Unionisation Triggers Tax Incentives To Attract Foreign Direct Investment
30 Jun 2011
Countries and regions with strong trade unions and relatively high wages are often surprisingly successful at attracting investment by multinational firms. Research by Professor Andreas Haufler and Ferdinand Mittermaier, published in the June 2011 issue of the Economic Journal, suggests that this happens because governments respond to unionisation by offering substantial subsidies to attract foreign direct investment (FDI).
Their results do not imply that unionisation is ''good'' for a country. In fact, the research shows that the high-wage country is worse off than its lower-wage neighbour because of the high subsidies it has to pay to attract FDI. The results do imply, however, that if wages cannot be affected directly, then attracting multinational firms is an attractive solution for governments to mitigate the effects of strong union power.
The researchers note that in recent decades, there has been a growing incidence of large government subsidies being offered to multinational firms to attract them to a specific country or region. The highest subsidies have typically been paid in regions with strong union power, high unemployment and weak economic activity, such as eastern Germany or southern Italy.
Multinational firms locating in these regions have often been able to receive subsidies worth between a quarter and a third of the total value of the investment – and in some cases even more. This raises the question of why governments are willing to offer such high levels of subsidies to individual firms.
The answer given by these researchers is that the high subsidy payments can be a rational policy for governments, as they give trade unions an incentive to exert wage restraint in exchange for additional jobs that are created in the newly attracted firms.
A government that acts in the best interest of its citizens will therefore be willing to offer multinational firms a subsidy that more than compensates the firm for the higher wage cost in this region. The final result is that FDI flows to countries that have higher wages, relative to productivity, than neighbouring countries with less union power.
These results are consistent with several empirical studies that show a surprising, positive relationship between the degree of unionisation in a given region and the volume of FDI inflows.
This empirical finding stands in stark contrast to the previous theoretical literature on unionisation and FDI, which has generally concluded that countries with stronger unions will be at a disadvantage in the competition for FDI.
The research also shows that high-wage countries may still be able to win the competition for FDI, even if they have additional locational disadvantages, such as a smaller home market, in comparison with their lower-wage competitors.
''Unionisation Triggers Tax Incentives to Attract Foreign Direct Investment'' by Andreas Haufler and Ferdinand Mittermaier is published in the June 2011 issue of the Economic Journal.
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