On Investments, Japan, R&D and Capital Markets

I was listening to one of  Jesper Koll’s talks in which he’s trying to sell Japan to global investors. His arguments, which include the creation of a new middle-class in Japan, an extremely asset-rich and liability-free layer of senior citizens and expertise in high-tech manufacturing, are all very persuasive arguments.

But one of his comments struck me as being odd – “You don’t invest in a country, you invest in its companies”.

While that does sound logical, it implies that the only way to invest in a country is through its capital markets – a thing that might be true for Japan but not true for many other markets – including almost all of the emerging markets.

In fact, if anything, Japan (through its companies) is probably one of the biggest investors in countries like India and China – directly setting up manufacturing plants across these countries and being one of the top foreign direct investors in numerous regions.

Which leads me to the conclusion that perhaps Koll’s comment is more of an exception – and one quite applicable to Japan – rather than the rule. Japan’s history of not opening itself up to the world till the Meiji-era has had a big role to play in this and, even during its economic hey-day during the 1980s, it was a very poor market for foreign exporters (barring luxury goods, tourism and raw materials).

While that has subsequently changed a bit with Japan now importing capital goods (such as machinery – and even much of that is a re-import of stuff produced by Japanese JVs in other countries), you’d scarcely find manufacturing plants belonging to foreign multinationals in the country (this, of course, isn’t true for the services sector).

However, Koll’s point does highlight an important feature of well-functioning capital markets – that it allows investors to get exposure to the upside of domestic companies – something a capital-starved country like India could definitely do with.

There is a complementary feature within the Japanese private sector that encourages foreign investors to take such an exposure – the bulk of R&D spending in Japan is performed by the private sector. (At 3.4% of GDP, this figure is higher than that of the US and is surpassed just by Korea and Israel – whose capital markets are much shallower than that of Japan).

Compare that with India – where the bulk of R&D spending is done by the government – the upside of which isn’t really available to investors. The Indian private sector must take the lead in doing credible research to attract capital flows – there are severe impediments to this currently – but, nevertheless, it is the way forward if India is to ever attract capital at the same scale as any of the developed markets.

(In fact I consider the current VC-funded startup boom in India as a reflection of this. It is currently more about risky D than R, as implementation and execution is key in the Indian markets – however, R cannot be that far behind).