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Journal of Developing Areas, Vol. 36 (2003), No. 2, pp. 39-58
Matthias Busse
Do Transnational Corporations Care About Labor Standards?
Abstract
The paper empirically explores the relationship between foreign direct investment, or
the activities of transnational corporations, and core labor standards. The results show
that, contrary to the conventional wisdom that transnational corporations engage
predominately in countries with low standards, higher labor standards are positively
associated with foreign direct investment inflows. Concerns about “social dumping” or
“a race to the bottom” on such standards appear to be mistaken. This result even holds
for poor developing countries. In view of the empirical evidence, the paper concludes
with a discussion of some policy implications for international institutions.
JEL Classification: F23, O19
Key Words: Transnational Corporations, Foreign Direct Investment, Labor Standards,
Cross-Country Regression Framework
2
1. Introduction
The rapid expansion of foreign direct investment (FDI), or the rise of transnational
corporations’ activities across countries, is maybe the clearest sign of the globalization
of the world economy over the past 15 years. The average annual growth rate of FDI
was 26 per cent between 1986 and 2000, much faster than other economic aggregates
like world production (7 per cent) or trade (9 per cent) (UNCTAD, 2001). Most
international investments take place within the Triad - Japan, the European Union and
the United States. In the period 1995-2000, they accounted for three-quarters of global
FDI inflows and 85 per cent of outflows.
Accordingly, absolute levels of FDI flows to developing countries are relatively small.
In the period 1995-2000, the 49 least-developed countries
1
attracted less than 1 per cent
of FDI inflows, which amounted to an annual average of only US$ 3.3 billion. Yet a
different picture emerges if shares of FDI flows of host country gross domestic product
(GDP) are considered. Whereas the ratio of FDI inflows to GDP in the least-developed
countries was as low as 0.2 per cent in the period 1980-1985, it increased to 2.2 per cent
in the period 1995-2000 (world average: 1.9 per cent), suggesting an increase in the
relevance of FDI to these countries (UNCTAD, 2001).
Though some political activists from non-governmental organizations doubt the
evidence, increasing FDI inflows and activities of transnational corporations, in
particular in developing countries, will benefit their host economies: FDI is likely to, for
the most part, introduce new technologies, augment the capital stock of the host
country, increase competition within key sectors of the economy, and benefit local
workers through more and better paid jobs.
2
Whereas FDI itself appears to have
favorable effects, a growing global competition among governments trying to attract
FDI might have less beneficial consequences. More specifically, worries have been
1
At present, 49 countries are on the United Nations (UN) list of least-developed countries (UNCTAD,
2001). They have in common a GDP per capita of less than US$ 900 in 1999 and low levels of capital,
human, and technological development.
2
See Klein et al. (2001) for a detailed survey of studies on the effects of FDI in developing and emerging-
market countries.
3
raised that there will be a lowering of workers’ rights, or, in other words, “social
dumping” or a “race to the bottom” on labor standards (Bhagwati, 1996; Drenovsky,
1992).
These issues have attracted interest not only from trade unions and governments, but
also from a large public audience, including humanitarian organizations, partly due to
concerns about the effects of the increasing globalization of the world economy. In
particular, non-governmental organizations have raised their voices. Amnesty
International (2002), for instance, stated in a recent report on the activities of
transnational corporations in developing countries:
“Many transnational corporations operate in countries with repressive
administrations where the rule of law is weak, where the independence
of the judiciary is questionable, and where arbitrary arrest, detention,
torture and extra-judicial executions occur. The government may ban
free trade union activity and deny its citizens freedom of association.
Factory workers in plants from which companies source their products
may be subject to inhuman and degrading working conditions.”
This paper seeks to address these concerns and elucidates the relationship between labor
standards and decisions of transnational corporations on where to invest abroad. It
focuses on the question of whether countries could gain a competitive advantage from
low labor standards, and thereby affect FDI flows. A second question, partly related to
the first one, is whether transnational corporations have an influence on labor standards
in the country of operation or whether they can improve respect for these standards.
This reversed link, however, is beyond the scope of this paper and hence not addressed.
Against this background, this paper is organized as follows. Section 2 gives a brief
introduction to different concepts of labor standards. Section 3 reviews previous
empirical work on the linkage between labor standards and FDI flows. The results of
empirical tests with respect to that relationship are reported in Section 4. Finally, some
4
policy implications are discussed in Section 5, and the paper concludes with a summary
of the major results and some concluding remarks in Section 6.
2. Definition and Scope of Labor Standards
Obviously, the extent of labor standards differs across countries, depending on political,
cultural, and social preferences and conditions, as well as income levels (Brown et al.,
1998; Bhagwati, 1996). There is, however, a lack of agreement on a definition or a
common list of labor standards. It is necessary to outline carefully the set of labor
standards used, since the choice of labor standards will definitely influence empirical
results. For the intention of analyzing the effects on FDI flows, and for more clarity, the
distinction between “core” and other labor standards is crucial. Core (or fundamental)
labor standards focus on important human and workers’ rights and include (ILO,
2002b):
• Freedom from forced labor, in the form of compulsory labor and slavery;
• The abolition of exploitative forms of child labor that put the safety and health of
children at significant risk;
• Equal opportunity in employment, that is, the right to equal treatment for all workers;
• Fundamental union rights like freedom of association and collective bargaining, i.e.
rights of workers to organize themselves and to negotiate freely their working
conditions with their employers.
Apart from these core standards, other standards, such as health and safety standards in
the workplace, annual leave with pay or minimum wages, are related to actual working
and labor market conditions. These other labor standards are extremely controversial,
whereas core labor standards receive overwhelmingly acceptance. For instance, the
5
three United Nations acts on core labor standards have been ratified by more than 130
countries (UN, 2002).
3
Separately from the three United Nations acts, the conventions of the International
Labor Organization (ILO) on core labor standards have come next to a set of standards
most countries can reach agreement on. Initially, the ILO was created in 1919 primarily
for the purpose of adopting international standards to cope with problems of labor
conditions, such as "injustice, hardship and privation" (ILO, 2002a; Sengenberger,
1994). Later on in 1944, the ILO standard setting mandate was broadened to include
more general, but closely related, human and civil rights and social policy matters. Core
labor standards, however, have remained one of the most important issues of the ILO.
Within the ILO framework, international labor standards are in effect expressions of
international tripartite agreement. The tripartite representatives consist of governments
as well as workers’ and employers’ organizations. Since its foundation, the ILO has
adopted more than 180 conventions and more than 190 recommendations (ILO, 2002a).
ILO conventions are international treaties subject to ratification by ILO member states,
whereas recommendations are purely advisory and non-binding instruments. The ILO
relies basically on voluntary compliance and monitors the carrying out of the ratified
conventions, since it does not have any enforcement power.
Starting with the Forced Labor Convention in 1930, so far the ILO has adopted eight
conventions on core labor standards, two each on union rights, forced labor, child labor,
and discrimination (see Table 1). Apart from the two on child labor, the total number of
ratifications by member states is in the range of 140 to 160.
4
Though most countries
agree on the principles of these conventions, only 80 countries have ratified all eight (as
of 1 September 2002). In some circumstances, the precise wording or the interpretation
of these conventions contradicts national laws or regulations (OECD, 1996). Ratifying a
3
The three United Nations acts are (1) the Convention on the Rights of the Child, (2) the Covenant on
Economic, Social and Cultural Rights, and (3) the Covenant on Civil and Political Rights; see UN (2002)
for details.
4
Since the Worst Forms of Child Labour Convention (No. 182) was only agreed on as recently as 1999,
member countries are still in the process of ratifying this convention.
6
particular convention, on the other hand, does not automatically entail enforcement.
Albania, for example, has ratified all eight conventions, and the United States only two,
but few would argue that Albania has higher labor standards.
Table 1: Ratification of ILO Fundamental Labor Standards (as of 1 September 2002)
ILO Convention
Number of countries
having ratified the
convention
Union Rights
(1) Freedom of Association and Protection of the Right to Organize Convention,
1948 (No. 87)
141
(2) Right to Organize and Collective Bargaining Convention, 1949 (No. 98)
152
Forced Labor
(3) Forced Labor Convention, 1930 (No. 29)
161
(4) Abolition of Forced Labor Convention, 1957 (No. 105)
158
Child Labor
(5) Minimum Age Convention, 1973 (No. 138)
117
(6) Worst Forms of Child Labor Convention, 1999 (No. 182)
129
Discrimination
(7) Equal Remuneration Convention, 1951 (No. 100)
159
(8) Discrimination (Employment and Occupation) Convention, 1958 (No. 111) 156
Source: ILO (2002b).
3. Previous Studies of Foreign Direct Investment and Labor Standards
Taking into account the extensive international discussion about the relationship
between labor standards and FDI, it is rather astonishing that only a few studies have
addressed that link empirically. Those studies available in the literature have focused
more on the consequences of labor costs and social and political stability on FDI flows.
5
So far, four studies have looked at the linkage between labor standards and FDI (see
Table 2 for an overview of the results).
In a first attempt, the OECD (1996) analyzed the linkage between a fundamental union
right, the freedom of association, and FDI flows. Based on ILO studies and reports from
5
See Brown (2000) for a comprehensive survey.
7
international trade union organizations, the OECD rated 76 countries on a scale from
1 (union rights almost non-existent) to 4 (union rights guaranteed in law and practice).
In the examination of the data, the authors of that study first relied on a simple chart in
relating freedom of association and FDI flows and, in an update (OECD, 2000), also
computed a partial correlation. Both the chart and the correlation coefficient (0.20)
indicate a positive but rather weak link between freedom of association and FDI flows.
Rodrik (1996) regressed several indicators for labor standards on the FDI by majority-
owned United States affiliates abroad as a share of the stock of such investment. In the
benchmark regression, he used control variables like the black-market premium for
foreign currency as a substitute for government policy distortions, population, and
income growth in the host country. Afterwards he added several indicators for core and
other labor standards. Only the indicators for child labor and democracy were
statistically significant, and the coefficients imply that countries with weaker
democratic rights and more child labor attract less United States capital than
democracies that protect child workers.
Alternatively, Cooke and Noble (1998) focused on the linkage between the total number
of ratified ILO conventions by each country and United States FDI abroad. This implies
that they did not incorporate any indicator which measures the de facto compliance with
rather than the de jure ratification of ILO conventions. Yet they discovered a positive
and statistically significant relationship between the two variables, which implies that
United States firms prefer countries with a stronger record of ratifications of ILO
conventions as a site for investment.
8
Table 2. Previous Studies of Foreign Direct Investment and Labor Standards
Author(s) and
Sample Period
Countries Dependent Variable Independent Variables Statistically Sign.
Variables
OECD (1996,
2000)
1995-98
76 OECD
and non-
OECD
countries
FDI inflows Freedom of association (Weak) pos.
Correlation
Rodrik (1996)
1982-89
40
countries
FDI by US firms
abroad / stock of FDI
Black-market premium for
foreign currency
Neg. correlation
Population Neg. correlation
GDP growth Pos. correlation
Total ILO conventions ratified
CLS* ILO conventions ratified
Democracy indicator Pos. correlation
Incidence of child labor Neg. correlation
Cooke and
Noble (1998)
33
countries
FDI by US firms
abroad
Total ILO conventions ratified Pos. correlation
1993
Raynauld and
Vidal (1998)
91
countries
Change in inward-FDI
shares
Indicator for labor standards Pos. correlation
1980-90
Note: * Core Labor Standards.
Finally, Raynauld and Vidal (1998) used the Human Development Index (HDI) of the
United Nations as an indicator of the extent of labor standards in each country. The HDI
comprises life expectancy, educational attainment, standard of living, and so on.
6
Assuming that the HDI is closely associated with the level of labor standards, they
found a positive and statistically significant relationship between the HDI and its
dependent variables, the percentage change in inward-FDI as a share of total FDI flows.
This implies that countries with a higher human development level attract more FDI
than countries with lower development levels. To sum up, the empirical evidence in the
literature is not very comprehensive, but the results indicate that low-standard countries
are likely to receive less FDI than nations with higher standards.
4. Data and Empirical Results
6
See UNDP (2002) for more information.
9
An appropriate basis for the empirical investigation of the relevance of labor standards
to investment decisions by transnational corporations would be to use a standard
theoretical model, incorporate labor standards and then analyze them. Unfortunately, we
do not have such a model.
7
Instead, for the empirical analysis we have to rely on the
results of other studies that have address the underlying reasons why transnational
corporations realize investment abroad.
According to the empirical studies, the two most important determinants of FDI flows
are the size and growth of a market (Chakrabarti, 2001). Thus, for the benchmark
ordinary least squares regression of the FDI model, only market size (the variable is
labeled GDP), quantified by GDP per capita in current US dollars, and market growth
(GROWTH), measured as real GDP per capita growth, are included as independent
variables. Since FDI flows, as the dependent variable, can vary significantly from year
to year for a single country, a period of six years from 1995-2000 has been chosen.
8
The
data used are average annual net FDI inflows per capita in the reporting economy for
that period in current US dollars (FDI).
9
For the quantification of labor standards, five indicators are used. First, there is GDI for
the extent of discrimination against women, representing the gender-related
development index of discrimination against women in education and working life,
computed by the UNDP (2002). The index quantifies gender inequalities in literacy
rates, the combined gross primary, secondary, and tertiary enrolment ratio, life
expectancy, and income. It varies from 0 (very high discrimination) to
1 (no discrimination).
Second, CHILD is used for the occurrence of child labor, defined as the share of
children of ages 10-14 who are not working. With this definition, CHILD measures thus
7
See Graham (1995) and Chakrabarti (2001) for overviews of the literature on FDI flows.
8
GDP and GROWTH are also averages for the period 1995-2000. Data sources of all variables are
reported in Appendix A.
9
The subsequent results do not change fundamentally if FDI stocks are used instead of flows. Given that
FDI stocks represent FDI flows over a longer period and the indicators used for labour standards are
relatively recent, the focus is on flows rather than stocks.
10
the non-prevalence of child labor. To ensure a straightforward interpretation of the
subsequent regression results, a higher number of CHILD, like the four other indicators,
implies a higher labor standard. Third, UNION is taken to represent basic union rights,
such as collective bargaining and freedom of association. This variable is the OECD
(1996, 2000) indicator for union rights (see Section 3).
10
Fourth, CONVEN stands for
the number of ratified ILO conventions on core labor standards.
And, finally, FORCED is the indicator for the prevalence of forced labor. Starting point
for this indicator is a comprehensive ILO (2001) report on forced labor. With the help of
this report, each country has been assessed as to whether there are insufficiencies either
in legislation or enforcement. Shortcomings in legislation are linked to the absence of
forced labor regulations or to specifications in national laws that are incompatible with
ILO conventions on forced labor. Inadequacies in enforcement, on the other hand, relate
to a lack of government ability or willingness to use existing legislation. In the analysis,
three numbers have been applied for FORCED: 1 if problems have been reported with
both enforcement and legislation, 2 if there are shortcomings with one of them, and 3 if
there are no insufficiencies at all.
11
Incorporated in the benchmark OLS regression were all 134 countries reporting FDI,
GDP, and GDP growth data for the considered period 1995-2000. Like most empirical
studies on the determinants of FDI, a semilog model has been applied, that is, the
logarithm for both FDI and GDP has been taken. As GDP growth rates can be negative,
GROWTH has been added without taking the logarithm to ensure the highest number of
countries included in the regressions. Then, the basic regression specification is
(1) Log (FDI) = α
0
+ α
1
LOG (GDP) + α
2
GROWTH + e,
10
Yet again, to ensure an easier interpretation of the regression results, the range from 1 to 4 has been
defined exactly opposite to that of the OECD.
11
See Appendix B for the assigned numbers for each country.
11
where e is an error term and α
i
are parameters. The results, reported in the first column
of Table 3, show that both explanatory variables have the expected signs and are
statistically significant at the 1 per cent level. To see whether labor standards also have
an impact on FDI flows (and to reduce the problem of multicollinearity), each indicator
is added one by one to the benchmark regression, without taking the logarithm:
(2) Log (FDI) = α
0
+ α
1
LOG (GDP) + α
2
GROWTH +
α
3
Indicator for Labor Standards + e.
The coefficients for the five indicators explained above are reported in the remaining
columns of Table 3. All four indicators that quantify the de facto compliance with the
ratification of the ILO conventions have positive signs and are statistically significant at
the 1, 5, or 10 per cent level. The results show that less discrimination against females, a
lower extent of child and forced labor, and improved basic union rights are associated
with higher FDI inflows. In other words, countries with higher core labor standards
received more FDI per capita in the period 1995-2000 than would have been forecasted
on the basis of the other country characteristics.
12
Table 3: Core Labor Standards and Foreign Direct Investment, All Countries
Independent
Variables
Dependent Variable: LOG (FDI)
Constant -3.737***
(0.507)
-3.511***
(0.551)
-4.448***
(0.674)
-4.231***
(0.528)
-3.516***
(0.684)
-3.741***
(0.566)
LOG (GDP) 1.117***
(0.068)
0.827***
(0.167)
0.979***
(0.097)
1.013***
(0.077)
1.030***
(0.113)
1.116***
(0.070)
GROWTH 0.149***
(0.046)
0.134***
(0.049)
0.155***
(0.047)
0.160***
(0.045)
0.001
(0.069)
0.149***
(0.047)
GDI 2.835**
(1.417)
CHILD 1.915*
(1.063)
FORCED 0.475***
(0.176)
UNION 0.720*
(0.413)
CONVEN 0.001
(0.063)
Adj. R
2
0.70 0.72 0.70 0.71 0.76 0.70
N 134 122 130 134 68 134
Notes: See Appendix A for data sources; standard errors, which have been checked for heteroskedasticity,
are reported in parentheses; multicollinearity has been tested by the creation of variance inflation factors
(VIF); *** significant at 1% level; ** significant at 5% level; * significant at 10% level.
Conversely, CONVEN, which stands for the de jure ratification of the ILO conventions,
seems not to significantly affect FDI flows. CONVEN is just above zero and not
statistically significant. In addition, the number of ratifications appears to be a rather
poor quality measure of the de facto compliance. To compare ratification and
compliance for each of the four core labor standards, the number of ratifications for
each of the four core labor standards is first computed. The variables are labeled
CONDISC for equal opportunity in employment (no discrimination) and the number of
ratifications of Conventions No. 100 and No. 111, CONCHILD for the abolition of
exploitative forms of child labor (No. 138 and No. 182), CONFORCE for freedom of
forced labor (No. 29 and No. 105) and CONUNION for fundamental union rights
(No. 87 and No. 98). Then the partial correlations between these four variables and the
equivalent indicators for compliance with labor standards are computed.
The results, shown in Table 4, indicate that the maximum partial correlation is 0.22 (for
union rights), which implies a weak positive correlation. The partial correlations for the
discrimination against females and forced labor are even negative, which indicates that
– on average – countries that ratify more conventions on these two core labor standards
13
are less likely to ensure their enforcement in practice. As has been pointed out in
Section 2, the interpretation of these results should not go too far, since some countries
do not ratify the conventions due to legal issues but nevertheless ensure the compliance
in their countries.
Table 4: Ratifications of Fundamental ILO Conventions
and Level of Labor Standards
Variables Partial Correlation
GDI / CONDISC -0.02
CHILD / CONCHILD 0.09
FORCED / CONFORCE -0.15
UNION / CONUNION 0.22
Note: See Appendix A for data sources.
By and large, similar to the outcome of previous empirical work on this subject, the
results clearly indicate that the level of core labor standards is positively associated with
FDI inflows. In fact, one probable reason for this finding is that most FDI for the
countries included in the data set (in absolute numbers) is horizontal rather than vertical.
Vertical FDI occurs when transnational corporations divide the production process
internationally by locating each stage of production in the place or country where it can
be done at lowest cost (Bjorvatn et al., 2001). Foreign affiliates of TNCs in developing
or emerging-market countries typically produce labor-intensive intermediate products
that are transported back to high-wage countries. This kind of investment is called
“efficiency seeking” FDI, since the main motive for the investment is to improve the
cost effectiveness of the firm’s production.
Horizontal FDI, on the other hand, takes place when transnational corporations produce
the same or a very similar commodity in various plants and service local markets
through affiliate production rather than through exports from their home base (Bjorvatn
et al., 2001). This type of FDI, sometimes called “market seeking” FDI, is to a very
large extent directed towards high-income countries, since market size or potential are
the most relevant determinants. There is strong evidence that horizontal FDI dominates
vertical investment flows. For example, according to Brainard (1997), only 13 per cent
14
of the overseas production of United States-owned foreign affiliates is shipped back to
the United States, and that only two per cent of the output produced by foreign affiliates
located in the United States is shipped to their parents.
Clearly, these findings are overwhelmingly influenced by the dominance of FDI flows
between high-income countries and regions like the United States, Japan, and the
European Union (see figures in Section 1), where horizontal is by far larger than vertical
FDI. To see whether the inclusion of high-income countries has a decisive role, high
and upper middle-income countries have been left out in a second set of regressions.
Based on a definition by the World Bank (2002), only developing countries with a low
or lower-middle income with a GDP per capita in 1999 of US$ 2,995 or less were
included in the regressions. Together, 87 developing countries have been identified with
combined FDI inflows of US$ 76 billion or 8.6 per cent of world FDI inflows in 2000
(UNCTAD, 2001).
Table 5 shows the results for the new set of regressions. Overall, they are much like
those of the first set. Whereas the overall fit of the benchmark and the other regressions
for the labor standards worsens, signs as well as statistical significance of all variables
are similar. The only exception is UNION, which implies that fundamental union rights
are less likely to be positively associated with FDI inflows in developing countries.
Unfortunately, there is evidence of multicollinearity between GDP, GDI and CHILD.
Given that the extent of child labor and the degree of discrimination against women are
likely to be substitutes for income levels in developing countries, GDP in these two
regressions has been omitted. Partly as a consequence, GDI and CHILD are highly
significant at the 1 per cent level. To sum up, there is not only a positive linkage
between labor standards and FDI flows if all countries are considered, but also in
developing countries with a low and lower-middle income.
12
12
Neither the statistical significance nor the signs change much if additional developing countries or
emerging-market economies with, for instance GDP per capita between US$ 2,995 and US$ 9,265, which
are middle- and upper-middle-income countries, are incorporated in the regressions. To save space, these
results are not reported.
15
Table 5: Core Labor Standards and Foreign Direct Investment, Developing Countries
Independent
Variables
Dependent Variable: LOG (FDI)
Constant -4.517***
(1.079)
-5.584***
(0.388)
-1.819*
(0.933)
-4.630***
(1.052)
-5.277**
(2.104)
-4.518***
(1.145)
LOG (GDP) 1.230***
(0.164)
1.056***
(0.176)
1.212***
(0.269)
1.230***
(0.166)
GROWTH 0.167***
(0.058)
0.131**
(0.066)
0.187***
(0.065)
0.184***
(0.057)
0.001
(0.120)
0.167***
(0.059)
GDI 3.568***
(0.975)
CHILD 6.249***
(1.080)
FORCED 0.501**
(0.212)
UNION 0.466
(0.367)
CONVEN 0.001
(0.083)
Adj. R
2
0.43 0.38 0.33 0.46 0.39 0.43
N 87 78 84 87 31 87
Note: According to a definition by the World Bank (2002), developing countries can be classified as low
and lower middle-income countries with a GDP per capita in 1999 of US$ 2,995 or less; see Table 3 for
further notes.
5. Policy Implications and the Role of International Institutions
Considering this empirical evidence, recent reflections
13
on whether labor standards
should be incorporated into a framework of an international institution, such as the
World Trade Organization (WTO), to enforce the rules at a global level seem to be
misguided. Yet in particular the European Union is still in favor of linking investment
(and trade) and core labor standards and brought the issue to the negotiating table at the
WTO conference in Doha in November 2001. However, this attempt was discarded by a
vast majority of developing countries and the issue of labor standards has not be
included in the new Doha Round of multilateral trade talks.
Though the empirical results are clear-cut, it is obvious that core labor standards may
influence investment decisions in some cases. To illustrate this, violations of workers’
13
For instance, see not only calls for binding labour standards by non-governmental organisations like
Amnesty International (2002), but also Morris (2001) for an economic analysis and an overview of the
literature.
16
rights have been reported in particular in export-processing zones in Asian and Central
American countries (OECD, 2000). Poor working conditions and low standards in these
zones may attract a few transnational corporations that use predominately unskilled
labor. Likewise, some governments in Asia, such as Bangladesh or Pakistan, have
exempted export-processing zones from national labor and industrial relations
legislation, thereby restricting workers’ rights, to help attract inward FDI (ICFTU,
2002).
Furthermore, there simply is no excuse on humanitarian grounds for repellent working
conditions to prevail anywhere in the world. Thus, the remaining question is how to
deal with these reported cases. In general, there are two approaches: binding rules
within international institutions or dealing with single firms that violate fundamental
labor standards. At the international level, an attempt was made with the Multilateral
Agreement on Investment (MAI), which had been negotiated by OECD countries from
1995 to 1998 (Hoekman and Saggi, 2000).
While global rules do exist to regulate trade in commodities, it was recognized by
OECD governments that there are none to regulate foreign investment. Apart from rules
for investment protection or dispute settlement, negotiators also discussed the issue of
standards related to working practices (Graham, 2000). More specifically, a provision
had been added that aimed at not lowering health, safety, or labor standards. It obligated
governments not to relax core labor standards as a means of encouraging investment
inflows. Also, it had been discussed whether the provision might be enforceable in the
sense that it could be the basis for bringing a dispute to the agreement’s dispute
settlement procedures.
But the MAI negotiations failed in late 1998 and that provision never went into force
(Graham, 2000). Indeed, the MAI had been in trouble from the beginning, partly
because the investment negotiations were taken on by the OECD and not the WTO.
This was an unfortunate idea on several counts. As a start, the OECD has only 30
members, most of them comparatively open to FDI; the talks excluded such countries as
Indonesia and India, where foreign investment is regulated to a large extent. Also, the
17
OECD, whose primary job is economic research, has no experience running such a
complicated negotiation. And third, while the WTO has a legal apparatus in place to
deal with nations that violate their commitments to open trade, the OECD does not. The
lack of possible enforcement power thus further weakened the negotiations and the MAI
talks failed.
Apart from the breakdown of these talks, imposing (trade or economic) sanctions on
countries where appalling working conditions exist by means of multilateral
agreements, whether within the WTO, OECD or ILO, does not seem to be the best way
forward. It clearly makes no sense to use sanctions against a whole nation if only one or
two firms violate labor standards. Punishing the innocent along with the guilty is rarely
a sound policy. Moreover, sanctions may result in negative economic consequences, as
measures to enforce fundamental workers’ rights are likely to be exploited by high-
income countries to protect their markets against alleged “unfair” imports from lower-
income developing countries with poorer standards (Graham, 1997). This would in turn
be harmful to GDP growth rates (and, thus, FDI inflows) in developing countries,
because their cost competitiveness and economic welfare would somewhat erode.
A more promising and effective approach is likely to sanction individual firms that
violate fundamental labor standards by using, for example, product labeling. This
method, argued at length by Freeman (1994) and Rodrik (1996), is also appealing to
economists, since the market mechanism can be applied. If imported commodities can
be appropriately labeled, consumers in high-income countries who might be willing to
pay a premium for high standards in all countries will be able to do so. Also, this could
reduce concerns about low standards by trade unions in the United States and Europe
and would generate the incentive for producers in the exporting nations to upgrade their
standards voluntarily.
For a number of reasons, the voluntary participation of all parties involved is the most
appealing argument for labeling (Rodrik, 1996): (1) It allows the willingness-to-pay rule
to determine the level of harmonization in labor standards; (2) developing-country
exporters are compensated for the costs of raising their labor standards by an increase in
18
prices; (3) import-competing workers in the high-income countries get certain
protection through the higher prices; (4) labeling avoids internationally binding trade
restrictions, as it does not involve any actions by governments apart from perhaps
setting some standards on labeling through associations, under which firms agree to
adhere to voluntary codes of labor standards; and (5) it reduces the chances that labor
standards are abused by protectionist groups.
First examples of product labeling are Levi Strauss and Wal-Mart in the early and mid-
1990s, following some critical publicity surrounding their use of underpaid workers in
appalling conditions.
14
More specifically, both introduced new rules for their foreign
subsidiaries/subcontractors and excluded suppliers who use child labor. Another
example is the Swedish furniture store IKEA, which announced in 1995 that it would
not put up carpets for sale that it could not certify as having been made without child
labor.
On the other hand, using labeling to identify and punish firms that violate core labor
standards may also involve some problems. First, it produces incentive problems for
private firms. In particular, consumers cannot check the claims made on the product
labels, as information about production circumstances cannot be obtained for free
(Freeman, 1994). Companies, in turn, have the incentive to overstate the standards by
which they abide. This problem could be controlled by close governmental monitoring,
but this raises the problem of bureaucratic interference and protectionism anew. Second,
since labor standards are multifaceted, that is, they consist of core and other standards,
simple labeling could not address all likely sources of concern. Consider core labor
standards: Even if labeling could truthfully deal with child labor, what about non-
discrimination, basic union rights or the complex issue of forced labor?
A role for international institutions might arise in this context, in particular for the ILO.
Since information on abuses of core labor standards is available to some extent, the ILO
can determine which countries and/or firms do not meet the provisions in their
conventions and recommendations. Also, the ILO could create corps of inspectors
14
See Rodrik (1996) and Freeman (1994) for details and more examples.
19
within its organization whose mission it would be to go to production facilities around
the world to decide whether core standards are being violated or not (Varley, 1998).
Finally, supporting the fundamental ILO operations by providing financial and technical
assistance to the countries involved, as well as more transparency, would show far
higher effects on the improvement of fundamental workers’ rights than binding
international regulations within the WTO framework.
6. Concluding Remarks
The main argument of this paper has been that, contrary to the conventional wisdom
that transnational corporations favor low-standard countries, higher labor standards are
positively associated with FDI inflows. The main line of attack from non-governmental
organizations is the conviction that due to the increasing integration of the world,
countries will engage in fierce competition to attract FDI, leading, among other things,
to “a race to the bottom” on labor standards; this assumption seems unable to be
justified. Employing aggregate FDI data for 134 countries, the regression results clearly
indicate that low standards are not an attraction for transnational corporations. This
result holds for all four core labor standards, that is, non-discrimination in employment,
abolition of child labor, basic union rights, and elimination of forced labor. Also,
separate regressions for relatively poor developing countries show that the results do not
depend on income levels.
Obviously, there are abuses of fundamental workers’ rights in a number of countries.
The number of reported cases, however, do not lead to the conclusion that workers’
rights in general are suffering from severe violations or that any of the empirical results
of the present study have to be looked at again. Weak core labor standards are not
considered a major factor in assessing investment opportunities by transnational
corporations in a potential host country. As has been shown, the empirical results point
rather to the opposite outcome: On average, transnational corporations prefer to invest
in countries where basic human and workers’ rights are higher.
20
Yet to address humanitarian concerns about the appellant mistreatment of workers’
rights in individual cases, two differing approaches have been discussed: binding rules
within international institutions and product labeling. Whereas the former is likely to be
unfair towards innocent workers and firms and less efficient in terms of economic
welfare, the latter seems to be more promising, as it allows for voluntary commitments
and monitoring for labor standards. Since numerous non-governmental organizations,
trade unions, and some governments of high-income (and high-standard) countries are
still interested in raising labor standards to a certain level in all countries,
15
the issue is
highly likely to arrive on the scene of future trade and investment talks again. Yet this
paper has indicated that human rights activists may be fighting the wrong enemy, as
labor standards and FDI are positively associated.
15
See Palley et al. (1999) for the trade unions viewpoint on labour standards and their demands.
21
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Appendix A: Definition of Variables and Data Sources
Variable Definition Source
FDI Foreign direct investment, net inflows in current US dollars,
annual average for the period 1995-2000
World Bank (2002)
GDP GDP per capita in current US dollars, annual average for the
period 1995-2000
World Bank (2002)
GROWTH Growth of GDP per capita, annual average for the period
1995-2000
World Bank (2002)
GDI Gender-related development index, index 0-1, annual average
for the period 1995-2000
UNDP (2002)
CHILD Percentage of children ages 10-14 who are not working, annual
average for the period 1995-2000
World Bank (2002)
FORCED Indicator for forced labor, scale from 1-3, 1999 ILO (2001) and
own calculations
UNION Basic union rights, scale from 1-4, 1999 OECD (1996,
2000)
CONVEN Number of ratifications of the eight fundamental ILO
conventions, Dec. 1999
ILO (2002b)
CONDISC Number of ratifications of the two fundamental ILO
conventions on discrimination No. 100 and No. 111, 1999
ILO (2002b)
CONCHILD Number of ratifications of the two fundamental ILO
conventions on child labor No. 138 and No. 182, 1999
ILO (2002b)
CONFORCE Number of ratifications of the two fundamental ILO
conventions on forced labor No. 29 and No. 105, 1999
ILO (2002b)
CONUNION Number of ratifications of the two fundamental ILO
conventions on basic union rights No. 87 and No. 98, 1999
ILO (2002b)
24
Appendix B: Indicator for Forced Labor
Group 1
Bangladesh, Cambodia, China, Congo (Democratic Republic), Congo (Republic), Haiti, India,
Madagascar, Nepal, Sierra Leone, Sudan, Vietnam
Group 2
Benin, Bolivia, Brazil, Burkina Faso, Central African Republic, Costa Rica, Cote d'Ivoire,
Dominican Republic, Ethiopia, Ghana, Guatemala, Honduras, Kenya, Mali, Mauritania,
Mexico, Niger, Pakistan, Paraguay, Peru, Philippines, Senegal, Sri Lanka, Swaziland, Tanzania,
Thailand, Togo, Zimbabwe
Group 3
Albania, Algeria, Angola, Argentina, Armenia, Australia, Austria, Azerbaijan, Bahamas,
Barbados, Belarus, Belize, Botswana, Bulgaria, Burundi, Chad, Chile, Colombia, Croatia,
Cyprus, Czech Republic, Denmark, Djibouti, Ecuador, Egypt, El Salvador, Estonia, Fiji,
Finland, France, Gabon, Gambia, Germany, Greece, Guinea, Guyana, Hungary, Iceland,
Indonesia, Iran, Israel, Italy, Jamaica, Jordan, Kazakhstan, South Korea, Kyrgyzstan, Latvia,
Lebanon, Lesotho, Cameroon, Canada, Cape Verde, Lithuania, Macedonia, Malawi, Malaysia,
Maldives, Malta, Mauritius, Moldavia, Mongolia, Morocco, Mozambique, New Zealand,
Nicaragua, Nigeria, Norway, Panama, Papua New Guinea, Poland, Portugal, Romania, Russia,
Samoa, Seychelles, Slovakia, Slovenia, South Africa, Spain, Switzerland, Syria, Trinidad and
Tobago, Tunisia, Turkey, Uganda, Ukraine, United Kingdom, United States, Uruguay,
Uzbekistan, Venezuela, Zambia
Source: ILO (2001) and own calculations; see text for explanations.
