FDI regulation versus labor market regulation: A political economy approach

Over the last decades, a dramatic increase in Foreign Direct Investment inflows (FDI) has been observed worldwide and especially  in developing countries (1990-2013 : 35000 to 77000 Million $, UNCTAD (2013)). To explain such trends, the literature has mainly focused on economic factors such as the market size and the growth potential of the host country and institutional factors such as the rule of law, the quality of the judicial system and labor market institutions (Benassy Quere et.al (2007), Kishan et. al(2013)). As FDI have proven to have benefical effects on stimulating economic growth and reducing unemployment in the host country (De Mello (1999), Spiezia (2004), Vacaflores (2011)), governments have been engaged in a “competition” to attract FDI. FDI policies such as lowering taxation on multinational corporations, creating special economic zones or relaxing the rules that govern ownership within an industry have been implemented so far. Few studies have investigated the determinants of FDI policies from a political economy perspective (Pandya (2007). In addition, there is a vast literature on the political economy of labor market reform (Saint-Paul (2004,2010)). This paper seeks to contribute to these strands of research and analyzes the interaction between FDI regulation and labor market regulation from a political economy perspective. Using the framework of a common agency model of lobbying (Grossman and Helpman (1994) and Jaeck and Kim (2014) it analyzes the setting of FDI regulation as a political compromise pressured by the direct lobbying of national business interests seeking to get protection and a multinational corporation seeking to gain market access. It also models the indirect information-based influence of a national trade union seeking to influence voters’ beliefs on the effect of FDI regulation on employment and wage increase. The paper analyzes the conditions under which interest group’s influence enables convergence towards the socially optimal level of regulation. It also seek to provide predictive behavior on the effects of an exogenous change in labor market regulation on the political equilibrium level of FDI regulation. Intuitively, these results depend on the weight the government attributes to special interests and social welfare, the distribution of population’s beliefs regarding the effect of the regulation and the « interdependence effect » between direct and indirect political influence, thus affecting the lobbies’ incentives to contribute for a policy change.