《《The Role of Japanese Direct Investment》.pdf

This paper appears in Empirical Economics Letters, 11(6), 527-534. (2011) U.S. Bilateral Trade Deficits with China and Japan: The Role of Japanese Direct Investment Sokchea Lim and Channary Khun∗ Abstract: This paper argues that Japanese Foreign Direct Investment (FDI) in China plays a critical role in home and host country’s bilateral trade imbalances with the U.S. Using six cross-sectional panel data from 1981 to 2007, we find strong evidence in support of the role of Japanese FDI in mounting U.S.-China trade imbalance and in reducing deficit of U.S. trade with Japan. The results also indicate that the devaluation of Chinese Yuan does not affect its bilateral trade balance with the U.S. and there are mixed evidence in terms of the relationship between the Japanese Yen exchange rate and the U.S.-Japan trade deficit. The implication of these findings is that U.S. trade deficit is a macroeconomic problem which cannot be blamed on the exchange rate alone. Policies to attract and retain Japanese firms in the U.S. will help reduce its trade deficit in the long-run. Keywords : Japanese Foreign Direct Investment, bilateral trade imbalance, devaluation of exchange rate. ∗ Sokchea Lim and Channary Khun are PhD students of the Department of Economics, Southern Illinois University Carbondale. We thank Kevin Sylwester and two anonymous referees for helpful comments on an earlier draft. All remaining errors are entirely ours. Electronic copy available at: /abstract=2034479 I. Introduction After its trade liberalization in the late 1970s, China’s exports of manufactures have expanded dramatically, leading to growing concern among developed and developing economies. The rapid rise of China’s trade surplus with the former and the competitio