Labor training and foreign direct investment

Abstract

Evidence shows that most foreign direct investment (FDI) flows from developed to developed countries (North-to-North) in skilled-labor-intensive industries. This paper builds a model which incorporates labor training to the proximity-concentration tradeoffs to analyze multinationals’ entry mode to a foreign country. Production requires both skilled labor and unskilled labor. A multinational taking FDI needs to provide training to some workers in the host country to equip them with skills which are specific to the firm’s production. Labor training and skill specificity leads to contract friction. We show that in skilled-labor-intensive industries, FDI increases with the host country’s economic development level; but in unskilled-labor-intensive industries, the reverse is true. This paper provides a theoretical explanation to the empirical findings on the prevalence of North-to-North FDI in skilled-labor-industries and North-to-South FDI in unskilled-labor-intensive industries.