Examining Determinants of Foreign Wage Premiums in China

• DOI: http://doi.org/10.1111/twec.12441
• Author: Theresa M. Greaney,Yao Li
• Published date: 01 October 2017
• Date: 01 October 2017

Examining Determinants of Foreign Wage

Premiums in China

Theresa M. Greaney

1

and Yao Li

2

1

Department of Economics, University of Hawai‘i, Honolulu, HI, USA and

2

School of Management and

Economics, University of Electronic Science and Technology of China, Chengdu, China

1. INTRODUCTION

THE empirical literature documenting wage premiums paid by foreign-invested enterprises

relative to domestic enterprises is extensive and so are the accompanying hypotheses on

why these wage premiums exist. What are much more limited, however, are tests of these

hypotheses. Of the many reasons why foreign firms might pay more than domestic firms,

which have empirical support and which do not? With worldwide foreign direct investment

(FDI) inflows totalling over $1 trillion every year since 2006, it is vital for policymakers to

understand fully the various host-country effects of FDI, including labour market effects.

1

In

this paper, we begin to address this gap in the literature by examining two hypotheses to

explain foreign ownership wage premiums using firm-level data for China.

Lipsey and Sjoholm (2004) suggest four possible hypotheses to explain foreign ownership

wage premiums: (i) host-country requirements or pressures; (ii) workers’ preferences for

working for a domestic, rather than foreign, employer; (iii) foreign firms’ disadvantage rela-

tive to domestic firms in identifying high-quality workers without paying wage premiums; and

(iv) foreign firms’ stronger aversion to worker turnover due to higher training costs or fear of

technology leakage to domestic rivals. The last of these hypotheses is the most amenable to

quantitative exploration with firm-level data, so we chose that one to pursue. This hypothesis is

based on efficiency wage models.

2

Firms will pay above market-clearing wages to reduce worker

turnover, and their willingness to pay higher wages increases with the costs of replacing workers.

If worker turnover is more costly for foreign firms than for domestic firms, foreign firms should

pay higher wages. Another variation of the efficiency wage concept involves the ‘fair wage’

hypothesis developed in Akerlof and Yellen (1990). Workers at more productive and profitable

firms expect to be paid more, otherwise they shirk. This hypothesis helps to explain the foreign

wage premium if foreign firms are more profitable than their domestic counterparts. We also

seek support for this hypothesis using firm-level data from China.

Lipsey and Sjoholm (2004) were among the first to confirm that foreign ownership wage

premiums exist even after controlling for region, industry, plant size and worker

The authors gratefully acknowledge financial support from the China National Social Sciences Foun-

dation (grant ID: 10XJL0019) and helpful comments from journal referees and from conference par-

ticipants at the Asia Pacific Trade Seminar at Sogang University, Seoul, June 2014; the fifth

International Symposium on Human Capital and the Labor Market at the Central University of

Finance and Economics, Beijing, December 2013; and the Midwest International Trade Meeting at

the University of Michigan, October 2013.

1

Another line of inquiry examines FDI impacts on host countries through technology transfers and spil-

lovers. See Damijan et al. (2013) for a recent summary of this literature.

2

See Yellen (1984) for a summary of these models, and Krueger and Summers (1988) for supportive

empirical evidence.

©2016 John Wiley & Sons Ltd

2056

The World Economy (2017)

doi: 10.1111/twec.12441

The World Economy

characteristics. They found a 12 per cent wage premium paid by foreign firms to blue-collar

workers and a 22 per cent wage premium paid to white-collar workers in Indonesian factories.

Aitken et al. (1996) find substantial foreign wage residuals for Mexico and Venezuela as host

countries, but not for the USA as a host country, when they control for plant size, location,

type of industry and skill mix. Some studies have gone further in trying to control for differ-

ences in worker characteristics using matched employer–employee data. Martins (2011) uses

matched data from Portugal to show that some of the pay differential between foreign and

domestic firms is explained by the foreign firms’ tendency to hire more able workers. Heyman

et al. (2007) use matched data from Sweden to conclude that foreign firms’ higher wages

mostly can be explained by firm and worker characteristics.

Egger and Kreickemeier (2013) argue that differences in observable firm-level characteris-

tics such as capital intensity and worker quality provide only partial explanations of the for-

eign wage premium. They develop a heterogeneous firms model in which firm-specific and

country-specific factors interact to explain the foreign wage premium. If firms in more devel-

oped economies have higher productivities on average, then foreign investment by these firms

into less developed economies produces one source of a wage premium (i.e. more productive

firms pay more). Another source of a wage premium is generated by multinational firms that

earn ‘global profits’ and share them with their workers worldwide. In a less developed econ-

omy, domestic firms with identical productivities to foreign-invested firms from a more devel-

oped economy can coexist but the foreign firms will pay higher wages due to their larger

global profits. Our exploration of the fair wage hypothesis relates only indirectly to the Egger

and Kreickemeier (2013) model because we are not able to observe the global profits of the

foreign firms in our data set. Instead, we examine whether foreign firms pay higher wages in

China due to their higher profits earned in China.

Greaney and Li (2013) examine wage differences across manufacturing firms in the same

2-digit industry in a single industrial region in China, the Yangtze River Delta. After control-

ling for firms’ exporter status, location, subsector, capital intensity, size, workforce education

and gender, they find foreign ownership wage premiums of 36 per cent and 15 per cent in the

general equipment and textiles industries, respectively. That research also finds overseas Chi-

nese-ownership wage premiums of 18 per cent and 12 per cent for the two industries, respec-

tively. Those findings of disparate foreign wage premiums across two different industries in a

single region prompted the more extensive inquiry in this paper. Using an efficiency wages

perspective, we seek to understand why foreign ownership generates such different wage

premiums in different industries in China.

We contribute to the literature by estimating foreign wage premiums for each 3-digit man-

ufacturing industry in China, while controlling for the standard set of observable firm and

workforce characteristics (i.e. firm capital-intensity, size, workforce education and gender,

location and industry subsector), plus exporter status.

3

We are among the first to estimate for-

eign wage premiums while controlling for exporter status, which should tend to reduce our

foreign wage premiums relative to other estimates as foreign firms are more export-oriented

than domestic firms and exporter wage premiums are widely acknowledged as a stylised fact

(See Bernard and Jensen, 1995, 1997; Schank et al., 2007). Even after controlling for all of

these firm-level differences, we find a wide range of foreign ownership wage premiums across

the manufacturing industries. We use the cross-industry variation in wage premiums to look

3

Exporter status is added due to the results found in Greaney and Li (2013).

©2016 John Wiley & Sons Ltd

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