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1 research paper seres Globalsaton and Labour Markets Research Paper 006/49 Multnatonal Companes, Backward Lnkages and Labour Demand Elastctes by Holger Görg, Mchael Henry, Erc Strobl and Frank Walsh The Centre acknowledges nancal support rom The Leverhulme Trust under Programme Grant F4/BF

2 The Authors Holger Görg s a Reader n Internatonal Economcs n the School o Economcs at the Unversty o Nottngham and an Internal Research Fellow n GEP. Mchael Henry s a Research Fellow at Aston Busness School, Aston Unversty. Erc Strobl s Assocate Proessor at École Polytechnque Pars. Frank Walsh s Lecturer at Unversty College Dubln. Acknowledgements An earler verson o the paper was presented at workshops n Stockholm, Nottngham and Dundee. The authors are grateul to Andrew Bernard, Danel Bernhoen, Patrk Gustavsson Tngvall, Lars Lundberg, Hassan Molana, Cata Montagna or helpul comments. Holger Görg grateully acknowledges nancal support rom the Leverhulme Trust (Programme Grant No. F4/BF) and Mchael Henry rom the ESRC (Grant No. RES ).

3 Multnatonal Companes, Backward Lnkages and Labour Demand Elastctes by Holger Görg, Mchael Henry, Erc Strobl and Frank Walsh Abstract Ths paper nvestgates the lnk between natonalty o ownershp and wage elastctes o labour demand at the level o the plant. In partcular, we eamne whether labour demand n multnatonals becomes less elastc wth respect to the wage the plant has backward lnkages wth the local economy. Our emprcal evdence, based on a rch plant level dataset, shows that the etent o local lnkages ndeed generally reduces the wage elastcty o labour demand. Ths result s economcally mportant and holds or a number o derent speccatons. JEL classcaton: F3, J3, L3 Keywords: labour demand, elastctes, lnkages, multnatonal companes Outlne. Introducton. Theoretcal background 3. Descrpton o the data 4. Estmatng labour demand elastctes 5. Conclusons

4 Non-Techncal Summary It has been well establshed n the emprcal lterature that workers n ndustralsed countres have eperenced hgher job nsecurty over the last ew decades, both n terms o hgher volatlty o employment spells and earnngs. Globalsaton has been made at least partly responsble or these trends, certanly n the popular debate as well as among academcs. It s not surprsng then, that the potental ootloose nature o FDI n response to changes n producton costs elsewhere has rased some concern about the jobs created through FDI, despte the generally hgher wages assocated wth such employment. As a matter o act, these ears have recently come to the ore n the wake o a number o plant closures by hgh prole multnatonals n Europe, oten attrbuted to lower wages elsewhere. It s mportant to note, however, that the potental ootloose nature o FDI n terms o plan closures s only one possble response to changes n producton costs. Alternatvely, multnatonals may, rather than completely shuttng down producton, smply downsze ther operatons and shed labour n the lght o the avalablty o cheaper labour elsewhere. Thus, one s to capture the complete pcture o lower job stablty n multnatonals then one arguably also needs to nvestgate derences n the wage elastcty o multnatonals relatve to the ndgenous ndustry. Ths paper eamnes the lnk between natonalty o ownershp and the wage elastcty o labour demand, and speccally nvestgates whether eorts at ntegratng multnatonals n the local economy through backward lnkages can reduce ther volatle nature by aectng ther elastcty o labour demand. Our argument that ths s lkely to be the case rests on the dea that locally purchased nputs may be more dcult to substtute or labour than other nputs. Ths may be plausble under the assumpton that locally sourced nputs are to some degree "specc" due to, e.g., better qualty and avalablty, or lower transport costs than mported nputs. We present a smple ramework that hghlghts how such channels are lkely to aect labour demand. Usng a rch plant level data set or manuacturng plants n the Republc o Ireland we then emprcally nvestgate whether wage elastctes depend on the etent o local backward lnkages and whether ths s more mportant or oregn multnatonals than or ndgenous rms. Arguably, Ireland s a partcularly nterestng case study gven that ts manuacturng ndustry s heavly dependent on oregn multnatonals. Moreover, Ireland has operated a number o eplct polcy programmes to oster lnkages between oregn multnatonals and domestc supplers. Our evdence shows that the etent o local lnkages ndeed reduces the wage elastcty o labour demand or oregn owned plants. In robustness checks we nd that the results hold when allowng or plant heterogenety n terms o sze and when takng account o et. Whle our labour demand estmatons show that ncreasng the level o lnkages may lead to economcally sgncant reductons n oregn plants wage elastctes, t s also clear that even a multnatonal sourced all o ts nputs n Ireland t would stll have a substantally hgher elastcty than a comparable domestc plant. Hence, whle lnkages are mportant n eplanng derences n elastctes they are not sucent to eplan away the act that oregn plants have hgher wage elastctes than domestc plants.

5 Introducton It has been well establshed n the emprcal lterature that workers n ndustralsed countres have eperenced hgher job nsecurty over the last ew decades, both n terms o hgher volatlty o employment spells and earnngs (e.g., OECD 997). Globalsaton has been made at least partly responsble or these trends, certanly n the popular debate as well as among academcs (e.g, Rodrk, 997; Scheve and Slaughter, 004). O all the drvers o globalsaton - trade, mgraton o workers, and oregn drect nvestment (FDI) - FDI s probably the most vsble. It s also lkely to be, at the margn, the most mportant aspect o globalsaton n economc terms. For nstance, over the last two decades global FDI lows have grown at least twce as ast as trade, now well eceedng $500 bllon and resultng n a total stock o more than $8 bllon (Unted Natons, 004). It s not surprsng then, that the potental ootloose nature o FDI n response to changes n producton costs elsewhere has rased some concern about the jobs created through FDI, despte the generally hgher wages assocated wth such employment (e.g., Lpsey and Sjöholm, 004; Grma and Görg, 007). As a matter o act, these ears have recently come to the ore n the wake o a number o plant closures by hgh prole multnatonals n Europe, oten attrbuted to lower wages elsewhere. For eample, the Japanese multnatonal Sony announced the closure o one o ts plants n Wales n June 005, wth the resultng loss o 650 jobs due to the avalablty o lower producton costs elsewhere. It s mportant to note, however, that the potental ootloose nature o FDI s only one possble response to changes n producton costs. Alternatvely, multnatonals may, rather than completely shuttng down producton, smply downsze ther operatons and shed labour n the lght o the avalablty o cheaper labour elsewhere. Thus, one s to capture the complete pcture o lower job stablty n multnatonals then one arguably also needs to nvestgate derences n the wage elastcty o multnatonals relatve to the ndgenous ndustry. In ths regard, there are only a ew studes whch compare the wage elastcty o labour demand n multnatonals and domestc rms. Fabbr et al. (003) dscuss the ssue and llustrate the theory wth a standard neo-classcal labour demand ramework. Ther dea s qute straghtorward: multnatonals are part o global producton networks and, Bernard and Sjöholm (003) and Görg and Strobl (003) nd that multnatonals have hgher et probabltes than comparable domestc plants, a ndng n lne wth ths argument.

6 wthn these networks, can more easly transer producton n response to changes n costs (n partcular wages). Usng ndustry level data they nd an ncrease n wage elastctes o labour demand (condtonal on output) over tme or low sklled US and UK manuacturng workers and argue that ncreased actvty o multnatonals may be partally responsble or ths. By contrast Barba-Navarett et al (003) n a cross country rm level study o a group o European countres nd that, n most countres, multnatonals adjust ther labour demand more rapdly than domestc rms n response to shocks, but have a more nelastc demand curve wth respect to wages. They argue that multnatonals have a more rgd demand or labour due to derences n skll structure. 3 The current paper re-eamnes the lnk between natonalty o ownershp and the wage elastcty o labour demand, but speccally nvestgates whether eorts at ntegratng multnatonals n the local economy through backward lnkages can reduce ther volatle nature by aectng ther elastcty o labour demand. 4,5 Our argument that ths s lkely to be the case rests on the dea that locally purchased nputs may be more dcult to substtute or labour than other nputs. Ths may be plausble under the assumpton that locally sourced nputs are to some degree "specc" due to, e.g., better qualty and avalablty, or lower transport costs than mported nputs. To dscuss these ponts n more detal we present a smple ramework that hghlghts how such channels are lkely to aect labour demand. Usng a rch plant level data set or manuacturng plants n the Republc o Ireland we then emprcally nvestgate whether wage elastctes depend on the etent o local backward lnkages and whether ths s more mportant or oregn multnatonals than or ndgenous rms. Arguably, Ireland s a partcularly nterestng case study n ths regard gven that ts manuacturng ndustry s heavly dependent on oregn multnatonals, and also the act that oregn plants account or about hal o total employment. Moreover, Ireland has operated a number o eplct polcy programmes to oster lnkages between oregn multnatonals and domestc supplers (Ruane, 00). 3 The paper by Konngs and Murphy (00) s also somewhat related. They look at the etent to whch multnatonals substtute employment towards parent plants n response to wage changes. They nd evdence o substtuton between EU parent rms and ther subsdares rather than towards low wage subsdares outsde the EU. In addton, Slaughter (00) looks at labour demand elastctes n the US to see whether ncreased openness to trade has ncreased the demand elastcty and ound lttle support or ths hypothess. 4 We do not consder plant et n ths paper. 5 Our paper s, hence, also related to the recent lterature on productvty spllovers rom FDI, whch argues that spllovers are most lkely to occur through multnatonals backward lnkages wth domestc supplers (e.g., Dreld et al., 00, Javorck, 004).

7 The remander o the paper s structured as ollows. Secton provdes the theoretcal background or our analyss. Secton 3 descrbes the data sources. Secton 4 outlnes the emprcal approach and dscussed our results. Secton 5 concludes. Theoretcal background We consder a oregn owned plant as a subsdary o a multnatonal rm that has already decded to locate the plant, thereby ncurrng ed costs, and also has an upward slopng margnal cost curve. Because the rm has several plants n derent locatons we assume the plant s a prce taker and the multnatonal rm wll mnmse costs by equalsng margnal costs across all plants. The head oce may have market power but wll treat each plant as a prot mamsng rm where the output prce equals the margnal cost across all plants. Thus the subsdary wll look lke a tetbook compettve rm where the plant manager has to mamse prots choosng output at a prce ed by head oce, where the prce equals the margnal cost o plants n other locatons. Ths means that or a oregn alate located n a host country we assume the mpact o an ncrease n wages on the output prce, whch s a uncton o the rm s global producton costs, to be neglgble. The plant s hence assumed to have a ed prce, a u-shaped average cost curve due to ed costs and ncreasng margnal costs. 6 In order to llustrate our argument as to why backward lnkages wth domestc supplers may mpact on labour demand elastctes we summarse the well known neoclasscal condtonal labour demand model. 7 A prce takng alate has a producton uncton wth n nputs: y,... ) () ( n The prce o each actor s w and total costs are Lagrangan uncton or cost mnmsaton s: c F + w... + l w + w + w + λ[ y (.. )] ().. n n n + w w n n. The The share o any actor j n varable costs s s j. The elastcty o substtuton between labour (actor ) and any other actor j s σ j. We show n the append that the labour demand elastcty condtonal on output s: 6 The plant may make prots n contrast to a compettve rm snce we do not epect ree entry to dsspate prots. 7 See also Fabbr et al. al (003) who use ths ramework to motvate derences n labour demand elastctes between oregn and domestc owned rms, or Hammermesh (993) or a more general dscusson. 3

8 n σ j j j n * w j n σ j w j η s (3) j Other thngs equal, equaton (3) tells us that the labour demand elastcty s determned by two aspects, namely, the elastcty o substtuton between labour and the other actor j, and the share o actor j. 8 There are a number o ssues wth regard to (3) that are mportant to pont out or our task at hand. Frst, wth regard to labour s share n total cost, snce theoretcal rameworks outlnng multnatonal rms suggest that such rms wll have ed costs (e.g. Markusen, 00), one should be wary about lookng at labour s share n output as a proy or s, as t s labour s share n varable costs that s relevant to the demand elastcty. For eample, alates whose parent has ncurred sgncant advertsng or R&D costs may have very hgh output per worker, so that labour costs may be a small share o output but a much larger share o varable costs. Equaton (3) also suggests that, locally purchased nputs are more dcult to substtute or labour than other nputs (low σ) rms that purchase more local nputs wll have smaller elastctes. Ths may be plausble under the assumpton that locally sourced nputs are to some degree "specc" due to, e.g., better qualty and avalablty, or lower transport costs than mported nputs. As an eample, a multnatonal rm swtchng sourcng rom a suppler abroad to a local s then n a better poston to obtan specc desgn or qualty standards, perhaps wth the help o provdng assstance to the local suppler n the rst nstance. 9 Thereore, t may be less lkely to substtute the locally sourced nput or labour than the prevously mported nput. 0 8 Whle equaton (3) s well known we derve t eplctly n the Append to pont out two mportant ponts that wll be relevant to our analyss. Frst whle much o the lterature usng equaton (3) assumes constant returns to scale, ths s not necessary. Secondly, s l s labour s share o varable costs, not total costs. A rm may ncur non-recoverable ed costs, e.g., rom advertsng or R&D, or other start-up costs to enhance output per worker but these wll not aect the calculaton n equaton (3). 9 Moran (00) provdes plenty o case studes between oregn subsdares and domestc supplers and provdes evdence o such assstance. 0 An addtonal possble eplanaton s that rms that locate close to an nput source do so partly because local nputs are more dcult to substtute or, and that these may oten be nputs such as agrcultural commodtes n ood and drnk producton etc. Thnk o a oregn owned producer o a ood or drnk product who would nd t dcult to substtute away rom labour wth a sotware rm who has sklled labour to some degree at a ed output level. (Kennedy, 99) provdes evdence that backward lnkages n the ormer ndustry are much hgher than n most other manuacturng ndustres, ncludng the computer ndustry.) However, n the econometrc analyss below we ocus on wthn rm changes, rather than derences across sectors, hence ths eplanaton s less relevant to our analyss. 4

9 One o Marshalls well known rules o labour demand s that t wll be less elastc the more elastc s the supply o other nputs. The ntuton s that the supply o another nput (say captal) s steep, a rse n wages wll ncrease the demand or captal as rms substtute rom labour nto captal, but ths wll drve up the prce o captal lmtng the degree to whch rms wll substtute. For the two actor case, Append shows how an ncrease n the prce o the other actor reduces the condtonal demand elastcty, summarsed n equaton (4) * η σs η w w ) (4) ( * The two actor analogue o (3) s η σs and η s the percentage change n w w the prce o actor (w ) assocated wth a percentage change n w. A rse n wages (prce o actor ) wll nduce rms to substtute rom labour nto other nputs. To the etent that these are purchased n the domestc economy rms wll ncrease the demand or such nputs and drve up the prce, hence lmtng the etent o substtuton away rom labour. Frms who substtute rom labour nto nputs sourced abroad would not epect the same to be true a small country has lttle mpact on the world prce o that actor. Hence, ther labour demand should be more elastc wth respect to the wage rate than that o rms usng local nputs. Fabbr et. al (003) argue that multnatonals may have more elastc demand than domestc rms because rms wth global producton networks may be able to more easly mport ntermedate goods that could alternatvely be produced by domestc labour. They argue that ths s especally lkely a rm s vertcally ntegrated nternatonally and derent plants engage n ntra-rm trade. To see how ths argument ts nto our ramework we assume that the multnatonal subsdary produces two outputs y and y where y s an ntermedate nput whch can be produced n the subsdary or mported at a ed margnal cost rom another branch o the company and y s output o the nal good. We assume the rm has two separate producton unctons or the two goods wthn the plant or smplcty where a s the racton o the workorce producng the nal good and a the racton producng the ntermedate good. I we estmate the demand elastcty or the plant holdng nal output ed ths does not condton on output o the ntermedate nput. The overall elastcty estmate condtonal on nal output wll be: η a η + (5) * ll * ll ( a ) ηll See Hcks (968) Append to chapter XI or a ormal dervaton n the constant returns to scale case, and Hamermesh (993) or a more general dscusson. 5

10 * where s the condtonal demand elastcty or employment o the nal good and s η ll the uncondtonal demand or the ntermedate good whch or a gven elastcty o substtuton may be substantally larger than the condtonal elastcty. We mght speculate that ther conjecture that rms can easly transer some stages o producton to another subsdary or a gven nal output would be less relevant or rms that purchase a large share o prmary nputs locally. η ll 3 Descrpton o the data The precedng dscusson llustrates that there are plausble reasons why one mght epect the source o nputs to matter or oregn rms labour demand elastctes. We now turn to eamnng ths ssue emprcally. The data or our analyss are taken rom the Irsh Economy Ependture Survey (IEE), undertaken annually by Foras, the government agency wth responsblty or enterprse development, scence and technology. Ths s an annual survey o plants n Irsh manuacturng wth at least 0 employees, although a plant, once t s ncluded, s generally stll surveyed even ts employment level alls below the 0 employee cut-o pont. The survey provdes plant level normaton on, nter ala, output, employment, natonalty o ownershp, as well as detals on plants' ependture on labour and other nputs. 3 The response rate to ths survey s generally estmated to be between 60 and 80 per cent o the targeted plant populaton. The data cover the perod and provde an unbalanced panel or,675 plants. A look at the data shows that total ets over ths perod n our data only account or 3.3 percent o total plants. Natonalty o ownershp s covered as a dchotomous varable ndcatng whether a plant s oregn or domestc owned. In ths contet one should note that Forás denes oregn plants as plants that are majorty-owned by oregn shareholders,.e., where there s at least 50 per cent oregn ownershp. Whle, arguably, plants wth lower oregn ownershp should stll possbly consdered to be oregn owned, ths s not necessarly a problem or the case o Ireland snce almost all nward oregn drect nvestment has been Append A3 derves the uncondtonal elastcty or the two actor case and a producton uncton that s s homogeneous o degree r. The uncondtonal elastcty s η [ σ s + ] whle the two ( r ) r * actor analogue o the condtonal elastcty s η σs. Whle s represents the share o varable costs n one case and output n the other clearly the uncondtonal elastcty may be much larger. 3 Note that the dataset does not allow us to dstngush skll groups or workers, thus we treat labour as homogeneous. 6

11 greeneld nvestment rather than acquston o local rms (see Barry and Bradley, 997). By way o summary statstcs, Fgure shows the development o total employment n oregn and domestc plants n Irsh manuacturng over the sample perod. One should note that employment n oregn-owned plants has ncreased more rapdly than domestc employment, wth a growth rom around 58,000 to almost 00,000 employees n 998. [Fgure here] The IEE survey also ncludes normaton on plants ependture on ntermedate nputs and breaks ths down nto domestcally sourced and mported ntermedates and we use ths normaton to calculate our measure o local sourcng. More precsely, we calculate a lnkage ndcator as the percentage o nputs sourced locally (see, e.g., Görg and Ruane, 000; Kennedy, 99; Cohen, 973). Table shows the development o total backward lnkages n 983 and 998 respectvely by NACE dgt ndustry. [Table here] One should note, rstly, that oregn-owned plants on average have lower lnkages than domestc plants, although there are some o eceptons (e.g., 9 - leather, n 998). Moreover, the table hghlghts sectoral derences wth the hghest lnkages occurrng or domestc plants n sectors 30 (computers & oce machnery) n 983 and 5 (ood & beverages) n 998, and or oregn plants n sectors 7 (basc metals) n 983 and 9 (leather) n 998. As epected, there are sgncant derences n lnkages between oregn and domestc plants, most noteworthy perhaps n sector 30 (oce machnery) n 983, although ths derence has all but dsappeared n 998. The table also shows that or multnatonals, backward lnkages have generally ncreased over the 983 to 998 perod. Ths may at least n part relect the emphass o the Natonal Lnkage Programme n Ireland on creatng lnkages between oregn multnatonals and local supplers (Ruane, 00). 4 Estmatng labour demand elastctes 4. Derences between oregn and domestc plants The rst step n our emprcal analyss s to establsh whether n our dataset there are derences n labour demand elastctes between domestc and oregn owned plants. In order to do so we specy the ollowng dynamc condtonal labour demand uncton or plant n year t, l t αlt s + β oregn + α w t t + β + α y 3 t w* oregn) ( t 3 + β ( y * oregn) t + d t + d + e t (6) 7

12 where l, w, and y are logged values o employment, wages per head, and output, respectvely. The varables d t, d, and e are tme specc eects, plant specc tme nvarant eects, and an..d. error term, respectvely; all unobservable to the econometrcan. 4 Dependng on observatons per plant one may want to nclude up to t-s lagged dependent varable n the equaton, snce, arguably, labour demand may be dynamc n nature because o a non-smooth adjustment process n plants' employment polcy (see, or eample, Hamermesh, 993). oregn n (6) s a dummy varable equal to one a plant s oregn-owned and zero otherwse. Ths varable s nteracted wth w and y to allow or natonalty o ownershp derences n the wage and output elastcty. In terms o estmaton o equaton (6) one should note that smply usng OLS s lkely to prove problematc. Speccally, employment s lkely to be smultaneously determned wth output and may also aect plant level wages the plant s not a prce taker n the local labour market. Also, the wage varable may not only capture labour costs but may also be a measure o rms skll ntenstes. Ths s because a rm that uses hgher sklled workers must pay hgher average wages due to a composton eect, leadng to another potental source o endogenety n the estmaton. I such endogenety bases were tme nvarant then smply rst derencng the data would provde a possble soluton. However, gven the length o the panel o ndvdual plants (up to 5 years) ths s unlkely to be the case. 5 One possble way o solvng ths problem would be to rst derence equaton (6) and apply a rst derenced generalzed methods o moments (GMM) estmator as developed by Arellano and Bond (99). Ths estmator uses sutably lagged levels o the endogenous varables as nstruments n the rst derenced equaton. However, ths approach has been crtcsed recently snce t has been argued that lagged levels o varables may only be weak nstruments or the varables n rst derences. In order to overcome ths problem o weak nstruments, whle also controllng or plant specc ed eects, Blundell and Bond (998) suggest usng a system GMM estmator whch uses an addtonal set o moment 4 A statc verson o the equaton ncludng only w and y can be derved rom a Cobb-Douglas producton uncton usng labour and captal as nputs. The cost o captal s dcult to measure at the plant level. We assume that the cost o captal s the same or all plants n the economy and s, hence, captured by tme dummes. 5 The ncluson o the lagged dependent varable would render a smple ed estmator napproprate n ths contet. In a transormaton rom the mean, the derence between the lagged dependent varable and ts mean ( lt l ) s by constructon correlated wth et e, as the mean e contans e t-, whch s correlated wth l t-. See, or eample, Baltag (995) or a dscusson. 8

13 restrctons to mprove estmaton. 6 Accordngly, the estmator uses a stacked system o rst derenced and level versons o the estmatng equaton, where or the ormer approprately lagged values and or the latter approprately lagged derences o the endogenous varables can serve as vald nstruments. The valdty o these nstruments can be tested usng a Hansen J test. The consstency o our estmates also rests on the assumpton that there s no second order correlaton o the resduals o the rst-derenced equaton. The standard procedure to very ths s to use an AR() test on the resduals developed by Arellano and Bond (99). The results o estmatng equaton (6) are reported n Table. Column () provdes the smplest model usng only one lag o the dependent varable. As the Hansen statstc ndcates, we reject the hypothess o nstrument valdty. Also, we reject the hypothess o no second order autocorrelaton (AR()). Hence, ths equaton s clearly msspeced. Column () adds the second lag o the dependent varable whch mproves on autocorrelaton, but stll leaves us wth an nstrument set that s not vald. Only n column (3) have we got a speccaton that has vald nstruments where we can also reject the hypothess o no AR() and we hence use ths as our benchmark speccaton. Turnng to the coecents, we nd rom column (3) that the wage and output elastctes look economcally sensble they are negatve and postve, respectvely, and statstcally sgncant n both cases. The pont estmates are also well wthn the range o those generally ound n the lterature (e.g., Barba Navarett et al., 003). More mportantly, the sgncant coecents on the nteracton terms suggest that multnatonals respond derently to wage changes n terms o ther demand or labour. Speccally, the wage elastcty or multnatonals s hgher (n absolute terms) than or domestc plants; a result ound by Barba Navarett et al. (003) or Fnland and Sweden. We do not nd any statstcally sgncant derences n the output elastctes, however. Overall, the results thus ar suggest that t s more reasonable to estmate the eect o lnkages on elastctes separately or domestc and oregn plants. [Table here] 6 The append provdes an llustraton o the weak nstrument problem n rst derenced GMM. As ar as we are aware there s no ormal test or weak nstruments n the contet o dynamc panel GMM and we hence ollow an approach used by Bond et al. (00). Estmatng a rst derenced verson o equaton (7) usng OLS would upward bas coecents on the lagged dependent varable, whle a ed eects (FE) transormaton would lead to a downward bas. As the table n the append shows, usng rst derenced GMM a la Arellano and Bond (99) produces coecents on l t- that are close to the FE model. Ths suggests that the rst derenced GMM model s based downwards whch can be due to weak nstruments (Bond et al., 00). The estmates produced by the system GMM estmator le comortably between OLS and FE estmates suggestng that t s more relable. 9

14 4. Lnkages and labour demand I multnatonals have hgher labour demand elastctes than domestc rms t may ndeed be the case that they are more lkely to reduce labour demand than comparable domestc plants labour costs ncrease. The ssue now becomes whether urther ntegraton o multnatonals through local lnkages may provde a counter orce to ths, and as dscussed n Secton, there may be reasons to thnk that t does. In order to nvestgate ths ssue we eamne whether labour demand elastctes depend on the degree to whch multnatonals are ntegrated nto the local economy. More speccally, we estmate a dynamc condtonal labour demand uncton, smlar to equaton (7) as l γ l + w + y + lnk + lnk w + ( lnk * y) + d + d + e t ( t s γ t γ 3 t λ t λ * ) t λ3 (7) where lnk s the measure o local lnkages whch s nteracted wth w and y. Hence, γ + λ (lnk) t represents the wage elastcty o labour demand, whch by constructon depends on the degree o local lnkages. The crucal pont o the analyss s, hence, whether λ s statstcally sgncantly derent rom zero, and whether t s derent or multnatonals and domestc rms. We check or the latter by ncludng approprate trple nteracton terms. Table 3 shows the results o estmatng equaton (7). Column () reports elastctes based on the ull sample o plants, not dstngushng between oregn and domestc owned establshments. The results ndcate that there s ndeed a statstcally sgncant mpact o lnkages on the wage elastcty o labour demand or all rms. However, allowng or derent eects o lnkages or domestc and oregn rms reveals some nterestng derences across natonalty o ownershp. To do so we construct a trple nteracton term o (w * lnk * oregn) whle also ncludng the nteracton o (w * oregn) as n Table. The latter nteracton term thus allows or derences n wage elastctes or oregn rms, whle the ormer allows or a derent eect o lnkages on the wage elastcty or oregn rms. The results n column () show that lnkages have a statstcally sgncant and postve eect on the wage elastcty or all rms (as apparent rom the nteracton o log wage * lnkage). However, we also nd rom the trple nteracton term (log wage * lnkage * oregn) that the postve eect s hgher or oregn rms at ( ) 0.08 than or domestc rms at The derence n results could perhaps relect the t t t 0

15 act that domestc plants source derent types o nputs locally, whch may be easly substtutable or local labour, hence there may be less eect o ncreased lnkages on the elastcty. 7 Usng the pont estmates n column () mples that the wage elastcty o labour demand or a oregn owned plant wth zero lnkages s ( ) 0.34, whereas a oregn plant wth a mean level o local lnkages has a wage elastcty o Increasng the degree o lnkages by two standard devatons rom the mean then mples a urther reducton n the elastcty to Hence, the estmated coecents are not only statstcally, but also economcally, sgncant. 8 One may want to notce also that even a oregn plant had a lnkage coecent o ts wage elastcty would stll be substantally hgher (at 0.43) than that o a domestc plant wth zero lnkages (at 0.7). Hence, whle lnkages may help to reduce the elastcty they are not enough to eplan away the hgher elastctes n oregn than n domestc plants. 9 [Table 3 here] Robustness checks One possble concern wth the estmaton above s that labour demand elastctes may depend on sze o the plant (Hamermesh and Pann, 996) and our results may thereore just relect the act that multnatonals are generally larger than domestc plants, and that larger rms have hgher lnkages (as ound by Görg and Ruane, 00 and Alaro and Rodrguez-Clare, 004). We, thereore, provde a robustness check to deal wth the ssue o plant sze. Speccally, we classy plants nto three sze categores accordng to ther average sze over the sample perod: small (employment less than 33 rd percentle o the sze dstrbuton), medum (employment between 33 rd and 66 th percentle o the sze dstrbuton), and large (employment greater than 66 th percentle o the sze dstrbuton) and estmate equaton (8) on these derent samples separately. Columns (4) to (6) n Table 3 present these results. Our ndngs on the eect o lnkages or multnatonals stll hold. Whle we ndeed nd that wage elastctes der by sze class we also nd that or all sze groups, ncreased lnkages are assocated wth 7 Unortunately our dataset does not dstngush derent types o nputs, hence we cannot ollow up ths conjecture wth urther analyss. 8 In 998, the mean rato o locally sourced nputs over total nputs or oregn owned plants s 0.4 (see Table ), the standard devaton s Column (3) presents an alternatve regresson whch only uses one lag o the dependent varable. However, as n Table, ths speccaton s ms-speced and we reject the hypothess o no second order autocorrelaton.

16 reductons n these elastctes or oregn rms, although the coecent on the trple nteracton term s, whle stll postve, statstcally nsgncant or large rms n column (6). Hence, our prevous ndngs are not just relectons o the act that we do not take nto account sze derences n the estmaton o wage elastctes. Another robustness check consders the unbalanced nature o our panel data whch contans et, so that the probablty o et were correlated wth the degree o local lnkages and employment then our results may be based. For eample, oregn multnatonals may have more sunk costs the more ntegrated they are nto the local economy and hence may be less lkely to et. However, etng plants are also lkely to adjust ther employment derently pror to et. As argued n Secton 3, there s very lttle et n our data and, hence, t may be consdered neglgble n our analyss. Regardless, we report some addtonal speccatons to ensure that are our results are not based due to plant et. In ths regard, Column () o Table 4 reports a regresson on the sample o survvng plants only, thus ecludng etors, whle column () ncludes a dummy equal to or the whole letme o a plant that ets the data, and nteracts ths dummy wth all varables contanng log wage and ts nteracton terms. Note rom column () that the results on the survvor sample s smlar to that reported n column () o Table 3. Consderng column (), whle we nd that the dummy varable and nteracton terms are all statstcally sgncant (ecept the nal our way nteracton o wage, lnkage, oregn and et dummy), we also nd that the postve and statstcally sgncant coecent on the trple nteracton o lnkage and wages or oregnowned plants s robust to ths speccaton. Hence, our result that hgher local lnkages decrease wage elastctes o labour demand s robust to the derent ways o dealng wth the potental bas ntroduced through plants etng the dataset. [Table 4 here] 5 Conclusons Ths paper nvestgates the lnk between natonalty o ownershp and labour demand elastctes at the level o the plant. In partcular, we eamne whether labour demand n multnatonals (or other domestc rms) becomes less elastc a plant has backward lnkages wth the local economy, proposng the possblty that locally purchased nputs may be more dcult to substtute or labour than other nputs, due to the very nature o the nputs. Our evdence shows that the etent o local lnkages ndeed reduces

17 the wage elastcty o labour demand or oregn owned plants. In robustness checks we nd that the results hold when allowng or plant heterogenety n terms o sze and when takng account o et. Whle our labour demand estmatons show that ncreasng the level o lnkages may lead to economcally sgncant reductons n oregn plants wage elastctes, t s also clear that even a multnatonal sourced all o ts nputs n Ireland t would stll have a substantally hgher elastcty than a comparable domestc plant. Hence, whle lnkages are mportant n eplanng derences n elastctes they are not sucent to eplan away the act that oregn plants have hgher wage elastctes than domestc plants. 3

18 Reerences Allen, R,G,D. (969) Mathematcal Analyss or Economsts, MacMllan St. Martns Press Alaro, Laura and Andres Rodríguez-Claré (004), Multnatonals and lnkages: An emprcal nvestgaton, Economa, Sprng 004, Arellano, Manuel and Stephen Bond (99), Some Tests o Speccaton or Panel Data: Monte Carlo Evdence and an Applcaton to Employment Equatons, Revew o Economc Studes, 58, Baltag, B.H. (995) Econometrc Analyss o Panel Data, Chchester, Wley & Sons. Barba Navarett, Gorgo, Danele Checch and Alessandro Turrn (003), Adjustng Labor Demand: Multnatonal Versus Natonal Frms: A Cross-European Analyss, Journal o the European Economc Assocaton, Aprl-May, pp Bernard, Andrew B. and Fredrk Sjöholm (003), Foregn owners and plant survval, NBER Workng Paper Blundell, Rchard and Stephen Bond (998), Intal Condtons and Moment Restrctons n Dynamc Panel Data Models, Journal o Econometrcs, 87, Cohen, B. (973), Comparatve behavour o oregn and domestc eport rms n a developng economy, Revew o Economcs and Statstcs, 55, Dreld, Ngel, Ma Munday, and Annette Roberts. 00. Foregn Drect Investment, Transactons Lnkages, and the Perormance o the Domestc Sector. Internatonal Journal o the Economcs o Busness 9(3): Fabbr, Francesca, Jonathan E. Haskel and Matthew J. Slaughter (003), Does Natonalty o Ownershp Matter or Labor Demand?, Journal o the European Economc Assocaton, Aprl-May, pp Grma, Sourael and Holger Görg (007), Evaluatng the oregn ownershp wage premum usng a derence-n-derences matchng approach, Journal o Internatonal Economcs, orthcomng. Görg, Holger, Mchael Henry, Erc Strobl and Frank Walsh (006), Multnatonal companes, backward lnkages and labour demand elastctes, GEP Research Paper, Unversty o Nottngham 4

19 Görg, Holger and Erc Strobl (003), Footloose multnatonals?, The Manchester School. 7: -9. Görg, Holger and Frances Ruane (000), An analyss o backward lnkages n the Irsh electroncs sector, Economc and Socal Revew, 3, Hamermesh, Danel S. (993) Labor Demand, Prnceton Unversty Press Hamermesh, Danel S. and Gerard Pann (996), Adjustment costs n actor demand, Journal o Economc Lterature, 34, Hcks, J.R. (968) The Theory o Wages, MacMllan, second edton. Javorck, Beata Smarzynska (004), Does Foregn Drect Investment Increase the Productvty o Domestc Frms? In Search o Spllovers through Backward Lnkages, Amercan Economc Revew, 94, Kennedy, Keran A. (99), Lnkages and overseas ndustry, n: Foley, A. and D. McAleese (eds.), Overseas ndustry n Ireland, Dubln: Gll and Macmllan, pp Konngs, Joze and Alan Murphy (00), Do Multnatonal Enterprses Substtute Parent Jobs or oregn Ones? Evdence rom Frm Level panel data, CEPR Dscusson Paper 97. Lpsey, R.E. and Sjöholm, F. (004). Foregn drect nvestment, educaton and wages n Indonesan manuacturng, Journal o Development Economcs, Vol. 73, pp Markusen, James R. (00) Multnatonal Frms and the Theory o Internatonal Trade, MIT Press Moran, Theodore H. (00), Parental Supervson: The New Paradgm or Foregn Drect Investment and Development, Washngton DC: Insttute or Internatonal Economcs. Mosak, Jacob, L. (938), Interrelatons o Producton, Prce, and Derved Demand, Journal o Poltcal Economy, Vol. 46, No. 6. pp OECD (997), Jobs outlook, OECD: Pars. Ruane, Frances (00), Relectons on lnkage polcy n Irsh manuacturng polcy chasng a movng target?, mmeo, avalable at Rodrk, Dan (997) Has globalzaton gone too ar? Washngton, DC: Insttute or Internatonal Economcs 5

20 Scheve, Kenneth and Matthew J. Slaughter (004), Economc nsecurty and the globalzaton o producton, Amercan Journal o Poltcal Scence, 48, Slaughter, Matthew J. (00), Internatonal Trade and Labor-Demand Elastctes, Journal o Internatonal Economcs, 54, 7-56 Unted Natons (004), World Investment Report 004, UN: Geneva and New York. 6

21 Append I: Theory A: Dervng the condtonal labour demand elastcty A prce takng rm rm has a producton uncton wth n nputs: y,... ) (A) ( n The Lagrangan uncton or cost mnmsaton s: l w + w + w + λ[ y (.. )] (A).. n n n For each o the n actors we get a rst order condton: w λ,.. ) (A3) ( n Derentatng the producton uncton and the n rst order condtons wth respect toλ, w and all the nputs we get the ollowng system o equatons: dy d dλ + λ d.. λ... ndλ + λ + n d.. d d... λ n d nn n n d 0 dw n n 0 Ths can be represented n matr ormat as: 0. n.. n dλ dw 0 λ n d n dw λ nn dn 0 dwn Applyng Cramers rule where B s the Bordered Hessan above and B replaces the second column wth the soluton vector, we get: w B λ B (A4) Allen (969) derves the ollowng epresson or the elastcty o substtuton: ( B n.. + n ) j σ j (A5) B j 7

22 Usng ths denton o the elastcty o substtuton 0 n (A5) along wth the rst order condton we get the labour demand elastcty condtonal on output: j n j j n j j n j j s w w * σ σ η (A6) A: Upward slopng supply or other actors We wll assume there are only two actor n ths case. The elastcty o substtuton n ths case can s: ) ( ) ( + + σ (A7) The cost mnmsaton problem can be represented as above n matr ormat ecept that we allow w to vary as well as w. That s we assume an eogenous change n the wage leads to an ncrease n demand and the wage o the other actor ts supply curve slopes upwards: λ λ λ λ 0 0 dw dw dw d dw d dw d Usng (A4) to get the soluton and notng rom (A7) that: B dw dw B B w λ λ (A8) 0 Usng ths denton B B n n ).. ( + σ where B s the determnant o the coactor o the bordered Hessan or the second o the n+ rows and columns. Also note rom Allen (969) p504 that n n n σ σ 8

23 Also note n the two actor case rom (A7) that: B σ ( + ) (A8) From (A7) and (A8) we get: * η σs ( η w ) w A3: The uncondtonat elastcty Net we look or the labour demand elastcty when output vares ater an ncrease n the prce o labour. We assume that the prce o output s ed. Mosak (938) analyses the mpact o a change n prces on actor and output demands or prce takng rms. Mosaks approach s more detaled and would allow us to calculate the substtuton and scale eects separately. For smplcty we assume that the producton uncton s homogeneous o degree r where r s less than unty. We wll assume that ed costs ensure an optmal sze at a postve level o output or the rm. The rm wll mamse prots: p (, w w F (A9) ) The rst order condtons are as n (A3) ecept lambda s now the output prce p. Derentatng the rst order condtons wth respect to, and w and solvng we get the change n labour rom a change n the wage: d dw (A0) p( ) Our assumpton that the producton uncton s homogeneous o degree r mples the ollowng: ry + (A) 9

24 ( r ) (A) ( r ) (A3) Substtutng A9- nto (A5) the elastcty o substtuton smples to to: σ (A4) ( r ) + r y Substtutng A9- nto (A0) we get: d dw [( r) + ] (A5) p( r)[( r) + ry] Usng (A.4) n the denomnator and agan applyng the rst order condton, the own prce elastcty o demand or actor at ed output prce s: d w η σ ( + ) (A6) dw ( r ) ry Note (A4) can be rearranged as: ( r). Usng ths n (A6) when σ s we get: y s η [ σ s + ] (A7) ( r ) r 0

25 Table : Development o backward lnkages (locally sourced nputs dvded by total nputs) NACE Descrpton domestc oregn domestc oregn 5 Food & beverages Tobacco Tetles Wearng apparel Leather Wood & wood products Pulp & paper Publshng & prntng Petroleum Chemcals Rubber & plastcs Non metallc mnerals Basc metals Fabrcated metals Machnery & equpment Computers & Oce machnery Electrcal machnery TV and telephone Medcal & optcal nstruments Motor vehcles Other transport equpment Not elsewhere classed Total Source: own calculatons rom Irsh Ependture Survey

26 Table : Labour demand elastctes, oregn vs domestc () () (3) log employment (t-) (0.006) a (0.007) a (0.007) a log employment (t-) (0.003) a (0.003) a log wage (0.05) a (0.04) a (0.00) a log output (0.00) a (0.008) a (0.006) a log wage (t-) (0.007) a log output (t-) -0.3 (0.005) a oregn dummy (0.07) a (0.06) a (0.038) a log output * oregn dummy (0.0) a (0.009) a (0.006) log wage * oregn dummy (0.05) a (0.05) a (0.008) a Hansen test (p-value) AR() test (p-value) Observatons System GMM estmaton Dependent varable: log(employment) Standard errors n parentheses c sgncant at 0%; b sgncant at 5%; a sgncant at %

27 Table 3: Condtonal labour demand ncludng backward lnkages () () (3) (4) (5) (6) all rms all rms all rms small medum large rms rms rms log employment (t ) (0.009) a (0.003) a (0.00) a (0.00) a (0.00) a (0.00) a log employment (t ) (0.005) a (0.00) a (0.00) a (0.00) a (0.00) a log wage (0.05) a (0.008) a (0.009) a (0.003) a (0.00) a (0.004) a log output (0.008) a (0.004) a (0.005) a (0.00) a (0.00) a (0.00) a lnkage (0.077) a (0.05) a (0.05) a (0.00) a (0.007) a (0.0) a log wage * lnkage (0.0) a (0.0) a (0.0) (0.005) a (0.003) (0.005) a log output * lnkage (0.0) a (0.005) a (0.005) a (0.003) a (0.00) a (0.00) a oregn dummy (0.07) a (0.05) a (0.008) a (0.005) a (0.00) a log wage * oregn (0.008) a (0.009) a (0.005) a (0.003) a (0.004) a log output * oregn (0.004) a (0.005) b (0.00) a (0.00) a (0.00) a log wage * lnkage * oregn (0.04)* (0.04) a (0.00) a (0.005) a (0.006) log output * lnkage * oregn (0.004) a (0.005) (0.003) a (0.00) a (0.00) a Hansen test (p

28 value) AR() test (pvalue) Observatons System GMM estmaton Dependent varable: log(employment) Standard errors n parentheses c sgncant at 0%; b sgncant at 5%; a sgncant at % Lnkage dened as nputs sourced n Ireland dvded by total nputs Denton o sze classes: small: employment less than 33 percentle (43 employees) medum: employment between 33 and 66 percentle large: employment larger than 66 percentle (99 employees) 4

29 Table 4: Robustness checks: Consderng et n condtonal labour demand Only survvors all rms wth et dummy log employment (t-) (0.00) a (0.00) a log employment (t-) (0.00) a (0.00) a log wage (0.006) a (0.007) a log output (0.00) a (0.003) a lnkage (0.03) a (0.03) a log wage * lnkage (0.008) a (0.0) a log output * lnkage (0.003) a (0.005) a oregn dummy (0.0) a (0.05) a log wage * oregn (0.005) a (0.007) a log output * oregn (0.00) a (0.003) a log wage * lnkage * oregn (0.009) a (0.03) a log output * lnkage * oregn (0.003) a (0.004) a log wage * et dummy (0.08) a log wage * lnkage * et dummy (0.0) a log wage * oregn * et dummy -0.0 (0.0) a log wage * lnkage * oregn * et dummy 0.09 (0.03) et dummy (0.035) b 5

30 Hansen test (p-value) AR() test (p-value) Observatons System GMM estmaton Dependent varable: log(employment) Standard errors n parentheses c sgncant at 0%; b sgncant at 5%; a sgncant at % Lnkage dened as nputs sourced n Ireland dvded by total nputs 6

31 Fgure : Employment growth by natonalty o ownershp domestc oregn 7

32 Append II: Comparson o derent estmators () () (3) (4) (5) (6) (7) (8) ols e d sys ols e d sys log employment (t-) (0.006) a (0.006) a (0.039) a (0.06) a (0.07) a (0.0) a (0.058) a (0.037) a log employment (t-) (0.06) a (0.008) b (0.03) (0.08) a log wage (0.009) a (0.008) a (0.09) a (0.046) a (0.033) a (0.009) a (0.099) a (0.07) a log output (0.005) a (0.005) a (0.048) a (0.07) a (0.03) a (0.006) a (0.06) a (0.069) a log wage (t-) (0.034) a (0.00) a (0.064) a (0.06) a log output (t-) (0.04) a (0.008) a (0.065) (0.069) a Hansen test (p-value) AR() test (p-value) Observatons Dependent varable: log(employment) Standard errors n parentheses c sgncant at 0%; b sgncant at 5%; a sgncant at %

33