FDI and the labor share in developing countries: a theory and some evidence

Abstract

This paper addresses the impact of FDI on the labor share of income in developing countries. We propose a theory that relies on the impacts of FDI on productive heterogeneity between firms in a frictional labor market. We argue that FDI have two opposite effects on the labor share: a negative force originated by market power and technological advance, and a positive force due to increased labor market competition between firms. Then, we test this theory on aggregate panel data through fixed effects and system-GMM estimations. We find a quantitatively meaningful U- shaped relationship between the labor share in the manufacturing sector and the ratio of FDI stock to GDP. However, most of the countries are stuck in the decreasing part of the curve, which we relate to multinationals' location choices.FDI; Matching frictions; Firm heterogeneity; Technological advance