The increase in inward foreign direct investment (FDI) since the late 1990s represents an important development at a time that Japan's economy – despite the recent recovery – continues to face severe challenges. Policy makers recognize, at least in principle, that if the country is to prosper, it will have to embrace globalization more fully. However, whether Japan is truly prepared to do so and, in particular, to provide the kind of environment that attracts foreign firms and allows them to play the same kind of role they do in other advanced economies remains in doubt. On the one hand, the country has certainly come a long way when compared with little more than a decade ago: in the mid-1990s, few would have expected that traditional patterns such as cross-shareholdings and lifetime employment practices would unravel as quickly as they did and mergers and acquisitions (M&As), including cross-border ones, become commonplace. On the other hand, these fundamental changes came about as a result of exceptional circumstances that are unlikely to be repeated, and many other features persist, including pervasive regulation, resistance to a more laissez-faire market system, and a low degree of internationalization of society in general.

Against this background, the purpose of the present chapter is to consider the longer-term prospects for FDI in Japan by looking at the factors that determine the country's attractiveness for foreign firms and its willingness and ability to play host to them. Four broad topics are considered.