Working conditions in the foreign operations of multinational enterprises

Alexander Hijzen 04 August 2008

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Multinational enterprises (MNEs) have become one of the key drivers of the world economy, and their importance continues to grow around the world. During the past fifteen years, the total stock of foreign direct investment (FDI) increased from 8% of world GDP in 1990 to 26% in 2006 (UNCTAD, 2007). The increased influence of OECD-based MNEs in developing countries is particularly striking. Today, developing countries account for almost one-third of the global stock of inward foreign direct investment, compared to slightly more than one-fifth in 1990. Indeed, since the mid-1990s, foreign direct investment has become the single biggest source of external finance for developing countries and is currently more than twice as large as official development aid.

The increased role of FDI in developing and emerging economies has raised expectations about its potential to contribute to their development. Through the introduction of modern production and management techniques, multinational enterprises may raise productivity in the host country and thereby promote better wages and working conditions. Such firms can do this directly, offering better wages and working conditions to their employees than those offered by local firms. Multinational enterprises may also stimulate local firms to improve wages and working conditions indirectly. For example, MNEs sometimes provide technical and training support to local firms incorporated into their supply chains.

However, the activities of multinational enterprises abroad have also aroused much controversy and many social concerns. The nature of these concerns depends on the normative standard that is used to judge how MNEs treat their workers abroad. For example, MNEs have been accused of practicing unfair competition when taking advantage of low wages and labour standards abroad (“home-country standard”). In some cases, MNEs have also been accused of violating human and labour rights in developing countries where governments fail to enforce such rights effectively (“universal standard”). In many OECD countries, civil society has appealed to multinational enterprises to ensure that internationally recognised labour norms are respected throughout their foreign operations.

New work by the OECD (2008a) adopts a “local standard” to evaluate the social impact of FDI in the host country. This involves comparing the wages and working conditions of employees in the foreign affiliates of MNEs and their supplier firms to the wages and working conditions that they would have received had they not been employed by a foreign firm or one of its suppliers. The difference may be interpreted as the contribution of MNEs to improving wages and working conditions in the host country as employment conditions in comparable domestic firms provide a plausible approximation (“counterfactual”) of the conditions that would have been offered to individuals had they not been able to work for MNEs (directly or indirectly).

New evidence on the effects of inward FDI for workers

Do foreign multinationals pay higher wages than domestic firms? Simple comparisons suggest they do. Moreover, wage differences between MNEs and local firms tend to be larger in developing countries, presumably reflecting the larger productivity advantage MNEs over local firms in those countries. Simple comparisons between MNEs and local firms, however, overstate the contribution of FDI to improving pay, because FDI is typically concentrated in the most advanced sectors and largest firms in the host economy, which would pay above-average wages even if they were locally owned. Even after correcting for this bias, it is still the case that MNEs offer better pay than domestic firms, particularly in developing countries where their productivity advantage is greatest.

Figure 1 presents new evidence on the effects of foreign takeovers on average wages within firms for two emerging economies (Brazil and Indonesia) and three OECD countries (Germany, Portugal and the United Kingdom). It shows that foreign takeovers raise average wages in the short-term, particularly in emerging economies. Wages rose between 10% and 20% following foreign takeovers in Brazil and Indonesia, and between 0% and 10% in the three OECD countries. While these figures show the effect on average wages, they do not tell how the change is distributed across workers within firms and, particularly, whether the increase in average wages reflects wage gains for incumbent workers or instead changes in the skill composition of the workforce. To the extent that foreign takeovers lead to skill upgrading, the evidence overestimates the positive effects of takeovers on individual wages.

Figure 1 Foreign takeovers raise average wages
The short-term effects of foreign takeovers on average wages, evidence from firm-level data (% differences)

Source: OECD (2008), OECD Employment Outlook 2008, Paris.

Figure 2 presents the effects of foreign ownership on individual workers. Foreign takeovers of domestic firms have a small positive effect on the wages of existing workers in Brazil, Germany and Portugal in the short-term, ranging from 1% to 4% and no effect in the United Kingdom. While the short-term impact of takeovers on incumbent workers is modest, the role of foreign ownership is more substantial for new hires. This is indicated by the relatively large wage gains of workers who move from domestic to foreign firms. They range from 6% in the United Kingdom to 8% in Germany, 14% in Portugal and 21% in Brazil. The differential effect of foreign ownership on incumbent workers and new hires may reflect more competitive conditions in the market for new hires that allow new employees to more widely share the productivity advantages of MNEs. In the longer term, however, one would expect the positive effects to spread across the entire workforce, as large pay disparities between new and old workers within firms are unlikely to be sustainable.

Whether multinational enterprises also promote improvements in other aspects of workers’ employment conditions, such as training, working hours and job stability, is a more complex question, and the existing evidence is scarce. Studies that have looked into this issue suggest that MNEs have a low propensity to export non-wage working conditions abroad. New analysis by the OECD suggests that, in contrast to wages, non‑wage working conditions do not necessarily improve following a foreign takeover. Even when they do, it is not clear whether these effects derive from a centralised policy to maintain high labour standards or merely reflect the optimal responses by MNEs to local conditions.

Figure 2 Foreign ownership matters, particularly for new hires
Evidence based on worker-level data (% differences)


Source: OECD (2008), OECD Employment Outlook 2008, Paris.

In addition to having direct effects on workers, FDI may also have indirect effects on workers’ employment conditions in domestic firms when there are knowledge spillovers associated with FDI. The effect on workers in domestic firms, however, is considerably weaker than the direct effect on employees of foreign affiliates of MNEs. While it is true that FDI typically has a strong effect on average wages in local firms, this largely reflects the competition between foreign and domestic firms for local workers. Positive productivity-driven wage spillovers do not necessarily arise. They are likely to be more important when there are strong links between local firms and foreign MNEs, such as through the participation of local firms in the supply chain or through worker mobility.

Policy implications

The potential of multinational enterprises to contribute to economic development in host countries provides a case for encouraging inward foreign direct investment. For a start, removing specific regulatory obstacles to inward FDI could be important. Under certain circumstances, it may also be appropriate to provide specific incentives to potential foreign investors. Such targeted policies should not, however, become a substitute for policies aimed at improving the business environment more generally. By contrast, lowering core labour standards in an effort to provide a more competitive environment for potential investors is likely to be counter-productive. It does not appear to be effective in attracting FDI and is likely to discourage investment from responsible MNEs, anxious to ensure that minimum labour standards are respected throughout their operations.

Initiatives to promote responsible business conduct can reinforce the contribution of MNEs to economic and social development. The OECD Guidelines for Multinational Enterprises provide a good example of a government-backed initiative that aims to promote responsible business conduct (OECD, 2000). The Guidelines are most widely known for their system of National Contact Points through which disputes between relevant stakeholders with respect to the implementation of the guidelines can be addressed. Since its revision in 2000, more than 160 cases have been raised at the National Contact Points. Most of these have dealt with employment, labour and industrial relations issues. The increasing share of these cases related to labour issues in non-OECD countries suggests that the OECD Guidelines are playing a growing role in the improvement of labour conditions worldwide.

References

OECD (2000), OECD Guidelines for Multinational Enterprises, Revision 2000, Paris: OECD.
OECD (2006), Policy Framework for Investment, Paris: OECD.
OECD (2008a), “Do Multinationals Promote Better Pay and Working Conditions?”, OECD Employment Outlook, Paris.
OECD (2008b), “The Social Impact of FDI”, Policy Brief, July 2008.
UNCTAD (2007), World Investment Report 2007, Geneva.

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Topics:  Global economy

Tags:  productivity, wages, foreign direct investment, multinational enterprises, working conditions

Senior Economist, OECD Directorate for Employment, Labour and Social Affairs

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