When OFDI moves productive activity offshore, it has the potential to crowd out domestic economic activities, especially production, exports and employment. This can happen when OFDI is trade-substituting and horizontal in nature, wherein the productive activity overseas replaces activities that were previously undertaken domestically.
However, whether an overseas investment that establishes a factory has such effects in the home country is not clear cut, because even in such circumstances, domestic production could supply the foreign factory with intermediate products that are potentially more technologically advanced than those produced overseas. The offshoring of low-cost and labour-intensive production could also induce industrial upgrading in the home country, shifting its employment composition from blue-collar jobs to white-collar professions. For developing home countries, labour costs are lower compared to advanced economies, reducing the likelihood that offshoring becomes a significant issue of concern. Sometimes, OFDI might become strategically necessary for a firm to preserve production, exports and employment in the home country (Knoerich 2017).
It is possible that OFDI has both favourable and unfavourable effects, for example benefiting high-skilled employees at the expense of low-skilled labour, or having limited impact in the short run but more distinct positive effects in the long term. Similar to the situation in international trade, OFDI can occasionally produce winners and losers. Supportive policies need to be put in place to make sure the benefits are nurtured and eventually exceed the risks (Perea and Stephenson 2018, UNESCAP 2020).
Finally, at least in theory, OFDI can induce environmental degradation in the home country and exploit domestic labour. This can occur when OFDI is aimed at enhancing exports from the home country to foreign markets, and the investing MNEs seek to compete internationally through lower labour and environmental standards in their home country production (UNESCAP 2020).
Key insights
- When OFDI is aimed at offshoring domestic economic activities to the host country, there is a risk that production, exports and employment diminish in the home country (Gu 2018, Liu, Tsai, and Tsay 2015), though this is by far not guaranteed. In fact, almost all empirical studies find that OFDI has a positive effect on home-country production and exports (see A2) Exports and production). A majority of studies also find a positive impact on employment and associated indicators such as wages (see A10) Employment), though quite a few do identify mixed or negative employment effects (Hong, Lee, and Makino 2019, Laffineur and Gazaniol 2019, Gu 2018, Liu, Tsai, and Tsay 2015, Debaere, Lee, and Lee 2010, Harrison and McMillan 2010, Jäckle and Wamser 2010, Blomström, Fors, and Lipsey 1997).
- Policy needs to promote the winners from OFDI and provide appropriate support for those who do not directly benefit.
Interactions
A2) Exports and production: Horizontal and trade-substituting OFDI can reduce exports from the home country (Gu 2018, Liu, Tsai, and Tsay 2015).. However, most studies find a complementary relationship between OFDI and exports (UNESCAP 2020, Tham et al. 2018, Yang 2017, Ahmad, Draz, and Yang 2016, Nishitateno 2013, Hijzen, Jean, and Mayer 2011, Navaretti, Castellani, and Disdier 2010, Lipsey and Ramstetter 2003, Lipsey, Ramstetter, and Blomström 2000, Kim 2000, Pfaffermayr 1996, Pfaffermayr 1994).
A6) Industrial upgrading: Empirical research still needs to further investigate to what extent industrial upgrading happens in response to offshoring via efficiency-seeking OFDI.
A10) Employment: Some OFDI may shift economic activities such as production overseas, potentially with a negative impact on employment (Gu 2018, Jäckle and Wamser 2010, Debaere, Lee, and Lee 2010, Elia, Mariotti, and Piscitello 2009, Konings and Murphy 2006, Becker et al. 2005). This is especially the case with OFDI to less advanced economies (Liu, Tsai, and Tsay 2015, Debaere, Lee, and Lee 2010, Harrison and McMillan 2010, Blomström, Fors, and Lipsey 1997). However, a majority of studies find a positive relationship on employment and associated indicators (Cozza, Rabellotti, and Sanfilippo 2015, Hayakawa et al. 2013, Hijzen, Jean, and Mayer 2011, Liu and Lu 2011, Navaretti, Castellani, and Disdier 2010, Desai, Foley, and Hines 2009, Becker and Muendler 2008, Federico and Minerva 2008, Masso, Varblane, and Vahter 2008), and some report mixed results (Lee, Hong, and Makino 2020, Hong, Lee, and Makino 2019, Laffineur and Gazaniol 2019, Liu, Tsai, and Tsay 2015, Harrison and McMillan 2010, Blomström, Fors, and Lipsey 1997, Lipsey, Ramstetter, and Blomström 2000). OFDI may simultaneously have favourable and unfavourable effects, e.g. benefiting high-skilled labour but harming low-skilled workers (UNESCAP 2020, Perea and Stephenson 2018).
Available Research Findings
Hong, Lee, and Makino (2019): Japanese OFDI made between 1996 and 2010 enhanced domestic employment when it was natural resources- and strategic-asset-seeking, but reduced employment when it was labour resources-seeking. The findings for market-seeking OFDI were mixed.
Laffineur and Gazaniol (2019): MNEs pay a wage premium to their employees. OFDI increased manager wages but reduced the wages of workers engaged in offshorable tasks.
Gu (2018): Japanese OFDI had a negative impact on domestic employment and production.
Liu, Tsai, and Tsay (2015): OFDI undertaken by a sample of 1,084 Taiwanese manufacturing firms between 2000 and 2010 had a favourable impact on domestic employment, production and investment when it was made in high-wage countries, but tended to result in job losses and hollowing out when made in low-wage economies. OFDI generally aggravated income inequality.
Debaere, Lee, and Lee (2010): South Korean OFDI made between 1968 and 1996 decreased employment growth, especially in the short term, when it was made in developing countries. There was no effect when OFDI was destined to advanced economies.
Sun, Fulginiti, and Chen (2010): In a sample of Taiwanese OFDI in 15 industries undertaken between 1991 and 2001, efficiency-seeking OFDI had a negative effect on Taiwanese competitiveness due to reduced innovative activity.
Harrison and McMillan (2010): Evidence from United States manufacturing MNEs indicated that offshoring to low-wage countries substituted for domestic employment. Yet, foreign and domestic employment complemented each other when the respective activities in parent and subsidiary were significantly different.
Jäckle and Wamser (2010): Newly founded German MNEs between 1996 and 2001 had a negative impact on employment growth, despite positive wage growth.
Blomström, Fors, and Lipsey (1997): United States OFDI undertaken in developing countries is associated with reduced home country labour intensity, whereas Swedish OFDI in advanced and developing countries is associated with greater employment at home.