The influx of foreign investment to Korea began in the 1980’s, and increased dramatically following the establishment of the ‘Foreign Investment Promotion Act’ in 1998. However, it declined in the early 2000s because of global economic slowdown due to events such as the 9-11 terrorist attack and Information Technology Bubble Decay, etc. Investments have rebounded since 2004 and attracted more than 10 billion dollars thereafter, reaching a peak of 19 billion dollars in 2014.
Most governments believe that FDI contributes to economic development by creating jobs and introducing advanced technology and management practices to the host country. Based on this belief, governments provided various incentives such as tax breaks, relaxed regulations, and cash grants to attract multinational companies to their respective countries. This includes the Korean government, which changed its restrictive strategy to actively attract foreign firms since the Asian financial crisis by providing a variety of incentives for foreign firms.
As a result, foreign firms now account for about 20 percent of total exports and 6 percent of employment, and have had significant impacts throughout the economy. In recent days, some questions have been raised concerning differential effect of foreign firms on domestic small and medium sized enterprises (SMEs) and skilled labor, with subsequent discussions on the relationship of FDI and economic polarization. As multinational firms which are known to be more productive and possessed of more advanced technology enter the domestic market, they might bring about intense competition and crowd out domestic firms from the market, in particular SMEs.
Also, foreign firms in technology-intensive and services industries might demand more skilled labor, and thus increase wage premium for high-skilled labor. Although both foreign direct investment and economic polarization are very important issues, there are relatively few studies which investigate their relationship. It is this lack of research on FDI and economic polarization that provided motivation for this report, which examines whether foreign firms have differential impacts on the survival and growth of SMEs and increase wage premium for high-skilled labor. This was done by using foreign investment data from Korea's Ministry of Trade, Industry, and Energy; firm-level data from Statistics Korea; and survey on labor conditions by type of employment from Ministry of Employment and Labor.
According to the empirical investigation on FDI and exit and sales of domestic firms, foreign firms exert pressures to drive domestic firms from the market, and SMEs in particular. In addition, crowding-out effects are shown to be stronger for SMEs in the manufacturing sector and the low-export group. In contrast, according to the empirical investigation on FDI and change in sales of domestic firms, the presence of foreign firms in the same industry increases sales of domestic firms; the magnitude of the change being larger, in particular, for SMEs. Also, the positive impact are larger for SMEs in the manufacturing sector and high-export group.
To summarize the results on FDI and survival/growth of domestic firms, we cannot say that FDI aggravates polarization of firms because while it drives SMEs from the market on one hand, its raises their sales on the other. From the perspective of the whole economy, foreign firms raise productivity of the economy by removing uncompetitive firms from the market and then increasing productivity of the surviving domestic firms. According to the theoretical and empirical investigation on FDI and wage premium for skilled labor, we found that FDI in specific sectors, such as electronics and electricity, food and accommodation, finance and insurance, machine equipment, business service, wholesale and retail distribution, other manufacturing, professional engineering in chemical industries; increases wage premium for high-skilled labor.
In other words, foreign firms in these industries are more skill intensive, demand more high-skilled labor, and hence increase wage premium for high-skilled labor. Also, since these industries have common characteristics of having high levels of FDI, the impact of FDI on the increase in the wage premium for high-skilled labor can be interpreted as not being limited to these industries but in general.
These results provide useful policy implications which bolster the positive impact of foreign firms. As foreign firms increase sales of domestic survival firms, the mechanism for linkage and technology diffusion effects should be expanded to reinforce growth of domestic firms. For example, there should be places to exchange business information and opportunities, and the government should provide various incentives for foreign firms to develop linkages with domestic firms. Furthermore, the linkage between foreign and domestic firms should be expanded to services such as R&D, accounting, consulting etc. beyond the manufacturing sector.
Also, as presence of foreign firms in the same industry increases wage premium for skilled-labor, adequate labor reallocation and job training are needed to balance supply and demand of skilled-labor forces. For example, the government should facilitate efficient matching through programs to connect domestic labor supply and demand of foreign firms. In addition, the government should strengthen the social safety net for low-skilled labor, to aim for inclusive growth.