Investment in Eastern Europe may cause unemployment in Western Europe
Andzelika Lorentowicz (University of Munich),
Dalia Marin (University of Munich and CEPR), Alexander Raubold (University of Munich)
DP3515 Ownership, Capital or Outsourcing: What Drives German Investment to Eastern Europe?
July 2002
What does a firm from an industrialized country (such as a German firm) bring to a
developing country (such an Eastern European country) when it invests
these in markets? Is it merely a shift in control from an Eastern to German
management or is more involved? Is the German firm relocating some
electronic activity from Germany to Eastern Europe or is it adding
new activity in Eastern Europe not undertaken before in Germany? In
CEPR Discussion Paper 3515, Lorentowicz, Marin and Raubold argue that
these questions are important because the economic effects of foreign
direct investment (FDI) will differ for the investing country and host
country depending on what form the FDI takes
Many developing countries are hostile to incoming FDI out of
the fear of giving too much control to foreign multinationals.
Fear of this loss of control has caused some developing countries
to pursue policies to restrict incoming FDI. For example, in Eastern
Europe during communism foreign ownership of assets was prohibited.
Does outgoing FDI mean unemployment at home?
More recently, the controversy surrounding FDI has recently shifted focus
from incoming to outgoing FDI. The question now centres on whether or not
outward FDI to low wage countries has contributed to the increase in the wage
gap between skilled and unskilled labour in the US and to the increase in the
level of unemployment in Europe.
If an outward investment involves a shift in production capacity,
then the issue is whether the outgoing FDI is vertical or horizontal
in nature. With vertical FDI, the rich country firm relocates the
labour intensive part of production to a low wage country and cuts
this production stage in the rich country where skilled labour is
abundant. Thus, vertical FDI leads to an increase in the wage of
skilled relative to unskilled labour in the rich country. In a
horizontal FDI the rich country firm produces the same product in
its foreign affiliate. Horizontal FDI is driven by market access
considerations, while vertical FDI is motivated by differences in
wages between countries. The crucial difference, in terms of the
effect on the level of unemployment in the home country is that
horizontal FDI has no effect on wage inequality or employment in
the rich country. FDI can only generate wage inequality or
unemployment in the rich country when it is vertical in nature.
This study explores these themes by taking
Germany as an example of an industrialized country, to take a
first look at the effects of FDI in Eastern Europe. The authors
use a new survey data of 1050 investment projects in Eastern Europe
by 420 German multinationals during the 1990s. The authors find that
German investors transfer a substantial amount of financial capital
to Eastern Europe. There is also strong evidence of vertical FDI from
the survey, as 28% of the sales of new production facilities in Eastern
Europe are exported back to Germany. The researchers conclude that German
corporations appear to be locating a substantial share of their production
to exploit the lower wages in the East. And that such action has the
potential to drive up unemployment rates of unskilled workers within Germany.
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