Low labor costs’ small role in attracting foreign investment

Schiesser Pallas’s recent closure of its Greek plant prompted a heated debate on the threat of the emigration of enterprises. The most popular explanation given focused on the issue of labor costs and their significance in attracting foreign direct investment (FDI) to less developed countries. In the clothing sector, the importance of low labor costs is indeed great. But as regards FDI as a whole, the factors that are the most attractive in a country need to be examined on the basis of serious econometric methodology. According to the Economist Intelligence Unit, Greece attracted only $1.2 billion in FDI in the 1998-2002 period. In the EU, the list of most attractive countries for FDI in the same period are Belgium ($75 billion), the UK ($74 billion), Germany ($71 billion) and the Netherlands ($43 billion). Surely, none of these countries has lower labor costs than Greece; evidently, despite its importance in some sectors, labor cost on the whole cannot alone determine FDI. A second observation is that a comprehensive answer as to which factors are conducive to FDI requires a consideration of theoretical and empirical studies. According to several such studies, the most important factors are the size of the local market – including its export potential, the existence of a trained and specialized work force and its cost, taxation levels, political stability and other institutional factors, and, finally, the geographical and cultural proximity of the source country to the receptor country. The third consideration is whether there are empirical studies about Greece. Because of the case which prompted the recent debate, it seems appropriate to look into the factors that attract investment away from Greece. In the economic policy laboratory of the Athens University of Economics and Business, we carried out a study using Bank of Greece data for the sum total of Greek FDI in 19 European countries and the USA for the 1998-2002 period. The econometric results were extremely interesting; labor costs did have a negative impact but this was statistically insignificant. By contrast, as expected, the size of the local market and its export potential, the level of training and specialization of the work force, low taxation and geographical and cultural proximity were shown to play a very important and positive role. We can therefore claim, with all the reservations that must always accompany econometric studies – but surely with fewer reservations than for claims often made in the press – that labor costs do not seem to have a decisive influence on FDI in Greece. On the contrary, Greek FDI is influenced by factors such as the receptor country’s ability to channel production to the local market or to exports, the level of training and specialization of the work force, taxation and proximity – in the sense of the better knowledge of the local market and the institutional environment. In this context, it is not difficult to understand why other, more developed European countries attract multiple levels of FDI compared to those of Greece; high taxation, combined with inadequate infrastructure and poorly trained workers will continue to drive investment to other countries. If the government adopted measures in the direction of correcting such shortcomings, it would probably offer workers a much better service than the Labor Ministry’s approach to Schiesser Pallas when it asked the firm to consider whether a reduction in wages would help to keep the plant working. (1) E. Louri-Dendrinou is a professor at the Athens University of Economics and Business.

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