INDUSTRY-WIDE RELOCATION AND TECHNOLOGY TRANSFER BY JAPANESE ELECTRONIC FIRMS. A STUDY ON BUYER-SUPPLIER RELATIONS IN MALAYSIA. Giovanni Capannelli Graduate School of Economics Hitotsubashi University, Tokyo Ph.D. Course Dissertation November, 1997 SUMMARY Main theme and structure of this study This study analyses the process of technology transfer from Japanese assembly firms of consumer electronics to local parts makers in Malaysia by means of buyer-supplier relations. The work is based upon the following two assumptions. First, an industry-wide relocation process of Japanese consumer electronics to Asia creates a bulk of opportunities for technological upgrading of host countries by means of manufacturing linkages. Second, buyer-supplier relations are an important and effective channel for Malaysian firms to acquire foreign technology. An extensive field-work carried out by the author in Malaysia in 1995, including a survey to forty-three firms, has provided the empirical ground for the development of an original model on the two sides of technology transfer. Such model relates the effective implementation of the process both to the transfer capacity of the technology source and the absorptive capacity of the recipient. The information obtained through the field work in Malaysia are used to estimate determinants and effects of technology transfer via buyer-supplier relations. Moreover, since the potentiality for technological upgrading of the host country created by buyer-supplier relations depends on the extent of local sourcing, this study presents also some econometric estimates of the variables affecting the local procurement strategy of Japanese electronics firms. The data-set for such estimates was obtained by the MITI s Fifth Basic Survey on Overseas Production Operations of Japanese Firms, 1992. This study is organised in six chapters. Chapter One introduces the theme of analysis and reviews some basic issues concerning foreign investment and developing countries. Chapter Two offers some evidence of the process of industry-wide relocation of Japanese consumer electronics to Asia. Chapter Three presents the hypotheses on technology transfer via buyer-supplier relations, discusses the findings of the field-work in Malaysia, and introduces the model on the two sides of technology transfer. Chapter Four, presents some case-studies, and the empirical estimates on the determinants and effects of technology transfer. Chapter
Five analyses in detail the issue of Japanese electronics firms local sourcing strategy through the findings of both the field survey in Malaysia and the estimates of the MITI data set. Finally, Chapter Six summarises the issues presented throughout the study and offers some policy suggestions for Malaysia. Industry-wide relocation of Japanese consumer electronics One of the major changes occurred in Asia during the last decade was a rapid increase in regional economic interdependence caused by massive flows of foreign direct investment (FDI) and trade. The abrupt appreciation of the yen in the mid-1980s fostered Japanese firms international production, as several lower-end industries, in which Japan lost comparative advantages, were progressively transferred abroad. Beyond the shift in comparative advantages caused by the yen appreciation, Japanese multinational corporations (MNCs) were pressured to relocate their manufacturing units abroad by two other factors, namely (i) international pressures to reduce the country s huge trade surplus, and (ii) oligopolistic firms reaction to competitors previous FDI. More recently, the need to establish production and sales networks to favour a closer interaction with local customers and suppliers has emerged as a fourth major investment determinant. The significance of such interaction has increased especially for two types of FDI: (i) those destined to Asia, where local markets are widening and becoming increasingly sophisticated; and (ii) those originated from assembly industries, where the control of an efficient suppliers network is a strategic mean to acquire competitive advantages. Consumer electronics is an interesting example of Japanese FDI in assembly industries. Overseas production assumed such large a share that most labour-intensive operations, such as small and medium screen colour televisions (CTVs), were transferred to Asian countries in the last few years. This study defines this overseas relocation of Japanese consumer electronics as an industry-wide process (Chapter Two). The adoption of such terminology is induced by the following two peculiarities. First, such process of industrial dismantle and transfer abroad has progressively expanded from low-tech to upper-end manufacturing operations. Second, the relocation deeply involves final products, as well as supporting industries. The decision to invest abroad is taken in fact not only by all large assemblers, but also by a myriad of small and medium sized part suppliers, forced to follow the relocation of their customers abroad, or to reconvert their business to different sectors. Industrial upgrading of host countries While the industry-wide relocation of consumer electronics is causing a problem of industrial adjustment in Japan, host countries are offered a unique opportunity for technological upgrading. Besides the direct positive effect due to the expansion of output, employment, and export, this opportunity occurs through the indirect potential transfer of new technologies, know-how, and operational skills. Such indirect potential effect of FDI may greatly benefit the local economy by generating new nodes of economic activity and strengthening existing ones through the linkage created between foreign subsidiaries and local economies. This linkage provides a pathway for the two-way flow of goods and technology between host countries and foreign subsidiaries. Furthermore, the intensity and quality of the linkage is the major determinant of the foreign subsidiaries level of embeddedness, or effective contribution in terms of innovative capacity of the host country. A major policy goal for host countries is, therefore, to encourage the level of embeddedness of foreign firms and favour a virtuous circle in which the two-way flow of goods and technology
leads to an upgrading of the innovative capacity of both foreign firms and host countries, and to an increase in the competitiveness of the two. Foreign subsidiaries strengthen their linkage with the local economy especially through investment in fixed assets, training of employees, co-operation with local vocational schools and research centres, procurement of inputs from local firms, and establishment of sales networks. On the other hand, an interactive strategy for the local authorities to attract foreign capital and technology is to provide peculiar assets, such as an educated labour force, a good level of social and economic infrastructures, reliable institutions, and a stable political climate. The provision of such peculiar assets can be regarded by host governments as a rewarding investment for two reasons. First, they contribute to enhance the embeddedness of foreign subsidiaries, to the extent that the competitiveness of the latter is increased. Second, they lower the risk of investment flight, since the presence of sunk costs suggests that a deeply embedded firm will not easily relocate its production facilities abroad, in reaction to external or internal shocks. Embeddedness of Japanese subsidiaries in Malaysia An interesting case of industry-wide relocation for consumer electronics is Malaysia, the country which has received the largest accumulated share of Japanese electronics FDI in Asia during the last decade. All major Japanese producers of consumer electronic goods and semiconductors have established manufacturing plants in Malaysia, and recently many suppliers of parts and components have relocated their production facilities as well. Despite the large presence of Japanese electronics subsidiaries in Malaysia, several studies have suggested that the linkage with local firms is still weak. This has been explained by the following four factors. First, the still short time span from the establishment of many Japanese electronic firms in Malaysia. Second, an international production strategy of Japanese electronic assemblers which supports the relocation of parts suppliers from Japan. Third, the initial conditions of the electronics industry in Malaysia, marked by a very scarce presence and low technological capability of local firms. Fourth, the few opportunities to enhance local technological capabilities created by the technology policy of the government. In addition to the above factors, this study has identified a fifth major problem in the lack of a local pro-active strategy, both from the public and private sectors, to internalise the potential technological spillovers created by the presence of Japanese electronic consumer assemblers. In particular, the findings of a survey carried out by the author in Malaysia have revealed that the technology absorptive capacity of local input suppliers is still insufficiently developed, especially when compared to that of Japanese or third-country firms. The thesis adopted in this work is that this is principally caused by local firms and authorities underrating the need to invest in increasing such absorptive capacity. Buyer-supplier relations as a channel for technology transfer The economic literature has identified three principal channels for international technology transfer: (i) intra-firm flow of knowledge and skills from parent companies to their foreign subsidiaries; (ii) contracts between firms located in different countries which generate arms length trade of technology, regulated by the payment of royalties form the technology recipient to the technology source; (iii) non-commercial activities for the spreading out of technical information and the training and flow of students. While admitting the importance of the three above channels, this work sustains that production
co-operation activities between foreign assemblers and local makers of intermediate goods, or buyer-supplier relations for parts and components, are a fourth major form of transfer to upgrade the technological capability of the host region (Chapter Three). Buyer-supplier relations, in analogy with subcontracting, has been classified in the past as a contractual form of technology transfer. However, this study suggests that it should be conceptually kept separated because the contract between the buyer and the supplier does not refer to the exchange of technology items, but to production inputs, such as parts and components of final goods. The economic relationship between buyers and suppliers of production inputs has been investigated as an intermediate way between arms length trade and internalisation, and in terms of market structure, bargaining power, and definition of contract terms between the two sides of the production relationship. In addition, this study identifies a further economic dimension and significance of the buyer-supplier relationship, namely being an effective channel for technology transfer between a source and a recipient of technology. It is however difficult to assess the relative importance of buyer-supplier relations among other channels for technology transfer. Such channel emerges only in assembly industries and is based upon the hypothesis of a significant technology gap between foreign assembly subsidiaries and local input makers. While these two conditions may seem quite restrictive, the empirical findings presented in this study show, on the contrary, that buyer-supplier relations are an effective form of technology transfer, especially for a developing country like Malaysia, which presents a low level of indigenous technological capability in the manufacturing sector and in particular in the electronics industry. This study supports the idea that the linkage for production co-operation between foreign firms and host economies is a complement to, not a substitute of, other forms of international technology transfer. However, while other forms have been analysed quite extensively by several authors, buyer-supplier relations is, in this sense, a relatively novel issue. Importance of buyer-supplier relations for Malaysia Developing countries suffer of several disadvantages in the process of technological development and the possibility for local firms to increase their technological capability through technology transfer from advanced countries is typically a major concern of local authorities. Due to the recent very high growth of Malaysian electronics primarily induced by the industry-wide relocation from Japan, the development of a local supporting industry for electronics is stressed in this study as an important step for Malaysian industrial upgrading. At the same time, the production co-operation with Japanese assemblers is identified as an effective channel for technology transfer. Accordingly, the transfer of technology via buyer-supplier relations from Japanese assemblers of consumer electronics in Malaysia to local suppliers of production inputs is the object of analysis of this study. It is assumed that Japanese assemblers are technologically more advanced than their suppliers, and that local firms can upgrade their technological skills and knowledge by means of production co-operation with buyers. Analytical framework The analytical framework developed in this study for the problem of technology transfer via buyer-supplier relations identifies the input buyer as the technology source and the input supplier as the technology recipient. In particular, a model on the two sides of technology transfer is developed (Chapter Three). This model focuses on the mechanism underlying the
decision of the technology source (buyer) to devote a certain amount of resources to transfer part of its knowledge stock to the technology recipient (supplier). Such decision is based upon the following factors: (i) the transfer capacity of the source, (ii) the absorptive capacity of the recipient, (iii) the bargaining power of both agents, and (iv) the degree of difficulty of the implied technology. The model explains how the technology source decides to deliberately transfer to the recipient the amount of technology which maximises its profit function. The potential transfer of technology to the recipient is increased by a certain amount of technology spillovers which are created without any further effort from the technology source. The actual transfer of technology, however, equals its potential only if the transfer capacity of the technology source and the absorptive capacity of the technology recipient are fully employed. The technology transfer process is enhanced, therefore, when the technology stems from buyers which have developed a relatively high capacity to transfer their knowledge to suppliers. Supposedly, buyers transfer more knowledge to those suppliers whose absorptive capacity of external technologies is higher than that of rival firms, as such suppliers can presumably make a better use of buyers technology for enhancing the quality (or lowering the cost) of inputs. As a consequence, the more the supplier-technology recipient invest in R&D to effectively absorb external technology, the higher the likelihood that it will benefit from technical assistance and other knowledge transferred by the buyer-technology source. The wider the technology gap between the two sides, and the lower the bargaining power of the technology recipient relative to that of the source, the larger the scope for technology transfer. However such bargaining power, which is endogenous to the process, increases as the technological transfer and R&D efforts by the technology recipient lower the gap. Therefore, the technology source s incentive to transfer its technology is reduced according to the extent to which the ability of the technology recipient to appropriate a larger share of relationship-specific rents expands. The absorptive capacity of the technology recipient is given particular attention in this study. The analysis also stresses the active role of the recipient to achieve an effective implementation of the technology transfer process. This is an original innovative approach aimed to overcome one of the basic limitations of traditional economic modelling, which emphasises the role of technology sources as major agents of transfer and neglects the importance of technology recipients. Field work in Malaysia A major tool used to examine the extent and efficacy of buyer-supplier relations as a channel for technology transfer was an extensive field work in Malaysia in 1995, and an interview survey with forty-three firms. The sample of firms consisted of nine Japanese assemblers and thirty-four parts makers, including both Malaysian and Japanese suppliers. The firms were selected using a proportional random sampling technique, in order to include inputs with different technology requirements, and a two-stage procedure based on a previous pilot survey carried out by the author in 1994. The findings confirmed that the buyer-supplier relation is an effective and relevant channel for technology transfer. Due to the wide technology-gap with Japanese buyers, the potential for technology upgrading was higher for Malaysian than for Japanese suppliers. However, the low absorptive capacity of the former was identified as the main factor hindering technology transfer from Japanese buyers. Training expenses, visits to customers offices, and R&D were observed as main indicators of absorptive capacity (Chapter Four). Different strategies were also observed among the Japanese assemblers. Some of them
developed a higher capacity than others in transferring the technology and getting a positive feed-back from their suppliers. Several variables were used to evaluate the transfer effort and capacity of buyers, including the dispatch of technical staff from the mother company in Japan to the supplier, the size of R&D centres in Malaysia, and the amount of resources devoted to train suppliers staff. Empirical study on local sourcing The assumption that Japanese electronic subsidiaries are important sources of technology for Malaysian suppliers depends upon the condition that the local procurement ratio of such firms be sufficiently high. Such ratio is an useful indicator to evaluate the potential technology transfer for host economies offered by the channel of buyer-supplier relations. The problem of local sourcing was analysed through the findings of (i) the field-work in Malaysia, and (ii) a firm-level, world-wide data set for the electronics industry obtained by the MITI s Fifth Basic Survey on Overseas Production Operations of Japanese Firms, 1992 (Chapter Five). The two data set seem to be consistent in the sense that the local procurement ratio in Malaysia, calculated as the value of local over total procurement, was approximately 35 percent in both sources. In addition, according to the results of the interview survey, the share of Malaysian firms was estimated as 6.4 per cent of total value of procurement, and 23.6 per cent of total number of firms. The low level of such shares implies that there is still large room for increasing the Malaysian share and improving the potential technological spillover created by the presence of Japanese subsidiaries. The second analytical tool used for the investigation of such problem was to estimate the determinants of local sourcing using the MITI data set. Such data set included a total of 328 firms world-wide, of which 40 were located in Malaysia. The results of the estimates suggest, in this case, that the local procurement ratio increases with (i) local production experience, (ii) local sales ratio, and (iii) when the regional linkage with keiretsu is more stringent. In contrast, the effect on local procurement is negative when (i) the R&D intensity of the parent firm is high, and (ii) either avoiding trade frictions, or benefiting from local government incentives is a major investment motive. The local procurement ratio is also higher for acquisitions and joint-ventures than for greenfield projects whose equity is totally owned by Japanese firms. These findings confirm the prediction of the transaction costs theory that vertical integration increases with the knowledge stock of the firm. In addition, as absorptive capacity and technology transfer are found to depend upon firms past experience and technical expertise, they support the validity of previous studies on technology transfer via FDI and absorptive capacity, suggesting the importance of an evolutionary approach to the problem of technology spillovers and embeddedness. However, the regressions operated in this work suggest that this effect of production experience is minimal, one year increase in local production in Malaysia yielded to an increase of a mere 1.5 per cent in the local sourcing ratio. The result on the positive influence of keiretsu and the form of equity on firms procurement strategy goes against the negative correlation found by other studies on the behaviour of Japanese electronics MNCs in Europe. This underlines major differences in the regional strategy adopted by Japanese MNCs and supports the study thesis of the industry-wide relocation and formation of industrial clusters in Asia. Another factor which inhibits an increase in local sourcing is found in the policy followed by local governments to attract FDI, either by offering fiscal incentives or imposing trade barriers. This
outcome, which is supported by similar findings for Europe and North America, endorses the hypothesis adopted in this work that the linkage between a foreign subsidiary and its host country depends on the investment motive of the former and on the initial conditions of the latter. It also indicates that the evolution of such linkage towards an increase in the embeddedness of the foreign subsidiary should be pursued through structural policies aimed to improve the country s level of infrastructure and education. Policy implications This study concludes that a policy priority of the Malaysian government is to enhance the formation of linkages between domestic firms and Japanese subsidiaries, so as to increase Japanese firms level of embeddedness. The field survey has identified major problems with the low product quality of Malaysian input suppliers, inappropriate selection of technologies to upgrade supporting industries, ineffectiveness of R&D institutions to increase the technological capability of local firms, and local firms disadvantage due to the adopted FDI policy. The policy recently introduced by the Malaysian government to attract foreign technology in advanced sectors, such as the multimedia and aerospace industries, is challenging and may push the development of related sectors when international competition is achieved. However, this study has found a dichotomy between the technological capability of Malaysian and Japanese suppliers, which calls for a revision of the priorities attributed to the growth of individual sectors and to the expected contribution from foreign MNCs. This study offers three policy recommendations. Malaysian authorities should: (i) improve education and technological infrastructures through new training programmes for the labour force, and expanded R&D activities, particularly in applied technologies; (ii) provide assistance to domestic firms through programmes aimed to increase local sourcing, for the medium-short period, and including a mechanism for reducing such incentives as local firms achieve sufficient competitiveness; and (iii) adopt a pro-active strategy for the development of local technological capabilities by favouring the formation of joint-ventures between local suppliers and foreign firms - especially for projects in applied industrial technology - and attracting foreign subsidiaries with an integrated R&D strategy.