(Excerpt) China is becoming the workplace of the world, so we are increasingly told. Jeffrey Garten, dean of the Yale School of Management, writes, "Will China's importance to global manufacturing soon resemble Saudi Arabia's position in world oil markets?" And the world economy might "soon become dangerously vulnerable to a major supply disruption [in China] caused by war, terrorism, social unrest, or a natural disaster" (Business Week, June 17, 2002).

Its growth in manufacturing is impressive. Manufactured goods exports rose during the 1990s at a 15 percent annual rate to about $220 billion in 2000. On one estimate, China now makes 50 percent of the world's telephones, 17 percent of refrigerators, 41 percent of video monitors, 23 percent of washing machines, 30 percent of air conditioners, and 30 percent of color TVs. Many companies in the United States, Japan, Taiwan and elsewhere are moving operations there. Jobs are shrinking in Mexico's factories as work shifts to China. The building space of foreign contract manufacturers grew from 1.6 million square feet in June 1999 to 5 million square feet two years later.

The causes are China's opening to the world; its abundant supply of cheap, competent labor (with wage rates 5 percent of those in the United States or Japan and one-third of Mexico's--and no trade unions); a high savings/capital formation rate; and an influx of direct investment that brings technology with it. Moreover, there are still around 300 million workers in low-income, primary producing sectors, largely agricultural, that is a reserve pool of labor for industry. ...

How much does it matter that Japan creates relatively few new high technology companies? Many observers estimate, or at least assume, that entrepreneurial dynamism and its associated innovations promote economic growth and in the long run are necessary for it. In recent years there has been much attention devoted to fostering such new firms in many countries, including Japan, with much of this interest derived from the example of Silicon Valley. Before the 1990s, after several decades of excellent performance by the Japanese industry, any observer noting that it had few new high tech companies would probably have met with indifference. Success spoke for itself. Now, after an economic plateau lasting over a decade, questions about the late and relatively small-scale emergence of high tech startups have become increasingly salient.

Foreign banks have long faced difficulties in attempting to enter certain Japanese financial markets. This is due partly to regulatory practices and partly to specific Japanese socioeconomic conditions, for instance the system of relationship banking. While retail banking is still a sector in which almost no foreigners have been able to succeed, some foreign financial institutions have been able to gain market share in investment and wholesale banking.

Today, Japanese financial markets offer a bizarre playing ground for foreign competitors.On the one hand, overdue reforms, deteriorating stock markets, and shockingly bad ratings should scare many foreigners away from making commitments to Japan's markets. On the other hand, it is just these problems and the dissatisfaction with the Japanese banking sector, as well as an increasing division of the Japanese economy into large global players and small domestic companies, that might help a few strong foreign banks with superior global capabilities overcome their liability of foreignness. Indeed, we assume that improved market opportunities for foreign banks in Japan are related to a fundamental lack of global capabilities on the part of Japanese financial institutions, despite their pronounced advantages as local players. In contemplating the future of foreign financial institutions in Japan, we propose three scenarios. Japan is often compared with Great Britain, where the term "Wimbledon effect" was coined after deregulation of Britain's financial markets--the "Big Bang"--resulted in the acquisition of many British banks by foreign companies. (The analogy refers to the fact that although Britain provides the world's foremost arena for tennis at Wimbledon, the winners of the Wimbledon tournament tend to be foreign players.) The Wimbledon effect would predict that market deregulation will strengthen the financial center but lead to asituation in which markets are dominated by foreign banks. Focusing on investment banking, our paper examines whether Japan faces the same developments as did Great Britain, whether the Wimbledon effect is a plausible scenario for Japan, and whether the analogy between the two financial centers is suitable.

The two other scenarios are strong positions of foreign-Japanese joint ventures ("mixed double") and the continuing dominance of Japanese financial-service providers ("home run").While domination by foreign financial institutions has come to pass in Britain, its BigB ang has at the same time boosted London's position as a financial center. However, in this paper we will explain why Japan's case is different from the situation in the British financialmarkets. Not only is market domination by foreigners in Japan an effect that cannot be expected in the medium run, but Tokyo's domestic orientation distinguishes it from so-called global centers such as London and New York and makes it highly vulnerable in the current situation. Japan's long-lasting economic problems, Tokyo's historical lack of a greater region it has served as a financial center, and an increasing need for globally competitive financial services by large international Japanese corporations cast doubt on the future status of Tokyo as a leading financial center.