VoxEU Column International trade

Venturing abroad at the cost of domestic employment?

Do firms reduce their domestic employment when they establish operations abroad? Evidence from South Korean firms suggests that the impact varies by destination and operation. This column shows that concerns about investment in developing countries slowing employment growth at home may have empirical support.

The recent wave of globalisation is characterised by a worldwide increase in exports and foreign direct investment (FDI). Multinationals play an important role in both. The public in many instances views these multinational activities with some scepticism, concerned that offshoring activities will reduce domestic employment in the firms that venture abroad. Such concerns are heard not only in the US and Europe, but also especially in Asia which is perhaps most directly affected by China’s economic performance. Recent research on what happens to domestic employment in multinationals that venture abroad can help inform the public debate.

It is increasingly accepted that there is a huge variety of modes in which firms operate in the global economy.1 Multinationals set up affiliates abroad for different reasons. Rather than exporting a product, they may want to produce it close to the customer abroad and save on transportation costs. Alternatively, they may want to take advantage of lower production costs abroad, by relocating stages of the production process to low-wage countries. Or, multinationals may decide to combine both strategies by setting up a plant in a low-wage country from which they supply the whole region more easily.

The variety of strategies that firms pursue in different markets raises the question whether the particular destination of a multinational’s FDI matters for its domestic employment as it ventures abroad. To test this hypothesis, we took advantage of a South Korean firm-level dataset that allows us to directly link South Korean parent plants with their affiliate locations abroad. We were especially interested in finding out whether it would make a difference whether a new multinational invested in developed or developing country.2

The methodology we employed is quite intuitive. It is not as easy as it may seem to assess the impact that FDI may have on the employment. True, some South Korean textile plants move to China when they can no longer compete with cheap Chinese exports. As they set up affiliates in China, employment in South Korea may shrink. However, in order to accurately assess the impact of multinational activity on employment, one should compare what happens to this firm’s employment to an alternative scenario. How much would its employment have diminished if the firm had not been able to open affiliates in China? Maybe the firm would have gone bankrupt? In other words, it is crucial to assess what is happening to a firm relative to a plausible alternative. Similarly, firms that are moving abroad are oftentimes expanding, which may generate additional employment in headquarter services: R&D, logistics, overhead or marketing services. To fully understand the impact of outward investment on employment, here also, the question has to be raised whether, compared to domestic firms that grow similarly fast, the new multinationals generate more or less domestic employment.

To better understand the impact of outward activities of multinationals, we carefully compared the employment of South Korean multinationals before and after they went abroad with that of firms without affiliates. South Korean parents firms were matched with similar Korean firms in terms of size, growth, etc. Based on those characteristics, domestic firms were ex ante equally likely to invest abroad as the multinationals that ended up doing so. A discernable difference in firm performance was found between multinationals that went to more advanced countries such as the US and Europe and those that invested in China and other emerging economies. Domestic employment in multinationals that ventured to China did not grow as fast as domestic South Korean firms' employment. On the other hand, domestic employment in multinationals that ventured to the US did not experience any negative impact compared to domestic firms. While these findings support popular concerns of costs in terms of employment due to multinational activities, they, at the same time, sound a note of caution. Effects of multinational activity may vary by the particular destination and the particular operations of the multinationals involved. Moreover, the employment effects were relatively small and did not persist in the long run.
The impact of multinational activities abroad may differ by the destination country of the multinationals and their particular operations. While there is some justification for concerns about slower employment growth in the parents of multinationals that go to emerging economies, this concerns seems only warranted in the short run.

1 Helpman, Elhanan, 2006, Trade, FDI and the Organization of the Firm, Journal of Economic Literature, Vol. XLIV, pp. 589-630.
2 Debaere, Peter, Joon Lee, and Hongshik Lee, 2008, It Matters Where You Go: Outward Foreign Direct Investment and Multinational Employment Growth at Home, Working Paper, Darden Business School, University of Virginia. Earlier version, CEPR WP 5737

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