By Boudewijn Vermolen

Student number: 325481

Supervisor: Prof. Dr. Enrico Pennings

Erasmus School of Economics

Bachelor Thesis

August 2012

The effects of inward

foreign direct investment

on employment

A review of the literature

AbstractForeign direct investment is one of the most important international factor movements. In this

capacity it can have a major effect on a host country its employment. The range of effects covers

different dimensions of employment, the quality, quantity and location are all affected differently.

This bachelor thesis examines what these effects are and their significance for employment. This

is done by reviewing the current body of literature on foreign direct investment. Furthermore

attention is given to policy with regard to foreign direct investment and employment. The many

intricacies surrounding foreign direct investment make it a topic of which parts are already well

documented but many others are still in need of additional research.

Keywords: Foreign direct investment, employment, quality, quantity, location, policy, literature

review

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Table of ContentsAbstract.............................................................................................................................................2

Table of Contents.............................................................................................................................3

1 Introduction..............................................................................................................................4

2 What is foreign direct investment?...........................................................................................5

3 Foreign direct investment and employment.............................................................................7

4 Foreign direct investment and the quantity of employment.....................................................9

4.1 The direct effects of foreign direct investment on the quantity of employment..............10

4.1.1 Greenfield type investment.......................................................................................10

4.1.2 Merger & Acquisition type investment....................................................................10

4.2 The indirect effects of foreign direct investment on the quantity of employment..........11

4.2.1 Local linkages...........................................................................................................12

4.2.2 Crowding in or out....................................................................................................13

5 Foreign direct investment and the quality of employment.....................................................15

5.1 Wages...............................................................................................................................15

5.2 Productivity......................................................................................................................17

6 Foreign direct investment and the location of employment...................................................20

7 Policy and foreign direct investment......................................................................................22

8 Conclusions............................................................................................................................24

Literature........................................................................................................................................26

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1 IntroductionForeign direct investment has been a subject of interest for many years now and has continued to

be one in recent years. One of the reasons for this interest is that foreign direct investment or FDI

has in the last decades seen a massive surge, according to UNCTAD (2012) the foreign direct

investment inward stock of the world has grown from 2.081 billions of dollars in 1990 to a

14.588 billion pre-crisis average in 2005-2007 and has continued to grow to reach a staggering

amount of 20.438 billion in 2011. An increase of more than 882% in little over 20 years. Because

of the current worldwide economic turmoil the foreign direct investment inflows dropped from a

pre-crisis average between 2005 and 2007 of 1.473 billions of dollars to only 1.198 in 2009.

However the inflows have gradually picked up again since then and have reached 1.524 billion in

2011, surpassing the pre-crisis average. Though the subject of foreign direct investment and its

pattern in time is interesting enough by itself it is not the subject of this thesis. The focus of this

bachelor thesis will be on how inward foreign direct investment affects the employment of a

country or region.

Though a relation between inward foreign direct investment in a country or region and the

employment of the country or region is evident, the direction and/or strength of that relationship

is not. There are many factors and mechanisms both direct and indirect through which foreign

direct investment has an influence on the employment of a region. Therefore much debate still

exists surrounding the topic. The purpose of this bachelor thesis will be to give an outline of

contemporary economic thought on the subject. In chapters 2 and 3 an outline is giving of what

foreign direct investment comprises, and how it may have an impact on employment. Chapters 4,

5, and 6 deal with the effects on the quantity, quality, and location of employment respectively.

In chapter 7 past and present policy towards foreign direct investment is discussed. Finally in

chapter 8 the conclusions will be presented.

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2 What is foreign direct investment?Foreign direct investment has been described slightly differently by different authors. Foreign

direct investment (FDI) is the process whereby residents of one country (the source country)

acquire ownership of assets for the purpose of controlling the production, distribution and other

activities of a firm in another county (the host country). (Moosa, 2002) FDI in a broader sense

can be referred to as an investment involving a long-term relationship and control or significant

influence by a resident enterprise of one economy (direct investor) in another enterprise resident

in an economy (direct investee) other than that of the investor. (Asafo-Adjei, 2009) In an effort to

get a working definition for foreign direct investment the OECD Working Group on International

Investment Statistics came with the following summarization of their definition. Foreign direct

investment (FDI) is a category of investment that reflects the objective of establishing a lasting

interest by a resident enterprise in one economy (direct investor) in an enterprise (direct

investment enterprise) that is resident in an economy other than that of the direct investor. The

lasting interest implies the existence of a long-term relationship between the direct investor and

the direct investment enterprise and a significant degree of influence on the management of the

enterprise. (OECD, 2008)

The keyword in most definitions and that of the OECD is control. This is what sets foreign direct

investment apart from indirect investments such as portfolio investment, where investors’ main

objective is usually not to exert control. This is also stated by UNCTAD (2011) in its World

Investment Report: The defining feature of FDI, to distinguish it from other forms of investment,

is a significant level of control (a minimum equity stake of 10 per cent in host-country business

entities) and a long-term interest in the host-country operation.

Foreign direct investment can either be done horizontally or vertically. Horizontal foreign direct

investment arises when a firm copies its existing activities to another country by means of foreign

direct investment in order to expand their operations. The activities in the host country are on the

same stage of the value chain as those in the home country. Vertical foreign direct investment is

when the foreign direct investment moves the company upstream or downstream in the value

chain.

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Besides making the distinction between horizontal and vertical foreign direct investment.

Contemporary literature often divides foreign direct investment into two primary modes of entry;

greenfield investments and mergers and acquisitions.

FDI may involve either the establishment of a new production facility, a so-called “greenfield”

investment, or a purchase of (shares in) an existing foreign firm, a cross border acquisition.

(Bjorvatn, 2000) In the context of public debate, a sharp distinction is often drawn between

“greenfield” investment, providing fresh capital and additional jobs, and M&As that are

perceived to include only a change of ownership in an existing corporate entity. (OECD, 2008)

There are diverging trends between the two main modes of FDI entry: M&As and greenfield

(new) investment. (UNCTAD, 2011) The literature distinguishes two primary modes of foreign

direct investment (FDI); greenfield (start-up) and acquisition. (Meyer & Estrin, 2001) When a

multinational enterprise (MNE) decides to invest equity in a foreign country, it faces at least two

strategically important decisions: firstly, whether to buy an existing foreign entity (launch an

acquisition) or establish a foreign operation from scratch (invest in a greenfield facility); and,

secondly, whether to do it alone (establish a wholly-owned subsidiary) or involve a local partner

(create a joint venture). (Dikova & Witteloostuijn, 2005)

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3 Foreign direct investment and employmentAccording to Figini & Görg (1999) the total employment share of foreign-owned multinationals

in Ireland has increased constantly between 1979-1995 to 44.9 percent in 1995, although there

are differences across sectors. UNCTAD (2012) shows an increase of 221 percent of employment

by foreign affiliates worldwide between 1990 and 2011. What these figures show is that inward

foreign direct investment is inextricably linked to employment. Potentially foreign direct

investment could have a positive effect on employment, both on the employment rate as on the

wage rate. However this is not necessarily true. To illustrate this argument let us take the example

of a fictitious European multinational corporation with the desire to expand its business across

the Atlantic. It chooses to do so by incorporating a completely new startup in the United States.

At first glance one could easily argue that the incorporation of a new startup in the US would

have a positive effect on the number of jobs in the US economy, as almost every new business

requires additional labor input. Furthermore the increase in labor demand would have a positive

effect on the wage rate. However one could just as easily make the counterargument that the

entry of the multinational enterprise crowds out the domestic firms, and therefore has no effect or

even a negative effect on the employment of the US. This could again be countered by saying

that the new enterprise might have an indirect effect on employment since it would require the

services of some of the domestic firms. Even a simple example such as the previous illustrates

that there are many different factors and mechanisms through which foreign direct investment is

linked to employment. Furthermore it illustrates the current discussion regarding foreign direct

investment and employment. As this is one of the reasons why contemporary scientific literature

dealing with foreign direct investment diverges on the subject of its influence on employment. A

similar conclusion was reached by (OECD, 1995) stating:

Numerous empirical studies have been undertaken throughout the last 20 years to examine the

employment effects of FDI in manufacturing industries. No general conclusion has evolved either

regarding the sign of the employment effects or their magnitude. (p. 140)

As stated before the effects of foreign direct investment on employment depend on several

factors. The first and most important factor is the mode of entry. Whether foreign direct

investment is done through a greenfield investment, or a merger or acquisition can affect the

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employment of an economy in different ways. A fact also recently brought forward by UNCTAD

(2012), “M&As clearly do not bring the same development benefits as greenfield investment

projects, in terms of […], employment and so forth.” (p. 6) In turn the effects can be either direct

or indirect, the sign of the relation can be positive or negative and can have an effect on both the

quantity and quality of employment. Furthermore they can have an effect on the location of

employment. UNCTAD (1994) gives a broad overview of the range of different effects inward

foreign direct investment may have on the employment in the host country, see Table 0-1.

In order to give a correct overview of the literature regarding this subject it is useful to continue

by classifying the research as either mainly focused on the quality dimension or the quantity. And

whether or not the proposed effects are direct or indirect.

Table 0-1 : The range of potential effects of foreign direct investment on the quantity, quality and location of employment

Direct Indirect

Area of impact Positive Negative Positive Negative

Quantity Adds to net capital and creates jobs in expanding industries.

Foreign direct investment through acquisition may result in rationalization and job loss.

Creates jobs through forward and backward linkages and multiplier effects in local economy.

Reliance on imports or displacements of existing firms results in job loss.

Quality Pays higher wages and has higher productivity.

Introduces practices in, e.g., hiring and promotion that are considered undesirable.

Spill-over of ‘best practice’ work organization to domestic firms.

Erodes wage levels as domestic firms try to compete.

Location Adds new and perhaps better jobs to areas with high unemployment.

Crowds already congested urban areas and worsens regional imbalances.

Encourages migration of supplier firms to areas with available labor supply.

Displaces local producers, adding to regional unemployment, if foreign affiliates substitute for local production or rely on imports.

Source: (UNCTAD, 1994, p. 167)

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4 Foreign direct investment and the quantity of employmentWhen we talk about the effects of foreign direct investment on the quantity of employment, the

main question that we face then is simple: Does foreign direct investment result in job creation or

job loss? Or is the status quo maintained? As stated before the effects of foreign direct investment

are twofold. We need to consider both the direct and the indirect effects. Let us first consider the

direct effects. What is the direct effect of an inflow of foreign direct investment to the host

country’s employment? If we look at the two main types of foreign direct investment we can

think of a few possible outcomes regarding the creation or destruction of jobs. When the

investment is done through a greenfield investment we expect job creation. A new business is

founded, which requires human capital input and therefore creates jobs. When we regard the

other entry mode, merger or acquisition, a few different scenarios are possible. The transfer of

control from domestic to foreign ownership may mean one of a few things. Either jobs are

created. Either because the business expands because of the new investment, or because without

the foreign investment the corporation would face closure. The level of jobs are maintained,

because the investment requires no change in human capital. Or, and this is often the most likely

scenario, jobs are destroyed. Because the new foreign control means a restructuring of the

corporation resulting in job loss. All this is of course an oversimplification of the possible direct

outcomes of foreign direct investment.

The fact that foreign direct investment is heterogeneous and that the impact on employment is

indeed dependent on amongst other factors on entry mode is also recognized by Williams (1999).

Who says that the mode of entry will have a considerable influence over impact. Where

development through a greenfield investment generally produces new employment effects (even

though employment within indigenous firms may be reduced). The effects resulting of foreign

entry by means of a merger or acquisition are ambiguous since they depend upon the nature of

the post-merger organization.

In addition of having a direct effect, foreign direct investment can also have a number of indirect

effects on employment. Domestic firms in the host country that are vertically linked to foreign

controlled entity, such as suppliers, subcontractors, consultants and buyers, are likely to see a

positive effect on employment when the investment increases the demand for local inputs.

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However transnational corporations often already have links with other firms, for instance those

in their home country, which could mean they would establish relatively fewer linkages with

domestic firms than a similar local firm would. Furthermore there are effects on the indigenous

firms competing with the multinational. The foreign entry gives rise to an increase in competition

forcing local firms to become more efficient, if they manage to do so these business may flourish

creating new employment opportunities. If these businesses are not able to compete with the

foreign controlled enterprise, this could lead to job loss. (Lall, 1995)

4.1 The direct effects of foreign direct investment on the quantity of employment

It is worthwhile to divide the direct effects of foreign direct investment between the two main

modes of entry: Greenfield, and mergers and acquisitions.

4.1.1 Greenfield type investment

Since greenfield investments actually add up to the productive capacity, it is highly likely that

they have a positive direct effect on employment. Regarding greenfield investment this is also

what Hastenberg (1999) found in his research of the effects of foreign direct investment on

Hungary: Our survey shows that greenfield investments indeed have a strong positive effect on

employment. In total, the greenfield companies in our survey have created close to 9,000 jobs.

According to Ernst (2005) "employment steadily increased in Mexico (21.6 per cent) due to

greenfield investments in maquiladoras" Williams (1999) examined the effects of regional

economic impact of the subsidiaries of foreign-owned firms in the UK, finding a direct effect of

companies entering by way of greenfield investment on employment. Those companies created

more jobs between entry and the time of the survey, with some 75 per cent recording an increase

in employment.

4.1.2 Merger & Acquisition type investment

The effects of acquisition are were also researched by Hastenberg (1999) though only of

privatization of state owned companies by foreign investors in Hungary. The conclusion of the

research was that contrary to their expectations the employment effects are not negative per se,

half of the foreign privatized companies in the research have shown an increase in employment.

According to Girma (2005), who examined the direct employment effects of acquisition foreign

direct investment in the U.K. manufacturing industry, foreign acquisitions lead to an increase in

labor efficiency. This increase in efficiency can have either positive or negative employment

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effects in the short to medium run. However since foreign direct investment promotes efficiency,

it may safeguard jobs in the long run since the survival prospects of the firms increase. Conyon,

Girma, Thompson, & Wright (2002) conclude from their empirical analysis of the effects of take-

over and merger activity on firm employment in the United Kingdom, using a specially

constructed database for the period 1967-1996 that merger activity is followed by “substantial

and statistically significant employment and output falls” however they also note that their

research probably overestimates job loss since acquisitions are often targeted at failing firms and

therefore in the absent of the merger or acquisition the loss of jobs would be even bigger. Though

their analysis does not take foreign investments in account their conclusions probably also hold

true for take-over and merger activity through foreign direct investment. Gugler & Yurtoglu

(2004) examined if mergers and takeovers have an adverse effect on labor demand. They found

that these effects were not significant in the USA. However European mergers do significantly

reduce the demand for labor by around 10 percent on average. Their analysis however is of all

mergers and acquisitions not just those done through foreign direct investment. It is however

interesting to see that there is a clear difference between the two continents, which the authors

ascribe to differences in employment protection laws.

4.2 The indirect effects of foreign direct investment on the quantity of employment

Jenkins (2006) made an attempt to map the effects of foreign direct investment on employment in

Vietnam in the 1990s, though “the results are suggestive rather than conclusive” it suggests that

the indirect effects have been minimal or even negative. Foreign investors in Vietnam import

most of their inputs, therefore they create only limited local linkages. Furthermore there is also

evidence that local firms are crowded out and rationalization by state firms to keep up with

foreign competition. Both leading in a reduction of employment.

What we also can conclude from the research by Jenkins (2006) is that the indirect effects on the

employment quantity are mostly comprised of two largely interrelated concepts or mechanisms.

Those of linkages, which may influence the demand for local products and services and

consequently the demand for employment. In turn the amount of linkages with local firms are a

large factor in either a crowding in or crowding out of indigenous enterprises, which again may

lead to a fluctuation in job creation.

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4.2.1 Local linkages

An important factor in indirect employment creation through foreign direct investment is the

amount of local linkages the foreign controlled entity may or may not have or will succeed or fail

to develop in the (near) future. The concept of backward and forward linkages, or inducement

mechanisms, was introduced by Hirschman (1958) and defined as follows:

1. The input-provision, derived demand, or backward linkage effects, i.e., every non primary

economic activity, will induce attempts to supply through domestic production the inputs

needed in that activity.

2. The output-utilization or forward linkage effects, i.e., every activity that does not by its

nature cater exclusively to final demands, will induce attempts to utilize its outputs as

inputs in some new activities.

To put more simply and apply the concept directly to foreign direct investment, local linkages

arise when the activities of the foreign controlled entity induces local firms to produce inputs for

the foreign entity (backward linkage). Or when the foreign entity does not supply in final

demand, it may induce local firms to utilize their outputs.

Linkages were the focus of a paper by McAleese & McDonald (1978), more particularly they

focused their attention on the development of linkages in new enterprises (greenfield investment)

in Ireland between 1952 and 1974, both foreign-owned as indigenous firms. They found that new

foreign-owned corporations tend to have lower linkages than new domestic enterprises. However

compared with total domestic industry the linkages of foreign-owned firms are only marginally

different from the national average. Furthermore linkages tend to increase over time in new

enterprises, particularly in new foreign-owned firms.

Barry, Bradley, & O’Malley (1999) also focused their research on Ireland and conclude that

“backward employment linkages per job in the foreign sector are now higher than for indigenous

industry”

Driffield & Noor (1999) conclude that there are significant linkages between foreign affiliates

and domestic firms in the electronics industry in Malaysia. Interesting is that there seems to be a

difference in embeddedness depending on the origin of the foreign affiliates. United States firms

have more local input linkages than that of Japanese, European or South-East Asian firms.

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However Brannon, James, & Lucker (1994) state that large number of assembly plants in

Mexico, or maquiladoras, which are mostly foreign owned use very little material inputs that are

made in Mexico.

Javorcik (2004) performed an analysis, on a firm-level panel data set from Lithuania, and provide

evidence of backward linkages from foreign presence to domestic firms in supplying industries.

The empirical literature on linkages does not seem to converge much, and seems to be fraught

with a number of problems. Giroud & Scott-Kennel (2006) still describes the literature

concerning linkages between foreign subsidiaries and host country firms as “emergent.”

Somewhat explaining the conflicting empirical evidence.

4.2.2 Crowding in or out

Largely interrelated to the concept of linkages is that of firm entry and exit. For instance strong

linkages may lead to an increase in firm entry. The consequences of foreign direct investment on

the possible entry and exit of local firms is an interesting subject by itself with regard to

employment. Evidently if a crowding out effect of domestic firms exists this would mean a

negative partial effect on employment, since the reduction of local firms would mean a loss of

jobs for the employees of those firms. In turn a crowding in of local firms would mean an

additional creation of jobs. Much research has been done on the subject. E.g. De Backer &

Sleuwaegen (2003) analyzed firm entry and exit across Belgian manufacturing industries. The

resulting in the conclusion that foreign direct investment indeed crowds out domestic

entrepreneurs on both the labor and product markets. Inward foreign direct investment leads to

both a decrease in domestic entry as an increase in domestic exit. However the results of the

analysis also suggest that long term structural effects between foreign and domestic firms can

moderate or even reverse crowding out effects.

Markusen & Venables (1999) provides a simple analysis of the different effects the presence of

multinationals may have on the host economy. First there is product market competition; the

foreign direct investment raises competition, lowering the prices of output, which may result in

some substitution of domestic firms with foreign firms on the final goods market. Second they

say there is a backwards linkage effect fostering the development of domestic intermediate good

producing firms. This would result in a fall in the price of intermediate goods, which in turn can

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have a positive effect on the development of the indigenous final good producing industry. They

present a theoretical model in which it is possible for foreign direct investment to act as a

catalyst, which will exert positive effects to the development of local industry of the host country.

Görg & Strobl (2002) applied the Markusen-Venables model and empirically tested it on the Irish

manufacturing sector. They find that the presence of multinational companies indeed has a

positive effect on the entry of indigenous firms. Mišun & Tomšík (2002) researched if foreign

direct investment has a crowding in or crowding out effect on domestic investment in the Czech

republic, Poland, and Hungary. They find that over the researched periods (1990-2000 for Poland

and Hungary, 1993-2000 for the Czech Republic) there was a crowding in effect in the Czech

Republic and Hungary, but a crowding out effect in Poland. However they note in their

conclusion that they expect that in the long term Poland will also experience a crowding-in effect.

Though their main conclusion is somewhat different saying that “the positive impacts of foreign

direct investment on domestic investment are not assured because, in some cases, total

investment may increase much less than FDI, or even fail to rise when FDI increases” Related is

the research by Agosin & Machado (2005) who used data from 36 countries, 12 in each of Africa,

Asia and Latin America from the 1971-2000 period to see whether foreign direct investment has

a crowding in or out effect of domestic investment. The main conclusion from their analysis is

that positive effects of foreign direct investment on domestic investment are not assured.

The current literature seems to indicate that the effects of foreign direct investment on indigenous

investment and firm creation vary between different economies. For the developing countries the

empirical research seems to suggest that foreign direct investment has little to no positive impact

on local investment and in some case may even be negative. The same seems to hold initially for

developed countries, however that is often if not always offset by a long term increase in net

entry in either complementary or the same industries. The implications of these results for

employment demand are straightforward. Since the effects of foreign direct investment on total

investment are ambiguous so are the effects for employment. Foreign direct investment may

indirectly lead to additional employment if it results in an increase in total investment. However

though this is often argued to be the case, especially for developed countries, it is not a necessary

condition. Especially for developing countries the effects of foreign direct investment on

domestic investment and therefore total investment the effects are ambiguous at best. And so are

they for total employment.

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5 Foreign direct investment and the quality of employmentWhen we consider the effects of foreign direct investment on the quality of employment there are

different things to consider. According to the literature foreign direct investment may or may not

cause a large array of different spillovers. Affecting in a multitude of ways the wages, the

productivity, education, labor conditions, job satisfaction etcetera of workers. The focus here will

be on the wages and the productivity of workers.

5.1 Wages

Foreign direct investments can have an effect on the wages in a few different ways. However

most of the literature converges on the fact that foreign-owned corporations seem to offer higher

wages than their domestic counterparts.

In the manufacturing industry of five African countries (Cameroon, Ghana, Kenya, Zambia and

Zimbabwe) Te Velde & Morrissey (2001) found that in the early 1990s firms owned by

foreigners paid higher wages on average than those who were locally owned.

Aitken, Harrison, & Lipsey (1996) explored the relationship between wages and foreign

investment in Mexico, Venezuela, and the United States. Despite the differences in economic

conditions and levels of development between the countries, they found one fact to be robust

across all three countries: higher levels of foreign investment are associated with higher wages.

Feenstra & Hanson (1997) found that in Mexico over the period 1975–1988, foreign direct

investment shows a positive correlation to the relative demand for skilled labor, accounting for a

large portion of the increase in the skilled labor share of total wages.

Bedi & Cielik (2002) conclude in their examination of the effect of foreign direct investment on

wages in Poland, that their results suggest a positive link between wages and foreign presence in

an industry.

It is often suggested that the positive correlation between foreign direct investment and wages is

merely a result of selection. The foreign owned firms tend to require a higher skilled labor force

which comes at a higher price. Meaning that the higher wages are merely displaced. In an effort

to address this issue Lipsey & Sjöholm (2004) found that foreign-owned plants in Indonesia pay

15

higher wages than do domestically owned plants. Not only because of a bias towards more

educated workers, but because these firms paid a higher price for labor; that is, they paid higher

wages for workers of a given education level. They also paid a higher premium for higher

education. Lipsey & Sjöholm (2003) present even more evidence for Indonesia stating that after a

foreign takeover of a domestically-owned plant, both blue-collar and white-collar wages rose

strongly, in absolute terms and relative to their industries. Whereas takeovers by domestic firms

of foreign-owned firms has the opposite effect on wages. This shows that takeovers by

foreigners, rather than takeovers in general, produce wage increases.

Why do these firms pay higher prices for labor than domestic firms, by paying higher wages for

workers of the same quality? Superior technology of foreign controlled firms compared to same

sized indigenous companies could allow them to pay higher wages if the superior technology

causes them to reach a higher marginal labor productivity. However it is more likely that the firm

would expand the output rather than to opt for higher wages. Different reasons for the higher

wages are mentioned. Host-country regulations may force foreign controlled firms to pay higher

wages. According to Findlay (1978) “we shall assume, quite realistically” that the foreign sector

pays a wage higher than the domestic sector for labor of the same quality, for purposes of good

public relations. A disfavor for foreign-owned firms of preference for local firms amongst

workers could exist, causing the foreign owned company to have to compensate with higher

wages for this preference. Employee turnover can be detrimental for foreign-owned firms

because it might mean that their proprietary technology leaks out to domestic competitors, paying

higher wages might reduce the worker turnover. Foreign firms might have more difficulty to

attract the better employees, because of an insufficient understanding of the local labor market. In

contrast to that of indigenous firms who are more abled in attracting the better workers. To

compensate the foreign firms would offer higher wages. (Lipsey, 2002)

Since the literature strongly suggests both theoretically as empirically that foreign firms pay

higher wages it is interesting to see whether or not these wages spill over to domestic firms or

raise the average wage level of an industry or region. The research on wage spillovers caused by

foreign direct investment however is still scarce, Görg & Greenaway (2001) suspect this is

“perhaps due to the higher data requirements that have to be fulfilled in order to estimate the

determinants of wages.” Though some research has been performed.

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Aitken et al. (1996) found that there was evidence in favor of wage spillovers in the United States

leading to higher wages in domestic firms, however not in Mexico and Venezuela. Wage

spillovers were also visible in Indonesian manufacturing plants in 1996 according to research by

Lipsey & Sjöholm (2001) using cross-section data. Driffield (1999) examines some of the

consequences for employment in the UK of inward investment, amongst them is the effect on

wages. The results suggest that 33% of the increase in wages paid by UK manufacturing over the

examined period was because of inward investors paying higher wages and therefore also raising

the wages paid by incumbent firms. Figlio & Blonigen (1999) analyzed data on foreign and direct

investment across industries and counties and over time in South Carolina, and found that foreign

firms tend to significantly raise wages. Their results are not able to identify however an

explanation of the rise in wages. However they do note that the within-industry raise in wages is

from such a level that based on earlier work by Howenstine & Zeile (1994) they find it very hard

to preclude any form of wage spillovers. Lipsey & Sjöholm (2005) give their own overview of

the literature concerning wage spillovers and establish that most of the evidence of positive wage

spillovers is found in developed countries. The lack of evidence for positive spillovers, or even

indications of negative spillovers, in developing countries they argue might be caused by a large

gap between foreign and domestic owned firms. Or differences in labor markets conditions.

5.2 Productivity

Productivity in the host country can be raised by foreign direct investment through a number of

different channels. First and foremost through their own productivity. According to Hymer

(1960) foreign firms are required to have some advantages that allow them to overcome the

additional costs of becoming a multinational. Since foreign direct investment often populates

industries with a high threshold for entry it may pare down monopolistic distortions, leading to

higher productivity by improving their allocation. There can be movement of highly skilled

employees from the foreign firms to domestic firms, improving the efficiency of indigenous

firms. ‘Demonstration effects’ may occur, where domestic firms learn from foreign owned firms

or copy utilized technologies. Furthermore an increase in competition by multinational entry may

force the domestic firms to become more productive by raising the efficiency of their resource

usage or update their technologies and techniques, which is referred to as the competition effect.

The competitive pressure from multinational firms may even force out the inefficient local firms,

further raising the average productivity. (Blomström & Kokko, 1998; Blomström & Wolff, 1994;

17

Caves, 1974; Girma, Görg, & Pisu, 2008; Girma, Greenaway, & Wakelin, 2001; Görg & Strobl,

2001; Javorcik, 2004)

Most of the empirical research avoids the question on explaining the exact mechanism that leads

to the spillovers and merely tries to map if foreign presence affects the productivity of indigenous

firms positively or negatively. This is understandable since the factors leading up to changes in

productivity are largely comprised of some form of knowledge flows. Either through learning of

workers or employment of different (better) technologies. These movements of knowledge are

inherently difficult to grasp, because of their often highly intangible nature. Furthermore much of

the literature fails to differentiate between the different factors of production and uses the total

factor production for their analysis.

One of the first empirical studies on the subject, if not the first, is by Caves (1974) who finds

evidence of positive productivity spillovers in the manufacturing sector of Australia. However no

evidence of spillovers was found for Canada.

Another study is by Blomström (1986) who found that “foreign presence is positively correlated

with structural efficiency in Mexican manufacturing industries.” A conclusion also reached by

Blomström & Persson (1983). As well as Blomström & Wolff (1994) who conclude “There is

strong evidence that the presence of multinational firms acts as a catalyst to the productivity

growth”.

Girma et al. (2001) find that in the UK, during the first half of the 1990s the labor productivity of

foreign firms was on average 10% higher, and total factor productivity is 5% higher than that of

domestic firms. Regarding any spillovers, they conclude that the aggregate productivity of all

domestic firms does not benefit from the presence of foreign firms. Individual firms might

however, whereas others will not, cancelling each other out. Liu, Siler, Wang, & Wei (2000)

however state that “The evidence suggests that multinational enterprises do generate positive

productivity spillovers in UK industries.” Interestingly they also note that the results suggest that

the spillovers are bi-directional.

What these results seem to indicate is that foreign owned firms indeed reach higher levels of

productivity themselves. The exact effects on the productivity of domestic firms seems to differ

however, as the research reports instances of both positive and negative spillovers.

18

Görg & Greenaway (2001) performed their own extensive analysis of the existing literature and

conclude that though the theory strongly suggests to expect spillovers “the evidence in support of

positive spillovers is rather limited”. They postulate that this is either because multinationals are

very well abled to shield the competition and protect their assets. Or it is the statistical

methodology used or the focus of the research that is at the wrong level, causing difference

results. And that further more comprehensive research is needed.

Lipsey & Sjöholm (2005) tried to unravel why different researchers find different results. They

argue that it is not so much the econometric method that biased the results, but that the most

plausible explanation is “that countries and firms within countries might differ in their ability to

benefit from the presence of foreign-owned firms and their superior technology.”

19

6 Foreign direct investment and the location of employmentForeign direct investment might have an influence on the location and distribution of

employment of a country or region. Foreign entry may be in areas of high unemployment

therefore potentially redistributing the employment in a more uniform manner. Or the opposite

might be the case, that multinationals enter in areas which already have an abundance of labor

demand making the regional imbalance even greater. Indirectly the effects can be enhanced or

countered through for instance linkages with local suppliers.

Various research has been done on the location choice of foreign direct investment. Determining

the factors that influence the choice of location for foreign direct investment. Some deal with the

choice between countries others focus on the location choice within a country. An inflow of

foreign direct investment in a certain area will have a direct effect on employment demand in that

area. Whether or not this partial fluctuation in demand is in fact additional demand or merely a

geographical shift in demand from other areas towards the area with the investment inflow is not

the focus of this chapter. This issue is more related to total employment demand and has already

been touched upon in the previous chapters.

Though the literature exploring the subject of foreign direct investment location choice is vast,

there is far less literature, or rather almost none, available with a focus on how this affects

employment location and, or, distribution. Since most literature revolves around the determinants

of location choice, and not the consequences of the ensuing choice it is difficult to determine the

effects for the location of employment. Completely reviewing all possible determinants of

location choice might prove interesting, but would go beyond the scope of this paper. Some

articles however make mention of factors highly related to employment location, which makes it

possible to make some inferences, though weak, on the effects of foreign direct investment on the

location of labor.

Some of the research argues that unemployment levels are amongst the determinants for the

attraction of foreign direct investment. For instance Billington (1999) finds that high

unemployment encourages foreign direct investment at both a country and a regional level in the

UK. A similar conclusion was reached by Coughlin, Terza, & Arromdee (1991) who researched

20

foreign direct investment within the United States, saying that “higher unemployment rates

tended to attract foreign direct investment”. These results could indicate that foreign direct

investment enters in those areas were job demand is highest, the areas with high unemployment,

therefore equalizing the employment levels within a country.

Coughlin & Segev (2000) find that a larger number of new foreign-owned manufacturing plants

are planned in urban counties than in rural counties in the U.S between 1989 and 1994. Chadee,

Qiu, & Rose (2003) find that foreign equity joint ventures in China its service sector “tend to

locate their operations in major metropolitan cities”. Though the body of literature is still small, it

suggests that foreign direct investment is more prevalent in the more urbanized areas. This would

also suggest that foreign direct investment shifts employment demand towards the urban regions.

21

7 Policy and foreign direct investmentAttracting foreign direct investment figures prominently in the list of policy priorities of many

governments. (Görg & Greenaway, 2001) Mainly because policymakers still view foreign direct

investment as a key factor in promoting economic growth. Policymakers have a multitude of

tools at their disposal to try and influence the level and composition of inward foreign direct

investment to their country. Host countries are ever changing in their attitudes towards foreign

direct investment. The current trend in policy is to “increasingly focus on the quality – and not

only on the quantity – of investment.” (UNCTAD, 2012)

Most of the literature pertaining policy and foreign direct investment, is of a more general nature

and tries to assess the effects of policy measure on attracting foreign direct investment. Drawing

from the current body of literature it is hard to identify the direct policy effects on employment

through foreign direct investment. However if we accept the disputable, but often referred to

notion that foreign direct investment has a larger potential to impact total factor production than

indigenous investment. Foreign direct investment would then be inherently beneficial for

employment, as a result we can make some assertions on foreign direct investment policy.

Government intervention can take place in several forms. One of these factors is trade policy,

Balasubramanyam, Salisu, & Sapsford (1996) find some evidence that the beneficial effect of

foreign direct investment is stronger in those countries that pursue an outwardly oriented trade

policy than those countries adopting an inwardly oriented policy.

Gastanaga, Nugent, & Pashamova (1998) examined the effects of various policies on foreign

direct investment in 49 less-developed countries over the period of 1970-95. One of their findings

is that corporate tax rates have a negative impact on attracting foreign direct investment. Another

is that the level of corruption in the host country is also negatively correlated with foreign direct

investment flows. Similar results were found by Wei (2000) “an increase in either the tax rate on

multinational firms or the corruption level in the host governments would reduce inward foreign

direct investment.”

Görg & Greenaway (2001) conclude in their extensive literature review that overall the current

literature on policy suggest that government intervention should be focused on providing a

22

supportive economic environment. This primarily means policies targeted at education and

training to raise the general level of skills and policies geared towards improving the

infrastructure to improve transportation and communication networks. These policies would raise

the attractiveness for foreign investors as well as potentially increase the benefits from possible

spillover effects.

23

8 ConclusionsForeign direct investment is an important factor in economic development and has a major

influence on employment. The key defining feature of foreign direct investment compared to

indirect types of investment is the level of control. Foreign direct investment influences

employment in a number of ways, and on different dimensions. It can have both a direct and, or

indirect effect on the quantity, quality, and location of employment.

The direct effects of foreign direct investment on the quantity of employment differ between the

modes of entry. For greenfield entry the current literature is almost unanimous on their

conclusion that greenfield investment creates jobs. Regarding merger and acquisition type of

investment the research is slightly more complex and the results more ambiguous. Some find

evidence for job creation, others for job destruction. Furthermore an initial decrease in

employment may change to an increase in the longer run. Moreover an observed decrease in jobs

could very well have been even bigger without the merger and acquisition activity.

The indirect effects on the employment quantity depend largely on the amount of local linkages

the foreign controlled firms have. There is little convergence in the literature on the subject of

linkages so no general conclusion can be reached. Related to the concept of linkages is whether

foreign direct investment crowds in local investment, or if it crowds out indigenous firms. Again

the literature is ambiguous, though it suggests that for developing countries the positive effects

are little or the effects are even negative. For developed countries the effects are similar though

they may be offset in the long run with net entry in the same or complementary industries.

Regarding the quality of employment both the wages and productivity of employees were

considered. Foreign controlled firms tend to pay higher wages and there is some, though little,

evidence that these wages tend to spillover to domestic firms. Most evidence of wage spillovers

was found in developed countries. The lack of evidence in developing countries, or even some

indications of negative spillovers are argued to be because of the larger gap between foreign and

domestic firms. Like the wages, the productivity in foreign controlled firms tend to be higher,

however the effects on domestic firms seem to differ.

24

The body of literature on the effects of foreign direct investment on the location of employment

is still very small. Nevertheless there are some indications that foreign direct investment shifts

employment to areas with high unemployment as well as urban regions.

Overall it is clear that foreign direct investment has a large impact on employment and on all its

dimensions. While there is still much debate on the exact partial effects of foreign direct

investment, overall the current body of literature tends to be slightly in favor of inward foreign

direct investment. Which is also the position taken by most policymakers who implement a wide

array of policies to attract foreign direct investment. The literature seems to suggest the best way

to do so is by providing a supportive economic environment.

If there is a general conclusion surrounding the topic of foreign direct investment that can be

reached, it is that its intricateness makes it very hard to identify and disentangle the different

effects. And more scientific effort is still required to map and completely understand the full

array of mechanisms set in motion because of, as well as the different direct effects of, foreign

direct investment.

25

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