Benefits of Globalization For The Developing Countries

Journal Identication = JPO Article Identication = 5905 Date: April 18, 2011 Time: 10:40 am
Journal of Policy Modeling 33 (2011) 511521

Available online at www.sciencedirect.com
Does globalization benet developing countries?
Effects of FDI on local wages
Akinori Tomohara
a,c,
, Sadayuki Takii
b,1
a
University of California Los Angeles, Anderson Forecast, United States
b
The International Centre for the Study of East Asian Development, Japan
c
Aoyama Gakuin University, Japan
Received 1 August 2010; received in revised form 12 October 2010; accepted 1 December 2010
Available online 20 January 2011
Abstract
Twodifferent reactions toglobalization(either supportingor opposingglobalization) are observedthrough-
out the world. Focusing on the effects on the labor market, we examine whether foreign direct investment
benets workers employed by local establishments in a host developing country. The analysis shows that
they received wages above the market-based wage that would otherwise prevail in the absence of foreign
establishments. Although concerns exist that growing multinational business might have negative impacts
on local workers, this paper suggests that those fears might be unwarranted.
2011 Society for Policy Modeling. Published by Elsevier Inc. All rights reserved.
JEL classication: F21; F 23; J31
Keywords: FDI; Wage spillovers; Equity; Globalization; Multinational companies
1. Introduction
Does globalization really improve standards of living in developing countries? This question
is of signicant policy concern in the area of economic development. International organi-
An earlier draft of this paper was prepared while the rst author visited the ICSEAD as a visiting scholar. The
rst author also would like to thank to seminar participants at Western Economic Association International 81st Annual
Conference, Osaka University, and University of Pittsburgh for their comments. Specically, we would like to thank to
Robert Lipsey and Eric Ramstetter for their support for this project. All errors are ours.
Corresponding author at: University of California Los Angeles, Anderson Forecast, 835 Nesconset Hwy. G4, Nescon-
set, NY 11767, United States. Tel.: +1 718 997 5456; fax: +1 718 997 5466.
E-mail addresses: jujodai@yahoo.com (A. Tomohara), takii@icsead.or.jp (S. Takii).
1
Research Department, The International Centre for the Study of East Asian Development, Kitakyushu, 11-4 Otemachi
KokuraKita, Kitakyushu Fukuoka, 803-0814, Japan. Tel.: +81 93 583 6202; fax: +81 93 583 4603.
0161-8938/$ see front matter 2011 Society for Policy Modeling. Published by Elsevier Inc. All rights reserved.
doi:10.1016/j.jpolmod.2010.12.010
512 A. Tomohara, S. Takii / Journal of Policy Modeling 33 (2011) 511521
zations advocate the merit of accessing the global economy via foreign direct investment.
Anti-globalization movements do not necessarily agree with this view. Those opposing glob-
alization argue that self-interested, multinational companies exploit the resources of developing
countries and impair development. Thus, for the purposes of long-run economic growth, it is
better to protect domestic infant industries rather than rely on foreign capital.
Several (anti-)globalization issues have been explored in the literature: topics include income
inequality across countries (Adams, 2008; Galbraith, 2007; Lee, 2006), and foreign direct invest-
ment (FDI) and economic growth (Laureti &Postiglione, 2005; Qin, Cagas, Quising, &He, 2006)
(refer to Bhagwati (2004) and Intriligator (2004) for overview).
Our study is motivated by wage gaps between foreign multinational companies and domestic
companies (Aitken, Harrison, &Lipsey, 1996 for Mexico and Venezuela; Lipsey &Sjholm, 2004
for Indonesia). Multinational companies tend to pay higher wages than domestic companies, even
after controlling for factors such as industry and worker characteristics. Globalization apparently
does not benet workers employed by domestic companies according to our observations of
wage inequality in a host country. Wage inequality attributable to FDI is a major policy concern
in developing countries. The government advises foreign and local establishments to remedy the
gaps.
We examine whether higher wages set by foreign establishments, operating in a developing
country, affect the wage levels of local establishments. Local establishments may enjoy increased
wages in the presence of FDI. The analysis utilizes empirical models used in the literature on
the key-industry hypothesis (Christodes, Swidinsky, & Wilton, 1980; Drewes, 1987; Lee &
Pesaran, 1993; Mehra, 1976; Shinkai, 1980; Smith, 1996). The hypothesis treats the wage set by
a key-industry as a reference wage. The literature examines whether wage determination by a
key industry affects wage levels of other industries. Our analysis employs a similar methodology.
Foreign establishments often dominate the market in developing countries. Their behaviors inu-
ences host countries economies. Assuming foreign establishments are wage-decision leaders, we
explore whether wages set by foreign establishments have externalities on the wage determination
of local establishments (i.e., wage spillovers).
We consider wage spillovers using the Indonesian manufacturing industry during 19891996.
The time period chosen corresponds to a period of foreign investment liberalization in Indonesia
and, thus, a period when Indonesia experienced a large FDI inow. The Indonesian case is one
good example for understanding this topics political importance.
Analyses showthat wage spillovers occur fromforeign establishments to local establishments.
Higher wages set by foreign establishments increase the wage levels of local establishments.
Employees in Indonesian local establishments enjoy increased wages in the presence of FDI. A
spillover channel results from a reference wage effect, which operates through equity concerns
and bargaining. Observing wage gaps, employees in local establishments may feel that they are
unduly underpaid and might therefore negotiate for higher wages. Therefore, wages paid by
foreign establishments impose an externality, a non-market-based wage determination, on wages
paid by local establishments.
The results are robust even if we assume restricted labor mobility and examine a sub-sample.
Furthermore, we examine whether wage spillovers differ between large wage-gap industries and
small wage-gap industries. The results indicate that a reference wage plays an important role in
determining the wage levels of local establishments in large wage-gap industries but not in small
wage-gap industries.
Our analysis suggests newpolicyimplications relatedtothe effects of FDI onthe labor market in
host countries. This paper presents analyses that are distinct fromthose of earlier works describing
A. Tomohara, S. Takii / Journal of Policy Modeling 33 (2011) 511521 513
wage spillovers. We include two different channels through which foreign establishments affect
local establishments wage decisions. A higher level of FDI could increase local establishments
wages via increased productivity. Previous works mainly consider this possibility. We introduce
non-market factors, specically equity and bargaining considerations, into the argument. The
literature points out the creation of job opportunities as a benet of FDI. The current analysis
adds possible positive wage spillovers to the argument.
The paper proceeds as follows. In Section 2, we summarize the data used for the analysis.
Section 3 describes an empirical model for studying wage spillovers. Results of the analysis are
presented in Section 4. Section 5 concludes the paper and suggests future lines of research.
2. Data
We use data based on an annual manufacturing survey conducted by the Central Bureau of
Statistics (CBS), Republic of Indonesia (Biro Pusat Statistik, Republik Indonesia) from 1989
to 1996. The Industrial Statistics Division of CBS (Biro Statistik Industri) conducts industrial
surveys on manufacturing establishments with 20 or more employees. The survey provides infor-
mation on industrial classication, the type of ownership (public, private, and foreign), location,
labor (number and salary/wages), xed assets, material and electricity costs, income, output, etc.
The survey data is commonly used in the literature on Indonesian industry analysis [e.g., the
relationships between FDI and technology spillovers (Blalock & Gertler, 2004; Takii, 2005);
wage gaps between domestic and multinational companies (Lipsey & Sjholm, 2004)]. Data on
Wholesale Price Index (WPI) is obtained from Monthly Statistical Bulletin. Additionally, we
calculate provincial unemployment rates from the labor force and unemployment data in Labor
Force Situation in Indonesia.
We use a panel dataset for Indonesian manufacturing from 1989 to 1996. The presence of
foreign establishments increased rapidly during the period, making it relevant for analyzing wage
spillovers. In fact, Indonesia experienced foreign investment liberalization during the time period
and, subsequently, a large FDI inow. After oil prices collapsed in the mid-1980s, Indonesia
tried to reduce dependency on oil and gas revenue. This effort resulted in policies encouraging
FDI during the late 1980s and early 1990s. Annual FDI inows increased tenfold from US$ 0.6
billion in 1988 to US$ 6.2 billion in 1996 until the Asian nancial crisis struck the economy in
19971998 (ICSEAD, 2005, Table 7.2, pp. 107110). The number of foreign establishments in
manufacturing sectors nearly doubled during the sample period from 708 in 1991 to 1318 in 1996
(Table 1). Another reason for the chosen time period is technical. Our empirical analysis employs
the ArellanoBond estimation method. The method uses differenced and lagged variables with
two or more periods as instruments. In the survey dataset, capital stock (at the beginning of period)
is available from 1989. Thus, we set up the effective sample period as 19911996 and use data
from 1989 to 1996 to estimate our empirical model (see Section 3 for details).
Table 1 presents the samples summary statistics. We have 27,066 observations (about 4500
plants for each year) after eliminating outliers and establishments with missing variables.
2
The
sample includes 29 industries at the 3-digit ISIClevel. We observe a signicant difference between
wages paid by local establishments and the ones paid by foreign establishments. A local estab-
lishments wage level is about one-third of a foreign establishments wage level. The ratio of
2
Our analysis focuses on local establishments that stay in the market for ve years or more. Thus, the positive wage
spillovers shown in this paper are not the results of efciency improvements, made possible as foreign establishment let
some inefcient local establishments exit from the market.
Table 1
Summary statistics of the sample.
19911996 1991 1992 1993 1994 1995 1996
Variables Mean Std. dev. Mean Mean Mean Mean Mean Mean
Local wage 1855 1608 1376 1538 1740 1910 2152 2318
Capital 8862 30,681 7188 7255 8591 9066 9980 10,727
Number of labor 261 904 248 255 253 266 266 276
Material 14,494 50,481 10,915 12,120 12,473 14,722 17,265 18,862
The ratio of non-production workers 16.59 15.49 16.94 16.96 16.85 16.71 16.31 15.8
Plant size 9224 75,014 5919 6998 8073 9439 10,934 13,517
Value added 7060 18,121 5273 6042 6306 7453 8070 8908
Sample size (Local) 27,066 3763 4269 4908 4790 5232 4104
Foreign wage 5257 5387 4097 4442 4786 5125 5647 6537
Sample size (Foreign) 708 897 991 1121 1200 1318
Number of industries 29 29 29 29 29 29 29
Units: Rupiah 1000 (except size that uses Rupiah million); all variables are measured by a per-employee unit at an
establishment level except the number of labor, plant size, and the ratio of non-production worker (%).
Source: Annual manufacturing survey by Indonesian Central Bureau of Statistics.
non-production workers is around 16% throughout the sample period. Standard deviations indi-
cate characteristic variations among establishments and across industries. We will control for
these observed characteristics, and other macroeconomic factors, such as unemployment rates in
the following empirical analysis.
3. Model
We construct a model of local establishments wage determination by referring to empirical
models used in the key-industry hypothesis literature. The literature on wage spillovers is clas-
sied as either a regional interaction or inter-industry interaction (including interactions such as
union vs. non-union sectors). The latter includes Latreille and Manning (2000), Lee and Pesaran
(1993), Mehra (1976), Shinkai (1980), Smith (1996) and Vroman (1982). Drewes (1987) is an
example of regional interaction for wage determination i.e., companies in the same region affect
the determination of wage levels each other. Christodes et al. (1980) and Drifeld and Girma
(2003) are spatial economy studies, and include both regional and industrial interactions. Despite
these differences, empirical models used in the wage spillovers literature do employ a similar
specication, including explanatory variables.
Wage spillovers from foreign establishments to local establishments are examined by the
following dynamic panel data model:
w
d
it
=
1
w
d
it1
+
2
k
it
+
3
va
it
+
4
w
f
jt1
+
5
wpi
jt
+
x
it
+
t
+
i
+
it
,
where w
d
it
is the wage paid by a local establishment i in year t, k
it
is capital per employee at
the beginning of year t, va
it
is value added per employee, w
f
jt1
is a weighted-average wage of
foreign establishments in industry j that i belongs to in year t 1, wpi
jt
is WPI for industry j,
and x
it
contains a set of control variables. As in the original survey, value added is dened as
total sales minus expenditures for capital and labor inputs. A time effect,
t
, controls for time
varying elements that affect all establishments in a given year. An individual effect,
i
, captures
time invariant elements that differ across establishments and/or industries.
3
An error term,
it
,
is assumed to be independently distributed across individual establishments. All variables are
measured in logarithm units.
Following the standard denition of MNCs, we classify an establishment foreign if 10% or
more of a rms equity is foreign equity. Foreign equity is the share of equity held by foreigners at
the establishment level. The weighted-average wage of foreign establishments, w
f
jt
, is calculated
as
m
r=1
rt
w
rt
, where
rt
is a weight and m is the total number of foreign establishments in
industry j that a local establishment i belongs to. The weight,
rt
, is the fraction such that the
number of employees in an establishment, r, is divided by the total number of employees in
all foreign establishments in industry j. We make use of the redesigned Indonesian industrial
classication at the ISIC 3-digit level.
4
The vector, x
it
, is the set of observable characteristics that inuence wage levels. The vector
controls for the differences among establishments. Observable characteristics include material
costs per employee, the ratio of non-production workers, provincial unemployment rates, and plant
sizes (which are measured by the previous years output). We cannot control for some differences
in workers characteristics. The survey does not have information (e.g., workers age) or give
complete information for the analysis (e.g., workers educational levels are available from 1995
forward and gender is available from 1993 forward). Other possible unobservable characteristics
that may inuence wage levels are controlled by a time effect,
t
, and an establishment effect,
i
.
Standard economic theory explains how wages are determined in the market. Prot maximiza-
tion requires wages to be equal to marginal revenue product (or marginal revenue multiplied by
marginal product). In the competitive market, this is expressed as w = P MP
L
, where w is a
nominal wage, P is the price of nal goods, and MP
L
is the marginal product of labor. The terms
of capital intensity, k
it
, and WPI, wpi
jt
, incorporate the idea. The level of the marginal product
of labor is a function of capital (Aitken et al., 1996, p. 348; Blomstrm & Sjholm, 1999, p. 917;
Drifeld & Girma, 2003, p. 457; Smith, 1996, p. 501). WPI is used to proxy for the price of goods
in each industry. The simple textbook explanation for determining wages is a static approach.
In our model, we include a dynamic wage decision process. One may regard the previous years
wage as a reference in deciding this years wage. Thus, wage levels are further adjusted based on
previous years wages, w
d
it1
.
In reality, wages are also determined by non-market factors. One example is an externality
such that wages set by foreign establishments affects the wage paid by domestic employers. Our
analysis distinguishes two wage spillover effects. The rst is wage spillovers via technology
spillovers. Increased wages of local establishments could be explained by increased productivity.
The second is wage spillovers introducing equity and bargaining considerations.
We include a value added term to capture the former wage spillovers. As local establishments
absorb foreign establishments advanced technologies, the result of foreign direct investment is
increased productivity. Other development that is not related to FDI (e.g., locally incurred tech-
nology progress) also increases productivity. The value added term controls for wage spillovers
via any productivity increases.
5
This approach is consistent with the literature on technology
3
One may suggest separating time invariant elements into industry xed effects and establishment xed effects. Our
results are not sensitive to the treatment since our estimation method takes the rst difference.
4
Oil-related industries (ISIC 353 and 354) are not included in the sample. The data on foreign establishments in the
industries seem to suffer extensively from missing information and are inappropriate for the analysis.
5
Previous works implicitly assumes a kind of causality between value added and wages.
spillovers, where the literature examines possible technology spillovers by using a model to eval-
uate whether FDI increases local companies value added (Blomstrm & Sjholm, 1999; Caves,
1974; Globerman, 1979; Haddad & Harrison, 1993; Kokko, 1994).
We also consider wage spillover channels introducing a reference wage effect. Local establish-
ments may increase wages in order to match wages paid by foreign establishments. This could
be explained by equity and bargaining considerations. As in the literature on fair wage (in which
the wage set by a leading company or industry affects wage determination by other companies or
industries), foreign establishments wages could serve as a reference wage. Employees working
at local establishments may feel unfair if their wages are far below wages paid for comparable
work by foreign establishments. Wage increases also encourage employees to work harder. These
wage spillover effects are captured by the coefcient,
4
. If
4
>0, then employees in local estab-
lishments benet from the activities of foreign establishments. Local establishments wages are
set higher due to positive wage spillovers from foreign establishments.
We use the generalized method of moments (GMM) proposed by Arellano and Bond (1991)
to estimate the dynamic model using panel data. The GMM is a standard method for estimating a
model using panel data when the model contains a lagged dependent variable with an unobserved
effect. The GMM is relevant to estimate our empirical model, which includes a lagged dependent
variable, w
it1
, and an unobserved effect,
i
. The method uses the levels of endogenous variables
dated t 2 and before as instruments in a rst difference model. Estimation is conducted by using
the DPD98 program for Gauss (see Arellano and Bond (1998) for the programs details).
4. Results of the analysis
Table 2 summarizes the results. Columns (1), (2), (5) and (6) showthe results using observations
dated t 2 and t 3 as instruments. Columns (3), (4), (7) and (8) are the results using observations
dated t 2 and all past observations as instruments. The left half of the table summarizes estimates
of the nationwide sample. The right half of the table presents estimates of a sub-sample (i.e.,
establishments in Java and Sumatra islands).
6
The results showthat the foreign establishments have positive externalities on the wage level of
local establishments even after controlling for value added. We observe wage spillovers resulting
from a reference wage effect. The wage level of local establishments increases by 45% for 1%
increase in the wages paid by the foreign establishment. The foreign establishments impose an
externality, a non-market-based wage determination, on the wages paid by local establishments.
The results imply that local establishments try to reduce wage gaps between foreign and local
establishments.
Employees in Indonesian local establishments enjoy higher wages because of FDI through
a spillover channel resulting from a reference wage effect. The effect operates through equity
concerns and bargaining. Employees working at local establishments may become disgruntled
if their wages are far below wages paid by foreign establishments. Local establishments may
need to alleviate wage gaps between local and foreign establishments in order to keep workers
and/or motivate workers efforts. Similarly, workers bargain with their employers using outside
work opportunities as the threat point. The presence of multinational companies offering a higher
6
Table 2 reports the m
2
statistic to examine the relevance of the ArellanoBond estimation method. The consistency
of the GMM estimators requires the assumption of no serial correlation in
it
. The m
2
statistic tests for lack of second-
order serial correlation in the rst-difference residuals. The m
2
statistic in Table 2 shows that the assumption of serially
uncorrelated errors seems to be appropriate. The test for rst-order serial correlation also shows a negative relationship.
Table 2
Analysis of wage spillovers.
Nationwide Java-Sumatra
Variables (1) (2) (3) (4) (5) (6) (7) (8)
Domestic wage (1)
0.441 0.427 0.449 0.434 0.451 0.437 0.461 0.444
0.018 0.019 0.017 0.018 0.017 0.02 0.018 0.019
Capital
0.03 0.024 0.03 0.023 0.03 0.023 0.029 0.022
0.005 0.005 0.005 0.005 0.005 0.005 0.005 0.005
Value added
0.081 0.1 0.081 0.101 0.081 0.101 0.081 0.103
0.005 0.005 0.005 0.005 0.006 0.005 0.006 0.005
MNC wage
0.051 0.048 0.045 0.042 0.052 0.05 0.048 0.046
0.014 0.014 0.013 0.013 0.014 0.014 0.014 0.014
WPI (ISIC 3-digit)
0.163 0.204 0.16 0.202 0.149 0.19 0.134 0.181
0.045 0.045 0.045 0.044 0.046 0.046 0.046 0.045
The ratio of non-production workers
0.067 0.069 0.067 0.069 0.068 0.069 0.069 0.068
0.009 0.009 0.009 0.009 0.009 0.01 0.009 0.009
Unemployment rates (Province)
0.007 0.006 0.008 0.007 0.007 0.006 0.008 0.007
0.002 0.002 0.002 0.002 0.002 0.002 0.002 0.002
Material
0.059 0.062 0.056 0.064
0.013 0.012 0.014 0.013
Plant size
0.055 0.054 0.057 0.05
0.014 0.014 0.015 0.015
Time dummies Yes Yes Yes Yes Yes Yes Yes Yes
Constant
0.065 0.06 0.064 0.059 0.064 0.058 0.062 0.058
0.007 0.006 0.007 0.006 0.007 0.006 0.007 0.006
m
2
test statistics 1.941 1.737 2.047 1.826 0.937 0.801 1.028 0.876
Sargan test 116.03 100.59 136.19 123.6 111.2 91.86 138.1 120.5
Sargan test-degree of freedom 31 21 46 36 31 21 46 36
Top values are coefcient estimates and bottom values are standard errors. All point estimates are statistically signicant
at 5% level (we use standard errors and test statistics corrected for heteroskedasticity). The numbers of observations are
27,066 for (1)(4) and 24,710 for (5)(8). Columns (1), (2), (5) and (6) are estimated in rst differences using observation
dated t 2 and t 3 as instruments and columns (3), (4), (7) and (8) are estimated using observation dated t 2 and all
past observations as instruments.
wage could raise the equilibrium wage in domestic companies. These factors also increase local
establishments wages.
The analysis examines the effects of wage spillovers within industry, when workers are freely
movable across the country. Since Indonesia consists of many islands, labor mobility may be
restricted. We introduce restricted labor mobility into the analysis. Further analysis assumes
that workers are movable between two large neighborhoods; Java and Sumatra islands only. We
examine the key industry hypothesis using the Java and Sumatra islands as a sub-sample. The
right half of the table presents the results from the sub-sample. The results, both direction and
magnitude, are similar to the ones obtained in the nationwide analysis. The results are robust,
even when using different samples.
We conclude that promoting foreign establishments benets employees of local establishments.
They received wages above the market-based wage that would prevail in the absence of foreign
establishments. While there are concerns that growing multinational business might have negative
impacts on local workers, our analysis suggests that the fear might be unwarranted.
Other variables indicate expected coefcient signs that are in agreement with economic theory.
Wages increase as capital or the ratio of non-production employees increases. Non-production
workers (i.e., managers) receive a higher wage. A higher wage level is the result of a higher
level of marginal product of labor, from w = P MP
L
. The marginal product of labor increases
with capital, and is larger for non-production workers. The results also show that wages are
positively correlated with unemployment rates. Intuitively, when the economy is suffering from
a recession, employees with lower marginal products are the rst ones who will lose their jobs.
Those with a higher marginal product of labor retain their jobs. Another possible interpretation
is that the term operates as an urban dummy. Larger cities often offer higher wages and, thus,
attract many workers. As the HarrisTodaro model states, higher expected wages may end up
with higher unemployment rates. The estimate captures an idiosyncratic cross-regional effect,
i.e., time variant regional shocks. All estimates in the table are statistically signicant at the 5%
level.
4.1. The level of wage gaps
We classify the sample into two sub-samples and examine whether a different policy impli-
cation is derived depending on industrial characteristics. The rst is industries with large wage
gaps between local and foreign establishments. The second is industries with small wage gaps
between local and foreign establishments. The analysis examines whether there are any differences
regarding wage spillovers between the two groups. This study is analogous to previous works on
technology spillovers. The literature examines whether the spillover effects are different between
industries with large technology gaps and small technology gaps. The results are controversial.
Some works show that only industries with small technology gaps benet. Small-gap industries
already possess the basic technology necessary for adoption of the more advanced technology.
Primitive industries are unable to utilize advanced technology. Production processes used by
primitive domestic companies may differ inherently from the ones by multinational companies.
Other works show that technology spillovers are effective only when there are large technology
gaps. When there are large technology gaps, the possibilities for learning are much greater.
We stratify the sample using the following procedure. We begin to calculate an industry-wide
wage gap between local and foreign establishments each year. Then, we calculate the average
industry-wide wage gap during the sample period.
7
We order these industry-wide average wage
gaps from the smallest to the largest at the ISICs last two-digit level and split industries into two
groups. The large wage-gap group includes 14 industries such as chemicals, iron and steel, and
electronics. The small wage-gap group includes 15 industries such as food, textiles, and paper.
The classication is stable during the sample period. The industry ordering based on average
wage gaps during the sample period is consistent with the ordering based on average wage gaps
from 1989 to 1991.
Table 3 shows the results for this part of our analysis. Columns labeled large represent large
wage gap industries and columns labeled small represent small wage gap industries. Columns
(1)(4) show the results using observations dated t 2 and t 3 as instruments. Columns (5)(8)
present the results using observations dated t 2 and all past observations as instruments. The
table summarizes estimates of the nationwide sample.
The results differ from those in the previous section regarding wage spillovers. A reference
wage plays an important role in determining wages of domestic companies in large-gap industries,
7
An industry-wide wage gap is calculated as ( w
f
jt
w
d
jt
)/ w
d
jt
, where w
f
jt
is an average foreign wage in industry j for
year t and w
d
jt
is an average local wage in industry j for year t.
Table 3
Large wage gap vs. small wage gap industries.
(1) (2) (3) (4) (5) (6) (7) (8)
Variables Large Small Large Small Large Small Large Small
Domestic wage (1) 0.416
*
0.450
*
0.415
*
0.422
*
0.422
*
0.442
*
0.425
*
0.413
*
0.026 0.023 0.027 0.024 0.025 0.022 0.026 0.024
Capital 0.031
*
0.026
*
0.026
*
0.018
*
0.029
*
0.026
*
0.025
*
0.017
*
0.007 0.006 0.008 0.006 0.007 0.006 0.007 0.006
Value added 0.078
*
0.082
*
0.097
*
0.102
*
0.079
*
0.082
*
0.099
*
0.102
*
0.008 0.008 0.008 0.007 0.008 0.007 0.008 0.007
MNC wage 0.046
*
0.044
***
0.047
*
0.034 0.036
**
0.037 0.037
**
0.029
0.016 0.025 0.016 0.025 0.015 0.025 0.015 0.025
WPI (ISIC 3-digit) 0.260
*
0.038 0.287
*
0.090 0.272
*
0.028 0.299
*
0.074
0.065 0.071 0.067 0.068 0.065 0.070 0.066 0.067
The ratio of non-production workers 0.079
*
0.041
*
0.080
*
0.047
*
0.081
*
0.039
*
0.082
*
0.043
*
0.012 0.012 0.013 0.013 0.012 0.012 0.012 0.012
Unemployment rates (Province) 0.004 0.009
*
0.004 0.007
**
0.005 0.010
*
0.005 0.009
*
0.003 0.003 0.003 0.003 0.003 0.003 0.003 0.003
Material 0.061
*
0.049
*
0.064
*
0.046
*
0.017 0.018 0.016 0.017
Plant size 0.043
**
0.070
*
0.041
**
0.071
*
0.018 0.020 0.018 0.020
Time dummies Yes Yes Yes Yes Yes Yes Yes Yes
Constant 0.065
*
0.070
*
0.064
*
0.062
*
0.065
*
0.072
*
0.064
*
0.062
*
0.008 0.010 0.008 0.010 0.009 0.010 0.008 0.009
m
2
test statistics 1.65
***
0.65 1.37 0.81 1.71
***
0.61 1.44 0.74
Sargan test 101.71
*
52.9
*
87.63
*
40.97
*
122.14
*
68.9
**
104.26
*
58.31
*
Sargan test-degree of freedom 31 31 21 21 46 46 36 36
Top values are coefcient estimates and bottom values are standard errors (we use standard errors and test statistics
corrected for heteroskedasticity). The number of observations are 14,631 for large and 12,435 for small. We use DPD98
described in Arellano and Bond (1998) for estimation. Lagged dependent variable was instrumented by its level dated
t 2 and t 3 in columns (1)(4) and by t 2 and all available past observations in columns (5)(8). Capital, the ratio of
non-production workers, material, and plant size were instrumented by corresponding levels dated t 1.
*
Statistically signicant at 1% level.
**
***
but not in small-gap industries. The row MNC wage shows that the wage level paid by local
establishments in large-gap industries increases by approximately 5%if foreign establishments in
large-gapindustries increase their wages by1%. We donot see statisticallysignicant relationships
regarding wage interaction between local and foreign establishments in small-gap industries. We
can conclude that employees working for local establishments in large-gap industries beneted
fromthe countries hosting foreign establishments. Large-gap industry employees received higher
wages due to a reference wage effect. Estimates using the sub-sample of Java and Sumatra islands
(not shown in the table) show similar results.
Two alternative scenarios arise in our wage spillover analysis. First, one may expect larger
wage spillovers when larger wage gaps between local and foreign establishments exist. Observing
large wage gaps, employees in local establishments may feel that they are unduly underpaid and
negotiate harder for their wages. The second possible scenario is that employers may not have
the sense of equity concern if the two establishments differ intrinsically. Employers in local
establishments may tolerate receiving a lower wage. Our analysis reveals that the rst scenario is
relevant in the Indonesian case.
5. Conclusions
People react to globalization differently: some support it and others oppose it. Various argu-
ments are possible depending on our concerns. Specically regarding the effects of globalization
on the labor market, this paper presents an examination of whether foreign direct investment ben-
ets workers employed by local companies via increased wages. The analysis utilizes empirical
models used in the literature on the key-industry hypothesis. Assuming foreign establishments
are wage-decision leaders, we study whether wages set by foreign establishments have exter-
nalities on wage determination by local establishments. The analysis shows that the activities of
foreign establishments benet employees in local establishments by increasing wages for local
establishments employees. The effects operate through a reference wage concerns. The litera-
ture frequently highlights job creation as a benet of FDI. The results of the current analysis
add positive wage effect to the list of FDIs possible benets. Our analysis also indicates that a
reference wage plays an important role in local establishments determination of wage levels in
large wage-gap industries, but not in small wage-gap industries.
Our model can be applied to explore other interesting questions. First, our model does not
deny spatial interaction among local establishments. For example, Drifeld and Girma (2003)
consider spatial interactions of wages in the UK electronics industry. Using wages of local and
multinational companies as independent variables, their empirical model examines the degree to
which these wages affect local companies wage decisions in an industry. Our analysis studies the
case where foreign establishments are a leader regarding wage decisions. Local establishments
wages are a function of foreign establishments wages. One may want to interpret our model
as a reduced form, where local establishments wages are solved as a function of foreign
establishments wages. While our analysis is motivated by a different policy concern from the
wage spillover literature in a spatial economy, our model specication does not deny possible
wage interactions among local establishments.
Second, one has to careful interpreting the results if the degree of wage spillover effects
differs across skilled and unskilled workers. The survey data do not provide skilled and unskilled
workers wages separately. The analysis tries to adjust wage differences related to skilled or
unskilled workers by including the non-production share as an explanatory variable. The results
do not change if the degree of wage spillovers is the same between skilled and unskilled workers.
Otherwise, the results provide a kind of weighted average of both types of workers.
Last, wage spillovers could be decomposed into vertical (backward and forward) and hori-
zontal externalities. Foreign establishments may affect wage decisions of local establishments
that provide intermediate goods to the foreign establishments (i.e., backward effects). Foreign
establishments may also affect wage decisions of local establishments to which the foreign
establishments sell their goods (i.e., forward effects). The analysis focuses on horizontal wage
spillovers, where foreign establishments affect wage decisions of local establishments within the
same industry. Such analysis requires additional information, including an inputoutput table to
relate different industries. All of these topics are future lines of research.
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