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Do foreign investors care about labor market regulations?

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  • Smarzynska, Beata
  • Spartareanu, Mariana

Abstract

The authors take a new look at the regulatory determinants of foreign direct investment (FDI) by asking whether labor market flexibility affects FDI flows across 25 Western and Eastern European countries. Their analysis is based on firm level data on new investments during the 1999-2001 period. The authors employ a variety of labor market flexibility measures that capture different aspects of labor laws along with a comprehensive set of controls for business climate characteristics. Indices of labor market regulations reflect the flexibility of individual and collective dismissals, the length of the notice period, and the required severance payment. The results suggest that greater flexibility in the host country's labor market relative to that in the investor's home country is associated with larger FDI inflows, and this effect is found to be stronger in the case of transition economies. The findings indicate that as the labor market flexibility in the host country increases from inflexible (for example, Slovakia) to flexible (for example, Hungary), the volume of investment increases by between 14 and 18 percent. FDI in service sectors appears to be more affected than investments in manufacturing.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 3275.

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Date of creation: 01 Apr 2004
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Handle: RePEc:wbk:wbrwps:3275

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Keywords: Environmental Economics&Policies; Banks&Banking Reform; Municipal Financial Management; Labor Policies; Labor Markets; Environmental Economics&Policies; Banks&Banking Reform; Trade and Regional Integration; Health Economics&Finance; National Governance;

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  1. Michael Devereux & Rachel Griffith, 1996. "Taxes and the location of production: evidence from a panel of US multinationals," IFS Working Papers W96/14, Institute for Fiscal Studies.
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