Risk Management Strategies of Japanese Companies in China

Political Crisis and Multinational Firms

Kristin Vekasi

• Publisher: Routledge
• Year: 2019
• ISBN:
  9780429557316
• Edition: 1
• Topic: Business
• Subtopic: Industrial Management
• Index: Business

In the context of political tensions and rising economic interdependence between Japan and China, this book studies how Japanese multinational companies try to minimize damages and manage their own fear and uncertainty to sustain their business interests.

Using a qualitative approach, including over 150 interviews with Japanese and Chinese business and industry leaders, combined with statistical analysis of unique firm-level data, this book brings a 'firm-level view' to this crucial case of political conflict amid economic interdependence. It argues that there is wide variation in the degree of material damages Japanese multinationals sustain in the aftermath of political disputes, and how threatening they perceive the risks of political conflict to be. This book then goes on to evaluate the different responses to risk, from promoting Japan's culture through privately funded tactics and building common cause with the government, to diversifying a portion of assets abroad and even leaving China entirely.

Presenting a new angle on economic globalization in the Asia Pacific region, Risk Management Strategies of Japanese Companies in China will be useful to students and scholars of Asian politics, business, and economics as well as international political economy.

1 Introduction

Seven Eleven had been operating in China for almost ten years when the Japanese government decided to nationalize islands disputed by the two countries. Starting from a base in Beijing, the company wanted to expand and establish a national presence in China. The stores offered drinks, snacks, and everyday services to China’s growing middle-class consumer population. But after the nationalization, Seven Eleven became known not for its slurpees or snacks, but for its country of origin: Japan. Chinese netizens called for their patriotic fellow citizens to boycott Seven Eleven, stores were vandalized, products destroyed, and some shops had to close down to mitigate the damage. A clash between consumerism, foreign investment, geopolitics, and the politics of national identity materialized in the aisles of small convenience stores.

Seven Eleven’s story is not unique. In the aftermath of international political crises rooted in events outside their control or responsibility, Japanese firms in China often become targets of popular nationalist anger or even state retaliation. Following such crises in 2005, 2010, and on an even larger scale in 2012 with the nationalization of the disputed Senkaku/Diaoyu Islands,¹ Japanese multinationals repeatedly and consistently reported that they were reconsidering their business plans or that they were uneasy about their ability to do business in a politically and socially hostile China. Despite their stated misgivings, most firms never pulled out and resumed business as usual in China as soon as possible. Seven Eleven managed to recover and open new stores in the western city of Chongqing by late 2013 and today has almost 3,000 stores in China.

The continued resilience of the Japanese business presence has produced a key puzzle in Japan-China relations: the phenomenon of “cold politics, hot economics,” a succinct four-character saying in Chinese and Japanese that summarizes the complex relationship between the world’s second and third largest economies. Despite persistent political tensions between the two countries, their economic relationship has flourished. The story of how and why unlocks new insights into the contemporary global economy.

The quiet persistence of these companies in the face of political and social hostility explains key elements of contemporary globalization. Firms internationalize seeking profit, but as they leave their borders they become overseas representatives of their home country, and its politics and society. To keep the profits flowing, multinationals must actively manage frictions arising from political crises. To sustain their international business interests while facing boycotts, property damage, export controls, and sometimes violence, multinational firms need to either manage the risks or exit the essential overseas markets. Their political crisis management can become an active political intervention as firms attempt to transform the foreign environment in which they are embedded.

This role of the multinational firm is under-theorized and little understood in the international political economy literature. Firms, not states, are at the front lines when a political dispute cascades into the market sphere, yet the analytic focus has rested largely at the level of the state. Multinationals have needed to formulate new risk management strategies as their constituency has increased from home-country stakeholders and consumers to host-country governments and local populations. These new strategies, in turn, bring new political roles for multinational companies. This book brings the multinational firm to the foreground in the study of international politics and economic exchange.

The complex and contentious case of Japanese firms in China provides an opportunity to unpack the dynamics of political and social risk management across borders. More cross-border direct investment flows have led to new roles for multinationals, as well as to new challenges. Multinationals are welcomed as bringers of much-needed capital, jobs, tax base, or new technologies, but can also be targets of xenophobia and nativism. Although they are seldom directly responsible, they can even be held accountable for the foreign policies of their home countries.

When the national identity of a firm presents serious challenges to their ability to conduct business, how does it affect their long-term viability in the foreign country? How and why does a multinational make the decision to stay, to go, or to try to actively manage the political situation? What variables influence the decision-making process? When a firm decides to stay, does it do so passively, or does it actively engage in political risk management strategies? How do those strategies affect the state and society hosting the firm? Using a unique combination of evidence from qualitative interviews in Japan and China and quantitative firm- and sector-level data, this book examines firms’ active responses to political crisis. We have long studied the role the multinational firm plays in encouraging globalization. Now we need to know the role of the multinational in globalization’s backlash.

International conflict and economic exchange

Existing literature contains conflicting arguments on how firms will react to interstate tensions: while some argue that the expectations multinationals hold about relations with economic partner countries means that trade or foreign direct investment are not linked with politics, others find robust evidence that politics can depress economic exchange. There are three related issues in this broad research tradition on the relationship between international politics and financial flows. First is how politics affect economic flows, traditionally examining how war affects trade. The empirical record is mixed for the relationship between conflict and trade, with some finding that “trade follows the flag” and decreases after incidents of conflict (e.g., Pollins, 1989; Keshk, Pollins, & Reuveny, 2004; Keshk, Reuveny, & Pollins, 2010), some finding no ex post correlation (Morrow, Siverson, & Tabares, 1998), and others discovering correlation conditional on how predictable the conflict was (Li & Sacko, 2002; Long, 2008).

The second research tradition, arising from the first, differentiates between types of conflict and types of flows (for example how war, civil war, or terrorism affect trade, direct investment, or portfolio investment). Much of the literature looks primarily at country risk in the lens of militarized interstate disputes (MIDs) or “historical cases of conflict in which the threat, display or use of military force short of war by one member state is explicitly directed towards the government, official representatives, official forces, property, or territory of another state” (Jones, Bremer, & David Singer, 1996, p. 163). MIDs are conflicts short of outright war, but still containing a threat of violence. There are also approaches that focus on specific types of conflicts, such as territorial disputes (Simmons, 2005, Wellhausen, Carter, & Huth, 2018), Dalai Lama visits (Fuchs & Klann, 2010), or terrorism (Nitsch, 2004). In his study of Taiwan-China relations, Kastner defines conflict more broadly as the “extent to which the political goals or interests of two countries diverge” (Kastner, 2009, p. 6). Interstate conflict is a continuum with outright war on one end, and spats between countries with closely aligned interests on the other.

The research on foreign direct investment directly addresses how multinational firms might respond to political problems on this continuum. Foreign direct investment is arguably even more sensitive to politics than trade because of investors’ longer time horizons and higher start-up costs. Brick-and-mortar investors have more to lose in the event that a political crisis prevents or slows down production, using the same logic that applies to political risks such as property expropriation. If a crisis makes the host country too dangerous to conduct business, particularly in a dramatic case like an all-out war, the company faces the danger of losing everything permanently.

The third approach is an extension of the first two, examining how economic actors such as firms specifically react to adverse events. Within the third research tradition, including this book, the analysis has been concerned with a key observation. In the aftermath of political violence or diplomatic conflict, there are consistent discrepancies between the stated and revealed preferences of multinational firms with regard to country risk. Businesspeople often claim they are deeply concerned about the diplomatic, political, and social risks of a foreign country, but their behavior often does not always reflect that stated concern. While surveys of investors show that they take political risk into account in their business decisions, empirical studies of risk and FDI flows have findings just as mixed and contradictory as those on trade (Li, 2006, see also Nigh, 1986; Li & Vashchilko, 2010; Czinkota, Knight, Liesch, & Steen, 2010). In other words, while the statements and surveys from businesspeople on the front lines of globalization indicate that politics are important in their decision-making, the results of many large-N statistical analyses contradict those statements.

A commonality – sometimes implicit – in these three approaches is the importance of how businesspeople actually understand the political situation and its implications for their firm. The degree of uncertainty firms (or sometimes states) have about the timing, severity, and duration of a conflict and whether it will affect their bottom line is instrumental in how they will respond. The influential rational expectations approach, for example, looks at the prior beliefs firms hold with regard to relations with their economic partners, and makes predictions based on the level of certainty a firm has about how these relations will affect their ability to do business. In this approach, firms either anticipate conflict ex ante and establish trading relationships or a level of FDI at the level where they are comfortable with the predicted costs of political conflicts, or react to conflict ex post, either by absorbing the higher transaction costs or withdrawing from the market. Addressing war and trade, Morrow states:

Because a dispute has no aggregate effect on trade flows, it appears that economic actors engaged in trade have already used the pre-existing state of political relations to judge the chance of a militarized dispute and reduced activities if poor relations indicate that a dispute may be in the offing. Consequently disputes themselves may have no direct impact on trade flows: their impact has been absorbed by economic traders’ anticipation of such conflict.

(Morrow, 1999, p. 488)

Businesspeople certainly can anticipate business risks from international relations and either refrain from engaging in economic exchange or preemptively scale back the extent of an economic relationship. They can, in other words, pre-pay “the costs of economic conflict in trade before a dispute occurs” (ibid.). The nature of the conflict, and how well firms can predict it, are pivotal in whether the conflict will depress trade. When conflict can be forecasted ex ante, firms expect that the future conflict will make investment less profitable, and adjust appropriately. Due to their adjustments, no statistical correlation between conflict and trade will be observed. In cases of conflict where the severity or duration cannot be reliably predicted ex ante, the ex post effects of unanticipated militarized disputes will cause an observable decrease in trade.

The rational expectations logic of international trade can be applied in a largely parallel way to FDI, predicting that firms will limit or forego their investments to countries with higher levels of risk or uncertainty, whether defined as international conflict or quality of political institutions, as is more typical in the literature. Political variables such as democratic governance or the strength of a property rights regime reduce uncertainty in the business environment and hence decrease risk firms face from host governments. Regime type (democracy versus non-democracy) (Jensen, 2003; Jensen & Young, 2008; Guerin & Mazocchi, 2009), the quality of a country’s governance infrastructure (Globerman & Shapiro, 2002a, 2002b), the strength of property rights regimes (Ahlquist, 2006), or a country’s credit or risk rating (Bevan & Estrin, 2000) can affect FDI flows. Investment overwhelmingly goes to democracies over non-democracies, and to countries with strong and durable property rights over countries with weak rule of law (Li & Resnick, 2003). Investors self-report that political risk, including unpredictable changes in FDI policies, property expropriation, labor unrest, or anti-foreign social movements in the host country, is a serious consideration when making investment decisions (Tarzi, 1992; Porcano, 1993). In cases where interstate political conflict remains largely nonviolent and involves powerful domestic interests with a stake in international economic integration, economic flows and conflict might also be decoupled (Kastner, 2009; Davis & Meunier, 2011).

An answer to the question of how ex ante expectations are formed and shared amongst co-patriots is less clear from existing research. Do all Japanese businesspeople, in other words, perceive the risks and benefits of the China market in similar ways? Spending ten minutes with any international business magazine will quickly leave you with the conclusion that there is little to no consensus about the future of the Chinese economy, the Chinese political system, or the extent or style of political intervention to expect in the market. Businesspeople likely share these knowledge gaps, and incorporating how their fears and uncertainties influence business strategy helps us understand the cold politics, hot economics phenomenon as well as broader lessons about contemporary globalization.

Economic sociologists offer some insight. They distinguish between risk, where actors can make clear probabilistic calculations of what a danger is and how it will affect their bottom line, and uncertainty, where they cannot (Beckert, 1996; Woll, 2008). Uncertainty arises partially from differences in what is often labeled “business culture,” or different negotiation styles, time horizons, and the everyday “common sense” of how people conduct business. These considerations lead to a root question in economic sociology: whether business actors “can, even in highly contingent situations, deduce their actions from a clear preference ranking and thereby maximize their utility” (Beckert, 1996, p. 8). Socially embedded economic actors formulate actions based not only on a rational calculation of costs and benefits, but also on social interactions within the society in which they are embedded (Granovetter, 1985). Multinational firms are certainly economic agents of their own societies, but also become embedded economic actors in a host society. As they struggle to manage political crises unavoidable because of their country of origin, they can become political agents in their own right as they undertake to transform the social attitudes of the location in which they are embedded. Firms’ risk management activities can become more than hedging strategies; they are political interventions, or attempts to transform and even control the nature of the risk itself. The issues firms struggle with arise from social attitudes within China towards Japanese, the relevance of bilateral history in contemporary politics, often tense interstate relations, and the nuanced and complicated ways Japanese businesspeople interpret these variables.

Risks include not only rapid changes in policies or political leadership, but also social uncertainties arising from the beliefs, values, and attitudes of the host state population. Sometimes the dangers come directly from the state, but often they arise from social forces within society. Tense political relations between countries are not just about uncertainty about future stability: they can also affect the bottom line of multinationals directly in the near term. Sometimes popular groups in society will target a business directly, without using the government as an intermediary. Consumer boycotts, property destruction, or lost contracts are all potential threats to a multinational’s profit line. So too is uncoordinated discriminatory consumer behavior if a product is not purchased because of the nationality of the parent company. When faced with these challenges, the company needs to respond to all sources of the risk, be it the host society or the state. Whi...