Firm productivity and foreign direct investment: a non-monotonic relationship

Abstract

The theoretical prediction of Head and Ries (‘Heterogeneity and the FDI versus export decision of Japanese manufacturers', 2003, Journal of the Japanese and International Economies, 17: 448-67) is that if the foreign plant is not used to serve the home market, the exporters can be more productive than the foreign direct investors only if the host-country wage is lower than the home-country wage. With unionized labor markets, we show that there always exist situations where the exporters are more productive than the foreign investors even if the host-country wage is higher than the home-country wage. Given the cost of FDI, a higher trade cost and higher bargaining powers of the labor unions make this result more likely.