Labor Legislation, Educated Labor & Foreign Direct Investment in Manufacturing in Taiwan.

AuthorLai, Yu-Cheng


Taiwan has witnessed a high economic growth post 1980s and this growth is largely attributed to its competitive labor quality and cost. At the same time, the foreign investments have played an important role in the country's economic development, especially with the inflow of foreign direct investment (FDI) from Japan, US and overseas Chinese. The country has had some amount of success in exerting a pull on FDI since the early 80's. But, after the enactment of Labor Standards Law (LSL) in 1984 and implementation of other stern measures by the Council of Labor Affairs (CLA) the comparative advantage of product price in Taiwan began to decline rapidly (Lai, 2010). As a result, Taiwanese firms started investing in the foreign markets in China and ASEAN countries (Lee &Wu, 1996) to maintain the product price competition.

As the global companies tried to keep its products competitive by investing around the world, the governments in host countries also tried out different policies to attract FDI into their countries. According to Carstensen and Toubal (2004) the FDI inflow is largely due to the host country's high market potential and legal and economic environment, even if their relatively high labor cost may not always discourage the inflow of foreign investment. Unlike China and India, Taiwan does not have a large domestic product market. But, it has the other two advantages--legal and economic environment alongside the low unit labor cost. Cheap labor and competitive labor quality play a critical role in attracting foreign investors, and holding back the domestic firms from investing abroad. But then again, the enforcement of stricter labor standards can encourage the domestic firms to invest overseas (Lai & Sarkar, 2017a). Therefore, it would be important to study the effects of the Labor Standards Law (LSL) on labor cost, and to what extent were these effects responsible for bringing changes in inward and outward FDI in Taiwan. Simply put, has the lower labor quality and standards in the pre-LSL era helped the country in attracting more FDI or have the stricter labor standards enforced after mid 80s incidentally discouraged the FDI inflow to Taiwan?

Trend of FDI & Labor Regulation Enforcement

The Labor Standards Law (LSL) in Taiwan was passed in 1984 soon after the foreign investment started rolling into the country. With the implementation of LSL, new enforcement procedures and personnel were introduced into the system. Even if, a small number of employers have followed the earlier laws, with the enactment of LSL, the situation changed considerably. In the post-enactment period, the country witnessed an upsurge in labor enforcement activities.

The political pressure that brought the LSL also prepared the ground for further reforms and subsequently the enforcement department--the Council of Labor Affairs (CLA) was set up in 1987. According to existing law, the CLA could inspect only those firms that employ more than 100 workers. The Council used to delegate its power to local authorities who were not always eager to enforce the LSL. Other problems included a handful of inspectors who were inadequately trained and an overlap with the jurisdiction of local inspection agencies. During this period, the local business also lobbied intensely against any significant penalty for defaulters. As a result, the CLA was unable to effectively conduct inspections under the LSL. Therefore, the enforcement department finally drafted the Labor Inspection Law (LIL) and implemented it in 1993. (1) Under the new statute, the enforcement machinery was further strengthened and centralized. The years following the enactment of LIL (viz., from 1994 onwards) have been considered as the third phase in labor law reform in Taiwan that signifies stricter enforcement of labor standards in the country (Lai & Masters, 2005).

But then again, within three years from the enactment of LIL Taiwan, like other neighboring Asian countries, witnessed these verity of Asian financial crisis that impacted its domestic sectors as well as its global businesses to a considerable extent. It affected the foreign investment inflows and outflows in Taiwan too. Mitton (2002) and Lemmon and Lins (2003) have claimed that the impact of the financial crisis was felt mostly by the Asian firms or foreign owned firms operating in Asia between 1997 and 1998. On the domestic front, the Taiwan government initiated the unemployment insurance provision under Unemployment Benefits Rules (UBR) from January 1999 to strengthen employment protection clause which the LSL did not provide. (2) However, under this scheme, other than merely arranging for some payments to guarantee the basic livelihoods of employees who lost their jobs, the UBR had no provision of the employment service, rehabilitation or training. Therefore, to rectify this lapse and in order to provide a more comprehensive employment protection, the government brought in a new legislation, the Employment Insurance Act (EIA) in January 2003.

From the above discussion we can say that there were five major reforms in labor legislations brought by the government in a span of twenty years towards consolidating the labor enforcement machinery. At the same time, the key changes in foreign investment inflows and outflows in every part of the world including Taiwan happened during these two decades. Therefore, it is pertinent to examine whether the reforms and its effects on labor standards account for any major changes in the inflow and outflow of investment in Taiwan during this period.

Literature Review

There is a strong division among those who studied the relationship between labor cost and foreign investment. On the one hand are those who point out a positive correlation between growing labor cost and plummeting inflow of foreign investment (Lai & Sarkar, 2011; 2017b). Some of them have drawn our attention to a positive relationship between the wage and outflow of foreign investment (Hatziu, 2000; Janicki & Wunnava, 2004; Feenstra & Hanson, 2001). On the other side are those who see a budding relationship between host country's market potential, legal, economic environment, labor quality and inflow of foreign investment thereby discarding other factors like labor cost as a potential threat to its investment climate (Carstensen & Toubal, 2004; Gao, 2005 for China). Hanushek and Kimko (2000) found that labor quality characterized by the human capital accumulation leads to higher economic growth in host country. It was also seen that quality of manpower helps in rapid and effective transfer of technology from foreign lands to host country. Through productivity spillover the foreign ownership has positively influenced the output of domestic firms in host country (Sarkar & Lai, 2009). In this regard, Rhee and Belot (1990) argued that the foreign multinationals act as a natural channel for knowledge of the overseas market to the domestic firms, and by this means it encourages the export activity in host country. Labor quality has been found to be one of the important advantages of the host country that helped it in attracting foreign investment from developed world (Gao, 2005; Noorbakhsh, Paloni & Youssef, 2001). In the context of China, Gao found that education level of Chinese workers has played an important role in attracting foreign investment to the country. Compared to sectors with junior secondary and primary level educated workers, the ones with college and senior secondary level educated workers have exerted greater pull on investments from developed world. He has not observed a similar trend in the case of foreign investment inflows from developing countries, however.

So, there are two aspects to the effects of labor standards on foreign investment: one, the labor standards in host country compared to that in home country and two, the extent of employment protection in the host country. Concerning the first, we have noticed that comparison between labor standards in host and home counties explains the effects of labor standards on foreign investment. For example, studies have shown that investment rolls from home country to host country since there is greater flexibility in host country's labor market in absolute and relative terms compared to that of the home country (Javorcik & Spatareanu, 2005; Kucera, 2002). Nevertheless, the appropriate (local government) regulations in host countries do help them in attracting more foreign investment (Busse & Groizard, 2006).At the same time, it was also seen...

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