The Impact of Foreign Direct Investment on State-O

TheImpactofForeignDirectInvestmentonState-OwnedEnterprisesReformXiaodongWu*DepartmentofEconomicsUniversityofNorthCarolinaatChapelHillDecember2003AbstractTheincreasingspeedofglobalisationhascreatedbothopportunitiesandchallengestomanytransitionaleconomies.Thispaperanalysestheimpactofforeigndirectinvestment(FDI)ontheproductivityoftheState-OwnedEnterprises(SOEs)andconcludesthatSOEreformisinevitable.TheSOEs’obligationstoprovidesocialwelfareshouldberemovedtoenablethemtocompeteonanequalfootingwithforeignfirms.Moreover,itisessentialtobuildasocialsafetynettoassistthelosersinthisreform.Thesepolicieswillfacilitatethetransitionfromcentralplanningtoopenmarketeconomywithouttriggeringdevastatingunemploymentandsocialinstability.JELclassification:F23,O19,O53,P33Keywords:labourmarketreform,transitionaleconomy*Address:GardnerHall300B,UniversityofNorthCarolinaatChapelHill,ChapelHill,NC27599-3305.Telephone:[phone].Fax:[phone].Email:[e-mail]tionaleconomiesembracedfreetradeandwelcomedforeigndirectinvestment(FDI),therehasbeenanincreasingliteratureonhowtradeandFDIcaninfluencetheproductmarketandtheorganizationoffirmsinChinaandEasternEurope.Thereisalsoarichliteratureontheimpactofdifferenttypesofeconomicandpoliticalreformsonacountry’ssocialwelfareinthetransitionfromaplannedeconomytoamarketeconomy.However,studiesfocusingonreformsinthelabourmarkethavereceivedincreasingattentiononlyveryrecentlyasreformusuallyfirststartsintheproductmarketwherecompetitionismorenoticeable.However,itbecomesmoreapparentthatlabourmarketreformcanbethekeyandthelasthurdletoasuccessfultransitiontoamarketeconomy.Inthelabourmarket,theemploymentsysteminthestatesectorinmosttransitionaleconomiesisinheritedfromthecommand-and-controlsystemoriginatedintheformerSovietUnion.Underthissystembeforereform,governmentofficialsallocatedjobsinthestatesectortopeopleenteringtheurbanlabourforceviaacentralplacementsystem,andmonitoredcloselyinternalpromotionsandexternaljobtransfers.Migrationbetweenruralandurbansectorswas,andisstilltosomedegree,restrictedbyregulationssuchastheHouseholdregistration(HuKou)systeminChina.Underthissystem,theStateOwnedEnterprises(SOEs)hadanadvantageinchoosingitsemployeesfirstfromthejobcandidates.Jobseekersenteringthelabourforcehadfewlegitimateways,exceptviaconnectionandcorruption,toapproachpotentialemployers.Ontheotherhand,jobsofformalemployeesinthestatesectorwereextremelysecure,andwerecalled“ironricebowls”(TieFanWan)inChina.SincemostSOEshadtomeetanemploymenttargetsetbythegovernmentandcouldnotcommitonfuturefiringexanteinatransitionaleconomy,thiscommand-and-controlsystem,overtheyears,hascreatedalotofsurpluslabour(Fella,2000).Forexample,thelatestpopulationcensusconductedinNovember2000inChina(MajorFigureson2000PopulationCensusofChina,2000)estimatesthatasmuchas25percentofthe711.5millionworkerswasredundant(includingdisguisedunemployment).Besidesreducingproductivityandcreatingdisguisedunemployment,thecommand-and-controlsystemhasbroughtanotherpitfall.MostSOEshavecoveredallmedicalexpenses,housingandfoodsubsidy,andsocialsecurityoftheiremployees.Somefirmsevenhavehadtheirowndaycarecentres,kindergartens,andpre-schools2offeringhighqualityeducationserviceatheavilysubsidizedrates.Thestatesectorwasallthree:afirm,aninsurancecompany,andasocialwelfareprovider.Duetovariousgovernmentrestrictionsandinsufficientdemandandfunding,privatemedicalandunemploymentinsuranceprovidersrarelyexistedinmosttransitionaleconomiesbeforeeconomicreform.Thus,mostofthefringebenefitsofferedbytheSOEswereavailableonlyforemployeesinthestatesector.Also,mostofthesebenefitsweredistributedamongworkersaccordingtotheirseniority,regardlessoftheireffortspentonacquiringexperienceonthejob.Inasense,thegapbetweenwageandmarginalproductivitywasapremiumpaidtoreceiveauniformwelfarepackagedesignedforallemployeeswiththesamenumberofyearsinservice.Duetothedisadvantagesinacquiringhuman,physical,andfinancialcapital,manycollectiveowneddomesticenterprisesinthenon-statesectorhad“backward”technologyandfailedtocompeteforthebestworkersinthelabourforce.1ThissituationischangingrapidlywiththeincreasinginfluxofFDIintothesetransitionaleconomiesastheygraduallyadoptmorefavourablepoliciestowardinternationaltradeandinvestment.Foreignfirmshaveopenedmanynewjobsearchchannels,includingprivateemploymentagencies,jobfairs,newspaperadvertisements,andInternetjobboards.Thesechannelshaveenabledeffectiveinformationexchangebetweenjobseekersandpotentialemployers,offeredmorejobopportunitiestoqualifiedworkers,increasedproductivity,andledtofasterwageincreaseinthenon-statesector,especiallyinforeignfirmseitherwhollyforeign-ownedorjointventures.Meanwhile,hiringandfiringaswellaswagesettinginthestatesectorisstilllargelyundergovernmentcontrol.Thus,ontheonehand,growthinthenon-statesectordefinitelyprovidesmoreemploymentopportunitiesforthesurpluslabourinthestatesector.Ontheotherhand,fastergrowthoutsidethestatesectoralsofacilitatesforeignfirmstorecruit(orcompetefor)high-calibreworkersfromtheSOEs.Thiscanhindertheproductivityinth