The UK and the international division of labour

Low labour costs have been thought to be the primary factor in attracting foreign direct investment, an argument fuelled by the example of the UK. However, as this feature highlights, the way that MNCs make decisions concerning where to invest may be a much more complex process.

Introduction

As the growth of foreign direct investment (FDI) into Europe by multinational companies (MNCs) continues to increase, so the debate concerning the factors attracting these companies to a particular location becomes more pertinent. The stock of inward investment in Western European countries in 1995 was valued at USD 1087.6 billion, an increase of 43.3% on 1990. This figure constitutes 38.2% of the stock of FDI in the world. The UK is the recipient of a larger share of this than any other country; 22.4% of the stock of FDI in Europe is located in the UK (according to 1997 United Nations figures).

A key issue concerns why the UK receives such a large share of inward investment. The previous Conservative administration attributed this to the role of labour markets; cheap, deregulated labour in Britain, it argued, contrasted with expensive, regulated labour in many other European Union countries and acted as a magnet for inward investment. For governments elsewhere in Europe, Britain's refusal to sign up to the social policy Agreement annexed to the Maastricht Treaty on European Union (the "Social Chapter") threatened to undermine attempts to create a floor of employment standards in the EU. While these viewpoints differ markedly in terms of how welcome these developments are, they both assume that labour costs and standards are a key determinant of the location decisions of MNCs. Indeed, variations in labour costs between EU countries are considerable (as Table 1 below indicates) and appear to present a strong motivation for MNCs to take advantage of these differentials.

Table 1, Labour costs in Europe, USD per hour (selected countries)
Germany 31
Belgium 26
Austria 25
Denmark 24
Netherlands 21
Sweden 21
France 20
Italy 16
Ireland 14
UK 14
Spain 13
Greece 8
Portugal 5

Source: "European integration and German FDI: Implications for domestic investment and central European economies", J Agarwal, National Institute Economic Review, 2, No. 160 (1997).

The limitations of the labour costs explanation

Can differences in wage costs between countries explain why the UK receives so much inward investment? Such an interpretation becomes problematic when we examine outward investment from the UK. If MNCs were attracted in large part by labour costs we would expect inward investment to exceed outward investment in those countries with low labour costs, such as the UK. In fact, the reverse is true; for every pound invested in the UK by overseas MNCs, British MNCs invest GBP 1.31overseas ("Overseas direct investment", Business Monitor, London, Business Statistics Office (1997)). This leads to a questioning of the importance of labour costs in determining the location of FDI.

However, it could be that British MNCs invest primarily in countries with wages as low as, or lower than, those in Britain. If this were so, then the labour costs explanation would still hold water. Examination of data for the geographical distribution of British outward FDI is revealing on this issue. This shows that Europe is the destination for 38.2% of British outward FDI, a geographical breakdown by country for which is provided in Table 2.

Table 2. British outward FDI in Europe, % of the stock, 1995
Netherlands 37.6
France 17.9
Germany 12.1
Ireland 6.1
Belgium and Luxembourg 4.4
Spain 4.3
Denmark 3.7
Italy 3.4
Sweden 2.0
Portugal 1.7
Austria 1.1
Greece 0.6
Others 5.2

Source: Business Monitor, 1997

The table shows that over two-thirds (67.6%) of British FDI in Europe goes to three countries - the Netherlands, France and Germany- all of which have wage costs of USD 20 per hour or above. A further 11.2% is located in other countries with wage costs at or above this level (Belgium and Luxembourg, Denmark, Sweden and Austria) while another 9.5% is in two countries with similar wage costs to the UK (Italy and Ireland). Only the remaining 6.6% is in countries with lower wage costs (Spain, Greece and Portugal). The clear implication is that labour costs are not the primary determinant of FDI. (Note: It can be argued that it is more appropriate to examine data for the flow rather than the stock of FDI because the latter is made up of investment decisions made in past years when wage differentials may have been different. Data for flows of FDI, however, are more volatile than those for the stock and we know that wage differentials between countries have been reasonably stable in the last two decades.)

This view is strengthened when we examine the location of British FDI in other parts of the world outside Europe. The USA receives 31.5% of this, despite wage costs being higher than in Britain, while a further 12.2% goes to other developed economies (Canada, Australia, Japan, New Zealand and South Africa) where labour costs are also high. Only the remaining 17.8% goes to developing economies where labour costs are generally substantially lower than in Britain (Business Monitor, 1997).

Other explanations

Why, then, are labour costs not such a key factor as is commonly believed? Part of the explanation lies in differences in productivity between countries, which go some way to cancelling out differences in wage costs. Thus, when we consider unit wage costs we find much smaller variations between countries ("Social dumping and European economic integration", N Adnett, Journal of European Social Policy, 5, 1, (1995)). A second part of the explanation lies in the small and declining proportion of total costs comprised by labour costs. This is particularly the case in the manufacturing sector, where labour costs constitute only around 10% of total costs, down from 25% in the 1970s. Given this, variations in other costs, such as those associated with rent, raw materials, transportation and power, may more than offset variations in labour costs ("Multinationals, 'relocation', and employment in Europe", A Ferner, in "Job creation: The role of labour market institutions", J Gual (ed), Edward Elgar (1997)).

A further factor is the importance of MNCs having a presence in the market that they wish to serve. In some industries, such as mining, a presence in a particular country is essential in order to gain access to a natural resource; in others, such as hotels and catering, it is essential in order to serve a market; and in yet others, such as defence, it is politically important to have a direct presence in the country in which the MNC is seeking to attract orders. More generally, MNCs may wish to establish a presence in a particular country in order to portray themselves as "local" producers, overcoming any marketing disadvantage arising from being seen as "foreign" ("Multinational Britain: Employment and work in an internationalised economy", P Marginson, Human Resource Management Journal, 4, 4, (1994)).

Commentary

This feature has sought to address the issue of MNCs' location decisions. We have argued that the role of labour costs in explaining these decisions is often exaggerated. Differences in labour costs between countries do not appear to be as central in attracting inward investment as is often implied; rather, productivity, other costs and market access appear to be more influential. The implication is that debates about "social dumping" should see labour costs and standards as only one factor affecting the location decisions of MNCs (Tony Edwards, IRRU).

Useful? Interesting? Tell us what you think. Hide comments

Eurofound welcomes feedback and updates on this regulation

Add new comment