Labour costs and FDI flows into Central and Eastern European Countries: A survey of the literature and empirical evidence

Abstract

We analyse the determinants of Foreign Direct Investment (FDI) across selected Central and Eastern European Countries (CEECs) focusing on labour costs. We propose a labour cost measure which is relevant for the location decisions of Multinational Enterprises. A panel-gravity model approach is used to empirically assess the impact of market-related and cost-related location factors. Our dataset comprises bilateral net-FDI flows between seven home and eight host countries for the period of 1995–2003. Results suggest that higher unit labour costs as well as higher total labour costs affect FDI negatively, whereas higher labour productivity impacts positively on FDI. Our results support the choice of unit labour costs as the proper measure of labour costs, not least to avoid an omitted variable bias resulting from the exclusion of labour productivity. Standardised beta coefficients imply that all cost factors taken together (distance, taxes, labour costs) exert a considerable influence upon the decision to invest in the CEECs. In order to compensate for the rising wage costs in many CEECs, future public policy should contribute to improvements in labour productivity via investments in production-related infrastructure.