Where Production Happens, Where Income Lands

The Japanese parent–affiliate mechanism becomes an economy-wide question once we ask how firms serve the same foreign customers. This chapter follows exports made in Japan and affiliate production made abroad into GDP, gross national income, the trade balance, direct-investment income, and the current account. The goal is to understand why a more affiliate-intensive economy can receive more foreign income from a depreciation while producing less of the adjustment at home.

Two channels can serve the same foreign customer

A Japanese multinational can reach a foreign customer through at least two organizational routes. It can produce a tradable good at a Japanese plant and export it. Or it can produce through an affiliate located in the foreign market. The customer may be buying a similar product either way, but the location of production and the path of the payment are different.

In the export route, production takes place in Japan. Japanese workers and firms supply the domestic value added, the shipment crosses a border, and the receipt enters Japan’s trade balance. If a weaker yen shifts foreign demand toward that good, the response can appear as more production in Japan, stronger exports, and a better trade balance.

In the affiliate route, production takes place abroad. The affiliate may use local workers and local facilities to serve customers in its host market or elsewhere. That output contributes to the foreign economy’s production, not Japan’s GDP. If part of the affiliate’s operating income accrues to the Japanese parent, the income enters Japan’s direct-investment-income receipts. It can raise Japan’s gross national income and support the current account, but it does not become a Japanese export or domestic GDP simply because the parent owns the affiliate.

This is the accounting form of the distinction between production location and income location. GDP measures production within Japan’s borders. GNI measures income accruing to Japanese residents, including income associated with assets and firms abroad. A Japanese-owned affiliate in Thailand can add to Thailand’s GDP while sending income to a Japanese parent that adds to Japan’s GNI. Conversely, an affiliate of a foreign multinational producing inside Japan contributes to Japan’s GDP because its production is located in Japan, while income paid to its foreign parent is a direct-investment-income debit. Physical location and ownership answer different questions.

The current account keeps those questions connected but does not erase them. In the paper’s decomposition, the current account equals the trade balance plus the direct-investment-income balance and other components, including portfolio income and secondary flows. An improvement in the current account can therefore be trade-led, income-led, or a mixture. A larger direct-investment-income surplus can offset a weaker trade balance, but it cannot turn production abroad into production at home.

Parent support complicates the classification further. In the model’s benchmark, support sent from a Japanese parent to its foreign affiliate is treated as an internal, unpriced input.