Focusing on the economic analysis of FDI, it appears that there are three different types of models which have been widely used to explain the nature and impact of (inward-outward) foreign direct investments: (a) real capital arbitrage models (b) market power/industrial organization models and (c) firm-theoretic models. Hymer (1960) has been the first to argue that real capital arbitrage models have basic shortages, and that a multinational company should rather possess a competitive advantage (e.g. higher productivity than local firms) in order to serve a foreign market. Regarding market structure, on the other hand, though earlier contributions have been mainly dealing with international monopolistic markets, most contemporary researchers focus their analysis on oligopolistic markets. Whilst, based on the works of Coase (1937), Arrow (1964) and Williamson (1975), and infused with ideas and surveys of internalization and endogenous approach, a multinational firm-theoretic paradigm has already been established.
As in particular regards the impact of FDI on labour market(s), and vice versa, Gaston and Nelson (2001) argue that FDI have negative effects on immigration, while the same authors (2000) claim that the most reasonable conclusion to draw is that the actual impact of FDI on the developed countries’ labour markets is negligible. Furthermore, there is a growing interest on the unionization and/or the wage bargaining structure as important factors for firms, and social planners, regarding FDI decisions, and relevant policies, respectively [see e.g., Brander and Spencer (1988), Mezzetti and Dinopoulos (1991), Ishiguro and Shirai (1998)].
One of the most interesting folds of the latter issue is the manipulation of the labour market institutional set-up in order to induce or deter FDI. Contributions to this framework mainly come from Naylor and Santoni (2003), who proposed that the
greater unions’ bargaining power is, the less likely FDI is to emerge. Moreover, Vlassis (2009) stressed out that if the FDI-associated unit costs are not high enough, then employment-neutral inward FDI will emerge if the domestic wage setting is credibly centralized (so that the foreign and the domestic firms to pay equal wages) and the unemployment benefit is sufficiently high.
Along similar lines of research, in the present analysis we consider two firms (home and abroad) which compete a la Cournot in a host country. The foreign firm has two options, either to build a plant abroad and serve the host country via exports or to invest in the host country and thus serve the local market via FDI. Each choice is considered to be credible due to the sunk cost of building a plant for serving the host market. Following Hymer (1960), we consider that the foreign firm possesses higher productivity than the home firm. Given the possibility of FDI, as above, two different unionization structures, centralized and decentralized, may then arise in the host country, giving rise to centralized or decentralized wage bargaining, respectively, as follows: Under the centralized union structure/wage bargaining, the home union bargains with both the home and the foreign firm about firm-specific wages considering that, in the event of a failure in any of those firm- specific negotiations, all union members will be employed only by the other firm (which will then become a monopolist). On the other hand, under the decentralized union structure/wage bargaining, on the other hand, the home union splits in two different firm-specific unions which, independently and separately, bargain with the home and the foreign firm over firm-specific wages.