Foreign Direct Investment and Employment Outcomes in Developing Countries IN FOCUS A Literature Review of the Effects of FINANCE, COMPETITIVENESS & FDI on Job Creation and Wages INNOVATION Abhishek Saurav, Yan Liu, Aarushi Sinha INVESTMENT CLIMATE © 2020 The World Bank Group 1818 H Street NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved. This volume is a product of the staff of the World Bank Group. The World Bank Group refers to the member institutions of the World Bank Group: The World Bank (International Bank for Reconstruction and Development); International Finance Corporation (IFC); and Multilateral Investment Guarantee Agency (MIGA), which are separate and distinct legal entities each organized under its respective Articles of Agreement. We encourage use for educational and non- commercial purposes. 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Photo Credit: World Bank Photo Library and Shutterstock.com INTRODUCTION 4 THE EMPLOYMENT EFFECT OF FDI 5 THE WAGE EFFECT OF FDI 10 LIMITATIONS OF EXTANT LITERATURE AND FUTURE DIRECTIONS 12 CONCLUSION 14 REFERENCES 15 ANNEX A: CHANNELS OF EMPLOYMENT AND WAGE EFFECTS AND 21 NUMBER OF REVIEWED STUDIES FOREIGN DIRECT INVESTMENT AND EMPLOYMENT OUTCOMES IN DEVELOPING COUNTRIES | 1 2 | FOREIGN DIRECT INVESTMENT AND EMPLOYMENT OUTCOMES IN DEVELOPING COUNTRIES T his survey of literature explores the heterogeneous effect of FDI on employment outcomes in three types of domestic firms: foreign-owned local firms that are affiliates of multinational corporations (MNCs), local firms that are suppliers to or customers of MNC affiliates, and local firms that compete with MNC affiliates (figure 1). Confirming expectations from FDI to create new and better paying jobs, evidence suggests that foreign-owned firms positively affect employment generation in affiliate firms. The gap between wages in domestic firms and foreign firms is larger for high skilled workers. For firms in upstream sectors (that is, suppliers of MNCs) there is a sizeable increase in jobs but only modest wage growth. The effect on domestic competitors, both in terms of jobs and wages is muted. The type of FDI, domestic firms’ size, domestic ownership share, and the sector’s technological capacity, are important conditioning factors. While various transmission channels are postulated, their presence has not been adequately examined in the empirical literature. Future research should more robustly attribute impacts to specific employment channels. Figure 1: Key Findings Regarding the Effect of FDI on Employment Outcomes Domestic Suppliers (firms in supplying sectors) Positive effect on employment by market-seeking MNCs Generally insignificant and Vertical upstream with demestic ownership potentially negative employment effects + Demand effects - Competition effects Foreign ownership increases - Productivity effect + Movement of labor employment in affiliate firms + Shared supplier strengthening + Access to foreign markets Small positive effect on wages - Displacement efffect (K and L) + Productivity effect MNC Parent Direct effects MNC Affliliate Horizontal Domestic Competitors Company through FDI (subsidiary of foreign firm) effects (firms in the same sector) Wage premia accrue to workers in affiliate Limited literature on the effect Vertical downstream firms and are higher for skilled workers on employment and wages, Generally insignificant but leans towards + Productivity of labor with no clear identification of positive wage effects effects + International rent-sharing transmission channels. + Competition for skills - Product market competition Net positive impact No net impact Domestic Buyers + Positive channel (firms in buying sectors) - Negative channel Source: Authors’ representation based on review of literature. Note: FDI = foreign direct investment. FOREIGN DIRECT INVESTMENT AND EMPLOYMENT OUTCOMES IN DEVELOPING COUNTRIES | 3 Introduction finds a one-to-one Granger-causal relationship from FDI flows to employment in a sample of 20 Foreign direct investment (FDI) is the largest Caribbean countries.4 Fu and Balasubramanyam source of external financing to developing (2005) find empirical support for the ‘vent for countries, greater than the contributions of surplus’ theory (Smith, 1776; Myint, 1958) of global remittances, private debt and portfolio equity, or trade using the case of China. Their results show that official development assistance (UNCTAD, 2019).1 export growth in the labor-intensive manufacturing Higher FDI inflows can ease capital constraints and sector, assisted by FDI, generated the demand for contribute to output and employment growth. FDI excess labor and productive capacity. Targeted is also likely to increase aggregate productivity investment promotion in developing countries has through positive productivity spillovers and been found to reduce information asymmetries and technology transfers. FDI deepens trade linkages lower bureaucratic burden to attract FDI inflows. (Freund & Pierola, 2012; Moran, 2014; Swenson, Thus generating about 68 percent more jobs for 2008): Inter- and intrafirm trade conducted by MNC affiliates in targeted sectors as compared to MNCs account for about three-fourths of global non-targeted sectors (Harding & Javorcik, 2011). exports (UNCTAD 2013). Thus, it can be a A review of literature by Rahman (2014) confirms significant driver of economic growth.2 that the evidence points to a positive effect of business entry simplification, tax policy reforms, Prior research has shaped the expectation that and investment promotion activities on job creation. FDI affects economic growth. Cross-country studies covering developing economies suggest that FDI significantly affects wages in affiliate FDI has a significant contribution to income and firms and thus welfare. Wage premia in MNC economic growth (Blomstrom, Lipsey, & Zejan, affiliates are argued to be driven by the presence 1994; Borensztein, De Gregorio, & Lee, 1998; of more productive workers (Girma, Greenaway, Hansen and Rand 2006). Thus, unsurprisingly, in & Wakelin, 2001; Lejarraga & Ragoussis, 2018), anticipation of more formal sector jobs, policymakers higher wages to prevent labor turnover (Aitken, in developing countries seek to attract, retain, and Harrison, & Lipsey, 1996; Fosfuri, Motta, & Ronde, expand FDI stock. To facilitate inward flows of 2001), and rent-sharing between MNCs and their FDI, governments undertake reforms to simplify affiliates (Budd, Konings, & Slaughter, 2005; Egger their trade and investment policy regimes, improve & Kreickemeier, 2013). In an analysis examining the business environment, and offer investment the impact of MNC presence on economic activity incentives. The investment climate of an economy by linking firm-level and household survey data in plays a key role in determining the benefits from Vietnam, Turkey and Ethiopia, Steenbergen and Tran FDI (Farole & Winkler, 2014). (2020) find that the wage benefits from FDI were positive and significant in all three countries. FDI Increases in FDI have been shown to directly can play an important role in supporting economic contribute to job growth3, drawing in surplus transformation in developing countries. MNCs labor from the agriculture sector. Craigwell (2006) 1 Totaling US$700 billion in 2018. 2 Multinational corporations may choose to locate in developing countries out of a variety of motivations. Dunning and Lundan (2008) identify four sources of FDI motivation. MNCs that enter host economies to exploit locally available natural resources, to gain access to local markets, to enhance capabilities by acquiring strategic assets (e.g. technology, brand) of local firms, or for offshoring to save costs through efficiency in internationally distributed production. 3 fDi Markets tracks cross border greenfield investment globally and estimates that in 2018 greenfield FDI projects created approximately 2.3 million new jobs. 4 Results remain unaffected (that is, robust) after removing the larger economies of the Caribbean. 4 | FOREIGN DIRECT INVESTMENT AND EMPLOYMENT OUTCOMES IN DEVELOPING COUNTRIES often possess superior management practices5, countries. In a study of Chinese manufacturing technologies, and access to export channels, which firms, Karlsson et al. (2009) find that MNC affiliates can raise domestic firm and sectoral productivity experience higher employment growth compared through spillovers (Das, 1987; Fosfuri, Motta, & to domestic firms in the same sector, as a result of Ronde, 2001; Wang & Blomstrom, 1992). This firm characteristics such as high capital intensity enables the private sector in developing countries and productivity, and in particular through access to create more and better (higher productivity) jobs. to export markets. Using similar data6, Gong, Görg and Maioli (2006) find that foreign ownership of Few sources provide policymakers and former state-owned enterprises (SOEs) results in researchers with an integrated view of the higher employment growth in the post-acquisition employment effects of FDI on developing period as compared with non-acquired SOEs. Such economies. FDI affects different market players— firms have average growth rate differentials of about MNC affiliates, suppliers, and competitors, through 5.5 percent in the 75th quantile and 12.5 percent different channels. The growth in production in in the 90th quantile of the employment growth MNC affiliates can create extra demand for labor distribution. Lipsey, Sjoholm, and Sun (2010) in host economies, but may also be accompanied find that Indonesian manufacturing plants7 taken simultaneously by the effects of competition, over by foreign owners experience significantly wage inequality and changes in firm productivity higher employment growth than their domestic in domestic firms. The overall effect of FDI on counterparts.8 Hijzen et al. (2013) find similar results employment in developing countries thus depends in Indonesia, estimating that foreign takeovers on the balance of such effects. This note synthesizes raise employment by 25 percent and lean towards evidence on the effect of FDI on job creation and more skilled workers with a significant decline wages, identifying the direction and transmission in low-skilled employment. New cross-country9 channels of effects. evidence (Ragoussis 2020) suggests that brownfield investments expand employment at a rate more than double that of similar domestic firms. The Employment Effect of FDI (see Figure 2) Despite substantial FDI inflows, longer-term employment creation in affiliate firms can be On Affiliate Firms limited in developing countries. Mexico attracted greenfield investments in the automobile sector, Firm-level evidence from developing countries resulting in several export-oriented manufacturing points to a positive employment effect of foreign units that catered to foreign markets (primarily the ownership on affiliate firms. A review of empirical United States). In this offshoring model, Ramirez literature by Javorcik (2015) suggests that FDI (2000) finds that FDI was used towards capital- inflows generate good jobs through higher wages intensive, computer-aided manufacturing, which at the firm level as compared to domestic firms had a limited labor demand effect on the domestic and enhanced firm productivity in developing economy. Furthermore, Farole and Winkler (2014) 5 For example, the use of wage incentives for good performance and the removal of less productive workers (Bloom & van Reenan, 2010). 6 China Industrial Enterprise Data 1998-2004 by Karlsson et al. 2009 and 1999-2003 by Gong, Görg and Maioli (2006). 7 Panel data of Indonesian manufacturing plants from 1975-2005. 8 No significant employment effects were observed when foreign-owned firms became domestically owned. 9 China, Indonesia, Vietnam, Cote d’Ivoire, Serbia and Moldova. FOREIGN DIRECT INVESTMENT AND EMPLOYMENT OUTCOMES IN DEVELOPING COUNTRIES | 5 Figure 2: Effect of FDI on Employment Domestic Suppliers (firms in supplying sectors) Foreign ownership increases Generally insignificant and Vertical upstream employment in affiliate firms potentially negative employment effects + Access to foreign markets Positive effect on employment - Competition effects - Displacement efffect (K and L) by market-seeking MNCs + Movement of labor with demestic ownership + Shared supplier strengthening + Demand effects - Productivity effect MNC Parent Direct effects MNC Affliliate Horizontal Domestic Competitors Company through FDI (subsidiary of foreign firm) effects (firms in the same sector) Limited literature on the effect Vertical downstream on employment, with no clear identification of effects transmission channels. Net positive impact No net impact Domestic Buyers + Positive channel (firms in buying sectors) - Negative channel Source: Authors’ representation based on review of literature. Note: FDI = foreign direct investment. find survey evidence that foreign investors prefer firms (Lipsey, Sjoholm, & Sun, 2010), particularly highly skilled local staff in situations in which the in the case of efficiency-seeking foreign investors linguistic distance between the FDI source and who organize GVCs to leverage input cost destination countries is high, but this is only to a advantages. As Haddad and Harrison (1993) find, limited degree. To preserve corporate culture and between foreign-owned and domestic firms in maintain effective communications with the head Morocco, foreign-firms tend to be more export office, certain positions in MNC affiliates are set oriented. By their nature MNC affiliates are adept at aside for foreign nationals and not open to local leveraging higher exposure to international markets technical and managerial staff.10 (a source of competitive advantage over domestic firms), which facilitates employment generation Transmission Channels (Karlsson et al. 2009). Access to Foreign Markets: MNCs are a central feature of GVCs, often as lead firms in international Displacement Effect: Foreign firms tend to production networks (WDR, 2020). Their exposure be more capital-intensive than domestic firms, to international markets is higher than domestic leveraging more technological inputs and less labor 10 Foreign Investor Surveys conducted by the International Trade Department of the World Bank in Chile, Ghana, Kenya, Lesotho, Mozambique, Swaziland and Vietnam. Surveyed firms’ profile: agribusiness (46), apparel (13), mining (5). 6 | FOREIGN DIRECT INVESTMENT AND EMPLOYMENT OUTCOMES IN DEVELOPING COUNTRIES for production. Assessing the employment effect supplier linkages in comparison to MNCs with of FDI in the Vietnamese manufacturing sector, globally integrated value chains. Farole and Jenkins (2006) argues that foreign firms can displace Winkler (2014) use survey data11 on direct MNC- local investment resulting in less labor-intensive supplier linkages from seven countries and find that production with lower employment. When FDI they develop fewer linkages with the local economy involves acquisition of local firms (brownfield), in terms of inputs and workers (technical services, rather than greenfield investments in new plants, transport, cleaning, catering and other services had there is no initial increase in employment. In fact, a higher potential for linkages). Furthermore, MNC further jobs may be lost as MNCs enhance labor affiliates with higher share of domestic ownership productivity through rationalization or strategic are more likely to create linkages with the local reorganization. Research in Central and Eastern economy (Toth & Semjem, 1999) as compared European countries has shown that FDI induced to wholly-owned subsidiaries and firms relying competitive pressures and the introduction of labor- exclusively on foreign technologies (Sanchez- saving technology led to job losses during 1995 and Martin, de Pinies, & Antoine, 2015). 2012 (Jude & Silaghi, 2015). Some evidence suggests that certain modes of entry (joint ventures and acquisitions) and On Suppliers market-seeking FDI are better positioned to In addition to jobs created directly in MNC establish supplier linkages. Using the case of affiliates, additional jobs may be created through Japanese electronics manufacturing MNCs with upstream inter-industry linkages. The employment affiliates in 24 countries, Belderbos, Capannelli generated through MNC-supplier relationships and Fukao (2001) show that MNC affiliates depends on the extent of upstream linkages. For instituted through joint ventures and acquisitions example, Jenkins (2006) analyze the employment utilize more local content in their production than effect of FDI in the Vietnamese manufacturing sector those established via greenfield investment, due and find that the employment effect on upstream to the former’s higher embeddedness in the local sectors was limited due to weak local linkages. economy. Similarly, MNC affiliates selling more of Foreign firms in the study primarily relied on their output in domestic markets utilized more local imports, as evidenced by substantially higher import content, suggesting that domestic market-seeking shares compared to domestic counterparts. investments better leverage local suppliers. Using the World Bank Enterprise Survey data for the The exclusivity of sourcing relationships, value Caribbean, Sanchez-Martin, de Pinies and Antoine chain configurations, and domestic ownership (2015) find that market-seeking investors are are important factors conditioning employment more inclined to establish backward linkages than effects in upstream sectors. Exclusive supply export-seeking investors, and a significant negative relationships imply that new procurement linkages relationship exists between the share of domestic are formed at the expense of relationships between inputs and the share of exports. Based on investor domestic firms and their former suppliers, limiting survey data, Farole and Winkler (2014) also find a employment creation (Rodriguez-Clare, 1996; Lin positive relationship between market-seeking FDI, & Saggi, 2005). Hansen, Pederson, and Peterson share of sales in the host country, and the probability (2009), using data from Danish MNCs located in of supplier assistance. A higher degree of domestic developing countries, find that MNCs with more ownership was associated with higher local sales dispersed value chains create more jobs through and supplier assistance. Foreign Investor Surveys conducted by the International Trade Department, World Bank in Chile, Ghana, Kenya, Lesotho, 11 Mozambique, Swaziland and Vietnam. Surveyed firms’ profile: agribusiness (46), apparel (13), mining (5). FOREIGN DIRECT INVESTMENT AND EMPLOYMENT OUTCOMES IN DEVELOPING COUNTRIES | 7 While more empirical attention is needed, Transmission Channels theoretical work sheds light on the factors Demand Effects: FDI often increases demand for that may condition employment effects in locally-produced intermediate goods (Javorcik, upstream sectors. The distance (that is, cost of 2004). Local suppliers may increase employment to communication) between the MNC parent and raise output in order to meet this increased demand. affiliate, the complexity of the production process, Lin and Saggi (2005) develop a theoretical model the sectors receiving FDI inflows, the size of the in which the effect can run in both directions. host economy, and the level of development of the That is, the net effect of FDI on supplier output source and host countries, can be important factors depends on whether the increased demand from conditioning employment effects on suppliers. MNCs outweighs decreased demand from domestic Alfaro (2016) demonstrates that FDI’s positive competitors due to exclusivity restrictions in MNC impacts are not exogenous but contingent on sourcing or the decline in demand from domestic complementarities such as a competitive business firms that have lost market share to MNC affiliates. environment or well-developed financial markets However, most literature on the topic tends to find that ensure the conversion of vertical upstream positive effects of FDI on the output of supplying relationships into robust linkages. Rodriguez-Clare firms in upstream sectors (for example: Blalock and (1996) argues that greater physical, cultural and Gertler, 2008). legal distance from parent MNCs creates stronger incentives for affiliates to create domestic supplier Productivity Effect: MNC affiliates are often linkages to source specialized intermediate goods. ‘pickier’ in their choice of suppliers, demanding Similarly, linkages are likely to be stronger if tighter timelines, higher quality, and lower costs. MNC affiliates intensively use intermediate inputs. This may induce productivity improvements both Sanchez-Martin, de Pinies and Antoine (2015) find at the individual firm level and via compositional that in the Caribbean, food, wood and furniture, and effects at the sector level pushing less productive automobile and auto parts sectors tended to develop suppliers out of the market (Crespo & Fontoura, more backward linkages as compared to garments, 2007; Javorcik, Keller, & Tybout, 2006). While electronics, and some service sectors, where there such productivity improvements may be good for was a low level of dependence on local suppliers. firm competitiveness and profitability, they may Additionally, smaller economies (such as those in actually lead to employment declines as less labor the Caribbean) usually have a limited number of is needed per unit of output (Javorcik, Keller, & firms with the capabilities required to supply to Tybout, 2006). MNCs affiliates, thereby resulting in fewer linkages with local firms. A smaller destination market also implies that the FDI is essentially efficiency-seeking On Competitors and export oriented. Finally, more developed host FDI’s effect on employment in domestic countries with firms capable of supplying MNC competitor firms is estimated to be null to affiliates, offer better conditions for MNC affiliates moderately negative. Reyes (2017), using World to establish linkages with upstream sectors. Lin and Bank Enterprise Survey data from 121 economies, Saggi (2005) show that the degree of MNC linkages finds that the presence of foreign firms in the sector with upstream sectors depends on the technological does not have a significant effect on employment gap between MNC affiliates and their competitors. growth for the average firm. However, a small section They argue that additional demand from MNCs of same sector, high-growth firms experience gains only outweighs decreased demand from affiliates’ from the presence of MNCs. High-growth firms are local competitors (who lose market share) when enterprises located in the top fifth percentile of the technology gaps are sizeable. distribution of employment growth in a country. 8 | FOREIGN DIRECT INVESTMENT AND EMPLOYMENT OUTCOMES IN DEVELOPING COUNTRIES The author posits that such firms are better able to Wang and Blomstrom 1992). On the other hand, internalize productivity-enhancing technologies and with higher capital stocks and more sophisticated counterbalance additional competition from MNCs. technologies, MNC affiliates can gain market share at the expense of domestic competitors (Aitken Some studies analyze FDI’s effect on competitors’ & Harrison, 1999). If the latter effect dominates, output and productivity and find insignificant or employment levels in domestic competitors are negative effects driven by loss of market share likely to decrease as they lose market share and to MNC affiliates (Irsova & Havranek, 2013; reduce production scale. Javorcik, Keller, & Tybout, 2006). If the demand for labor moves with production, then null or negative Shared Supplier Strengthening: MNC affiliates effects on output would translate into similar effects and their competitors in the same sector may rely on jobs. The net effect on jobs would depend on on a shared set of suppliers for inputs. FDI often firm productivity, whereby if domestic firms are leads to positive productivity effects on upstream able to produce more efficiently, additional labor sectors as MNC affiliates invest in local suppliers may not be needed. However, if the loss of market or induce the entry of new suppliers (Havranek & share drives productivity downwards, more labor Irsova, 2011). Consequently, suppliers enhance the would be required. quality of products and services, and the entry of new suppliers lowers prices for all buyers, including FDI may induce increases in employment among domestic competitors (Gorodnichenko, Svejnar, & competitor firms under special circumstances. Terrell, 2007; Kee, 2014). As Blalock and Gertler Looking at Indonesian manufacturing firms, (2008) suggest, for competitors that share suppliers Blalock and Gertler (2008) find that Indonesian with MNCs, the availability of higher-quality and/ firms which share suppliers with MNC affiliates or cheaper inputs may in turn increase output and experience an increase in production. Similarly, therefore jobs. analyzing data from Ghanaian manufacturers, Görg and Strobl (2005) observe increases in Movement of Labor: New technologies and output among firms founded by entrepreneurs who management practices can diffuse to domestic firms had previously worked at MNC affiliates in the when employees of MNC affiliates leave to join same industry. competitors. Such knowledge spillovers may occur from the migration of both managers and high- Transmission Channels skilled employees with knowledge of best practices Competition: The presence of MNC affiliates (Görg and Strobl, 2005; Glass and Saggi, 2002; increases competitive pressures on domestic firms Poole 2013) and workers, who have undergone in the same sector. Competition can affect domestic productivity enhancing training (Fosfuri, Motta, firms both positively and negatively. On the one & Ronde, 2001; Glass & Saggi, 2002). Benefitting hand, domestic firms are likely to invest in improved from specialized knowledge, local competitors are production techniques to compete and maintain likely to gain domestic market share as well as in market share (Blyde, Kugler, and Stein 2005; export markets, in turn increasing production and Glass and Saggi 2002; Görg and Greenaway 2004; employment. FOREIGN DIRECT INVESTMENT AND EMPLOYMENT OUTCOMES IN DEVELOPING COUNTRIES | 9 The Wage Effect of FDI but are significantly higher for workers with (see Figure 3) advanced skills. Using cross-sectional data from Indonesia’s manufacturing sector, Lipsey and Sjoholm (2004) find that foreign-owned firms paid On Affiliate Firms higher wages for workers at a given education level Consistent evidence suggests that the effect of as compared to domestic firms. The wage premium foreign ownership on workers’ wages in MNC reveals that foreign firms may be biased in favor affiliates is positive in developing countries. of more educated workers and offer higher wages. This is a well-studied relationship with empirical Lending further support to the skill-biased wage literature offering broad coverage of developing premium argument, Harrison and Scorse (2009), Lee regions, including East Asia and the Pacific, Latin and Wie (2015) and Hale and Long (2011) find that America and the Caribbean, and Sub-Saharan Africa. in Indonesia and China respectively, skilled workers The research primarily leverages manufacturing command sizeable wage premia.12 Hijzen et al. sector census and sample survey data, by national (2013) find that firms taken over by MNCs pay on statistical agencies and multilateral organizations. average about 21 percent more than their domestic counterparts and the difference grows over time. In East Asia, wage premia accrue to all These findings are broadly replicated in other regions: manufacturing workers in foreign-owned firms In Latin America (Aitken, Harrison, & Lipsey, 1996) Figure 3: Effect of FDI on Wages Domestic Suppliers (firms in supplying sectors) Vertical upstream Wage premia accrue to workers in affiliate Generally insignificant but leans towards firms and are higher for skilled workers positive wage effects effects + Productivity of labor Small positive effect on wages + Competition for skills + International rent-sharing + Productivity effect - Product market competition MNC Parent Direct effects MNC Affliliate Horizontal Domestic Competitors Company through FDI (subsidiary of foreign firm) effects (firms in the same sector) Limited literature on the effect Vertical downstream on wages, with no clear identification of transmission effects channels. Net positive impact No net impact Domestic Buyers + Positive channel (firms in buying sectors) - Negative channel Source: Authors’ representation based on review of literature. Note: FDI = foreign direct investment. Indonesia: 20-30 percent; China: 51 percent for managers, 30 percent for engineers. 12 10 | FOREIGN DIRECT INVESTMENT AND EMPLOYMENT OUTCOMES IN DEVELOPING COUNTRIES and in Africa (Velde & Morrissey, 2003) higher FDI International Rent-Sharing Mechanisms: Higher is associated with 16 to 40 percent increases in wage wages paid by foreign affiliate firms can also be premia compared to domestic ownership. attributed to profit-sharing across borders within multinational firms. Cross-border flows of capital, Evidence suggests that FDI increases wage labor, goods and information may exert strong inequality. The capital-intensive production in influences on the nature of profit-sharing between foreign-owned firms generates greater demand for firms and workers. Budd and Slaughter (2004), skills, pushing relative wages up for higher skilled Budd, Konings and Slaughter (2005) and Hildreth workers (World Bank, 2020). Examining the effect and Oswald (1997), using data on European and of service sector liberalization in the Philippines, British firms, find that parent firms share profits with Amoranto, Brooks and Chun (2010) find that the their foreign affiliates and the degree of rent-sharing reforms may have potentially been harmful for less through wages is stronger in the case of majority- skilled individuals, while creating more employment owned MNC affiliates. Using a two-country model, opportunities for men with higher skills. In Vietnam, an analytically tractable general equilibrium model McLaren and Yoo (2016) investigated the effects of with MNCs, Egger and Kreickemeier (2013) FDI inflows on income distribution and absolute demonstrate that MNCs pay higher wages in their living standards from 1989—2000. Their findings affiliate firms, when compared to domestic players, suggest that an increase in FDI in a province was due to higher global profits. associated with a slight decline in living standards for households that did not have a member employed On Suppliers by the foreign-owned enterprise, while indicating modest gains for households whose member(s) The few studies that have investigated the role were employed by the affiliate. On the contrary, of FDI presence on wages in upstream sectors Cornia (2016) find that in Ethiopia, Ghana and find a small positive effect. Using firm-level Mozambique, FDI in labor-intensive manufacturing manufacturing data from Turkey, Fatima and and infrastructure sectors increased the integration Khan (2018) find that higher foreign presence of domestic and international markets and reduced is associated with a positive effect on the wage inequality through employment growth in labor- bill in domestic firms that supply inputs to MNC intensive sectors. affiliates—an indication of increasing labor welfare from MNC linkages. Their estimates suggest that a Transmission Channels one percentage point increase in backward linkages Productivity of Labor: The main argument for (inter-sectoral linkages between MNC affiliates and higher wages paid to workers in foreign-owned domestic suppliers) results in a 0.7 percent increase firms is one of higher marginal productivity. in the total firm wage bill. Various authors postulate that MNC affiliates affect wages through the productivity channel The size of the firm and technological level of the (Aitken, Harrison, & Lipsey, 1996; Girma, Gong, sector are important factors conditioning wage Gorg, & Lancheros, 2015; Earle, Telegdy, & effects from FDI presence in upstream sectors. Antal, 2018; Peluffo, 2014; Javorcik B. S., 2015). Hoi and Pomfret (2010) shed light on the role of MNC affiliates hire more productive workers and firm heterogeneity on vertical wage effects using thus must remunerate at rates higher than their firm-level data from the mining, manufacturing, and domestic counterparts. Higher initial wage offers utilities sectors in Vietnam. Their estimates show may persist over time to retain more productive that a greater presence of foreign firms is positively workers and to prevent labor turnover (Fosfuri, related to higher wages in domestic private firms in Motta, & Ronde, 2001; Glass & Saggi, 2002). upstream sectors. They explain their results in light of possible productivity and technological spillovers from foreign firms accruing to domestic private FOREIGN DIRECT INVESTMENT AND EMPLOYMENT OUTCOMES IN DEVELOPING COUNTRIES | 11 firms that push wages upwards. Firms experiencing advanced production processes, increasing demand greater wage effects are smaller (fewer than 100 for skilled workers. In developing countries, the employees) and in lower technology sectors (such supply of required skills can be limited. In the short as textiles, food and beverage). to medium run, this supply is inelastic and can drive wages for skilled workers upwards in the sector The technological gap13 between foreign and (Hale & Xu, 2016). Some empirical work confirms domestic firms is likely an important determinant that the competition for skills leads to higher wages of the extent of upstream wage effects. Beginning for skilled workers in the sector (Hale & Long, 2011; with Hoi and Pomfret (2010), smaller wage Lipsey & Sjoholm, 2001; Feliciano & Lipsey, 1999). effects are observed from wide technological gaps Hale and Long (2011), using Enterprise Survey data between foreign and domestic upstream firms. in China, find that the presence of FDI in the same While no studies leveraging data from developing sector and region affects wages of skilled workers in countries were found to explore this factor, private firms but does not affect those of unskilled Pittiglio, Reganati, and Sica (2015) investigate workers or workers in SOEs. Using manufacturing this question using Italian manufacturing sector data from Indonesia, Tomohara and Takii (2011) data. The authors show that when the technological show that foreign-owned firms increase local gap between MNC affiliates and suppliers is large, employee wages by elevating reference wages. wages are negatively affected in upstream sectors. Employees in local establishment realize that they Conversely, positive wage effects materialize when are underpaid compared to the reference wage the technological gaps are smaller. and negotiate for higher wages. In manufacturing firms in Turkey, Fatima and Khan (2018) find that Transmission Channels higher foreign presence is associated with a small Productivity Effect: The inter-sectoral linkages positive increase in the wage bill (includes wages, between MNC affiliates and domestic suppliers can salaries, allowances, overtime payments, social be a conduit for productivity enhancement (Fatima contributions, etc.) in firms in the same sector— & Khan, 2018). Time, quality, and cost requirements confirming horizontal wage effects. Estimates imposed by MNCs on local suppliers are argued suggest that a one percentage point increase in to induce productivity improvements both at the foreign presence in a sector results in a 0.15 percent individual firm level and via compositional effects increase in the total real wage bill in that sector. at the industry level pushing less productive suppliers out of the market (Crespo & Fontoura, Evidence from Latin America on wage effects 2007; Javorcik, Keller, & Tybout, 2006).14 The resulting from the presence of foreign firms productivity increase among suppliers thus exerts on same sector domestic firms is mixed. Using an upwards pressure on real wages. a matched establishment-worker database from Brazil covering manufacturing, services and utilities sectors, Poole (2013) presents evidence on positive On Competitors wage effects due to labor turnover from MNCs to The literature on horizontal (intra-industry) domestic firms. In contrast, in a comparative study wage effects resulting from the presence of including Mexico, Venezuela, and the United States, foreign firms is limited and points towards a Aitken, Harrison, and Lipsey (1996) find that in the positive effect in developing countries. MNC manufacturing sector, while there is no evidence affiliates typically deploy more technologically of higher FDI presence (employment in the sector) resulting in wage effects for same sector firms in Defined as the difference in labor productivity between firms in a certain industry during a certain time. 13 Recall from the discussion of productivity spillovers affecting employment outcomes in upstream sectors that MNC 14 affiliates are often ‘pickier’ in their choice of suppliers. 12 | FOREIGN DIRECT INVESTMENT AND EMPLOYMENT OUTCOMES IN DEVELOPING COUNTRIES Mexico and Venezuela, such effects are significant more technologically advanced, market-seeking only in the case of the United States. foreign investors gradually gain market share at the expense of domestic producers, such that over The effect of FDI on wages in same sector time the output produced by incumbent domestic domestic firms may occur within a geographically firms decreases. Such a change pushes firms up the limited area. Using data from a manufacturing average cost curve and reduces labor productivity, census in Indonesia, Lipsey and Sjoholm (2001) find resulting in a reduction in wages. suggestive evidence of regional segmentation in the wage effect of FDI in a sector. Since labor mobility is more prevalent among firms within a province than Limitations of Extant Literature across provinces, the authors argue that any wage and Future Directions effect should be localized. Their empirical results To estimate the causal effects of FDI on confirm this argument and show that FDI presence employment outcomes (that is, employment affects wages within the same two-digit industry and wages) in MNC affiliates, time series firm- sector in the same province but not across provinces. level data with employer-employee matches are Hoi and Pomfret (2010) lend further support to the a requirement. Lack of such data in developing localized nature of wage effects from FDI in Vietnam. economies has been a key limitation. Investigating the relationship between FDI and its employment Transmission Channels outcomes is complicated by selection bias, induced Competition for Skills: If FDI increases demand by the non-random foreign ownership of firms in for skilled labor in a sector then, in labor markets host economies.15 This issue has been characterized with inelastic labor supply, wages for skilled as the “cherry-picking” phenomenon, in which workers are likely to increase (Hale & Xu, 2016). MNCs select firms that are more productive and This upward pressure on wages is likely a short- plausibly have higher growth prospects. Such to medium-term effect, as domestic competitors firms may experience faster employment and wage adjust to increased wages. Skilled workers may growth, with or without MNC affiliation and hence gravitate towards foreign firms in response to it is empirically challenging to identify the causal higher wage offers. To cope with increased wage effects of foreign ownership. Researchers have competition for skilled workers, domestic firms attempted to overcome this selection issue by using are likely to substitute skilled with lower skilled instrumental variables and matching techniques workers to preserve the average costs of production for identification.16 Few studies have used firm- (Barry, Görg, & Strobl, 2005). Such a change in the level panel data, controlling selection by netting skill-mix would have a downward effect on average out time-invariable unobservable characteristics wages in domestic firms. The net effect depends on of firms, to assess the effect of foreign takeover the degree of competition for skills and the ability on employment. A few studies have also used of competitors to substitute away skilled workers. employer-employee matched data, where available, to assess the effect of foreign ownership on Competition: The competition between foreign individual wages. However, the lack of information and domestic firms in product markets (Barry, on worker characteristics (skill level, education, Görg, & Strobl, 2005) can affect wages. Being age and so on), constrain the estimation of FDI 15 The selection issue (Barnow, Cain, & Goldberger, 1980) in foreign ownership: Firms that are identified by MNCs may differ from firms that are not acquired by MNCs on a variety of characteristics, some observable and some unobservable. These characteristics may influence foreign ownership decisions and employment outcomes of the affiliate firm simultaneously. Consequently, an estimate of the impact of foreign ownership on the affiliates’ employment outcomes, not controlling for these confounders is likely to be biased. 16 See Hale and Xu (2016) for an overview of instruments used. FOREIGN DIRECT INVESTMENT AND EMPLOYMENT OUTCOMES IN DEVELOPING COUNTRIES | 13 wage premia to only two skill groups, omitting increased total factor productivity of downstream other dimensions of worker heterogeneity. manufacturing sectors (Arnold, Javorcik, & Mattoo, 2011; Arnold J. M., Javorcik, Lipscomb, & Mattoo, Key aspects of the employment effect in the 2014; Duggan, Rahardja, & Varela, 2013). Finally, relationship between MNC affiliates and local the effects in downstream sectors, on buyers and suppliers are also under-studied. While research distributors have received relatively little attention. has shed some light on the positive job creation effect of FDI on domestic firms in upstream sectors, literature is relatively silent on the wage effects in Conclusion such firms. As Lin and Saggi (2005) suggest, a This note synthesizes evidence on the effect lack of theoretical models that provide empirical of FDI on job creation and wages in domestic predictions is a plausible first step in future research. firms in developing countries. MNC affiliates This is likely driven by the nascent understanding in developing economies experience a significant of vertical relationships between MNC affiliates increase in both jobs and wages from foreign and their domestic suppliers. The search for and ownership. The wage effect is larger for high identification of potential suppliers, the type of skilled workers. In upstream sectors, the increase foreign firms seeking domestic suppliers, and the in jobs is sizeable but the wage growth is modest. nature of contractual relationships (e.g. the role The effect on domestic competitors, both in terms and consequence of exclusivity), remain policy- of jobs and wages is muted. The type of FDI, relevant areas for future research attention. domestic firms’ size, domestic ownership share, and the sector’s technological level, are important Another limitation of the literature is the conditioning factors. While various transmission relatively light coverage of heterogeneities channels are postulated to be at work, it remains to and change mechanisms in FDI’s effect on job examine their presence empirically. Based on this creation and wage effects. Few studies estimating review of literature, postulated channels of effect FDI’s employment effects account for heterogeneity on job creation and wages are presented in Annex A across types of FDI (greenfield vs. brownfield), FDI Table 1 along with the number of studies that were motivation17, ownership modalities (joint ventures reviewed for this note in Table 2. vs. foreign control), source country/region, industry, and characteristics of domestic firms. Conditions Future research should address gaps in existing under which FDI leads to positive employment literature. The literature’s coverage of the channels outcomes remain a key area for policy research. through which FDI shapes job creation and wage Relatedly, few investigations attempt to disentangle outcomes and the mediating factors that influence the channels through which FDI affects jobs and such effects is modest. Additionally, there is limited wages in host economies, seldom exploring the information on the conditions in host countries and mechanism of change. Part of the issue relates to the in domestic firms that can lead to greater positive lack of detailed microdata that limits policy insights. effects in upstream sectors through MNC-supplier Furthermore, existing studies largely examine effects linkages. A responsive research agenda could in manufacturing in middle-income countries. thus focus on illustrative case studies to assess Services in low-income countries, particularly in the presence and relative significance of channels Africa, are thus key areas for closer future research. through which MNC affiliates affect domestic firms’ A new and emerging area of research examines employment outcomes. 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Washington, D.C.: World Bank Group. 20 | FOREIGN DIRECT INVESTMENT AND EMPLOYMENT OUTCOMES IN DEVELOPING COUNTRIES Annex A: Channels of Employment and Wage Effects and Number of Reviewed Studies Table 1: Employment and Wage Effects by Transmission Channels Stakeholder → MNC Domestic Domestic Transmission Channel ↓ Affiliates Competitors Suppliers Access to Foreign Markets Positive (job creation effect) - - Displacement Effect Negative (job creation effect) - - Negative (job creation effect) Competition Effect - - Negative (wage effect) Shared Supplier Strengthening - Positive (job creation effect) - Movement of Labor - Positive (Job creation effect) - Demand Effect - - Positive (Job creation effect) Productivity (of Suppliers) Effect - - Negative (job creation effect) Productivity of Labor Positive (wage effect) - Positive (wage effect) International Rent Sharing Mechanism Positive (wage effect) - - Competition for Skills - Positive (wage effect) - Table 2: Reviewed Studies on FDI’s Effect on Employment and Wages in Local Firms Evidence18 by Region Number of Studies Study Characteristics Number of Studies Global 15 Theoretical 11 East Asia and Pacific 18 Europe and Central Asia 11 Empirical 54 Latin America and Caribbean 7 Middle East and North Africa 1 South Asia 2 Literature Reviews 8 Sub-Saharan Africa 4 Counted studies have strong claims to internal and external validity, which covers characteristics such as country 18 coverage, data reliability, and empirical strategy. FOREIGN DIRECT INVESTMENT AND EMPLOYMENT OUTCOMES IN DEVELOPING COUNTRIES | 21