Multinationals and the Impact on Wages in

Developing Countries

Jonas Babics
5th November 2009 - jonas.babics@gmail.com

Foreign direct investment (FDI) from multinational enterprises (MNE) to developing countries
has increased tremendously in the last four years. In 2007, the flow of inward FDI in
developing economies reached its highest level ever with USD 500 billion, an increase of
21% over 2006 (UNCTAD, 2008). FDI is defined as an investment involving a long-term
relationship and control by the foreign direct investor and is separated against portfolio
investment, where the investor has profit as his main purpose (IMF, 2008). Usually, a
threshold of 10% of equity ownership or voting power is applied to identify an investor as a
direct investor.
Many governments in developing countries have adopted policies to attract FDI, since it is
seen as a driver for economic development. As the foreign investor has a lasting interest and
wishes control over the entity in the host country, he will also influence the HRM policies and
practices, which means that FDI must have an impact on wages and working conditions in
the foreign affiliate. FDI projects are mainly carried out through MNEs. Along with the
increase of FDI flow and the ongoing process of globalisation, there have also aroused social
concern about the effect of these investments in developing economies. MNEs are accused
of taking advantage of low wages and weak labour standards in the host countries and of
violating human and labour rights (OECD, 2008). However, a lot of studies have showed that
the presence of multinationals has a positive effect on wages and working conditions in
developing countries. In this paper I would like to give an overview of the current literature
and to present a case study of the Coca-Cola Company in Colombia.

Do foreign-owned firms pay more than local enterprises?

Foreign firms do pay more. This is showed by different researches in developing as well as
developed countries. A study from Lipsey and Sjöholm (2001) in Indonesia showed that
wages in foreign-owned plants are about 10% to 20% higher than in private domestic plants,
even after differences in labour quality (employee education) and establishment
characteristics are taken into account. Furthermore, the impact of FDI on wages may also
spill over to affect wages from workers employed by local firms (OECD 2008). As the below
figure shows, with increasing inflows of FDI in developing countries, also the wages tend to
increase.

Multinationals and the Impact on Wages in Developing Countries Page 1

 Figure: FDI and Wages in Developing Countries, 1980 - 2006
as % of GDP

Source: OECD (2008)

There are different reasons, why foreign enterprises pay higher wages than domestic owned
enterprises. Among the fact that foreign direct investment tends to take place in industry
sectors with a relatively high salary level, Lipsey and Sjöholm (2001) suggest other reasons
for the wage premiums:
1) MNEs have to face host-country regulations and pressure from governments and
consumers from their home country at the same time. 2) Workers usually have a preference
to work for locally owned employers, which makes it necessary that foreign enterprises offer
advantages. 3) To reduce employee turnover, foreign firms might offer higher salaries and
invest more in training, as they wish not to loose their technological advantage.
MNEs are also able to pay higher wages because of their higher productivity. However,
increased productivity does not automatically lead to higher incomes for the employees
(OECD, 2008). Foreign direct investment from MNEs may also have an indirect influence on
wages in developing countries, as the employment activities of foreign-owned firms affect the
local labour market. That leads to the thesis that higher foreign presence raises the general
wage level in a province and industry (Lipsey and Sjöholm, 2001). One simple reason is that

Multinationals and the Impact on Wages in Developing Countries Page 2

foreign investment leads to higher demand for labour, but the OECD (2008) specifies also
further reasons. Domestic enterprises may be able to imitate production and management
practices of foreign firms and therefore improve their productivity. Knowledge is transferred
by workers who move from foreign to domestic owned enterprises. Spillovers may occur in
the supply chain, since foreign firms collaborate with domestic suppliers and they will ensure
that the labour practices and quality standards correspond with their codes of conduct.
Additionally, the increased competition on the domestic market may encourage local firms to
remove inefficiencies in the production process.
Most of the studies prove that FDI has a positive impact on wages and working conditions in
developing countries. However, there are a number of studies that indicate negative effects
or that there are at least no wage spillovers from foreign-owned to domestic firms. Mosley
and Uno (2007) state that foreign direct investment could lead to downward pressures on
workers’ collective rights and they found out that in countries, where the accumulated stock
of FDI is higher, also the violations of collective labour rights are higher. Foreign firms may
also be concentrated in export-oriented sectors, where higher global competition could
thereby depress wages (Harrison and Scorse, 2005). Brown et al. (2002) explain that FDI
may produce increased income inequality between skilled and unskilled workers in the host
country, since the largest wage premiums in foreign-owned firms accrue to educated
employees. Furthermore, Aitken et al. (1997), who analysed the labour markets in Mexico
and Venezuela, state that only foreign firms were associated with higher wages and that
there were no wage spillovers leading to higher salaries in domestic firms.

It is not clear why there are these differences across studies regarding wage premiums in
foreign-owned enterprises and spillovers to domestic firms. Naturally, there are differences
among developing countries and their environments. The studies often examine one or few
countries and derive conclusions for all the developing economies. Furthermore, the market
entry strategy of the foreign enterprise may also have an effect. According to the OECD
(2008), FDI realised through greenfield investment, and not through acquisition, is more likely
to have a positive impact on wages and working conditions in the host country. Another
important aspect is the industry that was chosen for the research. High-tech industries need
more well educated and skilled labour, which could lead to an increased income inequality,
as they pay more wages, but only for skilled employees. However, the worldwide average
skill-intensity of an industry does not necessarily correspond with the skill-intensity of the
MNE’s affiliate in the host country, as the firms often carry out labour-intensive and
uncomplicated works in developing economies (OECD, 2008). Finally, the researchers use
different methodology to come to their findings and it also depends on who does the

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research for whom. One has to ask these questions to arrive to a conclusion, if multinationals
and their foreign direct investment have a positive impact on wages in developing countries.

Case study: The Coca-Cola Company in Colombia

The Coca-Cola Company is the biggest producer of beverages in the world and has an
interesting business practice. They usually do not export their beverages, but produce them
in the country itself for the domestic market. In Colombia, Coca-Cola has conducted
business for over 70 years and employs more than 2’000 Colombians. While only 4% of all
Colombian workers belong to unions, 31% of all Coca-Cola bottler employees unionize. The
labour practices of Coca-Cola in Colombia were investigated and evaluated by the
International Labour Organization (ILO) and according to Coca-Cola, their labour relations
practices are among the best on the planet.
Wages for Coca-Cola workers are on average 2 to 3 times higher than the minimum wage.
Although, Coca-Cola had to tackle many concerns from non-governmental organisations
(NGO), which accused the company to exploit labour in Colombia, the analysis showed that
working conditions in Coca-Cola bottler companies are at least better than in domestic firms.

Source: The Coca-Cola Company (2006)

Foreign Direct Investment and Developing Economies

The economies of the world have become increasingly linked by trade in goods and services,
but also through portfolio investment, as well as foreign direct investment. This had a huge
impact on the developing world and there have also aroused much controversy, if the
integration into the world market leads to local development or not (Todaro and Smith, 2009).
Globalisation may carry benefits and opportunities, but also costs and risks. Developing
countries can benefit directly and indirectly through cultural, social, scientific and
technological exchange and they may be more effectively in absorbing the knowledge of the
developed countries. However, globalisation brings the risk that the inequality between
developing and developed economies raises and the developed countries are often criticised
to practice a new form of colonisation. The process of trade liberalisation is encouraged by
the World Trade Organization (WTO), which led to intensive and long-lasting negotiations.
Developing countries have to decide to follow a strategy of opening their market or protecting
their own industries by implementing import tariffs.
If foreign direct investment leads to higher wages in foreign affiliates of MNEs and indirectly
also in local enterprises, this could help to contribute to the discussion about globalisation
and developing economies. There could be a shift from the public impression that MNEs
exploit weak labour standards and violate human rights in developing countries to the opinion

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that FDI and MNEs are beneficial for local development. The pressure on MNEs will remain
as long as there are cases, where human rights are violated and workers in developing
countries are exploited. However, the NGOs and consumers have to bear in mind that if
products are produced by local firms in developing countries, the working conditions often
are worse. Global brands are requested to control all their suppliers in the value chain that
they fulfil the worldwide applicable codes of conduct. This will likely lead to higher wages and
better working conditions in developing economies.

Conclusion

Since the rise of globalisation due to technological and economic development and
worldwide integration of all countries into the global market, there has been an increasing
interdependence among developing and developed countries. FDI inflows in developing
countries have accelerated enormously in the last years and inward FDI has become the
main source of external finance for developing economies (OECD, 2008). This has
intensified the competition among developing countries to attract FDI. However, there has
also been much controversy about whether FDI and MNEs are beneficial for local
development and whether they belong to an important driver of improvements in pay and
working conditions.
As shown in different researches among developing countries, FDI tends to raise wages not
only in the foreign affiliates, but also in local firms. The spillover effect to domestic
enterprises cannot be proved everywhere. However, due to the fact that an estimated 73
million workers, representing 3% of the global workforce, were employed in foreign affiliates
of MNEs in 2006 (OECD, 2008), the wage premium must have an impact on the local
economy. This is even more the case, if taken into account that the share of employees of
foreign MNEs is disproportionate in developing countries. That leads me to the conclusion
that MNEs and their foreign direct investment in developing countries have a positive impact
on local wages.

Multinationals and the Impact on Wages in Developing Countries Page 5

References

Aitken, B., Harrison, A. and Lipsey R. E. (1997) Wages and Foreign Ownership: A
Comparative Study of Mexico, Venezuela and the United States, NBER Working Paper No.
5102, New York, National Bureau of Economic Research.

Brown, D., Deardoff, A. and Stern, R. (2002) The Effects of Multinational Production on
Wages and Working Conditions in Developing Countries, NBER Working Paper No. 9669,
New York, National Bureau of Economic Research.

Harrison, A. E. and Scorse, J. (2005) Do foreign-owned firms pay more? Evidence from the
Indonesian manufacturing sector, ILO Working Paper, Geneva, International Labour
Organization.

IMF (2008) Balance of Payments and International Investment Position Manual, 6th edition,
Washington, International Monetary Fund.

Lipsey, R. E. and Sjöholm, F. (2001) Foreign Direct Investment and Wages in Indonesian
Manufacturing, NBER Working Paper No. 8299, New York, National Bureau of Economic
Research.

Mosley, L. and Uno, S. (2007) “Racing to the Bottom or Climbing to the Top? Economic
Globalization and Collective Labor Rights”, Comparative Political Studies, 40:8, pp. 923-948.

OECD (2008) The Impact of Foreign Direct Investment on Wages and Working Conditions,
Paris, Organisation of Economic Co-operation and Development.

The Coca-Cola Company (2006) “Company Statements: The Coca-Cola Company and
Colombia” (online) (cited 22 June 2009). Available from <http://www.thecoca-
colacompany.com/presscenter/viewpointscolombian.html>

Todaro, M. P. and Smith, S. C. (2009) Economic Development (10th edn), Harlow, Pearson
Education Limited.

UNCTAD (2008) World Investment Report 2008, Geneva, United Nations Conference on
Trade and Development.

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