is signi®cantly
negative while its cross eect with GDPCAP is
positive and signi®cant at the 10% level (twotailed test). Technology-intensive parent ®rms
operate aliates with lower local content but
this eect is smaller if the aliates are located
in developed countries. The estimated coecients imply that R&DINT no longer has a
negative impact if GDP per capita exceeds
US$17,500, a level reached by the United
States, Canada, and a number of Western
European countries. The operating experience
of newly established aliates EXPER_GRE is
positive as predicted, and signi®cant at the 10%
level. The estimated coecient implies,
however, that a doubling of experience years
(equal to roughly 10 years extra experience in
the sample mean) leads to an increase in the
local content ratio of no more 0.032 points. 16
Clearly, this magnitude of the experience eect
is rather small, and the results can only provide
partial support for the ``vintage eect'' explanation for Japanese ®rms' procurement
behavior. The coecient of experience for
acquired aliates, EXPER_ACQ, is negative
but has a very large estimated variance. The
hypothesis that operating experience plays no
role for acquired ®rms cannot be rejected. The
results show the importance of making a
distinction between entry modes when assessing
the impact of experience in the host economy.
A very large and signi®cant eect is estimated
for the ACQUIS dummy. It can be calculated
that an acquired aliate has a 0.47 point higher
local content ratio than a newly established
wholly owned aliate, ceteris paribus. The
coecient of the joint venture (JV) dummy is
signi®cant but its value is about seven times
lower than that of ACQUIS: joint ventures
have a 0.07 point higher local content ratio
than green®eld aliates. The percentage of
local sales in total sales of the aliate,
BACKWARD VERTICAL LINKAGES
199
Table 2. Determinants of the local content ratio of Japanese manufacturing aliatesa
R&DINT
R&DINT*GDPCAP
log EXPER_GRE
log EXPER_ACQ
ACQUIS
JV
LOCSALES
LOCSALES*GDPCAP
TARJUMP
INFRA
SUPPLIERS
LCR
LCR_AFF
Model 1
Model 2
Model 3
Model 4
Model 5
)1.370
)2.154
0.079
1.851
0.035
1.913
)0.021
)0.449
0.510
2.186
0.074
2.342
0.249
4.002
)0.008
)1.523
)0.149
)3.520
0.003
1.974
0.001
0.933
0.025
1995
)0.008
)0.233
)1.540
)2.443
0.074
1.750
0.042
2.339
)1.522
)2.412
0.075
1.756
0.042
2.307
)1.532
)2.446
0.082
1.927
0.038
2.078
)1.480
)2.353
0.079
1.866
0.038
2.083
0.467
4.71
0.067
2.165
0.237
3.852
)0.007
)1.453
)0.154
)3.656
0.003
2.239
0.001
0.836
0.029
2.220
)0.003
)0.085
0.085
2.663
0.001
1.068
0.463
4.648
0.067
2.169
0.233
3.773
)0.007
)1.430
)0.152
)3.617
0.003
2.243
0.001
0.844
0.028
2.210
)0.002
)0.068
0.072
1.745
0.001
0.712
0.001
0.472
0.442
4.484
0.071
2.318
0.232
3.793
)0.006
)1.252
)0.149
)3.569
0.002
1.742
0.001
1.014
0.025
1.989
0.006
0.180
0.085
2.696
0.436
4.416
0.073
2.366
0.229
3.747
)0.006
)1.263
)0.148
)3.550
0.003
1.800
0.002
1.058
0.024
1.886
0.006
0.177
0.062
1.401
0.009
1.932
KEIRINT
JSUPPLIERS
KEIRINT*JSUPPLIERS
JSUPPLIERS*DRATIO
)0.020
)0.448
)0.040
)0.628
)0.024
)0.541
0.330
2.435
)0.045
)0.979
)0.061
)0.975
)0.003
)0.072
0.318
3.451
)0.045
)0.981
)0.064
)1.009
)0.006
)0.131
0.324
3.484
)0.047
)1.037
)0.073
)1.151
0.014
0.287
0.328
4.027
0.007
1.278
0.006
0.749
)0.048
)1.057
)0.076
)1.207
0.009
0.179
0.338
4.102
15.233
272
19.042
272
19.153
272
20.321
272
20.601
272
KEIRINT*JSUPPLIERS*DRATIO
CONSUMER
TELCOMP
PARTS
CONSTANT
Log-likelihood
Observations
a
The omitted industry is other electronics, the omitted entry mode dummy is green®eld with full ownership.
Signi®cant at the 10% level.
**
Signi®cant at the 5% level.
***
Signi®cant at the 1% level.
*
LOCSALES, has the hypothesized positive
eect and is signi®cant. The cross eect with
GDPCAP has the predicted negative sign but
just fails to reach conventional signi®cance
levels. 17 The negative and signi®cant coecient of the TARJUMP dummy con®rms that
aliates established to circumvent trade barriers establish fewer vertical linkages. This
negative eect is relatively large: tari jumping
motivation reduces local content by 0.14
points. This result provides support for the
hypothesis that the role of trade barriers in
200
WORLD DEVELOPMENT
inducing Japanese FDI contributes substantially to the explanation of Japanese ®rms'
relatively less developed vertical linkages.
Among the country and industry variables,
the quality of the host country's infrastructure,
INFRA, is positive and signi®cant at the 5%
level. The coecient for SUPPLIERS (the
value of electronic parts production), on the
other hand, is positive but not signi®cant. A
possible explanation is that investing ®rms,
confronted with a small local supplier base,
compensate reduced local procurement with
extended intra-aliate vertical integration in
case the investment climate (as indicated by the
quality of the infrastructure) is supportive.
Hence, we expect a more pronounced eect of
SUPPLIERS on the local procurement part of
the local content ratio (we explore this issue
further below). The strictness of local content
regulations in the host country (LCR) has the
predicted positive and signi®cant eect on the
local content
Ó 2000 Elsevier Science Ltd. All rights reserved
Printed in Great Britain
0305-750X/00/$ - see front matter
www.elsevier.com/locate/worlddev
PII: S0305-750X(00)00086-3
Backward Vertical Linkages of Foreign
Manufacturing Aliates: Evidence from Japanese
Multinationals
BELDERBOS
RENE
Maastricht University, Maastricht, The Netherlands
GIOVANNI CAPANNELLI
University of Malaya, Kuala Lumpur, Malaysia
and
KYOJI FUKAO *
Hitotsubashi University, Tokyo, Japan
Summary. Ð We examine the determinants of backward vertical linkages established by
multinational ®rms in host economies through an analysis of the local content ratio of 272
Japanese electronics manufacturing aliates in 24 countries. Host country factors promoting
vertical linkages are the quality of infrastructure and the size of the local components supply
industry, while restrictive trade policies have a detrimental eect. Local content regulations have a
positive impact but do not stimulate procurement from locally owned suppliers. Experienced
aliates, joint ventures and acquired aliates, andÐin less-developed economiesÐaliates of less
R&D-intensive ®rms exhibit more extensive vertical linkages. Firms belonging to Japanese vertical
industrial groups (keiretsu) show higher procurement from local clusters of aliated Japanese
suppliers. Ó 2000 Elsevier Science Ltd. All rights reserved.
Key words Ð Japan, world, vertical linkages, foreign direct investment, subcontracting, electronics
industry
1. INTRODUCTION
The extent to which foreign direct investors
establish backward vertical linkages with host
country suppliers has been a focus of policy
concern in both less-developed and industrialized countries. Several less-developed and
* This
research was conducted as part of the project
``Economic Analysis Based on MITI Survey Data'' in
liaison with the Institute of International Trade and
Industry (ITI) and sponsored by the Japanese Ministry of
International Trade and Industry (MITI). We are grateful
to the ITI for the data compilations. We are also grateful
to Ashoka Mody, David Wheeler, and Krishna Srinivasan for providing the Business International data. Helpful
comments were received from two anonymous referees,
189
newly industrializing countries in Asia and
Latin America have instituted formal local
content requirements for foreign investors,
while others have made preferential investment
status conditional on local content, or have put
informal pressure on foreign investors to
extend their vertical linkages (Japan Machinery
Robert Pitkethly, Alexander Roy and participants at the
1999 CEPR Japan Network Conference at Oxford
University. Ren
e Belderbos' research was funded by a
fellowship from the Royal Netherlands Academy of Arts
and Sciences. Part of this research was conducted while
Giovanni Capannelli and Ren
e Belderbos were aliated
to Hitotsubashi University, and Hitotsubashi University
and the Science Policy Research Unit at the University of
Sussex, respectively. Final revision accepted: 8 July 2000.
190
WORLD DEVELOPMENT
Center for the Trade & Investment, 1997;
Commission of the European Communities,
1998). Although the use of local content rules
in industrialized countries has ocially been
banned after conclusion of the Uruguay Round
of the GATT, in practice local content rules for
foreign investors are present in several guises.
In the European Union, local content rules are
embedded in anti-dumping law and aect
foreign investors whose exports to the EU have
previously have been targeted by EU antidumping actions (e.g., Belderbos & Sleuwaegen, 1997). In the United States, local content
rules embedded in rules of origin regulated with
the establishment of the North American Free
Trade Association (NAFTA) have aected the
less integrated manufacturing operations of
foreign-owned ®rms. 1 In both the United
States and the European Union, subsidies
granted by regional governments to (foreign)
investors are often made conditional on direct
and indirect employment generation. Implicitly
or explicitly these conditions establish required
local content levels.
The concern about backward vertical linkages arises because the potential bene®ts of
foreign direct investment (FDI) in terms of
technology transfer and spillovers to the host
economy 2 can be enhanced considerably
through extended vertical linkages (e.g., Brannon, Dilmus, & Lucker, 1994; Lall, 1995;
Turok, 1993). If increased backward vertical
linkages, as measured by the local content of
manufacturing operations, are achieved by
sourcing materials and components from local
suppliers, this may involve transfer of knowhow to, and promote growth of, the local
supplying industry. 3 If backward vertical
linkages are extended, on the other hand,
through increased vertical integration of
manufacturing operations (by sourcing more
components from in-house plants or from
related component suppliers established
locally), it may be associated with an upgrading
of employee skills, in particular if the production of components is more technology and
know-how intensive. In either case, increased
vertical linkages are likely to enhance the local
employment and trade balance eects of the
investment project. A potential additional
advantage may stem from the fact that vertical
linkages are achieved through country-speci®c
investments in building up relationships with
the local economy. This makes it more costly
for highly integrated foreign ®rms to divest in
the future and increases the long-term viability
of FDI. In a recent paper, Schmitz and Nadvi
(1999) conclude that backward vertical linkages
and supplier±buyer cooperative relationships
are of increasing importance in the formation
and growth of industrial clusters in developing
countries. Such relationships are associated
with frequent information ¯ows, which allow
for quality improvements, reduced delivery
times, and fast upgrading of designs in response
to changing demand conditions for ®nal products. Cooperative supplier±buyer interaction is
one of the major forces behind sustained
competitive advantages of a regional or
national cluster of ®rms (e.g., Porter, 1990).
Given the importance of backward vertical
linkages, there is relatively little empirical evidence on the factors determining their establishment. A number of studies have examined
the extent and characteristics of backward
vertical linkages in the context of speci®c
industries and countries (e.g., Lim & Fong,
1982; Kelegama & Foley, 1999; Brannon et al.,
1994; Turok, 1993). O'Farrell and O'Loughlin
(1981) and Reid (1994) statistically examined
the determinants of local procurement levels
for cross-sections of foreign-owned plants in
Ireland and the United States, respectively. The
focus of all these studies on a single country
has, however, precluded a more comparative
analysis of the establishment of backward
vertical linkages in response to dierences in
host country environments and policies.
This paper contributes a systematic analysis
of the determinants of backward vertical linkages established by foreign-owned manufacturers across a variety of less developed as well
as industrialized countries. We analyze the
determinants of the local content ratio (the
ratio of the value of local procurement plus
intra-aliate value added over sales) of 272
Japanese electronics manufacturing aliates
operating in 24 countries. The local content
ratio captures both the value of vertical linkages established through arm's length transactions (procurement from unrelated local
suppliers) and vertical linkages established
through intra-®rm transactions (procurement
from related local suppliers or intra-aliate
vertical integration into component production). We use a detailed dataset derived from
the 1992±93 survey by Japan's Ministry of
International Trade and Industry (MITI)
among Japanese multinational ®rms. The micro
(aliate) level analysis allows for measurement
of the impact of host country factors such as
the imposition of local content rules, while at
BACKWARD VERTICAL LINKAGES
the same time controlling for the impact of
aliate and parent ®rm characteristics such as
research and development (R&D) intensity,
establishment mode and investment motives. 4
The focus on Japanese ®rms is an interesting
one since Japanese ®rms are often found to be
less inclined to establish such vertical linkages
but to rely on imports of components and
materials from Japan (Capannelli, 1997; Froot,
1991; Graham & Krugman, 1990; Murray,
Wildt, & Kotabe, 1995). A number of explanations have been put forward to account for
this pattern. It has been argued that Japanese
®rms' lower local procurement may be caused
by the relatively recent establishment of their
manufacturing plants, in comparison with
European or US ®rms (e.g., Graham & Krugman, 1990; Westney, 1996). Since it takes time
to establish relationships with local suppliers
and to secure reliable delivery of components,
the later ``vintage'' of Japanese aliates may
leave them still more dependent on existing
suppliers in Japan. Another explanation relates
to a more idiosyncratic practice of Japanese
®rms: the reliance on long-term relationships
with suppliers in Japanese vertical industrial
groups (or keiretsu) (e.g., Mason & Encarnation, 1994). 5 Hackett and Srinivasan (1998)
argue that Japanese ®rms face higher supplier
switching costs because of their relationshipspeci®c investments associated with the intensive
use of cooperative subcontractor relationships
with established Japanese suppliers, in particular suppliers within vertical keiretsu. These
tangible and intangible investments include
cooperation on, and transfer of, new product
and component designs, the use of specialized
machinery, and the organization of just-in-time
(JIT) delivery systems and components quality
control. The sunk character of these investments imply substantial costs of switching
procurement from these longstanding suppliers
in Japan to suppliers in host countries. A third
possible explanation relates to the motivation
for the rapid increase in Japanese overseas
investments in the late 1980s and early 1990s.
In industries responsible for a major share of
Japanese foreign investment, such as electronics, machine tools, and automobiles, an
important motive has been to ``jump'' trade
barriers erected against Japanese exports.
There is convincing evidence that voluntary
export restraints and quota, high taris, and
antidumping measures have induced investments substantially over and above levels that
would have been reached in the absence of such
191
trade policies (Belderbos, 1997b; Blonigen,
1998). If investments are merely a response to
trade barriers, they are not a ®rst-best managerial decision based on manufacturing cost
and eciency. Limiting investment to relatively
simple assembly tasks while sourcing components from abroad may be the most cost-eective response. Hence, the role of restrictive
trade policies in motivating Japanese investments may also contribute to the explanation of
the observed lower level of backward vertical
linkages (Belderbos, 1997a). Our dataset on
Japanese electronics aliates is well suited to
test the validity of these hypotheses. The electronics industry is the largest Japanese investor
abroad and has been an important target of
restrictive trade policies, electronics ®rms make
extensive use of subcontracting relationships
within vertical keiretsu, and electronics aliates
show a large variety in establishment dates
(ranging from the late 1950s until the early
1990s).
The remainder of this paper is organized as
follows. The next section reviews the previous
literature on backward vertical linkages, international sourcing, and local content. Section 3
develops hypotheses concerning the determinants of the local content of aliates' manufacturing operations and describes the
empirical model. Section 4 presents the empirical results and Section 5 concludes the paper.
2. BACKWARD VERTICAL LINKAGES,
INTERNATIONAL SOURCING,
JAPANESE SUPPLIER NETWORKS,
AND LOCAL CONTENT RULES
Since there is no well-de®ned theory of local
procurement, we develop our empirical model
after reviewing previous studies in a number of
related ®elds including the literatures on backward vertical linkages, strategic (international)
sourcing, Japanese subcontracting relationships
and keiretsu ties, local content rules, and
Japanese FDI.
The research tradition on backward vertical
linkages of foreign ®rms in the economic
geography literature had produced a limited
number of papers analyzing local procurement
levels of foreign-owned aliates. An early
paper by O'Farrell and O'Loughlin (1981)
examined a sample of foreign manufacturing
aliates in Ireland and found support for the
``vintage'' eect hypothesis: earlier established
plants showed signi®cantly higher procurement
192
WORLD DEVELOPMENT
levels. The only recent attempt to provide a
more comprehensive explanation of local
sourcing decisions in this tradition is Reid
(1994), but this study is primarily concerned
with the eect of JIT delivery systems on the
spatial clustering of suppliers. Reid found that
the use of JIT systems by Japanese-owned
manufacturing plants in the United States was
positively associated with the proportion of
material inputs procured at the county level,
but not at the state or national levels.
Other evidence concerning the extent of
vertical linkages by (Japanese) investors and
factors having an impact on these linkages is
provided by a variety of case studies. In an
early study, Lim and Fong (1982) interviewed
three foreign electronics producers in Singapore, one of which was Japanese-owned. They
found that while the Japanese ®rm used
subcontractors in Singapore most extensively,
these linkages were predominantly with Japanese-owned ®rms established there. The
authors argued that technology transfer and
stimulation of local entrepreneurship would
bene®t more from the establishment of supply
linkages with locally owned suppliers. A more
recent study by Capannelli (1993, 1997) examining sourcing practices of Japanese electronics
manufacturers in Malaysia found that the role
of locally owned ®rms in the supply chain was
still limited. A study of the subcontracting and
sourcing relationships of a number of Japanese
television and VCR assemblers in Asia and
Europe by Hiramoto (1992) also found that
Japanese assemblers have often failed in their
attempts to establish long-lasting subcontracting relationships with local parts suppliers.
Major obstacles were the suppliers' lack of a
strong attitude toward continuous improvement, the buyer's emphasis on quality and
reliability, the dominant position of the buyer,
and the buyer's preference for the use of relatively ambiguous contracts. Turok (1993)
investigated local sourcing by foreign-owned
®rms in the Scottish electronics industry (``Silicon Glenn'') in 1992 and generally found low
levels of vertical linkages. He suggested that
sourcing rates would have been even lower in
the absence of EU local content requirements.
Kelegama and Foley (1999) examined the
impediments for backward linkages in the
garment industry in Sri Lanka. Their analysis
suggested that the capital intensity and scale
economies of upstream fabric and accessory
production impeded entry by local ®rms, while
FDI in upstream manufacturing was rendered
unattractive given the poor quality of the local
(energy) infrastructure. They also found that
existing international supplier linkages of
multinational ®rms in some cases discouraged
procurement from local suppliers. Brannon et
al. (1994) and Lowe and Kenney (1999) looked
at supplier linkages of the ``maquiladora''
plants set up by foreign multinationals in
Northern Mexico. One impediment to the
development of backward vertical linkages with
Mexican suppliers were US and Mexican tari
(exemption) policies, which gave US investors
important incentives to import components
from the United States. Other major impediments were the export orientation of the foreign
plants, which was incompatible with the traditional domestic market orientation of suppliers,
the lack of proximity of Mexican suppliers to
the clusters of foreign investors at the Northern
border, and a lack of plant-level autonomy
concerning purchasing decisions.
Studies in the strategic management literature have also examined local and international
procurement strategies of multinational ®rms
but have focused primarily on the relationship
between sourcing strategies and ®rm performance. In general, this literature has stressed
the positive eect on performance of the use of
proprietary components developed in-house or
in close cooperation with longstanding suppliers and subcontractors. Kotabe and Omura
(1989) examined sourcing strategies of a
number of foreign-owned manufacturing ®rms
in the United States and found that the extent
of internal sourcing of major components was
positively related to US market performance of
the product. Murray et al. (1995) surveyed 104
foreign-aliated manufacturing aliates in the
United States in 1993 and found weak evidence
that reliance on nonstandardized components
and internal sourcing was related to better
market performance as measured by sales
growth. They also reported signi®cant dierences in procurement behavior between European- and Japanese-owned aliates in the
United States in 1991. Japanese aliates
sourced a signi®cantly smaller share of the
value of components in the United States and
combined a greater reliance on nonstandardized components with signi®cantly higher levels
of intra-®rm sourcing. Dyer (1996) found evidence that automobile assemblers are more
pro®table the greater the proximity (spatial
clustering) of their suppliers. Proximity was
associated with suppliers' dedicated investments in production facilities, greater sharing
BACKWARD VERTICAL LINKAGES
of know-how and more intense communication. These were found to be correlated with
faster design changes, improved quality, and
increased return on investment. Asanuma and
Kikutani (1992) and Okamuro (1995) emphasized the risk-sharing function of subcontracting relationships in the Japanese automobile
industry and found evidence that the intensity
of long-term supply relationships was positively
correlated with the stability of performance.
The role of Japanese supplier and subcontractor linkages has also been studied in the
context of Japanese ®rms' decision to invest
abroad and the location of these investments.
Belderbos and Sleuwaegen (1996) found that
vertical linkages between ®rms were an important factor in the decision to invest in Asia:
subcontractor ®rms within vertical keiretsu
were more likely to invest in Asia if the parent
®rm operated a large number of plants in the
region. Using location data on Japanese
manufacturing aliates in the United States,
Head, Ries, and Swenson, 1995 found that
Japanese plants were more likely to be set up in
a state, the greater the number of existing
Japanese plants in that state in the same
industry. The existence of plants set up by
parent ®rms or suppliers in the same vertical
automobile keiretsu exerted an additional
positive eect on the location decisions by ®rms
in the keiretsu. There is also evidence that
Japanese automobile manufacturers have
actively assisted their keiretsu component
suppliers to set up plants near their assembly
operations abroad (Cusumano & Takeishi,
1991). A recent study by Hackett and Srinivasan (1998) found that the strictness of local
content regulations in host economies exerted a
stronger negative eect on Japanese FDI than
on US FDI. They posited that the close
supplier±buyer relationships (in particular
within vertical keiretsu) characterizing Japanese
procurement practices imply greater costs of
switching to host country suppliers. The
necessity to increase local sourcing in case of
strict local content requirements pushes up the
cost of local manufacturing relatively much and
this discourages Japanese investment. On the
other hand, the Japanese investments that do
occur are also more likely to induce existing
suppliers in Japan to follow suit and invest in
local component plants in order to replicate
existing supplier relationships abroad. Hackett
and Srinivasan also found a positive and
signi®cant eect of the existing stock of Japanese FDI on new Japanese investments, which
193
is consistent with the ®nding of strong clustering eects in Japanese FDI reported by
Belderbos and Sleuwaegen (1996) and Head et
al. (1995). The net eect of local content rules
on inward Japanese FDI depends on these two
opposing forces but is dicult to sign.
Finally, the popularity of local content rules
among policy makers has in¯uenced a now
substantial body of literature analyzing the
welfare eects of local content rules under
various market structures (e.g., Richardson,
1993; Belderbos & Sleuwaegen, 1997; Lopezde-Silanes et al., 1996). The eect of local
content requirements is found to depend,
among others, on the market power of local
parts suppliers, the cost competitiveness and
level of vertical integration of local competitors
in the assembly industry, and on whether the
requirements induce FDI in component
production. With the exception of Hackett and
Srinivasan (1998), however, there has been no
empirical investigation of the actual impact of
such rules.
The literature reviewed above suggests that a
variety of factors are important for the creation
of backward vertical linkages by Japanese
investors. At the country level, characteristics
such as local content rules, infrastructure, and
the availability of and proximity to local
suppliers are important. In addition, aliate
characteristics such as the ``vintage'' eect and
the market orientation of investment aect
backward vertical linkages. Finally, parent ®rm
characteristics such as the strength of existing
long-term supplier linkages within vertical
keiretsu and the possibility of induced clustering eects through investments by keiretsu
suppliers are also expected to in¯uence vertical
linkages. We incorporate these factors in the
empirical model described below.
3. HYPOTHESES, EMPIRICAL MODEL
AND DATA
In this section we develop an empirical model
explaining the extent of backward vertical
linkages of Japanese manufacturing aliates.
Backward vertical linkages in the host economy
can be established through intra-®rm transactions (procurement from related local suppliers
or intra-aliate vertical integration into
component production) or through arm's
length transactions (procurement from unrelated local suppliers). Both types of transactions are expected to provide a number of
194
WORLD DEVELOPMENT
particular bene®ts to the host economy, and
our main analysis therefore focuses on the local
(host country) content of the electronics
manufacturing aliates, rather than on local
procurement alone. 6 On the other hand, it
would be of interest to make a distinction
between procurement from locally owned
unrelated suppliers and related suppliers, since
the former is likely to be associated with greater
technology transfer and the stimulation of local
entrepreneurship (e.g., Lim & Fong, 1982).
Unfortunately, our data do not allow us to
measure the importance of procurement from
locally owned ®rms. 7 As a second-best option,
we do report robustness tests of the empirical
model in Section 4 with the local procurement
to sales ratio substituted as the dependent
variable.
The local content ratio is measured as sales
of the aliate minus components and materials
imported from abroad, divided by aliate
sales. 8 This ratio encompasses value added
created by the aliate, a measure of in-house
vertical integration, and the value of local
procurement of components and materials. 9
Since the dependent variable is restricted within
the interval 0,1] two-limit Tobit analysis is used
to relate the local content ratio to a set of
explanatory variables. Below we will discuss the
hypotheses and corresponding explanatory
variables. The section concludes with a brief
description of the data set.
(a) Hypotheses and explanatory variables
A Japanese ®rm's decision concerning the
sourcing of components and materials for its
foreign manufacturing operations can be
subdivided into two decision problems: (i)
whether to procure components in-house (or
intra-keiretsu), and (ii) whether to procure the
components in Japan or abroad (e.g., Cavusgil,
Yaprak, & Yeoh, 1996). The ``internalization''
decision of (i) re¯ects the tradeo between
quality and reliability bene®ts of in-house
production of components of proprietary
design versus cost-reducing sourcing of standard components. If a ®rm chooses external
sourcing of components to maintain a
competitive cost structure, it will be more likely
to choose components produced in low-cost
locations abroad (produced by locally owned
®rms or independent Japanese transplants). If a
®rm chooses proprietary components manufacturing, it is still possible that overseas
manufacturing activities reach high local
content levels. A condition is that the overseas
manufacturing location allows for cost eective
production of the components within the
assembly plant or in a dedicated components
manufacturing aliate established by the
assembler or its related component suppliers.
Factors aecting local content levels will
therefore be related to both the importance of
transaction costs associated with arm's length
trade and the attractiveness of foreign locations
for components manufacturing. For convenience, we distinguish between determinants at
the parent ®rm, aliate, and country level in
the remainder of this section.
(i) Parent ®rm level determinants
Japanese ®rms dier in the intensity of longterm cooperative subcontracting and supplier±
assembler relationships (e.g., Sako, 1992; Dyer,
1996). Firms that are members of a large
vertical keiretsu with a substantial number of
related component manufacturers will make
particularly intensive use of these relationships.
Intra-keiretsu procurement is based on longterm relationships characterized by intensive
interaction between supplier and assembler
involving dedicated investments in equipment
and human resources and requiring the implementation of just in time delivery and total
quality control systems. There is evidence that
these relationships enhance performance and
reduce risk (Dyer, 1996; Asanuma & Kikutani,
1992; Okamuro, 1995). Since the assemblersupplier system is one of the bases for
competitiveness of Japanese ®rms, they have
followed a strategy to emulate it abroad. In
practice, however, it has proven dicult to
involve locally owned suppliers in such relationships (Hiramoto, 1992). The supplier
switching costs are higher for keiretsu ®rms
given the sunk investments in existing relationships with Japanese suppliers (Hackett &
Srinivasan, 1998). Supplier networks have
therefore often been replicated abroad through
the establishment of overseas manufacturing
plants by existing Japanese manufacturers of
parts and components, in which they were often
assisted by the ``core'' ®rm of the keiretsu
(Belderbos & Sleuwaegen, 1996). The consequences of keiretsu membership for the local
content of overseas operations are not unambiguous. On the one hand, keiretsu members
®rms' higher switching costs may lead to a
greater continuing reliance on supplies of
inputs from long-standing suppliers located in
Japan. On the other hand, if the suppliers
BACKWARD VERTICAL LINKAGES
follow the assembler abroad, keiretsu ®rms may
be able to reach higher local content than
independent ®rms. Hence, we are not able to
sign the eect of keiretsu membership a priori.
Since there are substantial dierences in the
importance of supplier networks within dierent vertical keiretsu, membership of a vertical
keiretsu as such is not a very distinctive characteristic. Instead, we devised a measure of the
intensity of supplier±assembler relationships
within keiretsu. We used Toyo Keizai's publication ``Nihon no Kigyou Guruupu'' (Japanese
corporate groups), to establish for each Japanese investor whether it belonged to a vertical
keiretsu. Then we proxied the intensity of
supplier±assembler relationships for keiretsu
members by taking the ratio of the size
(measured by paid-in capital) of all keiretsualiated manufacturing ®rms to the size of the
``core'' ®rm of the keiretsu in Japan. We call
this variable keiretsu intensity (KEIRINT).
KEIRINT reaches higher values the more the
``core'' ®rm relies on components sourcing
from other manufacturers within its keiretsu.
The values for KEIRINT corresponded well to
our intuition concerning the strength of
supplier networks, with, for example, the
highest ratios for Matsushita and Fujitsu and
the lowest for Sharp.
We posit that the R&D intensity of the
parent ®rm (R&DINT) has an impact on the
local content of its foreign aliates. R&D-intensive ®rms make greater use of proprietary
designs and in-house know-how. They possess
more intangible assets related to manufacturing
capabilities of nonstandardized high-technology components. They are less likely to transfer
component production to external suppliers.
Since production of components developed inhouse is generally human capital and technology-intensive, it is less likely that foreign
manufacturing locations provide substantial
cost advantages over production in Japan,
which is relatively abundant in these factors.
The attractiveness of foreign investment in
technology-intensive component production
positively depends on the technological capabilities and human resources, or the ``absorptive capacity'' (Cohen & Levinthal, 1990), of
host countries. 10 Hence, the greater these
capabilities and resources, the less we expect a
negative impact of the ®rm's R&D intensity on
local content. We therefore not only include the
variable R&DINT, but also a cross-eect with
a measure of economic and technological
development of the host country. As an
195
imperfect proxy for the latter we include GDP
per capita (GDPCAP). We expect a negative
sign of R&DINT and a positive eect of
R&DINT*GDPCAP.
(ii) Aliate-level determinants
At the aliate level, the experience in
manufacturing in a country is likely to be an
important determinant of the extent of vertical
linkages. Finding suitable local suppliers and
establishing links with these ®rms is a timeconsuming process, in particular if the suppliers
have to adapt to the demands of the Japanese
assemblers in terms of quality and delivery
schedules. In other cases, redesign of the
product is necessary to allow for the use of
locally made standardized components. As
foreign ®rms learn through time how to
develop relationships with local suppliers and
how to adapt products to local markets, local
procurement is expected to increase. O'Farrell
and O'Loughlin (1981) found a positive eect
of operating experience on the level of local
procurement by foreign-owned aliates in
Ireland, but Reid (1994) could not establish a
similar eect for Japanese ®rms in the United
States. One reason for the latter result may be
that no distinction was made between green®eld establishments and acquisitions. In case
the Japanese investor acquired the local aliate, it is natural to assume that the aliate is
relatively deeply embedded in the local economy at the time of the acquisition. Hence, the
number of years of operation under Japanese
ownership is not likely to have an important
additional impact on local content. 11 We
include two experience variables, EXPER_
GRE and EXPER_ACQ. EXPER_GRE
measures the number of years since operations
started in newly established (green®eld) manufacturing aliates; EXPER_ACQ measures the
number of years since acquired aliates came
under Japanese control. Because we expect a
relatively strong increase in local content in the
®rst few years of operating in the host country
and a smaller eect of additional years of
experience for older aliates, we include
EXPER_GRE and EXPER_ACQ in logarithmic form. We hypothesize a positive eect of
EXPER_GRE but no eect of EXPER_ACQ.
The entry mode is likely to have an impact on
vertical linkages in the host economy. Acquired
aliates are likely to have higher local content
given their pre-acquisition embeddedness in the
local economy as locally owned ®rms. We also
expect that joint ventures facilitate higher levels
196
WORLD DEVELOPMENT
of local content than wholly owned aliates.
This is because the local joint venture partner
or its related ®rms may have accumulated
expertise in either electronics components
manufacturing or components procurement
from local suppliers. Taking the wholly owned
green®eld aliate as the base case, we include
two dummy variables in the model, ACQUIS in
case the aliate was acquired, and JV in case
the aliate was established as a joint venture
with a local partner. We hypothesize positive
signs for both variables.
A feature of the overseas operations of
Japanese electronics ®rms is a certain dichotomy between the main motivation for the
establishment of the aliates (e.g., Ernst,
1997). One group of aliates is established to
access available pools of low-cost labor and is
export oriented, while another group of aliates is primarily established to improve access
to local customers and sells predominantly on
the host country market. The motivation for
investment and the associated market orientation may have an impact on vertical linkages of
the aliate in a number of ways (e.g., Lowe &
Kenney, 1999; Kelegama & Foley, 1999). If the
aliate's primary markets are local, it is more
likely to adapt products to local tastes and
circumstances, which involves local procurement or local development of components.
Second, competitive price pressures may be
lower on the local market compared with
export markets, in particular if the local market
receives some form of protection through tari
or nontari barriers. This may allow local
market-oriented producers to use local
components even if these come at higher costs.
Third, aliates selling on the local market have
an incentive to reduce reliance on imports from
Japan given the associated vulnerability of
pro®tability to an appreciation of the Yen.
Fourth, if the aliate is located in less-developed countries and sells locally, it will produce
and sell relatively mature and low-priced
products. In that case, it is of greater importance to use the low-cost standardized components that are more likely to be available
locally. In sum, we expect that aliates with
higher local sales ratios have higher local
content. LOCSALES measures the percentage
of aliate turnover destined for the local
market. We expect this positive eect to be
smaller the more developed the host economy.
We therefore include the cross-eect of
LOCSALES and GDPCAP and expect a
negative sign.
There is evidence that the establishment of a
substantial number of Japanese aliates has
been speci®cally motivated by the need to
circumvent trade barriers, such as antidumping
duties, targeting Japanese ®rms' exports to the
host economy (Belderbos, 1997b). If the main
motivation for setting up the manufacturing
aliate was to circumvent trade barriers, the
investment was not a ®rst-best managerial
decision based on manufacturing cost and eciency. Limiting investment to relatively simple
assembly tasks while sourcing components
from abroad may be the most cost-eective
response. In particular when trade policy
measures are seen as temporary (e.g., given the
®ve-year duration limit for antidumping
measures or the prospects of tari reductions
due to GATT negotiations or regional integration initiatives), ®rms may also wish to limit
their resource commitment, facilitating the
relocation of investment when measures have
expired. Hence we expect less extensive vertical
linkages if manufacturing investments were
primarily induced by trade barriers. The level
of trade barriers varies substantially across
products (e.g., taris) and trade protection is
often targeted at speci®c products (e.g.,
through VERs and antidumping measures).
The role of trade barriers is therefore preferably
measured at the product or aliate level.
Although we could not obtain detailed product
information for the aliates, we could measure
the ``tari jumping'' motivation directly, by
utilizing a question in the MITI survey
concerning the motivation for the aliate's
establishment. If the aliate chose ``trade friction'' from among the alternatives, the dummy
variable TARJUMP takes on the value 1. A
negative sign is expected. 12
Industry characteristics will have an eect on
the extent of vertical linkages. High local
content ratios may be more dicult to achieve
in high technology industries such as in telecommunications than in the more mature
consumer goods sector. Aliates manufacturing products that use components with a low
value to weight ratio will be more inclined to
use local components since transportation costs
associated with imports are relatively high. The
industry classi®cation of the MITI survey
distinguishes four subclasses in the electronics
industry: consumer goods, semiconductors
and electronics parts, telecommunication and
computer equipment, and other electronics and
electrical equipment. We attempt to control for
systematic dierences in local content across
BACKWARD VERTICAL LINKAGES
these industries by including three industry
dummies: TELCOMP, PARTS, and CONSUMER, and taking other electronics (OTHERIND) as the reference case.
(iii) Country-level determinants
The most obvious country characteristic
determining backward vertical linkages is the
availability of locally established component
suppliers. We include the variable SUPPLIERS, which measures the dollar value of electronic parts and components production in
each country in 1992. The variable SUPPLIERS measures the availability of locally
produced components and will also generally
re¯ect the attractiveness of a country to establish components manufacturing operations.
From both perspectives we hypothesize a
positive eect on local content. 13
The extent to which Japanese suppliers play a
role in the local components industry is also
expected to aect vertical linkages. By using
longstanding suppliers from Japan established
near the overseas manufacturing base, ®rms
can avoid switching costs and emulate best
practice in Japan. There may also be important
economies of agglomeration once a substantial
number of Japanese suppliers have set up local
manufacturing aliates. For instance, reduced
input costs can result from increased specialization and training of local personnel. We
include the variable JSUPPLIERS, which is a
measure of the role of Japanese ®rms in the
local components industry, and expect a positive sign. Since the presence of Japanese
suppliers is most likely to allow keiretsu ®rms
to avoid switching costs, keiretsu members are
expected to increase their local content most.
We include the cross eect of JSUPPLIERS
and KEIRINT and expect a positive sign.
JSUPPLIERS is de®ned as the number of
Japanese plants producing electronic components and materials in the country, divided by
SUPPLIERS. A comprehensive data source on
Japanese electronics production abroad
(Denshi Keizai Kenkyujo, 1994) was used to
calculate plant counts. To incorporate dierences in plant scale, we counted each component manufactured in multicomponent plants
separately.
The cost advantage of using a local network
of suppliers also depends on the quality of the
infrastructure. A good infrastructure facilitates physical transport of components within
the country and communication between
assembler and suppliers (Lowe & Kenney,
197
1999). The quality of infrastructure has also
been found to exert a signi®cantly positive
impact on inward investment (Hackett &
Srinivasan, 1998). As a proxy for the quality
of infrastructure we include the variable
INFRA, which measures the number of telephone lines per capita (International Telecommunication Union, 1995). We expect a
positive sign.
An important issue is to what extent local
content rules directed at increasing the local
content of (foreign-owned) manufacturing
operations are successful in increasing backward vertical linkages. We include a country
variable, LCR, which measures the severity of
local content regulations in host countries.
LCR is taken from a survey among US multinational ®rms conducted by Business International Corporation (1989) and measures the
severity of such regulations on a scale between
0 and 10. We expect a positive sign. As noted
before, a certain level of local content is often
required if investing ®rms wish to bene®t from
tax grants and other incentives schemes oered
by national and regional authorities in the
United States and Europe. In less developed
countries there often is a similar preferential
treatment to foreign investment projects
contingent on local content (among other
requirements). Malaysia, for instance, grants
``Pioneer status'' (entitling to tax exemptions)
to investments which meet a number of conditions, among which local content requirements
(Commission of the European Communities,
1998). These incentive schemes and their
conditions vary per investment project, introducing a degree of discretion in the application
of local content rules. This implies that there
could be an important ®rm-speci®c element in
local content regulations. We therefore also
include a measure of local content requirements
at the level of the individual aliate in addition
to the country variable LCR. LCR_AFF is a
dummy variable taking the value one if the
aliate indicated in the MITI survey that local
content rules are aecting its manufacturing
operations.
(b) The data set
The data on Japanese aliates are drawn
from MITI's 1992 Basic Survey among Japanese multinational enterprises and report on
operations in the ®scal year through March
1993. A representative number of 272 aliates
198
WORLD DEVELOPMENT
in the electronics industry had sucient information on the local content ratio and the
explanatory variables. 14
Table 1 shows the distribution of aliates
over countries and the average (unweighted)
local content ratio of the aliates. The local
content ratio is relatively high at 80% in the
largest developed economy, the United States.
Local content in European countries is lower
in general. The lowest ratios are recorded in
ASEAN countries (with the exception of
Singapore), China, and Ireland. In India and
Brazil, two countries known for strict regulations on multinational ®rms, local content is
relatively high, which appears to provide some
indication of the role of local content regulations. Caution should be exercised, however,
in drawing conclusions from simple tables
such as Table 1. Characteristics of aliates,
such as whether they are acquired or not,
vary across countries and have an important
impact on local content. More accurate
insight into the role of country, aliate, and
parent ®rm characteristics is provided by the
multivariate empirical analysis reported in the
next section.
Table 1. Number of Japanese manufacturing aliates
and average local content ratio by country
United States
Canada
United Kingdom
Germany
France
Spain
Belgium
Netherlands
Ireland
Hong Kong
South Korea
Singapore
Taiwan
Indonesia
Malaysia
Philippines
Thailand
India
China
Mexico
Brazil
Venezuela
Australia
Israel
# Aliates
Local content
ratio
44
5
19
7
5
4
2
2
2
6
20
24
34
5
36
4
27
4
7
2
10
1
1
1
0.81
0.71
0.66
0.57
0.50
0.73
0.80
0.65
0.49
0.63
0.63
0.68
0.74
0.72
0.56
0.54
0.53
0.87
0.54
0.95
0.86
0.60
1.00
0.88
4. EMPIRICAL RESULTS
The results of ®ve models explaining the local
content ratio of Japanese aliates are presented in Table 2. Model 1 ®rst tests the explanatory power of the independent variables if
Japanese supplier linkages and keiretsu
membership are not taken into account. The
model generally performs well. All explanatory
variables with the exception of LCR_AFF have
the expected sign and most variables reach
conventional signi®cance levels. In addition,
robustness tests showed no evidence of heteroskedasticity or correlated error terms. 15
As hypothesized, R&DINT is signi®cantly
negative while its cross eect with GDPCAP is
positive and signi®cant at the 10% level (twotailed test). Technology-intensive parent ®rms
operate aliates with lower local content but
this eect is smaller if the aliates are located
in developed countries. The estimated coecients imply that R&DINT no longer has a
negative impact if GDP per capita exceeds
US$17,500, a level reached by the United
States, Canada, and a number of Western
European countries. The operating experience
of newly established aliates EXPER_GRE is
positive as predicted, and signi®cant at the 10%
level. The estimated coecient implies,
however, that a doubling of experience years
(equal to roughly 10 years extra experience in
the sample mean) leads to an increase in the
local content ratio of no more 0.032 points. 16
Clearly, this magnitude of the experience eect
is rather small, and the results can only provide
partial support for the ``vintage eect'' explanation for Japanese ®rms' procurement
behavior. The coecient of experience for
acquired aliates, EXPER_ACQ, is negative
but has a very large estimated variance. The
hypothesis that operating experience plays no
role for acquired ®rms cannot be rejected. The
results show the importance of making a
distinction between entry modes when assessing
the impact of experience in the host economy.
A very large and signi®cant eect is estimated
for the ACQUIS dummy. It can be calculated
that an acquired aliate has a 0.47 point higher
local content ratio than a newly established
wholly owned aliate, ceteris paribus. The
coecient of the joint venture (JV) dummy is
signi®cant but its value is about seven times
lower than that of ACQUIS: joint ventures
have a 0.07 point higher local content ratio
than green®eld aliates. The percentage of
local sales in total sales of the aliate,
BACKWARD VERTICAL LINKAGES
199
Table 2. Determinants of the local content ratio of Japanese manufacturing aliatesa
R&DINT
R&DINT*GDPCAP
log EXPER_GRE
log EXPER_ACQ
ACQUIS
JV
LOCSALES
LOCSALES*GDPCAP
TARJUMP
INFRA
SUPPLIERS
LCR
LCR_AFF
Model 1
Model 2
Model 3
Model 4
Model 5
)1.370
)2.154
0.079
1.851
0.035
1.913
)0.021
)0.449
0.510
2.186
0.074
2.342
0.249
4.002
)0.008
)1.523
)0.149
)3.520
0.003
1.974
0.001
0.933
0.025
1995
)0.008
)0.233
)1.540
)2.443
0.074
1.750
0.042
2.339
)1.522
)2.412
0.075
1.756
0.042
2.307
)1.532
)2.446
0.082
1.927
0.038
2.078
)1.480
)2.353
0.079
1.866
0.038
2.083
0.467
4.71
0.067
2.165
0.237
3.852
)0.007
)1.453
)0.154
)3.656
0.003
2.239
0.001
0.836
0.029
2.220
)0.003
)0.085
0.085
2.663
0.001
1.068
0.463
4.648
0.067
2.169
0.233
3.773
)0.007
)1.430
)0.152
)3.617
0.003
2.243
0.001
0.844
0.028
2.210
)0.002
)0.068
0.072
1.745
0.001
0.712
0.001
0.472
0.442
4.484
0.071
2.318
0.232
3.793
)0.006
)1.252
)0.149
)3.569
0.002
1.742
0.001
1.014
0.025
1.989
0.006
0.180
0.085
2.696
0.436
4.416
0.073
2.366
0.229
3.747
)0.006
)1.263
)0.148
)3.550
0.003
1.800
0.002
1.058
0.024
1.886
0.006
0.177
0.062
1.401
0.009
1.932
KEIRINT
JSUPPLIERS
KEIRINT*JSUPPLIERS
JSUPPLIERS*DRATIO
)0.020
)0.448
)0.040
)0.628
)0.024
)0.541
0.330
2.435
)0.045
)0.979
)0.061
)0.975
)0.003
)0.072
0.318
3.451
)0.045
)0.981
)0.064
)1.009
)0.006
)0.131
0.324
3.484
)0.047
)1.037
)0.073
)1.151
0.014
0.287
0.328
4.027
0.007
1.278
0.006
0.749
)0.048
)1.057
)0.076
)1.207
0.009
0.179
0.338
4.102
15.233
272
19.042
272
19.153
272
20.321
272
20.601
272
KEIRINT*JSUPPLIERS*DRATIO
CONSUMER
TELCOMP
PARTS
CONSTANT
Log-likelihood
Observations
a
The omitted industry is other electronics, the omitted entry mode dummy is green®eld with full ownership.
Signi®cant at the 10% level.
**
Signi®cant at the 5% level.
***
Signi®cant at the 1% level.
*
LOCSALES, has the hypothesized positive
eect and is signi®cant. The cross eect with
GDPCAP has the predicted negative sign but
just fails to reach conventional signi®cance
levels. 17 The negative and signi®cant coecient of the TARJUMP dummy con®rms that
aliates established to circumvent trade barriers establish fewer vertical linkages. This
negative eect is relatively large: tari jumping
motivation reduces local content by 0.14
points. This result provides support for the
hypothesis that the role of trade barriers in
200
WORLD DEVELOPMENT
inducing Japanese FDI contributes substantially to the explanation of Japanese ®rms'
relatively less developed vertical linkages.
Among the country and industry variables,
the quality of the host country's infrastructure,
INFRA, is positive and signi®cant at the 5%
level. The coecient for SUPPLIERS (the
value of electronic parts production), on the
other hand, is positive but not signi®cant. A
possible explanation is that investing ®rms,
confronted with a small local supplier base,
compensate reduced local procurement with
extended intra-aliate vertical integration in
case the investment climate (as indicated by the
quality of the infrastructure) is supportive.
Hence, we expect a more pronounced eect of
SUPPLIERS on the local procurement part of
the local content ratio (we explore this issue
further below). The strictness of local content
regulations in the host country (LCR) has the
predicted positive and signi®cant eect on the
local content