Concerns have been raised that outward foreign direct investment may reduce domestic employment and lead to the ‘hollowing-out’ of the manufacturing industries at home. This column uses a unique dataset of Japanese firms' overseas activities to show that going abroad does not necessarily lead to a reduction of domestic employment. Investment by Japanese firms into other Asian countries has a positive impact on domestic job creation and a negative impact on job destruction, whereas the impact of investment into European and North American countries is negative for both job creation and destruction in Japan.
Outward foreign direct investment (FDI) from Japan has benefited Asian countries such as China, Thailand, Vietnam, and recently Myanmar, in terms of technology spillovers and employment opportunities. However, this phenomenon has also raised concerns that outward FDI may reduce domestic employment and lead to the ‘hollowing-out’ of the manufacturing industries at home. In fact, the effects of the firms' decisions on the reallocation of labour are much more complicated than what is easily observed. For example, foreign expansion can reduce the funds that are available to be spent domestically, which leaves less room for domestic employment; on the other hand, FDI can contribute to more technical progress and higher productivity, which help to create more new jobs. The overall effects of overseas investment on domestic employment have thus been somewhat inscrutable, and have drawn much academic and policy attention.
There is a wide body of literature that has investigated the relationship between outward FDI and employment in the home country. Markusen (1984) and Brainard (1997) show that theoretically, firms with moderate increasing returns should establish affiliates overseas to reduce transportation costs. Such expansion abroad acts as a substitute for exports, and thus foreign labour would substitute domestic labour. However, at the same time, moving to other markets could increase the headquarter services provided to affiliates and in fact lead to higher domestic employment in the long term. In the empirical verification, contrary to most critics' expectations and despite some of the earlier literature which identified a negative relationship between outward FDI and domestic operations, more recent studies find that net employment growth in FDI firms is higher than in non-FDI firms (Barba Navaretti et al. 2010, Hijzen et al. 2011, Desai et al. 2009, Hayakawa et al. 2013). In a more influential study, Harrison and McMillan (2011) use US firm data and verify that offshoring to low-wage countries does substitute for domestic employment. Nevertheless, if firms engages in more advanced tasks, the increase in foreign employment also promotes employment at home.
Due to the availability of firm-level data in Japan covering both domestic and overseas interests, there is a rising amount of literature on this topic (Note 1). Hijzen et al. (2007), Fukao and Yamashita (2010), and Tanaka (2012) all find that outward FDI has a positive effect on firms' domestic employment and performance. More recent studies such as those by Ando and Kimura (2015) and Kodama and Inui (2015) focus on gross job variations, which indicate aggregated increase or decrease in firms' net employment. Yet, no previous studies have attempted to disentangle the individual influence of outward FDI on firms' job creation or job destruction. However, this can lead to bias in the prediction because net employment growth is the difference between total job creation and destruction within a firm, and the overall effect does not necessarily reflect job creation and job destruction changes occurring in the same direction. To deal with this problem, in our recent study (Liu and Ni, 2018) we analyse data from the Basic Survey of Japanese Business Structure and Activities (BSJBSA), which is conducted annually by the Ministry of Economy, Trade, and Industry, Japan. The uniqueness of this dataset is that it allows for observation of the change (plus or minus) in each division within the firm, and the exploration of FDI's impact on job creation and job destruction separately.
Difference of job creation and job destruction between this study and previous studies
Most previous studies focused on the effect on net employment growth (i.e. job creation minus job destruction). A positive effect on net employment growth could result from increasing job creation and decreasing job destruction, but it could also indicate decreasing job creation with a greater decrease in job destruction. We follow the approach used in Davis and Haltiwanger (1999), but differ in that our calculations are based on the division level change of jobs. Job creation in a firm is defined as the sum of all new jobs in the firm's expanding and newly opened divisions, meanwhile job destruction in a firm is defined as the sum of all eliminated jobs in the firm's downsizing or closed divisions. Furthermore, the firm's branches or plants are considered to be similar to divisions. Newly set up and closed firms are excluded; they are not within the scope of this study's objectives because such job creation/destruction instances are quite different from those in existing firms. Figures 1 and 2 show the correlation between the total number of overseas affiliates and the rate of job creation/job destruction. Both show a negative trend, making it impossible for us to identify the impact of outward FDI on net employment change. This motivates us to conduct more rigorous empirical analysis.
A firm's FDI increases the net employment growth of the firm, which is consistent with most previous studies in Japan.
When we decompose the individual effects of FDI on job creation and job destruction, we find that both are negative. However, because the effect on job destruction is significantly negative and larger than the negative effect on job creation, the effect on the difference between job creation and destruction, which is net employment growth, is positive.
When we separate Japanese firms' overseas investment by destination (to be specific, Asia, the EU and North America), the effect on domestic job creation is positive for FDI in Asian countries, but negative for FDI in EU and North American countries. Further, the result shows that the effect on domestic job destruction is negative, both for FDI into Asian countries and FDI into EU and North American countries.
The explanation for the effects on job creation and destruction is as follows. The effect on job creation for FDI in EU and North American countries is negative because the capital effect – i.e. the negative effect of FDI on job creation due to the reduction in domestic capital – is larger than average technology effect, which is the positive effect on job creation due to the increase in average technology level of domestic jobs. It becomes positive for FDI in Asian countries perhaps because the capital effect is smaller than the average technology effect, for the possible reason that capital cost of FDI is relatively low in Asian countries. On the side of job destruction, when investing in Asian countries, it is possible that reservation productivity (i.e. a job's minimum productivity level that must be achieved to avoid being destroyed) reduces because the effect of reducing available domestic capital is smaller than the effect of increasing average technology level of domestic jobs. For FDI in EU and North American countries, on the one hand, the reservation productivity increases because of the smaller average-technology effect (the negative effect on job destruction by increasing average technology level of domestic jobs) than the capital effect (positive effect of FDI on job destruction by reducing domestic capital). On the other hand, FDI behaviour affects the distribution of productivity of jobs in the firm, in which the productivity of some low-skilled jobs rise to levels that are higher than the current reservation productivity, and thus, fewer jobs with productivity below the reservation level remain, and job destruction dropped.
The intuition behind the differences in the findings by destination is two-fold. First, the cost for investments is lower in Asian countries than in EU and North American countries, which leads to a smaller reduction of domestic capital necessary for FDI in Asian countries than in EU/North American countries and subsequently, smaller effects on domestic employment. For instance, when opening similar affiliates, the costs of investments are lower for Asian affiliates than for EU and North American affiliates; thus, the decrease in domestic capital is lower when investing in Asia than in the EU/North America. Second, Asian affiliates usually share low-skilled work with parent firms, and therefore, there is an increase in the general technology level of jobs in the domestic firms, which is rare in EU/North American affiliates.
Our findings are in sharp contrast to some of the existing literature (e.g. Harrison and McMillan 2011), which found that offshoring to low-wage countries can replace and therefore destroy domestic employment. It is commonly recognised that Japanese multinationals move to Asian countries to exploit the cheap labour and minimise production costs, and that more jobs are destroyed due to this substitution effect. However, this might be limited to ‘blue collar’ jobs. As Higuchi and Genta (1999) indicate, even though outward FDI of Japanese firms has led to a larger loss of blue collar employment, the number of white collar (office employees) jobs has been increasing. One possible explanation is that as more low-skilled jobs are outsourced to Asian countries, it creates more room for the employment of highly-skilled workers. In other words, during this process there will be a shift from the demand for manual labour to professional labour, such as management. We will leave thorough verification of this point to future studies.
This article first appeared on www.VoxEU.org on May 21, 2019. Reproduced with permission.
^ Other related studies have used the same dataset. For instance, Todo and Shimizutani (2008) and Edamura et al. (2011) investigate how overseas activities promote firm productivity.
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