مسابقه تا آحر؟ حفاظت از اشتغال و سرمایه گذاری مستقیم خارجی

A common critique of globalization is that it leads to a race to the bottom. Specifically, it is assumed that multinationals invest in countries with lower regulatory standards and that countries competitively undercut each other's standards in order to attract foreign capital. This paper tests this hypothesis and finds robust empirical support for both predictions. First, a reduction in employment protection rules leads to an increase in foreign direct investment (FDI). Furthermore, changes in employment protection legislation have a larger impact on the relatively mobile types of FDI. Second, there is evidence that countries are competitively undercutting each other's labor market standards.

A frequent critique of globalization is that it can lead to a race to the bottom, where countries lower their labor standards, environmental standards, or tax rates in order to attract foreign capital.1 More specifically, the race to the bottom hypothesis hinges on two important predictions. First, multinational enterprises (MNE) choose to invest in countries with less restrictive standards. Second, foreign countries competitively undercut each other's standards in order to attract foreign direct investment (FDI). While these are common fears associated with globalization, there is relatively little empirical evidence supporting either of these predictions. This paper tests these assumptions by examining the impact of employment protection rules on inward FDI and on labor market standards in other countries. The results provide compelling support for both predictions of the race to the bottom hypothesis. However, whether a race to the bottom is an undesirable outcome is a normative question that is outside the scope of this paper and ultimately depends on one's view of employment protection rules. Anecdotal evidence suggests that there is an important relationship between FDI and labor standards. For instance, in 1993 Hoover, an American multinational firm, relocated a vacuum cleaner plant from Dijon, France to Cambuslang, Scotland. At the time, the U.K. was encouraging inward investment by highlighting it's relatively flexible hiring and firing rules. In addition, a Hoover executive said that the significantly higher non-wage labor costs in France relative to Scotland was a factor in the company's decision to relocate.2 The French government indicated that this was a case of “social dumping” in which the competitive undercutting of labor standards was used to attract foreign investment and asked the European Commission to investigate.3 This and other highly publicized cases led to concern among European Union officials that countries were lowering labor standards in order to attract large multinational companies.4 This paper examines whether stories like this are indicative of a more general race to the bottom in employment protection rules. A preliminary check of the data seems to support these types of anecdotes. Foreign direct investment has increased substantially in the last twenty five years. For instance, the share of U.S. direct investment in OECD countries relative to U.S. gross domestic product has increased from 4.3% in 1985 to 14.5% in 2007 (see Fig. 1).5 In addition, employment protection rules in OECD countries have decreased from an average of 2.45 in 1985 to 2.04 in 2007 (see Fig. 1). Certainly there are many other factors that can influence both FDI and labor standards and thus the goal of this paper is to examine to what extent these trends in the data are related. According to the first prediction of the race to the bottom hypothesis, a reduction in labor market standards will increase FDI. As employment protection rules become less strict, the cost of operating a foreign affiliate falls, and thus multinationals will shift production activities to that country. Taking this prediction a step further, the response of multinationals to employment protection rules likely depends on the type of FDI. Relatively mobile types of FDI will be more likely to respond to changes in labor market standards than FDI that is tied to a specific location. For instance, vertical FDI, which is motivated by the desire to take advantage of low foreign factor prices, can be relocated to less expensive locations relatively easily. However, horizontal FDI, which is motivated by the desire to access a foreign market, needs to be near the foreign consumers and is thus less mobile. The second key prediction of the race to the bottom hypothesis is that countries lower their labor standards in order to undercut their competitors and attract FDI. As the average labor standard among your competitors decreases, the foreign host country will lower their own labor standards in response. Thus, the average employment restrictions in other foreign countries should have a positive impact on the employment protection rules in the host country. While the race to the bottom hypothesis is a common fear of globalization and the intuition is relatively straightforward, there is little empirical research studying either of these predictions. This paper tests these predictions using data on U.S. FDI and data on employment protection legislation in twenty six foreign countries which collectively account for over three quarters of U.S. outward FDI. FDI is measured using data from the Bureau of Economic Analysis (BEA) on U.S. MNE's foreign affiliate sales. This is appealing because it allows horizontal, export-platform, and vertical FDI to be separately identified based on the ultimate destination of these affiliate sales. The measure of employment protection used in this analysis is a composite index of hiring and firing costs obtained from the OECD. This provides a consistent and objective measure of differences in employment protection legislation across countries and over time. Spanning twenty six countries and twenty three years, the data set provides the scale and scope necessary to examine both predictions of the race to the bottom hypothesis.6 To test the first prediction, the impact of employment protection on FDI is estimated after controlling for time fixed effects, country fixed effects, and a wide variety of foreign country characteristics that influence FDI. This alleviates concerns that changes in employment protection rules could be inadvertently capturing other types of institutional or economic changes which are correlated with FDI. In addition to the baseline ordinary least squares (OLS) estimation strategy, an instrumental variables (IV) and a dynamic panel generalized methods of moments (Arellano–Bond GMM) are also used which more carefully address endogeneity concerns. The results are remarkably robust across all specifications and indicate that employment protection has a significant, negative impact on the foreign affiliate sales of U.S. multinationals. This is consistent with the prediction that a reduction in employment protection rules will decrease the costs of production in the host country and thus increase U.S. FDI to that foreign country. Even more compelling is that the impact of employment protection rules vary across different types of FDI in the manner predicted. While employment protection legislation has a negative effect on all types of FDI, the impact is relatively small on affiliate sales to the local market (horizontal FDI) but relatively large on affiliate sales back to the U.S. (vertical FDI). These contrasting results verify that employment protection rules have the largest effect on the relatively more mobile types of FDI. Thus, there is evidence that FDI responds to labor market restrictions and that this response is strongest among the most footloose types of FDI. This confirms the first prediction of the race to the bottom hypothesis and provides a motive for countries to competitively undercut each other's employment protection rules in order to attract FDI. To test the second key prediction of the race to the bottom hypothesis, this paper examines whether host country employment protection rules depend on labor market standards in other countries. Specifically, an unweighted average, a weighted average based on distance, and a weighted average based on U.S. affiliate sales is used to quantify the employment protection rules in other competing foreign countries. A baseline OLS estimation strategy is used, as well as IV and Arellano–Bond GMM specifications which more carefully identify causality. The results indicate that labor market standards in other foreign countries have a significant positive impact on host country employment protection legislation. As competitors lower their labor standards, the foreign host country responds by lowering their own employment protection rules. This result is robust to all three weighting schemes and all three empirical specifications. Thus, this paper finds compelling empirical evidence supporting both predictions of the race to the bottom hypothesis. Previous research has found little evidence of a race to the bottom in labor standards. Brown et al. (1996) and Martin and Maskus (2001) examine the theoretical implications of international labor standards on trade and are skeptical of the race to the bottom hypothesis. The few empirical studies that test this hypothesis typically just examine the first prediction by looking at the relationship between employment protection and FDI.7 For instance, Rodrik (1996), OECD (2004), and Kucera (2002) find a positive correlation between FDI and labor standards in a cross section of countries, contrary to the predictions of the race to the bottom hypothesis. Thus, in surveys of the literature Bhagwati (2007) and Brown et al. (2013) argue that there is no evidence that multinationals are attracted to countries with lower labor standards. Relative to these earlier studies, this paper makes a number of important contributions such as using a panel data set that is able to control for unobserved country and year characteristics and using IV and GMM approaches to address endogeneity concerns. More recent related studies, which are not explicit tests of the race to the bottom hypothesis, find that less restrictive employment protection rules do in fact increase FDI (Gorg, 2005, Dewit et al., 2009, Javorcik and Spatareanu, 2005 and Benassy-Quere et al., 2007). While similar in spirit, these papers typically rely on more subjective measures of hiring and firing costs than the employment protection measured used in this analysis. Furthermore, none of these papers examine the impact of labor market standards on different types of FDI. An important contribution of this paper is the finding that the impact of labor standards on foreign investment depends crucially on the type of FDI. While Azemar and Desbordes (2010) also look at different types of FDI, their measure of labor standards has no annual variation. In contrast, this paper uses a consistent and objective measure of employment protection rules that varies across countries and over time. Tests of the race to the bottom hypothesis tend to focus on whether multinationals invest in countries with lower regulatory standards. As mentioned, the evidence regarding this first prediction is mixed. Tests of the second prediction of the race to the bottom hypothesis are even rarer. While admittedly this is more difficult to prove empirically, it is an important component of the race to the bottom hypothesis. To the best of my knowledge, the only other study to examine whether countries competitively undercut one another's labor standards is Davies and Vadlamannati (2013). Using an alternate sample and a different measure of labor standards, they also find evidence that countries are competitively undercutting one another's labor standards. Thus, their findings complement the results of this paper. However, Davies and Vadlamannati (2013) do not examine the cause of this competition in labor standards or specifically whether it is motivated by the desire to attract FDI. Thus, by examining both the first and second predictions of the race to the bottom hypotheses, this paper is the first comprehensive test of this theory. The remainder of the paper proceeds as follows. Section 2 discusses the predictions of the race to the bottom hypothesis. The estimation strategy is described in Section 3, while the data and descriptive statistics are presented in Section 4. The results are discussed in Section 5 and extensions, such as an industry level analysis, are presented in Section 6. Finally, Section 7 concludes.

There are two implicit assumptions in the race to the bottom hypothesis. The first is that multinationals increase FDI in response to reductions in employment protection rules in the foreign host country. The second assumption is that countries competitively undercut each other's labor standards in order to attract FDI. The empirical results presented in this paper are consistent with both predictions of the race to the bottom hypothesis. First, employment protection rules have a significant negative impact on FDI. In addition, employment protection rules have a more negative impact on the relatively mobile types of FDI. Specifically, employment protection legislation in the host country has small impact on horizontal FDI, a more substantial negative impact on export-platform FDI, and a large, negative impact on vertical FDI. These results are consistent across a variety of different estimation strategies. Second, this paper examines whether labor standards in other foreign countries affect the employment protection rules in the foreign host country. Regardless of the weighting method or the estimation strategy, the results indicate a significant positive impact on the host country's own employment protection rules. Thus, there is evidence that countries are competitively undercutting each other's labor standards in order to attract foreign investment. Overall, this paper finds support for both predictions of the race to the bottom hypothesis. Multinationals invest in countries with lower labor standards and countries respond by competitively undercutting one another's labor standards in order to attract FDI. At the very least, the results in this paper indicate that a race to the bottom in labor standards cannot be easily dismissed by economists, as is often the case. Whether a race to the bottom is a desirable outcome depends on one's view of employment protection rules. If labor market standards are necessary to protect the rights of workers, then these results are discouraging. Multinationals are investing in countries with the least restrictive regulatory standards and this is promoting a race to the bottom. However, if labor standards are undesirable and hinder economic flexibility and growth, then the finding that countries are competitively lowering employment protection rules is encouraging. Attracting foreign investment provides an incentive for countries to liberalize their labor markets. Regardless of ones perspective on labor standards, this paper provides important new evidence that employment protection rules decrease FDI and that countries are competitively lowering their labor standards.