California ranks far ahead of other states and all but a handful of countries in Japanese manufacturing investment, but the state's dominant position is gradually eroding as Japanese firms choose Mexico and other parts of the United States, particularly in the Southeast and Midwest, for new investments and as sites to transfer existing operations from California, according to a new report. High labor and land costs are the primary factors underlying the trend, but another cause is a perception among Japanese executives that sites outside of California offer equal or superior work forces and supplier networks, according to Martin Kenney, a professor of applied behavioral sciences at the University of California, Davis, and co-author of the report with James Gordon, a research assistant. "California has to seriously reevaluate its perception of itself and its attractiveness to Japanese firms," Kenney said. "The Japanese have done it and are continuing to do it." The report, published Aug. 12 by the California Policy Seminar, examines the extent and geography of Japanese investment in California and the rest of the United States. It is based on an analysis of information gathered largely from the Japan Economic Institute and the U.S. Department of Commerce, as well as interviews with about 70 American and Japanese senior and mid-level managers at Japanese corporations. The California Policy Seminar is a joint UC-state government program that funds policy research. Japanese investment in the U.S. economy has become an increasingly politicized issue during the last decade but, the authors say, it has been an important contributor to the California economy, reaching $10.4 billion during that period. As of 1991, California had 20 percent of the Japanese majority-owned manufacturing plants in the United States. The bulk of the investment in California is concentrated in six counties, in order of investment level: Los Angeles, Santa Clara, Orange, San Diego, Alameda and Riverside. In California, the industry in which Japanese companies have invested most heavily is electronics, a broad category encompassing consumer electronics, semiconductors and semiconductor manufacturing equipment, computers and office automation. Automobiles, steel, chemical production, agriculture and food processing also have attracted Japanese investment. Historically, proximity and a pleasant lifestyle have been the basis for California's overwhelming edge in attracting Japanese investment. However, the recent and continuing trend of companies investing in sites outside of California, in addition to comments from Japanese executives, indicate that the state is losing some of its appeal, say the report's authors. The Southeast and the Midwest are rapidly increasing their share of Japanese manufacturing plants, and there is a growing trend of Japanese corporations moving their U.S. headquarters from California to Atlanta, Ga., and other East Coast locations. The significance of the latter trend, said Kenney, is that the movement of headquarters is likely to result in a subsequent movement of factories, because proximity to headquarters as a way of minimizing transportation time and communication costs is an important priority for Japanese plants. Tijuana has become an attractive site for locating operations involving labor-intensive activities. Japanese managers told the researchers that California workers receiving $5-6 per hour for electronic assembly work "were not significantly superior to Mexican workers" who are paid much less. Consumer electronics was the first industry in which Japanese corporations invested heavily in the United States, especially in California. Of the 13 Japanese television plants opened in the country since 1972, four are in California, more than any other state. However, of the six built since 1980, only one was in California, and Sony has announced that it will move the bulk of its television production activities to Pittsburgh. In addition, Toshiba and Matsushita have picture tube plants in Horseheads, N.Y., and Troy, Ohio, respectively, and Sharp has an assembly plant for flat-panel display screens in Camas, Wash. Other industries are choosing locations outside of California as well. Fujitsu originally planned to build a semiconductor fabrication facility in San Diego, but due to high costs decided to locate the plant in the Portland, Ore., area. In fact, the Portland area has been gaining Japanese production facilities in the semiconductor field at a steady pace, and will continue to do so, say Kenney and Gordon. Sixty percent of the silicon wafer production in the United States is located there, as are plants by Toshiba, Intel and Sharp. Although cheaper labor and land costs are the primary factors drawing Japanese investment away from California, Japanese managers interviewed for the report also cited a better trained work force and a superior manufacturing infrastructure in other parts of the country. Locations such as the South and Midwest have better supplier networks, and have begun programs to improve them. Manufacturing plants also often create a "multiplier effect" by attracting suppliers to their locations. Kenney and Gordon say that Japanese executives do not share the assumption by many California policy-makers that the state is such a large market that it will continue to attract Japanese investment. On the contrary, the authors say, the executives view California as a relatively small part of the entire U.S. market easily served from Asia. The Southeast and Midwest, on the other hand, are viewed as excellent options from a distribution standpoint, because plants can be situated within 500 miles of 40-50 percent of the national market. One area in which Japanese investment continues to be strong in California is in small, high-technology start-up firms. This represents a double-edged sword, however, because the investments often are accompanied by agreements granting the Japanese firms manufacturing rights to the products invented by the start-up firms. Consequently, the U.S.-made innovations do not necessarily lead to a "multiplier effect" of their own within their geographic region. If U.S. industry continues to decline and there are rapid cuts in defense spending, then Japanese investment will play an important role in the future, Kenney and Gordon say, especially in California, which has relied so heavily on military contracts. They say that coherent economic policies are needed to attract the foreign, and especially Japanese, investment necessary to revive and sustain California's economic health.