What possible relation, one might ask, can spas, online food delivery services and local supermarkets bear to national security? Indeed, the Finance Ministry’s recent announcement that 2,102 such companies will be subject to security-related governmental regulation was greeted with bewilderment.
The confusion was caused by amendments to the foreign exchange and foreign trade law, which were designed to boost Japan’s national security by introducing economic safeguards around foreign investment. Investigating this series of debates illuminates the challenges faced by Japan in its quest to balance the interests of two apparently separate realms: national security and the economy.
The law in question, amended last November, regulates foreign exchange, trade and other transactions. Under the previous version, all foreign investors obtaining a share of 10 percent or more in companies operating in any of 155 designated sectors of industry had to be pre-approved by the government. The principal aim of the amendment was to enhance national security by ensuring that undesirable foreign investment was kept well away from security-related companies.
The secondary goal was to achieve alignment with the standards of foreign investment regulation practiced in the United States and Europe, which, since around 2018, have been strengthening their control over investment inflows to counter the potential threat posed by China. It was also reported that the government aimed to be whitelisted by Washington by meeting the requirements of the Foreign Investment Risk Review Modernization Act, hence enabling Japanese companies to invest in the United States without having to undertake a complex and laborious process of review.
The objectives of the amendment thus seem both clear and reasonable; however, looking at the changes actually made to achieve them takes us into muddier waters. First of all, the minimum share threshold under which foreign investors must be passed by government has been drastically reduced, from 10 percent to just 1 percent. Moreover, the circumstances in which government review and approval is necessary have also been expanded: foreign investors must now be pre-approved not only when they acquire shares, but when they are involved in essential corporate activities such as appointing a board member or proposing a business transfer.
At the same time, however, certain investors, including financial institutions and qualified sovereign wealth funds, are exempt under the revised measures. Of the recently disclosed list of 2,102 companies that are to become the subject of heightened government scrutiny, 518 will fall into the category for which government pre-approval is an essential requirement, while 1,584 fall into a less restrictive category for which pre-approval is required only for certain investors, including foreign state-owned companies.
This revision will certainly strengthen state control over investment inflow by expanding the range of companies requiring pre-approval. However, is it really necessary to tighten control over the whole of this newly expanded range for purposes of national security? The 518 companies now subject to government pre-approval for foreign investors to take a stake include spas, online food delivery services and local supermarkets, whose connection to national security is tenuous, to say the least.
There are also inconsistencies in the new provisions: Even within a single industry, such as automobiles or electrical components, certain companies have been placed in the more restricted category while others have not. This lack of transparency and consistency inevitably raises concerns that the national security aspect of the new legislation has not been properly thought through. In addition, an announcement made by the U.S. Treasury in January revealed that Japan has not, in the end, achieved the rumored aim of being whitelisted for investment in designated U.S. industries.
More importantly still, insufficient consideration may have been given to the probable impact of the revised law on the economy and particularly on incoming investment. Not only may the new regulations cause a decline in investment appetite among foreign investors, but they could also enable backsliding in recent efforts to improve corporate governance.
Japan has long been seen as a less attractive investment market than the U.S. and European countries, and this gap will only be widened by the extra procedural costs that foreign investors will now incur. Certainly, the exemptions and series of clarifications made so far will mitigate the potential negative impact; however, there remains an urgent need for greater clarity and consistency, especially regarding the criteria on how designated companies are selected.
Returning to the second point, improving corporate governance has been a key component of Abenomics, but any advancements made could be stymied by this amendment: from an investors’ perspective, there is no guarantee that the Japanese government will not indirectly intervene in the management of designated companies under the new regulatory arrangement. Likewise, some management bodies might seize on the new regulations as an opportune means to shield themselves from “undesirable” foreign activist funds. These potential consequences will have a negative impact on the Japanese economy in the long run.
Hence, the recent amendment not only seems to fail the stated objective of tightening national security, but has also had the unintended consequence of damaging incoming foreign investment, which is of considerable importance. Subsequent clarifications have gone some way toward addressing the concerns of foreign investors; however, further — indeed, ongoing — review is required to ensure that the legislation works as intended.
The range of designated companies should be narrowed to include only those that have an obvious relation to security. At the same time, no entity connected to security interests should escape the new regulatory regime. The existing bureaucracy, especially at the Finance Ministry, will be severely tested and may be found wanting in terms of the skills required to review and implement this amendment, largely due to dysfunction and infighting.
Consideration should be given to establishing a panel of experts within the government along the lines of the Committee on Foreign Investment in the U.S. given the fact that the amendment was also aimed at fostering international cooperation on investment monitoring.
We are living in times when national security and economic interests are perhaps more tightly bound together than ever before, and the debate engendered by the amended law reveals the challenges that Japan faces in its attempts to balance these two key policy elements. Nor are the issues raised peculiar to this amendment; on the contrary, this debate is the first act in a drama which will be played out over many years to come.
As confrontation between the U.S. and China becomes the new norm and with the unforeseeable COVID-19 pandemic causing an unprecedented level of recession, the delicate art of balancing national security and economy assumes ever greater importance. In this context, the launch in April of the economic division within the National Security Secretariat could be seen as a positive move.
Indeed, the government would do well to utilize this body to balance and synthesize its policies, incorporate wisdom from non-bureaucratic sources such as academia and the private sector, and overcome the persistent sectionalism with which it is riddled. As we transition into the “new normal,” the policymaking process, too, will require unprecedented transformation if the multiple fragile policy balls which government juggles are not to tumble and shatter.
Michio Ueda is a manager at a global consulting firm based in Tokyo. He leads a wide range of projects across industries, and provides unique perspectives on Asian politics and its implications for the business sector. Ueda received an M.A. distinction in Southeast Asian Studies from the University of Wisconsin-Madison, where he studied as a Fulbright fellow. He previously worked in the Defense Ministry and the Boston Consulting Group. 2020, The Diplomat; distributed by Tribune Content Agency, LLC