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Small Business Economics

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13-11-2018

Wage and competition channels of foreign direct investment and new firm entry

Authors: Marzieh Abolhassani, Seçil Hülya Danakol

Published in: Small Business Economics | Issue 4/2019

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Abstract

Using a rich data set of the Dutch manufacturing sector between 1995 and 2010, we investigate the effect of foreign direct investment (FDI) on domestic new firm entry. The emerging empirical literature has focused on the direct relationship between FDI and entry, but has not explored the mechanisms behind the observed effect. Drawing on a simultaneous equations model, our analysis features both the direct effect of FDI as well as indirect effects through two channels: industry competition and wages. We estimate the parameters through 3SLS and take into account the endogeneity of competition and wages with respect to entry. Our results show that there is a significant negative direct effect of FDI on entry. At the same time, FDI decreases competition and increases wage levels, which then impact entry positively and negatively, respectively. The total effect of FDI is negative, but small and virtually disappears after one year. Policy implications are discussed.

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The assumption maintained throughout this paper is that lower (higher) industry concentration is regarded as proxying more (less) competition. This is a widely used approach in relevant studies. For the theoretical foundation of our choice, please see Appendix A.

See Lipsey (2004) for a summary of the literature on FDI and wages.

Statistiek financiën van grote (niet-financiële) ondernemingen in Dutch.

Statistiek financiën kleine ondernemingen in Dutch.

As of 2000, SFGO and SFKO merged into a single data set; the so-called statistics on finances of non-financial enterprises (NFO-statistiek financiën van niet-financiële ondernemingen in Dutch). However, SFGO as such is still available.

Gemeentelijke basisadministratie persoonsgegevens in Dutch.

SBI stands for “standaard bedrijfsindeling” which corresponds to the Dutch version of the NACE industry classification.

This value is based on model 1 in Table 3 where no lag structure is imposed. Alternative models with different lag lengths and the breakdown of industries based on technological intensity culminate in different number of observations.

All unreported results are available from the authors on request.

Details on this issue for the US are available at URL: goo.gl/SfuHTH (retrieved on 09/10/2013).
More information on the competition legislation within the EU is available at URL: goo.gl/dGTaqW (retrieved on 09/10/2013).

Note that in this study, we only consider FDI of firms with total assets of at least 22.7M€ and entry rates are predominantly measured through small firms with total assets below 22.7M€. This means that we only investigate effects of FDI in larger firms on the entry of primarily small firms in order to solve the potential endogeneity of the former.

A few studies (e.g., Almeida 2007; Heyman et al. 2007) use matched employer-employee data to address this issue. The results in both papers show that higher wage premiums in foreign firms, although existent, are lower than previously thought. The data in this study, however, does not allow for such a matching procedure.

ZZPs (zelfstandige zonder personeel in Dutch, i.e. independent professional without personnel) are those people who work for themselves but do not hire any other employees.

The Dutch tax regime has been structured in such a way that there are large financial benefits for freelancing: one often has to pay no taxes at all in the first few years. As a result, many people have opted to start one-(wo)man businesses and become a ZZP-er.

Industries in our data set are very narrowly defined: at the five-digit. Two of our 252 industries (in a given year) consist of only one-(wo)man firms. Therefore, when these firms are excluded in the robustness checks, these two industries drop out of our sample. The original sample size is then reduced by two observations from 3784 to 3782 in the robustness analysis. In contrast, the remaining 250 industries consist of both one-(wo)man and other firms and we can still compute all of our industry-level variables in a similar way as before. This means that all of these 250 industries remain in the sample used in the robustness analysis.

Eurostat uses the following aggregation of manufacturing industries according to technological intensity: high technology, medium high technology, medium low technology, and low technology. We combine the first two categories and label it as high tech, and subsequently merger the last two categories and label it as low tech.

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Title: Wage and competition channels of foreign direct investment and new firm entry
Authors: Marzieh Abolhassani
Seçil Hülya Danakol
Publication date: 13-11-2018
Publisher: Springer US
Published in: Small Business Economics / Issue 4/2019
Print ISSN: 0921-898X
Electronic ISSN: 1573-0913
DOI: https://doi.org/10.1007/s11187-018-0115-4

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