Foreign Direct Investment

The effect of MNEs on labour demand

In this section, we review the evidence on the effects of MNEs on workers and their wages in the host country.[1]1.See Javorcik (2015) for a complementary review on the topic.

Effects on workers employed by MNEs

Historically, before worker-level data became available to researchers, the measurement of an MNE wage premium was based on comparisons between the average wages paid by MNEs and domestic firms.[2]2.In most empirical studies, what is computed is the premium in overall monthly labour earnings, not a per-hour wage premium. We will use the terminology “wage premium” to refer loosely to the premium in monthly labour earnings. The concern with this measurement approach was that average wages reflected both compositional differences in the workforce of MNEs relative to domestic firms and the MNE wage premium of interest. The concern about the compositional difference was based on consistent evidence that MNEs tend to hire relatively more high-skilled workers compared to domestic firms, which would mechanically lead to higher average wages. Even conditional on observed characteristics, MNEs might have superior screening technologies, which again would justify higher wages for the workers selected by MNEs.[3]3.Chapter 5.2. in the Handbook of Development Economics chapter of Harrison and Rodríguez-Clare (2010) provides a detailed literature review of the earlier and very influential work on this topic. We invite the interested reader to familiarise oneself with that work.

More recently, matched employer-employee data has become available in a growing number of countries, allowing researchers to use ‘movers’ designs’ to estimate the MNE wage premium. This design tends to be an event study where one tracks the outcomes of a given worker as they transition from one type of employer to another (e.g. from domestic to MNE or domestic to domestic). While the MNE wage premium tends to have a slightly different definition in each paper, in general, it captures the extra change in the labour earnings of workers moving from a domestic firm to an MNE relative to the change experienced by workers moving from one domestic firm to another.[4]4.The second difference with respect to the labour earnings change upon domestic-domestic transitions is not always implemented but is recommended given that (voluntary) worker moves tend to be motivated by improved conditions. For instance, in papers that use acquisitions of domestic firms by MNEs to estimate the MNE premium, there is no comparison to a counterfactual increase when the same domestic firms are acquired by other domestic firms (Girma and Görg 2007).

Most worker-level estimates of the MNE wage premium came from developed economies where the matched employer-employee data first became available for research. This data allows the researcher to control for worker selection into MNE employment. These wage premium estimates tend to be positive and lie in the range of 2% to 7%. Evidence on the MNE wage premium from less developed countries is scarcer, with the estimates of 6% for Brazil (Hijzen et al. 2013) and 9% for Costa Rica (Alfaro-Ureña et al. 2021) standing out. Table 2 summarises wage premium estimates from around the world and describes the “event" used in the event study (typically mergers and/or acquisitions of domestic firms by MNEs or worker moves from domestic employers to MNEs).

While there is mounting evidence of the existence of a wage premium, the jury is still out on its interpretation. One potential explanation is that higher MNE wages compensate workers for undesirable job attributes (e.g. more stressful work), higher labour demand volatility at MNEs (Fabbri et al. 2003), or higher MNE closure rates (Bernard and Sjoholm 2003). The evidence so far points towards a high desirability of MNE jobs. For instance, Alfaro-Ureña et al. (2021) show that, if anything, MNEs offer better amenities than domestic firms (MNE workers enjoy better in-kind and monetary benefits while working a similar number of hours). The same authors show that MNEs have higher worker retention rates. For developed countries, Malchow-Møller et al. (2013) show (for Denmark) that workers at MNEs experience a steeper wage growth (which would be hard to rationalise with ever-worsening amenities) and Balsvik et al. (2023) show (for Norway) that MNE jobs tend to be relatively more desirable than domestic jobs (i.e. MNEs sit at the upper rungs of the job ladder). Future work should inquire whether a similar ranking of employers exists in developing countries.

Table 2: Estimates of the MNE wage premium from matched employer-employee data

Another explanation of the MNE wage premium is that MNEs use it to prevent technological spillovers through labour turnover (Fosfuri et al. 2001). The wage premium might be due to rent-sharing arrangements within MNEs (Budd et al. 2005, Hjort et al. 2020). More research is needed to understand the relative importance of these potential drivers.[5]5.In a survey to MNEs in Costa Rica on their wage setting behaviour in their affiliates, MNEs declare that they pay a higher wage to the same worker compared to domestic firms to avoid worker turnover, motivate the worker, and ensure cross-country pay fairness within the MNE (Alfaro-Ureña et al. 2021).

As employers, MNEs can benefit their workers through more than just higher wages. For instance, workers at MNEs can acquire valuable knowledge from foreign managers that future domestic employers will reward them for (Balsvik 2011, Poole 2013). Note that communication frictions (e.g. due to language barriers, as in Guillouet et al. 2021) or a lack of absorptive capacity of the domestic workers might reduce knowledge transfers from foreign managers to domestic workers within the local MNE affiliate. These frictions are likely to be most severe in developing economies, and more research is needed to both quantify the importance of these frictions in attenuating the gains from MNEs and identify policies that can address them.

Effects on workers employed by domestic firms

The entry and expansion of MNEs in an economy might not only affect those workers employed by the MNEs, but also indirectly affect those employed by domestic firms, by affecting their labour market outside options and the performance of domestic employers.

The literature on the effects of MNEs on workers in domestic firms is thinner than that on the MNE wage premium (and it is dwarfed by the ample literature on the potential of productivity spillovers from MNEs). Among the first papers addressing the topic, Aitken et al. (1996) studied the effects of MNEs on wages at domestic establishments in Mexico and Venezuela and found that the increase in industry-level wages is only driven by the higher wages of the MNEs — they found no evidence of higher wages for domestic firms. Feenstra and Hanson (1997) show that in Mexico, over the period 1975–1988, the increase in FDI can account for a large share of the rise in the skilled labour share of total wages.[6]6.The authors note that the increase in the skilled labour share of total wages in Mexico has resulted mainly from within-industry changes in wage shares rather than between-industry shifts in employment. Lastly, Alfaro and Chen (2018) jointly evaluate the distinct roles of within-firm productivity improvement and between-firm reallocation in determining the aggregate productivity gains from MNEs (and their implications on workers). The authors find that the increased competition in both output and labour markets coming from MNE entry leads to the exit of the least productive domestic firms and to an increase in average wages.

More recent work benefits from worker-level data and the ensuing research designs can control away potential confounding factors, such as contemporary industry-level shocks. As an example, Alfaro-Ureña et al. (2021) study the effects of MNEs on workers in domestic firms by combining matched employer-employee data and firm-to-firm transaction data in Costa Rica with an instrumental variable approach that exploits shocks to the size of MNEs in the country.[7]7.Alfaro-Ureña et al. (2021) exploit variation in the growth of employment in MNE subsidiaries outside Costa Rica – this growth is correlated with the local growth in employment of MNE subsidiaries and is plausibly exogenous to labour and product market conditions in the country. As MNEs bring jobs with a wage premium, they improve outside options by altering the level and composition of labour demand towards higher paying jobs. MNEs can also enhance the performance of domestic employers through (direct and indirect) input-output linkages. Shocks to firm performance (and rents) may then pass through to wages. Alfaro-Ureña et al. (2021) find that the annual earnings growth rates of workers exposed to MNEs’ directly or indirectly outstrips those of workers with no change in exposure by one percentage point.

Vrolijk (2023) uses microdata on worker-firm and firm-firm relationships in Uganda and an event study approach to study the effects of MNE entry into a municipality on workers at domestic firms in that municipality. The findings show that — following the initial MNE entry — domestic firms increase both their employment and wages. After controlling for domestic input-output linkages, the positive effects are substantially reduced, which suggests that much of the effects are driven by these linkages. In Ethiopia, Abebe et al. (2022) use plant-level census data to show that in the four years after an MNE plant opening, domestic plants increase their employment, but do so without increasing average wages.

Table 3: Effects of MNE entry and expansion on workers at domestic firms: Recent empirical evidence using firm-, transaction- and worker-level data

In the context of a developed economy (the United States), Setzler and Tintelnot (2021) use employer-employee data and an instrument based on the past spatial clustering of MNEs by country of ownership to identify the indirect effects of an increased exposure to MNEs on workers at domestic firms. The authors find that expansions in the foreign MNE share of local employment substantially increase the employment and wages at local domestic firms for higher-earning workers (the average effect across all workers was not statistically significant).[8]8.In their framework, wage gains derive from either labour demand effects or productivity spillovers that benefit all domestic firms in the same commuting zone.

One additional feature of MNEs is their size and potential importance in the receiving labour market. If there are few other options for work, one might be concerned about the monopsony power that MNEs can exert. Méndez-Chacón and Van Patten (2022) find positive effects of the United Fruit Company in Costa Rica (where the company was the only employer in a large land concession), but these positive effects can be explained by the relatively high labour mobility in the area. Their calibrated framework suggests that had workers been less mobile, the welfare effects could have been negative due to the monopsony power of the MNE. Lastly, workers at domestic firms can benefit from the presence of MNEs by hiring former MNE workers. The extent to which attracting such workers is valuable depends on the knowledge and skills they acquired during their tenure at the MNE. Provided that learning occurred, workers can share information with their new domestic employer about the better managerial practices of MNEs (Burstein and Monge-Naranjo 2009, Bloom and Van Reenen 2010) or information about specific export markets (Masso et al. 2015).

Policy implications and next steps

The current body of research suggests optimism on the ability of MNEs to positively impact workers, both directly and indirectly. For instance, a back-of-the-envelope calculation suggests that in the US, the net present value of the average wage gain attributable to MNEs exceeds the typical subsidy by $34,000 per job (Setzler and Tintelnot 2022). It is reasonable to also expect significant benefits in developing countries, where labour markets often lack MNE-like domestic employers. However, this optimism warrants a note of caution. The 'footloose' nature of MNEs creates incentives for governments worldwide to compete for their presence, often through increasingly generous tax incentives. More than 70% of developing countries currently offer such incentives, and their value has risen over time (World Bank 2018). This competition might induce a race to the bottom, posing the risk of enabling MNEs to extract most of the benefits, particularly in large-scale agreements or 'megadeals' (Slattery 2024). International cooperation might be needed to mitigate these risks.

More research is needed to understand the potential benefits of MNEs on labour markets in developing countries. The research discussed above is entirely silent on the informal sector, which is dominant in LICs. This is because this research relies on tax records, which automatically exclude informal firms and workers, or surveys that tend to focus on firms over a size threshold that typically is too high for informal firms. How the presence of a large informal sector influences the effects of MNEs on workers is currently unexplored. Moreover, we do not know whether MNEs trigger reallocations towards or away from the informal sector, and whether workers in informality see higher or lower wages when MNEs grow in importance.

While the focus on wages and employment is relevant, job creation in and of itself should not be a measure of success. In an economy with full employment, the multiplier of (direct or indirect) MNE jobs is -1 (one direct or indirect job from an MNE corresponds to one job discontinued elsewhere in the economy).[9]9.For instance, an estimated increase in local domestic employment could simply reflect the migration of workers towards areas with an increased presence of MNEs (without new domestic jobs created in the overall economy). Therefore, an open question is to quantify the general equilibrium employment multiplier of MNE jobs in contexts with unemployment (similar to Costinot 2009, in the case of trade) or underutilised workers that MNEs, directly or indirectly, help employ. Finally, to the extent that MNEs provide good jobs, we need further evidence to understand the complementarities that trade policy or other types of industrial policy can have with MNE job creation. For instance, McCaig et al. (2023) show that the US–Vietnam Bilateral Trade Agreement had long-run employment effects for Vietnam, and these effects were mostly driven by MNEs’ entry and expansion.

Enforcement of labour standards

A key question about MNEs’ impacts on workers in developing countries is how MNEs influence adoption of labour standards, both at the country and firm level. ‘Labour standards’ is a broad term encompassing rules governing employment relations and working conditions, freedom of association rights, discrimination, and child labour. Rules governing minimum wages are closely related and sometimes considered part of labour standards. A central concern about MNEs’ impacts is that competition for MNE production or sourcing incentivises countries to keep labour standards low in order to offer lower labour costs – in other words, that MNEs spur a “race to the bottom” on labour standards. On the other hand, there are reasons why MNEs’ production or sourcing activities might raise labour standards, such as increasing local incomes and enabling governments to pass some of the cost of improved labour standards to foreign countries.

Theoretical frameworks

The theoretical literature on globalisation and labour standards generally underscores the ambiguity of potential impacts, although the possibility of the cost of higher labour standards being partly borne by trade partners commonly features in these models and pushes toward raised standards (Im and McLaren 2023a). Chau and Kanbur (2006) model labour standards in the context of developing countries that vary in size and compete in an industrial export market; they show that larger countries have more of an incentive to raise standards compared to small countries, which is because raising standards increases local labour costs that are passed on to foreign consumers and large exporters take this into account, while small countries do not. Im and McLaren (2023b) consider MNEs selecting host countries, and host governments choosing the strength of collective bargaining rights that allow rent-sharing with workers. Increased globalisation — defined as lower transaction costs — has no impact on collective bargaining rights, but adding more countries to the trading system tends to weaken them. Given these two forces, the effect of globalisation on collective bargaining rights is ambiguous in their model; they corroborate this prediction with panel data that shows no meaningful association between FDI and collective bargaining rights. Although related to different types of labour standards, this is consistent with evidence from Edmonds and Pavcnik (2005) and Edmonds and Pavcnik (2006), who show that international trade lowers the overall incidence of child labour in agriculture, and with Tanaka (2020), who shows that international trade improves working conditions in export-oriented manufacturing.

Institutions and market structure

Turning to the empirical literature, recent research emphasises the importance of two characteristics of developing countries for understanding MNEs’ impacts on labour standards. These features have not yet been considered in the theoretical literature, hence this could be a fruitful direction for future research. First, developing countries have weak institutions, including those that govern labour markets. As a result, even when strong de jure labour standards exist, de facto, domestic firms may face very little enforcement.

The Rana Plaza disaster in Bangladesh in 2013, where a building housing five exporting garment factories collapsed and killed over 1,130 workers, is often cited as an example of the tragedy that is possible when global value chains intersect developing countries with weak local institutions.

MNEs responded to the disaster by forming two coalitions that stated commitments to improve the safety and health standards among their members’ suppliers. The MNE coalitions also stated a commitment to enforce a local mandate for joint worker-manager occupational safety and health (OSH) committees. Boudreau (2023) randomised the roll-out of one MNE coalition’s enforcement initiative across 84 supplier factories. She documents that the MNEs’ enforcement intervention increased suppliers’ compliance with the mandate by 20% of a standard deviation and that stronger OSH committees had small improvements on workers’ health and safety (14% of a standard deviation), with no adverse effects on wages, employment, or labour productivity. The results are consistent with implementation of the committees not being very costly to employers or employers exercising labour market power. Bossavie et al. (2023) find evidence consistent with the latter. Using data from Bangladesh’s Labour Force Survey and a triple difference research design, they show that post-Rana, international scrutiny increased working conditions in the garment sector by 80% of a standard deviation and increased wages by 10%, with no changes in the employment growth rate.

A growing body of evidence documents that monopsony power of exporters – due to their relatively large size and small number, combined with other market frictions – is another important characteristic of labour markets and agricultural value chains in many developing countries (Amodio and de Roux 2022, Zavala 2022). This suggests that, at least in certain value chains, MNEs may play an important role in influencing workers’ and farmers’ gains from exposure to international trade. Macchiavello and Miquel-Florensa (2019) provide a case study of the Nespresso AAA Sustainable Quality Program in Colombia. To ensure that it can reliably source large volumes of coffee, Nespresso combines contractual arrangements at the export gate with training and agricultural extension services to farmers; its contract with the exporter specifies the price premium that must be paid to upstream farmers. They find that this programme increases total surplus by 30%, with at least half of the gains going to farmers.

Sourcing strategy responses

These features of developing countries – weak institutions that result in contracting problems and market power along the value chain that implies the existence of rents – often lead parties to rely on long-term trading relationships (Macchiavello 2022). Scholars have argued that MNEs’ efforts to privately enforce labour standards on third-party suppliers can be understood through the lens of relational contracting, in which the future value of trade provides MNEs with the incentive and opportunity to monitor (Boudreau et al. 2023). For example, Amengual and Distelhorst (2019) study Gap, a multinational apparel retailer that primarily sources from developing countries and that maintains a supplier code of conduct for labour (and environmental) issues. In 2016, Gap revised its sourcing policy to condition future orders on suppliers’ getting a passing grade on its labour audits. Using a regression discontinuity design, the authors find that prior to the change, a failing grade had no effect on suppliers’ future compliance, while after it, it increased suppliers’ compliance by 80% of a standard deviation.

In addition to incentives, a growing body of evidence indicates that firms’ capabilities are important in determining their adoption of labour standards and that many firms lack the capacity for compliance (e.g. Giorcelli 2019 and Bertrand and Crépon 2021). As discussed elsewhere in this review, trading relationships with MNEs have been found to enhance domestic firms’ capabilities in developing countries. Many MNEs that establish long-term relationships with suppliers engage them in management and compliance-related capacity building. Distelhorst et al. (2017) use a difference-in-differences design to study Nike’s engagement of its suppliers to adopt lean manufacturing. They find that it led to substantial improvements in suppliers’ adoption of labour standards related to wages and working hour practices, although not to OSH. This underscores that improvement in managerial capabilities due to long-term trading relationships between MNEs and exporters can lead to increased adoption of some labour standards. The possible links between MNEs’ use of relational contracting and impacts on labour standards in global value chains is an emerging area of research, and more work is needed.

While much of the empirical evidence has provided grounds for optimism about MNEs’ impacts on labour standards, the literature remains thin – indeed, too thin to warrant a summary table of comparable estimates from different contexts. More research is needed on varied countries and sectors; reasons for caution remain. First, while the discussion above emphasises exporters’ labour market power, it is also indicative of MNEs’ wielding market power in many supply chains, which in principle can suppress prices in product markets and wages and labour standards in labour markets. Further, as argued by Aisbett et al. (2021), a key question for understanding MNEs’ impacts on labour standards is the counterfactual used to evaluate MNEs’ activities against. This discussion emphasises MNEs’ impacts relative to how a worker would have fared had they not been exposed to the MNE. These authors also consider alternative ethical frameworks that emphasise fairness considerations in the extent to which profitable firms share profits with workers and human rights considerations in the extent to which MNEs’ standards deviate from internationally accepted human rights. Against these standards, MNEs’ impacts on workers are not consistently positive.

In addition, many MNE interventions studied in the literature were reactions to industrial disasters or non-governmental organisations’ (NGOs) campaigns. In the case of post-Rana Bangladesh, Koenig and Poncet (2022) document that while the overall imports of French retailers sourcing from Bangladesh did not fall, the handful of importers sourcing directly from Rana Plaza firms relocated their supply chains away from Asia and closer to France. This suggests that at least some MNEs can respond to labour-related scandals by relocating production outside of the poorest countries. It also suggests that reputational concerns are one driver of MNEs’ engagement in enforcing labour standards, consistent with larger- and consumer-oriented firms headquartered in wealthy countries being more subject to NGO campaigns (Hatte and Koenig 2018, Koenig et al.2021) and anecdotally being more likely to enforce labour standards along their supply chains. Harrison and Scorse (2010) study anti-sweatshop campaigns against Indonesian contractors for Nike, Reebok, and Adidas in the 1990s. They find that the campaigns resulted in wage increases among foreign-owned and exporting textile, footwear, and apparel firms of 10-20%, primarily through increased compliance with local minimum wages, with no declines in employment but negative impacts on profits among foreign-owned firms. The post-campaign period is six years, so it’s possible that the erosion of profitability would lead to employment declines in the longer-run. The focus on effects in the short- to medium-term is a general limitation of the existing literature on MNEs and labour standards.

Finally, while the evidence above focuses on workers in the MNE’s supply chain or in the same industry, it is also important to understand the overall impact on workers in developing countries. Alfaro-Ureña et al. (2022) develop a quantitative general equilibrium model to study the incidence of responsible sourcing policies – including all Environment, Social, and Governance (ESG) practices – and show that the predicted welfare impacts are ambiguous. They depend on whether MNEs face consumer demand that values these practices, on the potential monopolistic market power of MNEs relative to their suppliers, and on suppliers’ potential market power over workers. They apply the model to Costa Rica and find that these policies have positive but very small impacts on overall welfare, but heterogeneously impact workers. For the 30% of low-wage workers employed at MNE suppliers, they result in welfare gains of 8%, while for the remaining low-wage workers, they result in income losses of 3%. While this research takes an important step forward, more evidence is needed on industry- and economy-wide impacts.

Policy implications and next steps

The evidence on MNEs’ impacts on labour standards is growing, but it remains underdeveloped, especially in light of the continued push of policymakers in wealthy destination countries toward regulating sustainability in global supply chains. In 2023, the European Union passed multiple regulations requiring companies to integrate labour and environmental impacts into their management systems, including increasing responsibility for labour standards in their value chain (European Union 2023b,a). In the United States, the ‘Rapid Response Labor Mechanism’ of the 2019 US-Mexico-Canada Agreement adopts a different tactic, allowing a government to take legal action against a worksite in another country if it believes its workers are being denied freedom of association rights (Bown and Claussen 2023).

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