How does foreign investment affect jobs?

With the growing activities of multinationals, one of the major concerns for policymakers in developed countries is the disemployment caused by multinationals, especially in the manufacturing sector.[1] For example, increased competition with foreign countries forces firms to relocate their production sites overseas, which results in disemployment in the home country. In particular, the decline in manufacturing jobs is believed to have been the consequence of globalisation. However, previous studies, including those conducted in Japan, have not necessarily confirmed this phenomenon of ‘exporting jobs’.[2] One reason is that foreign direct investment (FDI) usually initiates increases in the production of final goods in foreign countries, which positively affects the production of intermediate inputs in the home country, resulting in the maintenance of, or an increase in, the demand for domestic labour. Such positive effects may offset or even exceed the negative effects.

Disemployment and FDI

We empirically examine how and to what extend disemployment is related to FDI. We focus on Japanese multinationals, especially in the manufacturing sector. An advantage of Japanese data is the availability of parent-foreign affiliate matched data. These data include information such as employment and wages at both the parent firm and foreign affiliate levels. This enables us to identify the relationship between global resource allocation by the multinational firms and changes in prices at home and in foreign countries.

Our study builds upon research by Yamashita and Fukao (2010) and Harrison and McMillan (2011).[3] Yamashita and Fukao estimated the labour demand function for domestic manufacturing employment in Japan, to which they added the amount of FDI, conditional on the domestic output of each firm. Their study found “some evidence that expansion of overseas operations may have helped to maintain the level of home employment” (p. 88). However, they did not distinguish between the destinations of FDI. Given the rapidly expanding Asian markets, the effects of FDI may vary according to its destination; namely, impacts may differ depending on whether FDI occurs in China, Vietnam, Thailand, or outside of Asian markets, such as the US. In addition, because changes in domestic output may result from FDI itself, the estimated coefficients of FDI may include a substantial bias that prevents evaluation of the magnitude of its effects.

To overcome such shortcomings in the literature, Harrison and McMillan estimated the unconditional labour demand function for domestic employment based on a price vector of domestic and foreign countries. Their results indicated that “offshoring to low-wage countries substitutes for domestic employment” (p. 857), but they also found that the wage differential between countries explained only a small proportion of the decline in US manufacturing employment. Other factors, such as falling investment goods prices and import competition, are a more important quantitative determinant. While Harrison and McMillan employed a sophisticated empirical framework, because of data constraints, they used only three classifications for locations: the US, high-income countries, and low-income countries. However, as they stated, “in principle there could be as many factors and final goods prices as there are countries” (p. 863).

New evidence

Extending these studies, we estimate the unconditional labour demand function for Japan à la Harrison and McMillan, to quantify the magnitude of the effect of FDI on domestic disemployment. We utilise parent-affiliate matched data at the affiliate level. Thus, the factor and final goods prices can be decomposed for each destination country. Distinguishing between the different effects for Asian countries such as China, Thailand, and Vietnam, we quantify the extent to which the price differential between Asian countries and Japan caused the ‘exporting of jobs’.

Our main findings are as follows.

• First, the effect of factor prices on domestic employment depends on the destination of FDI.

Changes in Chinese wages had negative effects on domestic employment in Japan, but the size of this impact was almost the same as that of the changes in other East and Southeast Asian countries such as Indonesia, the Philippines, and Thailand. The increases in the investment goods price in China but the decreases in the investment goods price in the US negatively affected the domestic labour demand of multinationals in Japan. This contrast may reflect the difference in specialisation patterns caused by FDI across countries.

• Second, in general, the negative effect of foreign wages on domestic employment is negligible.
• In contrast, the decline in the price of investment goods has significantly larger negative effects on domestic employment than on foreign wages.

These results together suggest that disemployment in Japan is mainly driven by substitution between capital and labour, rather than the reallocation of labour caused by FDI.

Editor’s Note: The main research on which this column is based (Kambayashi and Kiyota 2014) first appeared as a Discussion Paper of the Research Institute of Economy, Trade and Industry (RIETI) of Japan. The revised version is forthcoming in Review of World Economics.

References

Desai, M A, Foley, C F, and J R Hines Jr (2009), “Domestic Effects of the Foreign Activities of US Multinationals,” American Economic Journal: Economic Policy 1: 181-203.

Hayakawa, K, Matsuura, T, Motohashi, K, and A Obashi (2013), “Two-dimensional analysis of the impact of FDI on performance at home: Evidence from Japanese manufacturing firms,” Japan and the World Economy 27: 25-33.

Harrison, A and M McMillan (2011), “Offshoring Jobs? Multinationals and U.S. Manufacturing Employment,” Review of Economics and Statistics 93: 857-875

Kambayashi, K and K Kiyota (2014), “Disemployment Caused by Foreign Direct Investment? Multinationals and Japanese Employment,” Review of World Economics, (RIETI Discussion Paper Series 14 E-051).

Yamashita, N and K Fukao (2010), “Expansion Abroad and Jobs at Home: Evidence from Japanese Multinational Enterprises,” Japan and the World Economy, 22: 88-97.

Footnotes

[1] In the literature, disemployment by multinationals is also called job offshoring, or the hollowing out of industries.

[2] See Desai et al. (2009) for a survey.

[3] A recent study by Hayakawa et al. (2013) also examined the effects of FDI on domestic employment in Japan. However, their analysis focused only on whether firms are multinationals, and global resource allocation by multinationals is beyond the scope of their paper.

Published in collaboration with VoxEU

Author: Kozo Kiyota is a Professor of Economics at the Keio Economic Observatory at Keio University and a Faculty Fellow at RIETI.

Image: Visitors look at the bourse at the Tokyo Stock Exchange in Tokyo March 3, 2014. REUTERS/Issei Kato.