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Trade Unions, Wage Bargaining Co-ordination and Foreign Direct Investment
Roxana Radulescu Business School,
University of Newcastle upon Tyne, Newcastle upon Tyne,
NE1 7RU
and
Martin Robson∗ Department of Economics and Finance,
University of Durham, 23-26, Old Elvet,
Durham, DH1 3HY
October 2006
Abstract Conventional wisdom asserts that high trade union bargaining strength and a system of co-ordinated wage bargaining tend to reduce the attractiveness of an economy as a location for foreign direct investment. However, empirical evidence on these issues is rather limited. This study provides further evidence on the issues through an econometric analysis of the determinants of inflows of foreign direct investment based on panel data for 20 OECD economies. In particular, the study examines the proposition that there may be interaction effects in the relationship between trade union bargaining strength, bargaining co-ordination and the incentives for foreign direct investment. JEL codes: F21, F23, J51 Keywords: Trade unions; Wage bargaining; Foreign direct investment Acknowledgement: Earlier versions of this paper have been presented at the Scottish Economic Society annual conference 2004 and at the 2004 annual conference of EALE. We are grateful to the audiences at those conferences and to Kevin Lang and Les Reinhorn for their helpful comments. We accept sole responsibility for any remaining errors in the analysis or interpretation.
∗ Corresponding author. Department of Economic and Finance, University of Durham, 23-26, Old Elvet, Durham, United Kingdom, DH1 3HY. Tel. +44 (0)191 334 6349, fax. +44 (0)191 334 6341. Email: [email protected]
2
1. Introduction
Increasing recognition of the benefits that may accrue to nations from the
attraction of foreign direct investment into the economy (e.g. in terms of the effects on
productivity growth and employment) has led to a resurgence of interest in the factors
that help to make a country a more or less attractive location for investment by
multinational enterprises.1 Recently, attention has been attracted to the role of
domestic labour market institutions – in particular, the strength of trade unions and the
nature of trade union bargaining arrangements - as potential influences on the
direction of foreign direct investment flows. The conventional wisdom on this issue is
that a strong trade union presence will tend to make a country a less attractive location
for foreign direct investment, due to concern on the part of multinational enterprises
that the rent-extraction activities of trade unions will tend to limit the profitability of
their investments. Following on from this, it is argued that multinational enterprises
will prefer to locate in economies with decentralised or uncoordinated bargaining
arrangements, as these will tend to restrict the degree of trade union power and leave
the firm relatively free to determine the wage and employment conditions in its own
plants.
Theoretical work by Naylor (2003) and Naylor and Santoni (2003) supports
the proposition that foreign direct investment in a potential host economy is less likely
the stronger is the wage bargaining power of domestic trade unions. In contrast,
Bughin and Vannini (1995) show that a high degree of unionisation amongst domestic
firms might help to attract foreign direct investment if the ‘foreign’ firm is able to
recruit labour in the host country market at the competitive wage. The degree of
centralisation or co-ordination in wage bargaining is clearly of relevance in this
1 For a survey of the theoretical and empirical literature on this issue see chapter 2 of Moosa (2002).
3
context. If wage bargaining is centralised or co-ordinated so that wages in the foreign-
owned plant are tied to those in domestic firms then in Bughin and Vannini’s model
foreign direct investment will be deterred. In contrast, Leahy and Montagna (2000)
show that in circumstances in which the multinational enterprise has a productivity
advantage over domestic firms, centralised wage bargaining will tend to encourage
foreign direct investment. This is because under centralised bargaining the
multinational enterprise will be faced with a lower wage rate than under decentralised
bargaining as domestic trade unions will tend to moderate their wage demands in
order to preserve employment in the relatively inefficient domestic firms.2
To date, there has been relatively little empirical evidence on the effects of
trade unions and wage bargaining structures on the location of foreign direct
investment. Studies by Cooke (1997) and Cooke and Noble (1998) find that foreign
direct investment by U.S. multinational enterprises is attracted to economies with
decentralised wage bargaining systems and discouraged by high levels of trade union
density, thus supporting the conventional wisdom in this area. In contrast, Traxler and
Woitech (2000), using cross-national data for two time periods (1981-5 and 1988-92),
find that the number of ‘employment-inducing investments’ by U.S. multinationals is
positively related to the level of trade union density. Moreover, while in the second
time period foreign direct investment is observed to be negatively related to the
degree of bargaining centralisation, no such relationship is evident in the first period.
2 It is important in this discussion to draw a distinction between ‘bargaining co-ordination’ and the degree of centralisation in wage bargaining. Co-ordination refers to mechanisms under which the wider employment implications may be taken into consideration when wage bargains are being struck. ‘Centralisation’ refers to the level at which bargaining takes place (e.g. plant, industry or national level). Co-ordinated bargaining can be achieved under a centralised system of bargaining or, if appropriate institutional arrangements exist, under decentralised bargaining (Nickell, 2003, cites Germany and Japan as examples of the latter). Studies in the literature often fail to make this distinction, treating the two terms as synonymous. In what follows it should become clear that in this study we are concerned with the effect of bargaining co-ordination.
4
Each of these studies is limited in that the analysis is based solely on the
decisions of U.S. multinationals. While this focus might be justified by the
observation that the U.S. is the largest contributor to global foreign direct investment
flows, nevertheless it may be argued that that the findings might not be representative.
Firms from the U.S., with its tradition of relatively unregulated labour markets might
be particularly sensitive to labour relations factors when making their multinational
investment decisions (Traxler and Woitech, 2000).
In the light of this limitation and the contrasting findings that have emerged
from the studies discussed above, the aim of the present study is to try to shed further
light on the issue of how trade union strength and wage bargaining arrangements
affect the attractiveness of a country as a location for foreign direct investment. To
investigate this issue, we examine the theoretical foundations of the relationship
between trade union strength, wage bargaining co-ordination and foreign direct
investment and undertake an econometric analysis of foreign direct investment flows
using cross-national time-series data on 20 OECD economies. The theoretical analysis
affirms the conventional predictions concerning the relationship between trade union
bargaining strength, bargaining co-ordination and foreign direct investment but in
addition highlights the possibility that there may be important interactions between
the effects of the first two variables. In particular, it is shown that there might be
circumstances in which a high degree of bargaining co-ordination could serve to
weaken the negative effects of trade union bargaining strength on the incentives for
foreign direct investment. The findings from the empirical analysis provide varying
degrees of support for these predictions. There is, however, strong evidence that a
high level of trade union density – as a proxy for trade union bargaining strength – has
5
a detrimental effect on the attractiveness of an economy as a location for foreign
direct investment.
The pattern of the remainder of the paper is as follows. In section 2, we set out
a theoretical model that highlights the relationship between trade union bargaining
strength, the degree of co-ordination in wage bargaining and the attractiveness of an
economy as a location for foreign direct investment. Section 3 presents some relevant
data for our sample of OECD economies and reports the results of the econometric
analysis. Section 4 concludes.
2. Theoretical Background
In this section, we set out a theoretical framework that attempts to capture the
main features of the relationship between trade union bargaining power, the degree of
co-ordination in union wage bargaining and the choice of location for FDI.
Specifically, we examine the location decision of a multinational enterprise (MNE)
that has taken the decision to establish a new production facility in one of a number of
potential host economies, in each of which it will compete with a single incumbent
producer.3 The firm is assumed to enter the market in which the expected level of
profit is highest. The basic theoretical structure, which draws on and extends the
results of analysis presented in Naylor (2003) and Naylor and Santoni (2003), is that
of a three-stage game. In the first stage, the MNE decides which of the host countries
to enter. In stage two, the wage rates in the MNE and the host country firm are
determined through a process of bargaining between employers and trade unions.
3 We abstract from consideration of alternative means of supplying the domestic market, e.g. through exporting or licensing. Naylor and Santoni (2003) justify such an approach by assuming that the firm operates in the service sector so that exporting is not a viable alternative. However, as the FDI data we examine includes non-service sector items we do not pursue this assumption and assume simply that the firm has already taken the decision to engage in FDI. The assumption that there is a single incumbent producer in the domestic market is made for analytical convenience. The results may be generalised to the case of n incumbent producers.
6
Finally, in stage three, the firms choose their profit maximising level of output (and
hence employment).
In the first instance, we assume that the cost functions of the MNE and the
domestic firm are identical and examine the outcomes in terms of the wage rate and
the level of profits to the MNE under two sets of wage bargaining arrangements. In
the first, wage bargaining takes place between each individual firm and a trade union.
In the second, the trade unions are assumed to co-ordinate their actions to negotiate a
single wage for both firms.
The firms are assumed to face the following symmetric linear demand
functions in the host country market:
pm(xm,xh) = a – xm – bxh (1) ph(xm,xh) = a – bxm – xh (2) where pm (ph) denotes the price of the product of the MNE (incumbent producer), xi (i
= m,h) denotes the quantity of output produced by each firm in the host country
market, and b (0 < b ≤ 1) represents the degree of substitutability between the two
firms’ products.
We assume that labour is the only input to production and that each unit of
output is produced using a single unit of labour. The wage rate is determined by
bargaining between the firm and a trade union at stage two.
The profit functions for the two firms are given below: πm = (a – xm – bxh – wm)xm (3) πh = (a – bxm – xh – wh)xh (4)
Under the assumption that each firm acts as a Cournot competitor in the
product market, the following expressions may be derived for the equilibrium output
(and employment) levels of the two firms, in terms of the wage rate paid by each firm:
7
xm* = 1 [(2 – b)a – 2wm + bwh] (5) 4 – b2 xh* = 1 [(2 – b)a + bwm - 2wh] (6) 4 – b2 Substituting equations (5) and (6) into equations (3) and (4) gives us expressions for
the optimal level of profits for each firm. For example, optimal profits for the MNE
are given by:
In the absence of any co-ordination in wage bargaining each firm is assumed
to bargain with a single trade union. We assume that bargaining is carried out within a
‘right to manage’ framework, such that the trade union and the employer bargain over
the level of the wage and the employer is then free to determine the level of
employment.4 Trade unions are assumed to be interested in rent maximisation, hence
the objective function of the union in the MNE-owned plant is:
_ where w is the wage rate of non-union workers.
The Nash bargaining solution for the wage rate in the MNE plant is obtained
by maximising the following expression with respect to wm:
4 There is a substantial literature on the issue of whether bargaining between trade unions and employers is best modelled within a ‘right to manage’ or efficient bargains framework. In the former, negotiated wage-employment outcomes are assumed to lie on the employer’s labour demand curve; in the latter bargained outcomes lie on a positively sloped contract curve (in wage-employment space). While empirical work has not produced a definitive guide as to which framework is most appropriate, the fact that bargaining between unions and employers over employment is seldom observed (as the
22
2*)(]2)2[(
4
1* mhmm xbwwab
b=
+−−−
=π (7)
]2)2[(4 2
_
hmm
m bwwabb
wwU +−−
−−
=(8)
ββππ ][][_
1_
UUV m −−= −(9)
8
where β (0 ≤ β ≤ 1) denotes the exogenously determined bargaining power of the
trade union and _
U and _
π denote the conflict payoffs to the union and to the MNE.
For simplicity, we set the level of these conflict payoffs to zero. Substituting
equations (7) and (8) into (9), we may rewrite the expression for the Nash maximand
as:
From equation (10), the first order condition for the Nash bargaining solution
may be derived as:
where K is a positive constant.
From the above first order condition, we can obtain an expression for wm in
terms of wh, the non-union wage and the bargaining power of the MNE:
Considering a symmetric equilibrium in which the wage in the MNE and the
host country firm are identical, we obtain (Naylor, 2003):
Equation (13) gives the wage paid by the multinational firm in the host country under
individualistic bargaining.
efficient bargains model implies that they should) means that the ‘right to manage’ framework is more
βββ
−−
+−−−
−= 2
_2
2]2)2[(][
4
1hmm bwwabww
bV
{ } 0])[2(2]2)2[(_
=−−−+−−= wwbwwabKdw
dVmhm
m
ββ (11)
_
2
)2(
4
])2[(w
bwabw h
m
ββ −++−
= (12)
__
)4(
))(2(w
b
wabwm +
−−−=
ββ (13)
(10)
9
Co-ordinated Bargaining
With symmetric firms it is assumed that under co-ordinated bargaining, the
unions and employers act to negotiate a single wage that maximises the weighted
product of the utilities of the parties to the wage bargain, i.e.
1( ) ( )m h m hV U Uβ βπ π −= (14)
The Nash maximand can be written as:
where wc denotes the wage rate under co-ordinated bargaining. The first order
condition for a maximum is now:
where, again, ψ denotes a positive constant. From (16), we obtain an expression for
the wage rate under co-ordinated bargaining:
From a comparison of equations (13) and (17), it can be seen that the wage rate is
higher under co-ordinated bargaining than under individualistic bargaining. The
intuition for this is that under individualistic bargaining wages are strategic substitutes
for the domestic firm and the MNE and strategic complements for the trade unions
(Naylor, 2003). Hence, the strategic interaction between unions and firms leads to
commonly adopted in contemporary theoretical analyses. For a discussion, see Naylor (2003).
ββ
2_
)2(2
)()2(
)(ww
b
waV c
c −
+−
=−
0))(2()((_
=
−−−−Ψ= wwwa
dw
dVcc
c
ββ (16)
__
2
)(w
wawc +−= β (17)
(15)
10
wage moderation that enables oligopoly profits or trade union surplus to be captured.
Under co-ordinated bargaining this wage moderation effect does not occur.5
It follows from the above that profits for the multinational enterprise (and the
domestic firm) will be lower under co-ordinated bargaining than under individualistic
bargaining. This result implies that other things equal multinational enterprises will
prefer to locate new plant operations in countries with individualistic rather than
coordinated bargaining systems, a result that accords with conventional wisdom on
this issue. In addition, it can be seen that under both types of bargaining regime the
wage rate is an increasing function of trade union power, as represented by β. Hence,
the model gives formal support to the conventional view that multinational enterprises
will tend to locate in markets in which trade union power is relatively weak.
Through differentiating equations (13) and (17) with respect to β, it can be
seen that in general (as long as b > 0) the effect of an increase in trade union power on
the wage rate is stronger under co-ordinated bargaining than under individualistic
bargaining:
2
_
)4(
))(2(4
β−−−=
β∂∂
b
wabwm
2
)(_
wawc −=β∂
∂
The implication is that in empirical analysis we might expect to observe interaction
effects between trade union power and the nature of the wage bargaining regime, such
that the deterrent effect of trade union power on FDI inflows is greater the greater the
degree of bargaining co-ordination.
5 See Naylor (2003) for further details.
(18)
(19)
11
However, the interaction effects between the level of trade union power and
the degree of wage bargaining co-ordination need not always work in this direction.
Suppose, as is commonly assumed, that the MNE has a productivity advantage over
the firm in the potential host country market. In particular, suppose that the unit
labour requirement for the MNE is given by α, where α < 1 (Leahy and Montagna,
2000). In these circumstances, it can be shown that under certain conditions the
presence of co-ordinated bargaining and a high degree of trade union bargaining
power could actually serve to benefit the MNE.
With a unit labour requirement of α, Cournot equilibrium profits for the MNE
are given by:
22
2]2)2[(
4
1* hmm bwwab
b+−−
−= απ (20)
Note that:
βπ
βπ
βπ
∂∂
∂∂
+∂
∂∂∂
=∂
∂ h
h
mm
m
mm w
w
w
w (21)
With asymmetries between the productivity of the multinational and the domestic
firm there seems little reason to suppose that under co-ordinated bargaining the trade
unions would act to negotiate an identical wage in each firm.6 If instead we adopt the
weaker assumption that under co-ordinated bargaining:
βββ ∂∂
≡∂∂
=∂
∂ chm www (22)
(i.e. that the effect on the wage of a change in the level of trade union bargaining
power is the same for the host country firm and the MNE) then it can be shown that:
6 This is the assumption adopted by Leahy and Montagna (2000) in their analysis of the effects of centralised wage bargaining on the relationship between unionisation and the incentives for foreign direct investment; an assumption which seems reasonable in that particular context but which seems less attractive here.
12
β
ααβ
π∂∂
−+−−
−=
∂∂ c
hmm w
bbwwabb
)2](2)2[(4
12
2
2 (23)
On the further assumption - which is likely to be valid in a plausible range of
circumstances - that (∂wc/∂β) > 0, it follows from (23) that:7
)2.(sgn.sgn αβ
π−=
∂∂
bm (24)
The implication of equation (24) is that if the products of the MNE and the domestic
firm are sufficiently close substitutes and the productivity advantage of the MNE is
sufficiently high then an increase in trade union bargaining power could actually lead
to an increase in the profits of the MNE, making the host country a relatively
attractive market in which to locate. The intuition for this result is that, under the
circumstances outlined above and given the productivity advantage held by the MNE,
the effects of a co-ordinated increase in the wage (induced by an increase in union
bargaining power) lead to a reduction in the output of the domestic producer that is
beneficial to the MNE.
More generally, the analysis in equations (20) to (24) indicates that there are
circumstances in which bargaining co-ordination might soften the deterrent effect that
a high degree of trade union bargaining power might otherwise be expected to have
on the incentive for inward investment by multinational enterprises. Taken together
with the results from equations (18) and (19) the implication is that in analysing the
empirical relationship between trade union bargaining power, bargaining co-
ordination and inflows of FDI we might expect to find evidence of an interaction
7 In the case where the unit labour requirement for the MNE is given by α (0 < α < 1) the derivation of an expression for (∂wc/∂β) is not straightforward. However, for a plausible range of circumstances, it seems reasonable to assume that the sign of the derivative will be positive.
13
effect between the former two variables, though the direction of this effect cannot be
signed a priori.8
3. Data and Econometric Analysis
In order to investigate the empirical relationship between trade union
bargaining strength, wage bargaining arrangements and foreign direct investment
(FDI), we undertake panel data regressions using data on the real value of FDI
inflows for a sample of OECD countries. Our proxy for union bargaining power is the
level of trade union density, as is often used in empirical models of wage
determination (e.g. Manning, 1993).9
The measure we use for the degree of co-ordination in wage bargaining is
constructed by Ochel (2000) (as reported in Nickell et al 2003), and is based on data
reported in OECD (1997) and other sources. The measure is an index with a range 1-
3, which is increasing in the degree of co-ordination in the bargaining process, both
on the employers’ side and between trade unions. Five degrees of co-ordination are
identified, ranging from indirect methods of co-ordination such as pattern setting in
wage bargaining to more direct methods such as state-sponsored co-ordination, in
which the state enters as an additional party in the bargaining process. Within each
type, recognition is also given to the intensity of co-ordination.
The data we use covers the period from the early to mid 1970s (the precise
date varies between countries) to 1997. The start date is dictated by the availability of
8 To further complicate matters, it is possible that in the case in which the MNE has a productivity advantage over the domestic firm an increase in trade union bargaining strength might also lead to an increase in the profits of the MNE under individualistic bargaining. Consider the extreme case in which α = 0. Then the MNE uses no labour and so it doesn’t enter into any wage negotiations. Nonetheless, an increase in β leads to an increase in the wage rate paid by the domestic firm and so leads to an increase in the profits of the MNE (from equation (20)). We are indebted to Les Reinhorn for this observation.
14
data on FDI flows, while the end date is dictated by the measures of trade union
density and bargaining co-ordination.10
Table 1 presents selected data on trade union density, the incidence of co-
ordinated bargaining and real inflows of foreign direct investment for the countries in
our sample, while Figure 1 presents a cross-plot of national average values of the data
on trade union density and inflows of FDI (both in logs).11 From Table 1, it can be
seen that trade union density is highest typically in the Scandinavian economies of
Sweden, Denmark and Finland, and lowest in Spain, France, and the USA. In most of
the countries in our sample, the trend has been towards a decline in the level of
unionisation, though a small number of countries have seen a significant increase (e.g.
Finland, Sweden).12 Unsurprisingly perhaps, the degree of wage bargaining co-
ordination has tended to be relatively high in the highly unionised economies of
Scandinavia (though less so in Finland) but notably also in Austria, Germany, Ireland
and Japan. In contrast, the USA has been characterised by uncoordinated bargaining.
As with the level of unionisation, where changes in the degree of wage bargaining co-
ordination have occurred the tendency in most countries has been in favour of
measures that have reduced the degree of co-ordination. For example, in the United
Kingdom the move away from multi-employer bargaining that has taken place since
1980 has been accompanied by a significant weakening of attempts at co-ordination.
9 Trade union bargaining power may also be positively related to the degree of bargaining co-ordination. For example, the threat of strike action may be a more powerful weapon if unions act in concert rather than acting individually. 10 The data on trade union density are taken from the Labour Market Institutions database of the Centre for Economic Performance – as described in Nickell and Nunziata (2001) – updated with information from Ebbinghaus and Visser (2000). 11 The data in Figure 1 cover a slightly longer time period – from 1960-4 through to 1995. Data are missing for some countries for some of the earlier years. 12 For an analysis of the determinants of cross-national variations in rates of trade union density, see Checchi and Lucifora (2002).
15
The cross-plot in Figure 1 provides preliminary evidence of a negative
relationship between union density and inflows of FDI, but one that is subject to a
significant degree of dispersion.
Econometric Specification
In examining the empirical relationship between trade union density, wage
bargaining co-ordination and inflows of FDI, we need to control for the existence of
other potential determinants of FDI flows. We therefore include in our regressions a
list of explanatory variables that have been found in other studies to have a significant
effect on the attractiveness of an economy as a location for multinational investment.
Most prominent amongst these is the level of real GDP, which is included as a
measure of market size in the host country economy and is generally found to have a
positive effect on inflows of FDI (see Moore, 1993; Bajo-Rubio and Sosvilla-Rivero,
1994; Wang and Swain, 1995; and Billington, 1999, amongst others). The rate of
growth of real GDP is also included, to capture the effects of rising market demand on
the incentives for multinational enterprise investment. Other variables include the
extent of an economy’s openness to trade (measured as the sum of exports and
imports as a percentage of GDP), a measure of real exchange rate depreciation, and
the level of corporate taxes as a percentage of GDP.13 In addition, following recent
evidence from a number of studies on the potential significance of this variable, we
include an index of the strictness of employment protection legislation in the domestic
13 The empirical evidence on the effects of these variables is rather mixed, with some studies finding evidence of a positive effect, some a negative effect, and others still, no significant effect. Evidence on the effects of trade openness may be found in Kravis and Lipsey (1982), Edwards (1990) and Yang et al (2000). Recent studies on exchange rate effects include Blonigen (1997), Görg and Wakelin (2001) and Yang et al (2000). Finally, Grubert and Muti (1991), Wheeler and Mody (1992), Hines and Rice (1994), Swenson (1994), Jackson and Markowski (1995), Loree and Guisinger (1995), Mudambi (1995), Porcano and Price (1996), Cassou (1997), Kemsley (1998), and Billington (1999) are among a number of studies that have examined the effects of corporate tax rates on FDI.
16
economy.14 Finally, a linear time trend or alternatively a set of year dummies is
included to capture the influence of any common aggregate effects that may have led
to changes in the level of FDI inflows across the OECD economies over time.15 16
We estimate fixed effects regressions to allow for the influence of persistent
characteristics – geographical location, proximity to markets, etc. – that make some
countries more attractive locations than others for investment by multinational
enterprises. Table 2 reports the first set of results.17 Four columns of estimates are
shown, the first of which includes the (log of) trade union density on its own,
excluding the measure of bargaining co-ordination. The results from the first column
show a strongly significant negative effect from trade union density, supporting the
conventional wisdom on the effects of trade unions on FDI. Other things equal, a 10
percent increase in union density is found to lead, on average, to a decrease of over 6
percent in the real value of inflows of FDI.
Elsewhere in the equation, there is support for the common finding that a high
level of real GDP helps to make an economy a more attractive location for FDI,
though we find no significant effect for the rate of growth of real GDP. A strict
employment protection regime is found to have a deterrent effect on inflows of FDI,
14 Evidence that the strictness of employment protection legislation (EPL) and/or the degree of labour market flexibility (which is assumed to be inversely related to the strictness of EPL) might affect the attractiveness of an economy as a location for FDI is reported in Cooke (1997), Haaland et al. (2003), Görg (2005) and Javorcik and Spatareanu (2005). 15 We have also estimated equations that include a measure of trend productivity in the host country. However, this variable is never significant and its omission has no discernible effect on the results for the other explanatory variables. The results are available from the authors, on request. 16 The list of control variables includes the main set of explanatory variables that have been found to have a significant effect on FDI in cross-national studies of developed economies. Other variables that have been found to be significant in some studies include labour costs (e.g. Wheeler and Mody, 1992; Moore, 1993; Billington, 1999), product market regulations - including regulations restricting the scope for FDI (Cooke and Noble, 1998; Javorcik and Spatareanu, 2005), labour standards (Cook and Noble, 1998), participation of left of centre parties in government (Traxler and Woitech, 2000) and host country population size (Javorcik and Spatareanu, 2005). Unfortunately, in most cases constraints on data availability preclude us from including these variables in our analysis. We deliberately exclude a measure of labour costs from the specification as the effects of this variable are assumed to be subsumed by the effects of trade union density and wage bargaining co-ordination. 17 All results are obtained using version 8.0 of Stata.
17
in line with evidence from recent studies on this issue. In contrast, inward investment
is found to be greater in economies with greater openness to trade. This is consistent
with evidence reported in Kravis and Lipsey (1982) and Edwards (1990) but contrary
to the findings of Yang et al (2000) for FDI flows into Australia.18 Finally, a
depreciation of the real exchange rate is found to have a negative effect on FDI, while
the effect of the ratio of corporate taxes to GDP is statistically insignificant.
In the second equation, we introduce the index of wage bargaining co-
ordination. The coefficient for union density is largely unaffected by this change and
remains significantly negative. Meanwhile, the estimated coefficient for the co-
ordination index provides strong evidence that countries with less co-ordinated
systems of wage bargaining are more successful in attracting FDI. A one-unit increase
in the index of wage bargaining co-ordination is associated with a reduction in real
inflows of FDI of approximately 18 percent. This result is therefore strongly
supportive of the conventional wisdom, which suggests that multinational enterprises
prefer to locate in countries in which they can expect to enjoy a relatively high degree
of flexibility in setting wages.19
The third column of Table 2 illustrates the effect of allowing for interactions
between trade union density and the degree of bargaining co-ordination. This follows
on from the theoretical analysis of the previous section, which suggested that the
effects of trade union bargaining strength on inflows of FDI might be dependent on
the degree of wage bargaining co-ordination. The results show a positive interaction
effect between trade union density and bargaining co-ordination, indicating that a
higher degree of co-ordination in wage bargaining weakens the deterrent effect of a
18 A negative effect of trade openness on inflows of FDI can be explained by the argument that FDI might be motivated by a desire to circumvent tariff and non-tariff barriers to trade. 19 We obtain similar results when the incidence of wage bargaining co-ordination is measured using a simple zero-one dummy variable indicating the presence, or otherwise, of co-ordinated bargaining.
18
high level of union density. This finding is therefore consistent with the notion that
under certain circumstances a co-ordinated increase in wages can facilitate an increase
in the profits of multinational enterprises at the expense of domestic producers.
In the final column of Table 2, the linear trend term, which is significantly
positive in the first three equations, is replaced by a set of time dummies. The
restrictions on the coefficients of the time dummies implied by the imposition of the
linear trend term in fact are narrowly rejected.20 The results for the main variables of
interest are largely unaffected by this change to the equation specification, with one
notable exception: the coefficient for the log of real GDP now becomes significantly
negative. This finding is something of a curiosity but implies that once the effects of
common ‘global’ influences on the level of FDI inflows are allowed for, FDI is
attracted to smaller rather than larger economies. This might be because the prospects
for future growth and the expected returns to FDI are greater in economies with
relatively low levels of real GDP.
A further curiosity in the results in column (4) is that the coefficient for
bargaining co-ordination becomes significantly positive; a finding that does not sit
easily with the theoretical framework developed in section 2.
Tests – not reported – on the residuals of the equations in Table 2 reveal
evidence of serial correlation in the regression disturbances, raising question marks
over the reliability of the estimates as a basis for inference. To address this problem,
the equations have been re-estimated with a correction for first order autocorrelation
in the regression disturbances, using the Prais-Winsten modification to the well-
known Cochrane-Orcutt procedure. In addition, experiments were conducted with a
20 The F-test value is F(29, 405) = 1.91, which compares with an approximate 1% critical value of 1.70.
19
lagged dependent variable added to the list of regressors, with estimation performed
using the GMM technique of Arellano and Bond (1991). Table 3 presents a selection
of the results.
The first column of the Table repeats the final specification from Table 2. It
can be seen that the key effect of the correction for autocorrelation is to eliminate the
significance of the coefficient for bargaining co-ordination and the interaction effect
between this variable and the log of trade union density. Indeed, the only variables
that are statistically significant in this equation are the log of union density, the log of
real GDP and the index of employment protection, plus the constant term. As a
consequence, the interaction term between union density and wage bargaining is
deleted from the equation reported in the next column. The coefficient for wage
bargaining co-ordination regains the negative sign it attracted in column (2) of Table
2 and moves closer to statistical significance (t = 1.59). The negative coefficient for
the log of trade union density is once again strongly significant.
For a more direct comparison with column (2) of Table 2, the next column
again substitutes a linear trend term in place of the time dummies. The results are very
similar to those obtained previously, though this time the coefficient for real exchange
rate depreciation is not statistically significant.
Finally, column (4) of Table 3 reports the results from a dynamic specification
of the equation for the log of real inflows of FDI, with the lagged dependent variable
included as an additional regressor. The test statistic indicates that the addition of the
lagged dependent variable is successful in remedying the problem of autocorrelation
evident in the disturbances of the static equation.21 The coefficient for the log of trade
21 The Arellano-Bond procedure involves taking first differences of the regression specification in order to remove the fixed effects, which leads to first order autocorrelation in the disturbances of the differenced equation. The relevant test for the presence of autocorrelation in the disturbances of the levels equation, therefore, is a test for second order autocorrelation in the equation estimated in first
20
union density remains significantly negative in this equation, but the coefficient for
wage bargaining co-ordination, though negative, is no longer significant. The index of
employment protection likewise is no longer significant in the dynamic specification
– most likely because the first differencing procedure inherent in the Arellano-Bond
estimator and the inclusion of the year dummies in the equation mean that there is no
longer sufficient independent variation in the index to permit identification of a
statistically significant effect.
In summary, the results from the empirical analysis are strongly supportive of
the conventional view that the presence of a high level of trade union density in the
domestic economy reduces the attractiveness of a country as a location for investment
by multinational enterprises. In contrast, the evidence concerning the effects of wage
bargaining co-ordination is rather mixed. While the study has found some evidence of
a negative effect of bargaining co-ordination on inflows of FDI, in line with
conventional wisdom on this issue, the results are sensitive to the manner in which the
effects of common ‘global’ influences on the level of FDI across countries are
modelled and to the way in which evidence of autocorrelation in the disturbances of
the static specification is treated. There is some evidence that a higher degree of co-
ordination in wage bargaining might help to soften the deterrent effect of trade union
density but here too the findings are sensitive to attempts to correct for the presence of
autocorrelation in the disturbances of the regression.
An objection that might be raised in response to these results is that trade
union density is a relatively weak measure of union bargaining strength and that a
better measure would be provided by data on the coverage of trade union bargaining
agreements. Unfortunately, cross-national data on the coverage of collective
differences. The value of the test statistic, which has an asymptotic standard normal distribution, is
21
agreements is not generally available. As an alternative, we experimented with
estimating equations including a measure of the prevalence of mandatory extension
laws, which have the effect of extending the coverage of collectively negotiated wage
agreements to non-unionised workers in an economy. Data from OECD (1994) was
used to construct a 0-2 dummy variable, with higher values corresponding to more
pervasive extension practices. As the measure is available only for a single year the
equations were estimated using random effects estimation. The initial results
suggested a negative relationship between the prevalence of extension laws and real
inflows of FDI, other things equal. However, the significance of the estimated
relationship disappears once the equation disturbances are corrected to allow for the
presence of serially correlated disturbances. The results are available from the
authors, on request.22
4. Summary and Conclusions
The present study has attempted to investigate how the power of trade unions
in an economy may affect the attractiveness of the economy as a location for foreign
direct investment. Conventional wisdom on this issue asserts that multinational
enterprises will prefer to locate in economies in which they can expect to enjoy a high
degree of discretion in the determination of wages in the plants that they operate.
High levels of trade union density and a regime of centralised or co-ordinated wage
bargaining will therefore tend to have a negative effect on the inflows of foreign
direct investment into an economy. Recently, however, this conventional wisdom has
0.40, which is insignificant. 22 The country for which the discrepancy between the coverage of collective bargaining agreements and trade union density is greatest is probably France. As an alternative, therefore, we experimented with re-estimating the regression equations with observations for France deleted. The deletion of observations for France did not have any material impact on the results. Again, the results are available from the authors, request.
22
been challenged by Leahy and Montagna (2000). They demonstrate that in some
circumstances at least, it might be beneficial for a multinational enterprise to locate in
an economy in which a system of centralised wage bargaining leads to the wage rate
in the multinational-owned plant being tied to that in its domestically owned
competitors.
Previous empirical work on this issue has been rather limited. The study by
Cooke (1997) examines the effect on the location decisions of U.S. owned
multinational enterprises of trade union density and the degree of bargaining
centralisation (amongst other labour market institutional variables) for a particular
cross-section, and finds evidence in support of the conventional wisdom.
In this study, we have set out a theoretical model that illustrates the potential
relationships between trade union bargaining strength, the degree of co-ordination –
as distinct from the degree of centralisation - in wage bargaining, and the
attractiveness of an economy to foreign direct investment. We have then extended the
empirical analysis of Cooke (1997) by examining panel data for a number of OECD
countries over the period from the mid-1970s through to 1997. Our results provide
further evidence in support of the view that a high rate of union membership in an
economy helps to deter inward investment by multinational enterprises. In addition,
there is evidence too – albeit rather weaker – that a co-ordinated bargaining regime
may act as a deterrent to FDI. Finally, we have found tentative evidence to suggest
that a higher degree of co-ordination in wage bargaining may help to soften the
negative effect that a high level of trade union density might otherwise be expected to
have on the flow of inward investment. This evidence, however, is qualified by the
presence of autocorrelation in the disturbances of the estimated regression.
23
The effects that the study has identified concerning the impact of trade union
density on inflows of FDI are quantitatively as well as statistically significant. Our
most conservative estimates suggest that a decline of 10 percent in the level of trade
union density might be expected to lead to an increase in real inflows of FDI of
around 5.7 percent.23 Evaluated at the sample mean of the dependent variable, this is
equivalent to around $479.3m in 1995 prices.
In addition to the finding of a negative effect of trade union density, the study
has found evidence – in static specifications of the equation for the dependent
variable, at least – of a negative effect on inward investment from an index of the
strictness of employment protection legislation. Taken together, these findings
suggest that labour market rigidities, whether created by the presence of powerful
trade unions or through regulations that restrict the flexibility of companies to adjust
the size of their workforce, are a significant factor in determining the direction of
inward investment flows amongst OECD economies. It appears that, other things
equal, countries with relatively inflexible labour markets are likely to experience
difficulties in attracting high levels of mobile multinational investment. For
governments seeking to raise the attractiveness of their economies as a location for
foreign direct investment these findings might be seen as having significant
implications for public policy.
23 This comes from the estimated coefficient for the log of trade union density in the second column of Table 3.
24
Table 1. Trade Union Membership Density, Bargaining Co-ordin ation and FDI in Selected Years Country Period Union Density
(%) Bargaining Co-
ordination Real FDI Inflow
($m) Australia 1975 49 2.36 1115.2 1985 48 2.31 2747.0 1995 35 1.63 12432.0 Austria 1975 53 2.5 193.6 1985 52 2.5 230.4 1995 41 2.42 1901.0 Belgium 1975 52 2.1 2340.7 1985 51 2.55 1399.5 1995 54 2 10689.0 Canada 1975 34 1.63 8299.0 1985 37 1.08 1806.9 1995 37 1 9319.0 Denmark 1975 69 2.96 654.4 1985 78 2.54 147.8 1995 77 2.42 4139.0 Finland 1975 65 2 166.7 1985 69 2 150.5 1995 80 2.38 1044.0 France 1975 22 2 3823.5 1985 14 2 3462.1 1995 10 1.92 23730.0 Germany 1975 35 2.5 1691.2 1985 34 2.5 652.5 1995 27 2.5 11990.0 Ireland 1975 56 2.91 387.3 1985 56 2.08 218.4 1995 46 2.75 1447.0 Italy 1975 48 2 1580.9 1985 43 1.81 1427.4 1995 39 1.95 4842.0 Japan 1975 31 2.5 - 1985 26 2.5 852.2 1995 24 2.5 40.0 Netherlands 1975 38 2 3019.6 1985 28 2.38 2004.0 1995 24 3 12104.0 Norway 1975 52 2.96 539.2 1985 56 2.72 567.2 1995 55 2.84 2393.0
25
New Zealand 1975 37 2.5 338.2 1985 33 2.32 1685.8 1995 24 1.25 3659.0 Portugal 1975 61 2.56 281.9 1985 56 1.58 364.8 1995 32 1.88 685.0 Spain 1975 09 2.64 1674.0 1985 12 2.3 2620.5 1995 18 2 6297.0 Sweden 1975 74 3 196.1 1985 84 2.53 523.3 1995 90 1.94 14939.0 Switzerland 1975 32 2 - 1985 28 2 1687.1 1995 24 1.63 3599.0 UK 1975 54 1.77 8137.3 1985 51 1.08 7310.3 1995 37 1 20320.0 USA 1975 26 1 6274.5 1985 18 1 26644.5 1995 15 1 59640.0
Note: The measure of wage bargaining co-ordination is an index with a range of 1-3. Higher values correspond to a greater degree of bargaining co-ordination between employers and/or trade unions. The data were compiled by Ochel (2000) and taken from Nickell (2003). See text and Data Appendix for further information on data sources and details of the construction of the variables.
26
Table 2. Trade Union Density, Bargaining Co-ordination and F DI – Fixed Effects Estimates The dependent variable is the log of real inflows of FDI in U.S. dollars (1) (2) (3) (4) log [real GDP] 0.2642*** 0.3155*** 0.2964*** -0.3086** (0.1014) (0.1023) (0.1013) (0.1566) Real GDP growth 0.0038 0.0042 0.0024 0.0005 (0.0058) (0.0058) (0.0057) (0.0065) log [trade union density] -0.6627*** -0.7338*** -1.4921*** -1.3769*** (0.1271) (0.1288) (0.2608) (0.2642) Bargaining co-ordination -0.1829*** 0.1592 0.2210* (0.0666) (0.1220) (0.1215) log [trade union density]*Bargaining co-ordination
0.3714*** 0.3680***
(0.1115) (0.1109) Employment Protection -0.4411*** -0.4799*** -0.4303*** -0.3082*** (0.1237) (0.1235) (0.1230) (0.1313) Openness 0.0046* 0.0060** 0.0058** 0.0035 (0.0026) (0.0026) (0.0026) (0.0028) Real exchange rate depreciation -0.0045*** -0.0044** -0.0045*** -0.0045* (0.0017) (0.0017) (0.0017) (0.0026) [Corporate taxes/GDP] 0.0003 -0.0070 -0.0028 0.0146 (0.0227) (0.0227) (0.0225) (0.0230) Trend 0.0183*** 0.0135*** 0.0144*** (0.0048) (0.0051) (0.0051) Constant 4.3892*** 4.1465*** 3.5952*** 12.0911*** (1.2374) (1.2312) (1.2280) (2.0776) Year dummies No No No Yes Number of observations 453 453 453 453 F-test of overall significance F(26, 426) =
55.95*** F(27, 425) = 54.92***
F(28, 424) = 54.59***
F(57, 395) = 29.15***
Standard deviation of residuals 0.3438 0.3412 0.3373 0.3291 Notes: ‘Within’ estimates. Coefficient standard errors are given in parentheses. *, **, *** denote statistical significance at the 10%, 5% and 1% significance levels, respectively. See the Data Appendix for the list of countries included in the estimation sample.
27
Table 3. Trade Union Density, Bargaining Co-ordination and F DI – Fixed Effects Estimates with Remedies for Serial Correlation The dependent variable is the log of real inflows of FDI in U.S. dollars (1) (2) (3) (4) log [real GDP] -0.4120* -0.4016* 0.2867** -0.1818 (0.2208) (0.2254) (0.1308) (0.1505) Real GDP growth 0.0023 0.0024 0.0018 0.0034 (0.0042) (0.0041) (0.0036) (0.0056) log [trade union density] -0.9683** -0.5655*** -0.7185*** -0.3703*** (0.4486) (0.1975) (0.1867) (0.1331) Bargaining co-ordination 0.0564 -0.1165 -0.1447** -0.0437 (0.1836) (0.0735) (0.0737) (0.0621) log [trade union density]*Bargaining co-ordination
0.1949
(0.1757) Employment Protection -0.3055** -0.3201** -0.4811** -0.2079 (0.1509) (0.1516) (0.1892) (0.1728) Openness 0.0025 0.0028 0.0058** 0.0006 (0.0032) (0.0032) (0.0029) (0.0034) Real exchange rate depreciation -0.0007 -0.0005 -0.0010 0.0010 (0.0023) (0.0023) (0.0015) (0.0023) [Corporate taxes/GDP] 0.0356 0.0353 0.0215 0.0366* (0.0305) (0.0307) (0.0315) (0.0218) Trend 0.0155** (0.0067) Constant 15.7269*** 16.0659*** 4.3033** 0.0565 (3.5437) (3.5536) (2.0268) (0.2776) log [real FDI inflows]t-1 0.4799*** (0.0474) Year dummies Yes Yes No Yes Estimated value of rho 0.545 0.555 0.559 Number of observations 453 453 453 413 Test of overall significance F(58, 395) =
4778.33*** F(57, 396) = 6042.39***
F(28, 425) = 7011.15***
Chi2(28) = 41.52**
Standard deviation of residuals 0.3330 0.3364 0.3451 0.3923
Notes: Estimates in columns (1)-(3) are ‘within’ estimates with a correction for first order autocorrelation in the regression disturbances using the Prais-Winsten modification to the Cochrane-Orcutt procedure. The estimates in column (4) are obtained using the GMM estimator of Arellano and Bond (1991). Coefficient standard errors are given in parentheses. *, **, *** denote statistical significance at the 10%, 5% and 1% significance levels, respectively. See the Data Appendix for the list of countries included in the estimation sample.
28
Figure 1. Trade Union Density and Inflows of Foreign Direct I nvestment in OECD Economies
8
8.5
9
9.5
10
10.5
-2.5 -2 -1.5 -1 -0.5 0
Country average log(real FDI inflows)
Co
un
try
aver
age
log
(net
un
ion
den
sity
)
Source: authors’ calculations based on data from Nickell and Nunziata (2001) and the IMF.
USA
UK
France
Netherlands
Canada
Spain
Germany Belgium
Australia
Italy Switzerland
Japan
New Zealand
Ireland Norway
Austria
Denmark
Sweden
Finland
29
Data Appendix The countries included in the data sample are: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, the Netherlands, Norway, New Zealand, Portugal, Spain, Sweden, Switzerland, the UK, and the USA. FDI Inflows Figures for inflows of foreign direct investment in national currencies dollars are compiled from the International Financial Statistics Yearbook of the IMF. These are converted into U.S. dollars using current exchange rates and then deflated using the U.S. GDP deflator. Trade Union Density This is defined as the ratio of reported trade union membership to the number of wage and salaried employees. The data are taken from Nickell and Nunziata (2001), which contains details of the methods and sources used in the construction of the variable. Bargaining Co-ordination This is an index that ranges between 1-3, with higher values indicating a greater degree of co-ordination in the bargaining process on the employers’ and/or the trade unions’ side. The index was compiled by Ochel (2000), based on data reported in OECD (1994) (1997), Traxler and Kittel (1999), Wallerstein (1999), Windmuller et al. (1987), and Bamber and Lansbury (1998). Employment Protection This is an index of the strictness of employment protection that has been interpolated from the series of five-year average values constructed by Blanchard and Wolfers (2000). The latter series in turn was constructed by chaining OECD data with data from Lazear (1990). The index used here is readjusted in mean and lies in the range {0-2}, with higher values denoting stricter employment protection regulation. Real GDP and Real GDP Growth Nominal GDP figures in national currencies are obtained from the International Financial Statistics Yearbook. These are converted to U.S. dollars using current exchange rates. Real values are then obtained by dividing by the U.S. GDP price deflator. The growth series is calculated as the percentage change from the previous year’s real GDP figure. Real Depreciation The percentage change in the real exchange rate from the previous year (a positive value means a depreciation). Real exchange rates are calculated by multiplying the nominal exchange rate by the ratio of the U.S. GDP deflator to the GDP deflator of the home country. The source for all series is the International Financial Statistics Yearbook. Openness This is defined as the sum of exports plus imports as a percentage of GDP. The component series are obtained from the International Financial Statistics Yearbook. Corporate Taxes/GDP Income from corporate taxes as a percentage of GDP. The data are published in various editions of Revenue Statistics of OECD Countries. We are grateful to John Ashworth for supplying us with the data.
30
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