Optimal Labor Market Institutions and inward FDI

This paper proposes labour market institutional arrangements as a strategic device to optimally induce exports substituting inward FDI. In this setting, the emergence of inward FDI is considered to be optimal insofar as it does not ensue negative effects on domestic employment relative to exports accommodation. In a union-oligopoly context we show that, if the FDI-associated unit costs (FC) are sufficiently low, inward FDI would optimally emerge, irrespectively to the structure of wage bargaining and the level of the unemployment benefit in the host country. However, for intermediate values of the FC, inward FDI may optimally emerge only if the wage bargaining structure is centralized, a non-compliance tax on union rents is in effect, and the unemployment benefit is sufficiently low. Yet, whatever is the wage bargaining structure, so long as the FC are high enough inward FDI may emerge with a negative effect on domestic employment. The unemployment benefit should be then set high enough to deter FDI, and instead accommodate exports, in equilibrium.