Academic journal article Economic Inquiry

Foreign Direct Investment and Country-Specific Human Capital

Academic journal article Economic Inquiry

Foreign Direct Investment and Country-Specific Human Capital

Article excerpt


The past three decades have witnessed an unprecedented increase in foreign direct investment (FDI) in the world; annual FDI flows from and to Organisation for Economic Cooperation and Development (OECD) countries have increased more than 30-fold from 1982 to 2005, while the world trade merely quadrupled during the same period; the ratio of gross private capital flows to gross domestic product (GDP) has risen from 10.3% in 1990 to 32.4% in 2005; the ratio of FDI flows to GDP has climbed up from 2.2% in the early 1990s to 4.4% in 2005. (1) As FDI gained importance in the international movement of capital, a variety of theoretical and empirical studies have investigated the factors that determine FDI. (2) In this article, we offer an important but under-studied determinant of FDI: foreign-educated labor in FDI host countries.

Specifically, using international bilateral data on FDI and foreign education, we present empirical evidence on the role of country-specific foreign-educated labor in an FDI host country as a determinant of foreign direct investments.

Production involves the process of combining physical capital and the human capital of employees. Human capital includes the general skills of workers, but it also includes their knowledge of firm-specific technology, managerial skills specific to the organization, and efficient communication skills with co-workers. Consequently, the labor that possesses these firm-specific skills, which can be readily used by a firm, can be more productive in that firm than in other firms. When a firm invests in a foreign country through a subsidiary that shares the technology of the parent firm, the labor force that has acquired various types of human capital specific to the parent firm, and thus to the subsidiary, can be more productive in the foreign subsidiary. For instance, the local managers of a foreign subsidiary who are able to speak the same language of the managers of their parent firm, or who know thoroughly well how the parent firm and its subsidiaries are organized and operated, can be more productively utilized in the subsidiary firm. Since human capital specific to a firm and its foreign subsidiaries can be acquired through education provided in the country of the parent firm, the availability of workers in a potential FDI host country who studied in the parent-firm country can be an important deciding factor for a firm in investing abroad through its foreign subsidiary. (3)

Foreign training can provide various types of country-specific human capital that would increase labor productivity more in the host country of training than in other countries. Country-specific human capital includes language capital, which has been shown by numerous papers such as Chiswick and Miller (1993) and Lazear (1999) to have considerable importance in labor market performances. Knowledge on firm organization and social system is another example of country-specific human capital that can be acquired through foreign training. Foreign education can also enhance the productivity of students in firms of the host country, because it provides information about the ability and potential of students in a form that can be more easily processed by firms in the host country. Greater knowledge regarding employees allows firms to utilize manpower more efficiently and enhance workers' productivity, as pointed out by Becker (1993), who discusses low worker mobility across countries as evidence of the importance of country-specific training.

Earlier theoretical models in international trade, such as MacDougall (1960), attribute international capital movement to the difference in factor endowment measured by physical capital per worker. (4) Empirical findings, however, show that the actual capital flows fall short of the theoretical prediction that capital moves from developed economies to developing economies to take advantage of the higher rates of returns to capital. …

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