Capital flows in Japan

Capital began to flow in and out of Japan following the Meiji Restoration of 1868, but policy restricted loans from overseas. In the aftermath of World War II, Japan was a debtor nation until the mid-1960s. Subsequently, capital controls were progressively removed, in part as a result of agreements with the United States. This process led to rapid expansion of capital flows during the 1970s and especially the 1980s, when Japan became a creditor nation and the largest net investor in the world. This credit position resulted both from foreign direct investment by Japanese corporations, and portfolio investment (holdings of foreign exchange by the central government). In particular, the rapid increase of Japan's direct investments overseas, much exceeding foreign investment in Japan, led to some tension with the US at the end of the 1980s.

Motivations for Japan's drive to invest overseas included: to obtain access to raw materials; to overcome barriers to exports from Japan; and to maintain the international competitiveness of traded products in the face of the high value of the Japanese yen.

After the Meiji Restoration, as Japan ended sakoku, the policy of isolation and opened up to participation in international markets, the state followed a policy of discouraging foreign investment. Borrowing abroad was only done if deemed necessary and unavoidable, given state concerns about vulnerability to foreign debt. There were fears that Japan could see a challenge to her sovereignty if debts became large, and foreigners could find a justification for intervention, as happened to some contemporary states of the time like Mexico and Egypt. Encouragement and state support was given to domestic investors, including the sponsorship of new industrial ventures under state ownership, and then their eventual privatization (to Japanese investors).

After World War II, Japan's return to world capital markets as a borrower was slow and deliberate. Even before the war, Japan did not participate in world capital markets to the same extent as did the United States or West European countries. Caution and control remained strong until well into the 1970s, when Japan was no longer a net debtor nation. Since that time, deregulation has proceeded steadily, and capital flows have grown rapidly. The rapid growth of investment abroad in the 1980s had made Japan the largest net investor in the world by the end of the decade.

Capital movements offset the surpluses or deficits in the current account. A current account surplus, for example, implies that rather than using all the foreign currency earned by selling exports to buy imports, corporations and individuals choose to invest the money in foreign-currency-denominated assets instead. As measured in Japan's balance of payments data, capital movements consist of long- and short-term investments and movements in official foreign exchange reserves and private bank accounts. Capital movements include loans, portfolio investments in corporate stock, and direct investment (establishment or purchase of subsidiaries abroad). A capital outflow occurs when a Japanese individual or corporation makes a loan, buys foreign stock, or establishes a subsidiary abroad. A capital inflow occurs when foreigners engage in these operations in Japan.

A country recovering from a major defeat, Japan remained a net debtor nation until the mid-1960s, although it was never as far in debt as many of the more recently developing countries. By 1967 Japanese investments overseas had begun to exceed foreign investments in Japan, changing Japan from a net debtor to a net creditor nation. The country remained a modest net creditor until the 1980s, when its creditor position expanded explosively, altering Japan's relationship to the rest of the world.

In Japan's balance of payments data, these changes are most readily seen in the long-term capital account. During the first half of the 1960s, this account generally showed small net inflows of capital (as did the short-term capital account). From 1965 on, the long-term capital account consistently showed an outflow, ranging from US$1 billion to US$12 billion during the 1970s. The sharp shift in the balance of payments brought about by the oil price hike at the decade's end produced an unusual net inflow of long-term capital in 1980 of US$2.3 billion, but thereafter the outflow resumed and grew enormously. From nearly US$10 billion in 1981, the annual net outflow of long-term capital reached nearly US$137 billion in 1987 and then dropped slightly, to just over US$130 billion, in 1988.

Short-term capital flows in the balance of payments do not show so clear a picture. These more volatile flows have generally added to the net capital outflow, but in some years movements in international differentials in interest rates or other factors led to a net inflow of short-term capital.