Using a new measure of labor market freedom from the Economic Freedom of the World Report, 2001, the authors estimate the impact of labor market regulations in 16 OECD and 11 non-OECD countries on U.S. direct investment abroad. Previous research relating labor market regulation to foreign direct investment has used subjective measures of the intensity of the regulatory environment. In addition, prior research combines OECD and non-OECD countries in the estimation procedure. The authors find that the new more objective measure of labor market regulation results in a highly significant and robust coefficient for OECD countries, but is not significant for non-OECD countries. U.S. firms are less likely to invest in OECD countries where job security provisions are high. Furthermore, we find that OECD and non-OECD countries respond differently to the determinants of foreign direct investment and therefore those sets of countries should be estimated separately.
Both the popular press and academic literature have given significant attention to corporate international decision making. This focus should not be surprising given the increasingly global nature of our economy. Thus, we face a paramount need to clarify our understanding of how firms make decisions regarding international issues, such as determining foreign production locations. One important, though largely ignored, avenue of economic research is the role that labor laws and/or institutional restraints (specifically, hiring and firing laws or job security provisions) play in a firm's decision to locate production or service facilities within another country.
Labor economists have produced many studies regarding the additional explicit and implicit costs faced by firms located within countries with job security provisions which inhibit a firm's ability to reduce the size of their workforce. The U.S. is one of the only countries in the world that preserves the right to "fire at will". The primary form of restriction faced by firms located in the U.S. today is the 1988 Worker Adjustment and Relocation Notification Act (WARN). WARN requires large employers (with more than 100 employees) to give their employees 60 days advance notice before shutting down or conducting large layoffs. No severance pay is required by these firms unless previously negotiated through collective bargaining. However, with no enforcing body to supervise the Act, it has virtually no impact on the provision of advance notice of the length mandated by law (Addison and Blackburn, 1994). U.S. job security is further thwarted by the notion that simple threats of plant closings impede the impact of union activity in the U.S. (Worklife Report, 2001).
Alternatively, most European firms face far more stringent levels of worker protection. For example, laid-off workers in Spain are entitled to receive up to 45 days' pay for each year of service (The Jobs Letter, April 1996). According to Bertola, Boeri, and Cazes (1999, Annex C), firms in Germany must notify a works council prior to any alteration of running a business that entails any measure "which might have disadvantageous consequences for the workforce or substantial sections of the workforce." This works council is required to "examine ways in which the redundancies can be avoided or reduced" and devise a social compensation plan. In fact, firms in many OECD countries must have termination conditions and compensation examined by a works council. Termination must be for legitimate economic reasons to be justifiable. Even hiring costs can also be substantial when works councils are involved. Recently, a bid from Volkswagon to expand its labor force within Germany was rejected because the company only offered three year contracts rather than lifetime contracts (Williams, 2001).
Many studies have shown how stringent statutory job security provisions such as these in Europe raise unemployment within a country. …