Multinational Firms: Easy Come, Easy Go?

Abstract

Abstract:Although many countries welcome inward investments by multinational firms (MNEs), it is often perceived that MNEs readily close down production in bad times. We study the choice of an MNE in deciding whether to establish a branch plant within a region, explicitly taking into account exit, as well as entry, costs. Protecting workers by having strict lay-off rules deters potential investment while subsidies attract it. We examine the policy trade-off for a host government and investigate how uncertainty affects the attractiveness of investment in a particular location. Just how much does the ease of exit influence the entry decision?

How important is employment protection legislation for Foreign Direct Investment flows in Central and Eastern European countries?1

“…Haaland et al (2002) Republic, Hungary and Poland) and using data from the Fraser Institute as proxies for labor market flexibility generally find no statistically significant negative impact of labor market flexibility on FDI. Their proxy for labor market flexibility enters significantly only in a few cases and in these cases it carries the wrong sign.…”

“…To test the hypothesis that labor market rigidities impose adjustment costs which become especially relevant in uncertain or risky environments as argued in Haaland et al (2002), we also estimate a specification where risk jt (lagged) is interacted with epl jt , (epl * risk) jt . Since labor market rigidities may hamper FDI flows especially in the case of high unit labor costs, we also estimate a specification where ulc jt (lagged) is interacted with epl jt , represented by (epl * ulc) jt .…”

“…An MNC which invests in a country characterized by a large degree of labor market rigidity commits itself in a sense to maintaining its workforce rather stable. Haaland et al (2002) formalize this point and argue that these considerations are especially relevant for companies operating in risky environments. Since riskiness increases the likelihood of a considerable reduction of the production level, firms may take poten-tial adjustment or exit costs into account to a greater extent when making investment decisions.…”

“…In contrast, Haaland et al (2002) and Benassy-Quere et al (2007b) include unit labor costs along with a proxy for labor market flexibility. Haaland et al (2002) Republic, Hungary and Poland) and using data from the Fraser Institute as proxies for labor market flexibility generally find no statistically significant negative impact of labor market flexibility on FDI.…”

“…Finally we analyze the possibility that labor market rigidities are more relevant in relatively risky countries along the lines of Haaland et al (2002). We add the political risk level (lagged) of the host country, risk jt , as an explanatory variable and also interact it with epl jt , (epl * risk) jt .…”