Home-country Employment Protection Matters for Firms’ Relocation Propensity

Since the 1990s a great number of policy measures have been observed to promote inflows of foreign direction investment (FDI), with the expectation that foreign investors would not only bring in financial resources but also know-how and technologies to support and facilitate the economic and societal development of the host countries. Some of these policy measures aimed at improving host countries’ business and investment environment to enhance their attractiveness for foreign firms. Labour market regulation was one of the key aspects considered here. Many previous studies showed that less strict labour market regulations, or say a higher level of labour market flexibility, may attract more foreign investors to move in and invest. What was rather hardly studied in the past, was the relevance of home-country labour market regulations on firms’ propensity to relocate (parts) of their operations abroad.

A new KCG study, carried out by Prof. Holger Görg, Ph.D., Managing Director of KCG, and his co-authors, Dr. Gerda Dewit (National University of Ireland) and Yama Temouri, Ph.D. (Aston Business School), tries to fill this literature gap. In so doing, they construct a theoretical model of firms’ relocation decision. From the model they derive three key hypothesis related to general determinants of firms’ relocation decisions and the relevance of home-country employment protection in this regard, taking firm-specific features into consideration. They check these hypotheses based on analyzing a firm-level dataset for 28 OECD countries for the period 1997-2007.

They find that home-country employment protection indeed matters for firms’ relocation propensity. Firms operating in countries with more strict employment protection regulations are generally less likely to relocate (parts) of their business operations abroad. The relocation propensity of firms with different features in terms of, for example, firm size, productivity and labour intensity, is, however, not equally affected by the strictness of home-country employment protection regulations. The reduction in relocation propensity in case of more strict employment protection regulations is stronger with increasing firm size, rising firm productivity and increasing labour intensity.

In other words, their analysis shows that particularly firms which would otherwise be more likely to relocate (parts) of their business operations abroad would have a lower propensity to do so if they are currently operating in countries with more strict employment protection regulations. Their findings have important policy implications. They suggest, on the one hand, that firms operating in such countries may not easily reap the benefits of internationalization to enhance their competitiveness in the global market. On the other hand, countries with stronger employment protection may not be challenged by immediate large-scale employment losses as strongly as their counterparts with less strict regulations. The lower relocation propensity may also leave these countries more time for carrying out economic restructuring required and bear the social adjustment costs caused by the industrial relocation.

The abovementioned paper is accepted to be published in Economica. Its working paper version is available here.