FDI and wages
A large number of empirical studies find that foreign affiliates pay higher wages relative to domestic firms in developing countries. The wage differential between domestically and foreign-owned firms ranges from about 10-70% depending on the country considered (see studies cited by Heyman, Sjoholm, and Tingvall 2007) [1].
Several explanations have been proposed for this phenomenon. Foreign firms may pay a wage premium in order to reduce labour turnover, which prevents knowledge spillovers from benefitting their domestic competitors (Fosfuri, Motta, and Ronde 2001). Higher productivity and the resulting higher profitability of foreign affiliates may translate into higher wages because of rent-sharing arrangements between foreign firms and their employees (Budd, Konings, and Slaughter 2005). Higher wages paid by foreign affiliates may serve as compensation for a higher labour demand volatility in foreign plants (Fabri, Haskel, and Slaughter 2003) or for a higher foreign plant closure rate (Bernard and Sjoholm 2003). It is also possible that due to a lack of knowledge of the local labour market, foreign firms may find it difficult to identify and attract good workers without paying a wage premium (Lipsey and Sjoholm 2004). Higher wages paid by foreign affiliates may also be a result of cherry picking: foreign companies only acquiring domestic firms with above average human capital (Almeida 2007). Finally, higher wages may reflect unobservable worker characteristics such as higher ability or greater motivation.
A formal argument for the FDI wage premium in developing countries was proposed by Egger and Kreickemeier (2013). The authors develop a general equilibrium two-country model with heterogeneous producers and rent sharing at the firm level due to the fairness preferences of workers. There are two sources of an FDI wage premium in the model. First, because multinational firms are more productive, they earn higher profits and can therefore pay higher wages. Second, since rent-sharing relates to a firm’s global profits, multinational can pay higher wages than an otherwise identical firm that does not choose a multinational status. In a setting with identical countries, the multinational wage premium disappears once firm characteristics, such as productivity, are controlled for, because all firms above certain productivity threshold will choose to become multinational. In a setting with asymmetric countries, the threshold productivity level necessary to become multinational is higher for multinationals headquartered in the less advanced economy - a finding that is consistent with the stylized fact that most FDI flows are from more advanced to less advanced countries. Therefore, in the less advanced economy foreign multinationals and purely national firms with identical productivity levels can coexist. These multinationals pay higher wages than their otherwise identical national competitors since they have higher global profits, which they share with their workforce in both countries. Thus, the FDI wage premium would only exist in less advanced countries.
Examining the causal effect of foreign ownership on wages is quite challenging due to the lack of necessary data: ideally, we would like to trace the pay of individual workers continuously employed in firms that changed ownership, and control for worker- and firm-specific characteristics. Firm-level studies are unable to separate the effect of wage changes of continuing workers from the impact of the changing composition of the labour force: if foreign acquisitions result in greater reliance on skilled labour, they will automatically result in average wage increases and a firm-level foreign wage premium. The recent availability of linked employer-employee data has allowed researchers to make progress in this area. The broad message emerging from these studies is that the FDI wage premium is positive in developing countries. Hijzen et al. (2013) rely on linked employer-employee data from Brazil, Germany, Portugal, and the UK. They define foreign acquisitions in terms of majority ownership: a change from having 50% or less of foreign-owned assets to over 50% of foreign-owned assets. In their most stringent specification, they construct a counterfactual using propensity score matching at the firm-worker level[2]. The average estimated effect is equal to about 6% in Brazil and 3% in Germany, but it is much smaller and not statistically significant for the UK and Portugal (possibly due to smaller sample sizes). Earle, Telegdy, and Antal (2013) benefit from a very long panel encompassing 4,926 foreign acquisitions in Hungary, and linked employer-employee data from a random sample of about 6.6% of production workers and 10% of non-production workers in the firms considered. They employ a majority ownership definition of FDI. Acquisitions they study nearly always involve large changes in ownership share: 70% of acquisitions occur in firms whose pre-acquisition foreign share is zero. To construct a comparison group, they conduct propensity score matching at the firm level, and matches are restricted to the same industry and year. Considering incumbent workers only, the estimated FDI premium is about 4.5%[3]. The authors find positive effects for all education, experience, and gender groups, occupations, and wage quantiles. Interestingly, subsequent divestment to domestic owners largely reverses the estimated effects.
As a result of knowledge brought by foreign investors to the host country, marginal productivity of workers in foreign affiliates should be higher than in domestic firms. If this productivity advantage is significant, equilibrium wages should rise in response to increased FDI. In other words, there would be pecuniary spillovers: an overall shift in the aggregate labour demand curve could lead to upward pressure on wages faced by both domestic and foreign firms. Alternatively, there could be spillovers due to human capital accumulation. The entry of multinationals brings new knowledge that is then absorbed by domestic workers, increasing the domestic stock of human capital and making the local labour force permanently more productive. While in the US there is evidence of wage spillovers from domestic to foreign firms, in Mexico and Venezuela, FDI is associated with higher wages only in foreign affiliates. There is no evidence of wage spillovers leading to higher wages for domestic firms in these countries (Aitken, Hanson, and AE Harrison 1997).
FDI and worker training
From the worker’s perspective, employment in a foreign affiliate may be more rewarding than employment in a local firm if the former offers more opportunities for training and professional development. The existing evidence supports this view: Filer, Schneider, and Svejnar (1995) find that foreign-owned firms in the Czech Republic spend 4.6 times more than domestic firms on hiring and training, and a study on Malaysia also shows that foreign-owned firms provide more training to their workers than domestic enterprises (Bank 1997).
FDI and job stability
Workers tend to value stable jobs, and most of the evidence suggests that multinationals offer greater job stability. Data from the US (1980s-1990s) and Indonesia (1975-1989) suggests that multinational firms are less likely to shut down than domestic firms, due to their larger size and superior productivity relative to domestic firms. After accounting for differences in size and productivity, multinationals are more likely to shut down than domestic firms (Bernard and Jensen 2007, Bernard and Sjoholm 2003), though in the case of Indonesia this result is due to features of the available data. Prior to 1990, the number of foreign-owned enterprises in Indonesia was small and consequently a few plants could lead to large rates of entry and exit. More recent data from Indonesia, spanning the period 1988-1996, gives the opposite result (AE Harrison and Scorse 2010).
[1] The foreign wage premium is smaller after controlling for firm characteristics, such as size (AE Harrison and Scorse 2010. However, a larger size of foreign affiliates may reflect their superior productivity and thus a direct effect of their ownership status per se (see Arnold and Javorcik 2009).
[2] Firm controls include industry and region fixed effects, log employment and its square, and the average wage, while worker controls encompass wages, gender, age, age squared and tenure.
[3] However, these results most likely suffer from attenuation bias due to measurement error, since nearly half of workers with both pre- and post-acquisition observations have only a single observation for one or more periods
