Foreign Direct Investment: Who Gains?
Oliver Morrissey - Research Fellow, ODI
Dirk Willem te Velde -Research Fellow ODI
Sheila Page - ODI
Oliver Morrissey and Dirk Willem te Velde held a lunchtime seminar on Tuesday, 26 March 2002 to present their recent research into the effects of Foreign Direct Investment on poverty. This DFID-funded study identifies the impact of FDI and foreign ownership on both skilled and unskilled wages in five African and East Asian countries. Both speakers gave a short presentation followed by discussion.
There is increasing interest in FDI and its importance as an external source of capital for developing countries. However, if FDI contributes to average growth and productivity, can we also say that it helps to reduce poverty? To answer this question we need to understand how the gains from FDI are distributed within a country. This project asks whether skilled and unskilled workers both gain and to what extent?
The study was in two parts and looked at the effect of FDI on wages in five East Asian and five African countries.
Dirk Willem te Velde
Theory would suggest that FDI has a more beneficial effect on the wages of skilled than unskilled workers because it:
- raises the demand for skilled workers by locating in skill-intensive sectors and introducing skill-biased and more efficient technologies;
- may change the bargaining position of labour, with a differential impact on wages; and because
- MNE training generally goes to skilled workers.
Most of the macro evidence for developed countries suggests that skilled workers gain relative to unskilled workers as a result of FDI, but systematic evidence for developing countries is lacking.
East Asia - Hong Kong, Korea, Singapore, Thailand and Philippines
This study looks at the relationship between wages and a measure of FDI, controlling for other influences. It was a data-driven exercise that used the ILO database on wages and linked this to the ILO database on employment.
It found that while FDI raised the wages of both skilled and unskilled workers, there was no consistent impact on wage inequality in the countries examined, except in Thailand owing to the composition effect (i.e. FDI actually goes to the high skilled sectors rather than 'exploiting' unskilled labour) and the impact on bargaining (MNEs pay more not because they are more efficient than local firms but because there is a shortage of the type of labour that MNEs require due to the lack of appropriate education provision).
The study concluded that:
- FDI raises average wages but does not reduce and may increase wage inequality in developing countries.
- Support for good quality and appropriate education and general training for low-skilled workers is important to make FDI work for development for all types of workers.
- More attention should be given to the bargaining position of low-skilled workers in a globalising world and the extent to which MNEs promote or discourage unionisation.
Although there may be a link between FDI and poverty, there is no general direction either positive or negative. However, there are indirect mechanisms that can be explored:
- Growth. Indirect link because FDI is good for growth, which is good for poverty. However, the evidence from developing countries is fragile when other factors are controlled for. There is a positive association but not a strong one.
- Employment. The study does not provide conclusive evidence on whether FDI increases employment for the poor because of lack of data but it does provide pieces of the jigsaw as foreign-owned firms tend to be larger than local firms. However, this does not mean that there is necessarily an overall national effect.
- Higher wages. Although there is strong evidence that foreign-owned firms pay more than local firms for workers with similar qualifications, this will not generally benefit the poor as FDI increases the demand for skilled workers.
Africa - Cameroon, Ghana, Kenya, Zambia and Zimbabwe
The results of this study is available as a CREDIT Research Paper (01/19): Foreign Ownership and Wages: Evidence from Five African Countries
This study relates to firms owned by a foreign national rather than FDI. There were some technical limits such as not being able to account for unobserved worker-specific effects and the possibility of double counting. The study also cannot talk about wage differentials at firm level because it did not look at all employees within a sector.
It found that the foreign ownership premium was high if other characteristics were not controlled for. If factors such as location, sector, size of firm were controlled for, the wage differential between foreign-owned and local firms was reduced but remained significant. The differential was more pronounced in some sectors but this was not uniform. At all skill levels, foreign-owned firms paid more but this increased with education levels. In some countries occupation had no effect on the differential but in others blue collar workers gained more. The size premium of firms was reduced if foreign ownership was controlled for.
The study concluded that:
- Workers employed in foreign-owned firms do earn more (10-20%).
- Those employed in larger firms also earn more but there is no direct relationship to foreign ownership.
- Although the effect on poverty cannot be stated, it can be said that foreign owners pay more at all skill levels, even if there is a preference for skilled workers.
- FDI is associated with higher earnings.
Many specific and substantial questions were raised during the discussion. A selection of the questions and answers follow:
Do higher wages increase the price of essential goods?
The study does not look at this specifically because the data is not available but, given that manufacturing firms deal with processed rather than staple foods, one would be no obvious effects on poor consumers. However, foreign firms may push up factor prices which could have a crowding out effect on local firms.
Did the studies on the impact of FDI on growth control for the policy environment and type of FDI?
Certain policies certainly influence the relationship between FDI and growth e.g. education, linkage polices (the comparison between East Asia and Africa is stark in this respect as East Asian countries are able to focus on linkage, whereas African countries have less that they are able to link to, for example, natural resources).
The study does not distinguish between Mergers and Acquisitions (M&A) and other types of FDI. UNCTAD data indicates that about 10% of African FDI is M&A, whereas in Latin America this increases to around 30-40%. However, there was little difference in impact between M&A and Greenfield FDI, except in the areas of competition and concentration.
What is the source of skill bias? Does FDI sometimes arise because it is profitable to relocate to less developed countries and they take with them production technology?
The Mexico paper (by Feenstra and Hanson) hypothesised that as activities were relocated from US to Mexico, they were less skill intensive than the US but more so than Mexico and therefore inequality was increased in both countries.
Does the data account for seasonal labour?
The East Asia study does not control for temporary migrants and is based on annual ILO employment survey.
Does the study look at the wage effect according to the nationality of foreign owners, and does this have an impact on the relationship between wages and foreign ownership?
The survey of the African countries appear to indicate whether the owner was foreign not where he was from. This issue is also complex because there could be a difference in what an owner would categorise himself as and what those conducting the survey would record. However, although this issue cannot be addressed, the study can say that foreign-ownership does not push the wage rate down.
Does the study set up a man of straw in terms of the relationship between FDI poverty? DFID claims that FDI matters to low-income countries but domestic investment is always more important and this is where the emphasis should lie. However, as both foreign and domestic investment have a tenuous link with growth and poverty, the question should be about why investment does not generate growth in sub-Saharan Africa? Investment matters because of its relationship with growth and, as DFID believes growth is good for the poor, a direct link does not need to be established. Where FDI could make a difference is in improving productivity e.g. by facilitating innovation and further research in this area would be useful.
There is less work looking at the links between FDI and productivity (in the African context). From those that have been done it is not evident that foreign firms are more productive (in the African context). The East Asia study controls for the effects of FDI on productivity, where productivity increases would translate in wage increases.
It would be useful if the study could refer to UNCTAD's work in the studied countries on FDI and employment.
The link between FDI and employment is not a simple one. It is most straightforward in the textile sector as FDI is most likely to add to the productivity capacity and low-skill employment. However, in other sectors and at the national level in particular, there is no simple relationship i.e. depends on factors such as the time scale, industry, country, effect on productivity, exports etc.
Related to the evidence cited on FDI and wages for developed countries, did Ireland's aggressive FDI programme reduce its rural poverty?
During the 60s and 70s, Ireland attracted FDI through a consistent policy of skill upgrading and education and aggressive FDI promotion. In the 1980s, however, it realised that not all gains of FDI remained local and a linkage promotion programme was established which helped improve the linkages with the local economy. Ireland's ability to pursue such an FDI policy is enhanced by factors such as historic links with the US, language, markets, tax breaks etc. which most developing countries do not share. Further information on FDI policy and best practice in Ireland and other countries can be found here.
While Foreign Direct Investment is usually associated with higher growth in host countries, less is known about who gains within societies. The speakers will discuss the results of a study into the effects of FDI and foreign ownership on wages in African and East Asian countries. The studies suggest that low-skilled workers do gain but much less than highskilled workers. It also addresses policy implications. The speakers will give a short presentation followed by a discussion.