Foregin Direct Investment and competition from low wage countries

Abstract: Foregin Direct Investment, FDI is often seen to be an important factor to economic growth across the globe. It gives Multinational Enterprises the opportunity to come closer to their customers, but also a chance to achieve economies of scale. In the same way that FDI is considered to benefit a company, economists are also discussing the impact that it brings to the local market. Investments in China and Eastern Europe have increased significantly in the last decade and sometimes it can be argued that workers in industrialized countries are in competition with those in low wage countries. I examine a sector level panel of FDI inflows between low wage and high wage countries and find evidence that suggests that labor cost is a great determinant to localization of production. The result supports the vertical perspective of the Knowledge Capital model in the sense that the inflow of FDI will increase when labor cost is relatively cheap. In addition I confirm the theory of the gravity model that when distance between countries increases, the flow of FDI decreases. The result puts attention to the importance of MNEs responsibility in employees working conditions and not to take advantage of cheap labor and poor working conditions when locating production across the globe.