Economic Insecurity and the Globalization of Production Kenneth Scheve Yale University Matthew J.Slaughter Tuck School of Business at Dartmouth and NBER July 2003 A central question in the international and comparative political economy literatures on globalization is whether economic integration increases worker insecurity in advanced economies.Previous research has focused on the role of international trade and has failed to produce convincing evidence that such a link exists.In this paper,we argue that globalization increases worker insecurity,but that foreign direct investment(FDI)by multinational enterprises (MNEs)is the key aspect of integration generating risk.FDI by MNEs increases firms'elasticity of demand for labor.More-elastic labor demands,in turn,raise the volatility of wages and employment,all of which tends to make workers feel less secure.We present new empirical evidence,based on the analysis of panel data from Great Britain collected from 1991-1999,that FDI activity in the industries in which individuals work is positively correlated with individual perceptions of economic insecurity.This correlation holds in analyses accounting for individual- specific effects and a wide variety of control variables. Kenneth.Scheve@Yale.Edu and Matthew.Slaughter@Dartmouth.Edu.For financial support we thank the National Science Foundation for award #SES-0213671,the Yale Center for the Study of Globalization,the Carnegie Corporation's Globalization and Self-Determination Project at the Yale Center for International and Area Studies,the Leitner Program in International Political Economy,and the Institution for Social and Policy Studies.For very helpful data assistance we thank Simon Harrington at the U.K.Office of National Statistics and Ralf Martin. For helpful comments and discussion we thank Chris Anderson,Samuel Bowles,Jose Cheibub, Rafaela Dancygier,Keith Darden,Esther Duflo,Jonathan Haskel,Michael Hiscox,Hyeok Kwon,Lisa Martin,Fredrik Sjoholm,Mike Tomz,Michael Wallerstein,and seminar participants at Binghamton University,Cornell University,Duke University,the Santa Fe Institute,the University of Michigan and the University of Nottingham
Economic Insecurity and the Globalization of Production* Kenneth Scheve Yale University Matthew J. Slaughter Tuck School of Business at Dartmouth and NBER July 2003 A central question in the international and comparative political economy literatures on globalization is whether economic integration increases worker insecurity in advanced economies. Previous research has focused on the role of international trade and has failed to produce convincing evidence that such a link exists. In this paper, we argue that globalization increases worker insecurity, but that foreign direct investment (FDI) by multinational enterprises (MNEs) is the key aspect of integration generating risk. FDI by MNEs increases firms’ elasticity of demand for labor. More-elastic labor demands, in turn, raise the volatility of wages and employment, all of which tends to make workers feel less secure. We present new empirical evidence, based on the analysis of panel data from Great Britain collected from 1991-1999, that FDI activity in the industries in which individuals work is positively correlated with individual perceptions of economic insecurity. This correlation holds in analyses accounting for individualspecific effects and a wide variety of control variables. * Kenneth.Scheve@Yale.Edu and Matthew.Slaughter@Dartmouth.Edu. For financial support we thank the National Science Foundation for award #SES-0213671, the Yale Center for the Study of Globalization, the Carnegie Corporation’s Globalization and Self-Determination Project at the Yale Center for International and Area Studies, the Leitner Program in International Political Economy, and the Institution for Social and Policy Studies. For very helpful data assistance we thank Simon Harrington at the U.K. Office of National Statistics and Ralf Martin. For helpful comments and discussion we thank Chris Anderson, Samuel Bowles, José Cheibub, Rafaela Dancygier, Keith Darden, Esther Duflo, Jonathan Haskel, Michael Hiscox, Hyeok Kwon, Lisa Martin, Fredrik Sjoholm, Mike Tomz, Michael Wallerstein, and seminar participants at Binghamton University, Cornell University, Duke University, the Santa Fe Institute, the University of Michigan and the University of Nottingham
1 1.Introduction Determining whether international economic integration in advanced economies increases worker insecurity is critical to competing explanations of welfare-state policymaking and the politics of globalization.An influential argument in the welfare-state literature is that increases in economic insecurity from globalization generate demands for more generous social insurance that compensates workers for a riskier environment (e.g.,Cameron,1978;Rodrik 1997,1998; Garrett 1998;Burgoon 2001;Hays,Ehrlich,and Peinhardt 2002;Boix 2002).The connection between globalization and welfare spending in this argument depends on the causal mechanism that international economic integration increases worker insecurity.Claims that no such link exists undermine this explanation for variation in welfare-state spending. The link between economic integration and worker insecurity is also an essential element of explanations for patterns of public opposition to policies aimed at further liberalization of international trade,immigration,and foreign direct investment (FDI)in advanced economies. Economic insecurity may contribute to the backlash against globalization in at least two ways. First is a direct effect in which individuals that perceive globalization to be contributing to their own economic insecurity are much more likely to develop policy attitudes against economic integration.Second,if globalization limits the capacities of governments to provide social insurance,or is perceived to do so,then individuals may worry further about globalization and this effect is likely to be magnified if labor-market risks are heightened by global integration. Previous empirical research has focused on whether one particular component of globalization,international trade,generates economic volatility.This research has been inconclusive.Among others,Rodrik (1997,1998)argues in the affirmative and presents evidence that exposure to external risk from trade,measured by the interaction between trade
1 1. Introduction Determining whether international economic integration in advanced economies increases worker insecurity is critical to competing explanations of welfare-state policymaking and the politics of globalization. An influential argument in the welfare-state literature is that increases in economic insecurity from globalization generate demands for more generous social insurance that compensates workers for a riskier environment (e.g., Cameron, 1978; Rodrik 1997, 1998; Garrett 1998; Burgoon 2001; Hays, Ehrlich, and Peinhardt 2002; Boix 2002). The connection between globalization and welfare spending in this argument depends on the causal mechanism that international economic integration increases worker insecurity. Claims that no such link exists undermine this explanation for variation in welfare-state spending. The link between economic integration and worker insecurity is also an essential element of explanations for patterns of public opposition to policies aimed at further liberalization of international trade, immigration, and foreign direct investment (FDI) in advanced economies. Economic insecurity may contribute to the backlash against globalization in at least two ways. First is a direct effect in which individuals that perceive globalization to be contributing to their own economic insecurity are much more likely to develop policy attitudes against economic integration. Second, if globalization limits the capacities of governments to provide social insurance, or is perceived to do so, then individuals may worry further about globalization and this effect is likely to be magnified if labor-market risks are heightened by global integration. Previous empirical research has focused on whether one particular component of globalization, international trade, generates economic volatility. This research has been inconclusive. Among others, Rodrik (1997, 1998) argues in the affirmative and presents evidence that exposure to external risk from trade, measured by the interaction between trade
2 openness and the standard deviation of a country's terms of trade,is positively correlated with growth volatility.In contrast,Iversen and Cusack (2000)contend that there is no convincing evidence that international trade increases economic insecurity.They argue that Rodrik's correlation is not sufficient,and that it is necessary either that price volatility in international markets be greater than in domestic markets or that trade concentrate rather than diversify economic risks.Iversen and Cusack then present evidence that,at least for advanced economies, there is no correlation between trade openness and volatility in output,earnings,or employment. In this paper,we investigate whether international economic integration increases economic insecurity.Our analysis makes a substantial departure from existing research by focusing on a relatively overlooked dimension of globalization:the cross-border flow of FDI within multinational enterprises(MNEs).This focus on FDI rather than trade is rare in the literature, and we argue that this omission matters for both empirical and theoretical reasons. Empirically,in recent decades,cross-border flows of FDI have grown at much faster rates than have flows of goods and services.UNCTAD (2001)reports that from 1986 through 2000, worldwide cross-border outflows of FDI rose at an annualized rate of 26.2%,versus a rate of 15.4%for worldwide exports of goods and services.In the second half of the 1990s this difference widened to 37.0%versus just 1.9%.Moreover,it is the multinationalization of production that a number of scholars have pointed to as the distinguishing feature of the current phase of globalization compared to previous eras(e.g.,Bordo,Eichengreen,and Irwin 1999). This lack of attention to FDI also matters because,as we will discuss,there are strong theoretical reasons to believe that FDI can substantially influence economic insecurity.The globalization of production by MNEs gives firms greater access to foreign factors of production, and thus greater ease of substitution away from workers in any single location.As a result
2 openness and the standard deviation of a country’s terms of trade, is positively correlated with growth volatility. In contrast, Iversen and Cusack (2000) contend that there is no convincing evidence that international trade increases economic insecurity. They argue that Rodrik’s correlation is not sufficient, and that it is necessary either that price volatility in international markets be greater than in domestic markets or that trade concentrate rather than diversify economic risks. Iversen and Cusack then present evidence that, at least for advanced economies, there is no correlation between trade openness and volatility in output, earnings, or employment. In this paper, we investigate whether international economic integration increases economic insecurity. Our analysis makes a substantial departure from existing research by focusing on a relatively overlooked dimension of globalization: the cross-border flow of FDI within multinational enterprises (MNEs). This focus on FDI rather than trade is rare in the literature, and we argue that this omission matters for both empirical and theoretical reasons. Empirically, in recent decades, cross-border flows of FDI have grown at much faster rates than have flows of goods and services. UNCTAD (2001) reports that from 1986 through 2000, worldwide cross-border outflows of FDI rose at an annualized rate of 26.2%, versus a rate of 15.4% for worldwide exports of goods and services. In the second half of the 1990s this difference widened to 37.0% versus just 1.9%. Moreover, it is the multinationalization of production that a number of scholars have pointed to as the distinguishing feature of the current phase of globalization compared to previous eras (e.g., Bordo, Eichengreen, and Irwin 1999). This lack of attention to FDI also matters because, as we will discuss, there are strong theoretical reasons to believe that FDI can substantially influence economic insecurity. The globalization of production by MNEs gives firms greater access to foreign factors of production, and thus greater ease of substitution away from workers in any single location. As a result
3 workers feel more insecure.Stated in terms of the underlying labor economics,the central idea is that FDI by MNEs increases firms'elasticity of demand for labor.More-elastic labor demands, in turn,raise the volatility of wages and employment-and thereby raise worker insecurity. This theoretical framework motivates our empirical analysis of the relationship between the multinationalization of production and the economic insecurity of workers.We present new evidence,based on analysis of individual-level panel data from Great Britain over 1991-1999, that FDI activity in the industries in which individuals work is positively correlated with individual perceptions of worker insecurity.This correlation holds in analyses accounting for individual-specific effects and a wide variety of control variables.Moreover,FDI exposure has one of the largest substantive effects in accounting for the within-individual variation in insecurity.We regard these individual-level panel results as the first valid evidence consistent with a causal relationship from FDI to worker insecurity. There are four remaining sections to the paper.The next section provides a theoretical framework for the economics of FDI and worker insecurity.Section 3 describes the data to be used in the study and the econometric models to be estimated.Section 4 reports the empirical results and the final section concludes. 2.Theoretical Framework for FDI and Worker Insecurity 2.1 Defining Worker Insecurity Although there are a number of alternative definitions of economic insecurity,most often it is understood to be an individual's perception of the risk of economic misfortune (Dominitz and Manski 1997).Consequently,researchers have focused on the risk of events such as the loss of health insurance,being a victim of a burglary,losing a job,and significant decreases in wages (e.g.,Anderson and Pontusson 2001,Mughan and Lacy 2002)
3 workers feel more insecure. Stated in terms of the underlying labor economics, the central idea is that FDI by MNEs increases firms’ elasticity of demand for labor. More-elastic labor demands, in turn, raise the volatility of wages and employment—and thereby raise worker insecurity. This theoretical framework motivates our empirical analysis of the relationship between the multinationalization of production and the economic insecurity of workers. We present new evidence, based on analysis of individual-level panel data from Great Britain over 1991-1999, that FDI activity in the industries in which individuals work is positively correlated with individual perceptions of worker insecurity. This correlation holds in analyses accounting for individual-specific effects and a wide variety of control variables. Moreover, FDI exposure has one of the largest substantive effects in accounting for the within-individual variation in insecurity. We regard these individual-level panel results as the first valid evidence consistent with a causal relationship from FDI to worker insecurity. There are four remaining sections to the paper. The next section provides a theoretical framework for the economics of FDI and worker insecurity. Section 3 describes the data to be used in the study and the econometric models to be estimated. Section 4 reports the empirical results and the final section concludes. 2. Theoretical Framework for FDI and Worker Insecurity 2.1 Defining Worker Insecurity Although there are a number of alternative definitions of economic insecurity, most often it is understood to be an individual’s perception of the risk of economic misfortune (Dominitz and Manski 1997). Consequently, researchers have focused on the risk of events such as the loss of health insurance, being a victim of a burglary, losing a job, and significant decreases in wages (e.g., Anderson and Pontusson 2001, Mughan and Lacy 2002)
It is likely that most people's perceptions of economic insecurity depend heavily on their purchasing power,which in turn depends on both their asset ownership and their labor-market status-both employment and income earned there from.In reality,the large majority of people rely much more on labor income than capital income for purchasing power.Accordingly,we think labor-market status is the main determinant of perceptions of economic insecurity. In light of this labor-market focus,we conjecture that the economic misfortunes underlying people's economic insecurity stem mainly from more-volatile employment and/or wage interactions with their employers.That is,risk-averse workers are not indifferent between employment options that yield the same amount of expected earnings but with differing degrees of certainty.More-certain earnings outcomes-due to more-certain wage and/or employment realizations-are preferred to less-certain ones,and insecurity rises with this uncertainty. 2.2 Worker Insecurity in Labor-Market Equilibrium:Why FDI Matters Equilibrium in a standard competitive labor market is set by the intersection of labor supply and labor demand.The labor-supply curve is aggregated across individuals,and at each point It is important to note that there is now a large body of evidence that labor-market volatility has been rising in many countries,especially in the 1990s,in terms of greater earnings volatility, declining job tenure,and self reports.Gottschalk and Moffitt (1994)report substantial increases in year-to-year earnings volatility for the United States over the 1970s and 1980s.Looking at the 1990s as well,a symposium issue of the Journal of Labor Economics (1999)documented declines in U.S job stability,especially in the 1990s for large groups of workers such as those with more tenure.Within that symposium issue,Schmidt's(1999)analysis of individual surveys finds that U.S.workers in the 1990s were more pessimistic about losing their jobs than they were during the 1980s-despite the ongoing economic expansion of the 1990s
4 It is likely that most people’s perceptions of economic insecurity depend heavily on their purchasing power, which in turn depends on both their asset ownership and their labor-market status—both employment and income earned there from. In reality, the large majority of people rely much more on labor income than capital income for purchasing power. Accordingly, we think labor-market status is the main determinant of perceptions of economic insecurity. In light of this labor-market focus, we conjecture that the economic misfortunes underlying people’s economic insecurity stem mainly from more-volatile employment and/or wage interactions with their employers. That is, risk-averse workers are not indifferent between employment options that yield the same amount of expected earnings but with differing degrees of certainty. More-certain earnings outcomes—due to more-certain wage and/or employment realizations—are preferred to less-certain ones, and insecurity rises with this uncertainty.1 2.2 Worker Insecurity in Labor-Market Equilibrium: Why FDI Matters Equilibrium in a standard competitive labor market is set by the intersection of labor supply and labor demand. The labor-supply curve is aggregated across individuals, and at each point 1 It is important to note that there is now a large body of evidence that labor-market volatility has been rising in many countries, especially in the 1990s, in terms of greater earnings volatility, declining job tenure, and self reports. Gottschalk and Moffitt (1994) report substantial increases in year-to-year earnings volatility for the United States over the 1970s and 1980s. Looking at the 1990s as well, a symposium issue of the Journal of Labor Economics (1999) documented declines in U.S job stability, especially in the 1990s for large groups of workers such as those with more tenure. Within that symposium issue, Schmidt’s (1999) analysis of individual surveys finds that U.S. workers in the 1990s were more pessimistic about losing their jobs than they were during the 1980s—despite the ongoing economic expansion of the 1990s