Skill and Foreign Firm Premium: The Role of Technology Gap and Labor Cost

Skill and Foreign Firm Premium: The Role of Technology Gap and Labor Cost

Bahar Bayraktar Saglam (Hacettepe University, Turkey) and Selin Sayek (Bilkent University, Turkey)
DOI: 10.4018/978-1-4666-1978-4.ch010
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In this chapter, the authors construct a model that allows for joint discussion of foreign firm and skill premium in wages, and their evolution upon increased foreign firm activities. They allow for (1) dynamic interaction between the domestic and foreign firms in the labor market, via a two-sided search model, (2) technology differentials between domestic and foreign firms, and (3) varying cost of doing business between domestic and foreign firms. Analytical and numerical results point to the importance of modeling all three features. Both the level and the changes in the relative wages depend on the productivity differential (technology gap) and the job creation costs.
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1. Introduction

Multinational Enterprises (MNEs) have become one of the key players in extensively integrated economies since they have gained an important ground in transmitting new technologies, managerial techniques, skills, and capital across borders1. In this context, to benefit from new technology, knowledge and market opportunities, domestic policy makers (as well as firms) encourage foreign firms to establish local subsidiaries2. Alongside their effect on local firm productivity through technology transfers, investments by foreign firms have important implications for local labor market conditions. According to the World Investment Report (UNCTAD, 2007) around 3% of worldwide employees work for foreign affiliates of MNEs, representing a threefold increase from 1990 to 2006 in the absolute number of these workers. The same report further emphasizes the importance of understanding the impact of increased foreign firm presence which is evident in the increasing employment opportunities by foreign firms, where the share of employment in foreign affiliates in total employment ranges from around 1% in Japan to as high as 51% in Ireland3.

The effects of increased foreign firm presence is not limited to employment effects in the host country labor market, in fact two stylized facts stand out in the data regarding the wage effects of MNE activities. First, a change in the structure of domestic production upon the entry of foreign firms alters the wage gap between skilled and unskilled workers (see Gopinath & Chen, 2003; Markusen & Venables, 1997, among others). Second, foreign firms tend to pay different wages than domestic firms (see Aitken, et al., 1996; Feenstra & Hanson, 1996; Lipsey & Sjöholm, 2004, among others). The literature is dominated by theoretical studies that explore the first issue regarding the relative wages between the skilled and unskilled labor, i.e. the skill premium, and by empirical studies exploring the second issue regarding the relative wages paid by foreign and domestic firms, i.e. the foreign firm premium.

The evidence detailed in these studies regarding the evolution of both the skill and foreign firm premium is quite mixed across host countries. Regarding the skill premium’s evolution evidence suggests an upward move for several host countries, but with ample countries experiencing the exact opposite trend. Looking into the wage effects of international economic integration, studies have shown mixed evidence regarding the issue4. A similar mixed pattern is suggested in studies of the relative wages paid by foreign and domestic firms. While studies by Driffield and Girma (2003), Conyon et al. (2002), Martins (2004), and Aitken et al. (1996) document higher wages being paid by foreign firms, Lipsey and Sjöholm (2004), Almeida (2007), Barry et al. (2005), and Girma et al. (2001) note that foreign firms do not always pay more than local firms. None of the existing studies look into the joint determination of the skill and foreign firm premia. This chapter fills this gap in the literature, building a framework that explains the two observations synchronously and allowing for a detailed parametric identification of the absolute and relative wage implications of increased MNE activities in the host country. The below framework furthermore allows investigation of employment effects of MNE activities alongside their wage effects, which enriches the analysis.

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