The Effect of Foreign Competition on UK Employment and Wages: evidence from firm level panel data1
By Jozef Konings and Hylke Vandenbussche
Catholic University of Leuven, Faculty of Economics, Naamsestraat 69, 3000 Leuven, Belgium

April 1995

Abstract This paper contributes to the sparse empirical literature on the effects of foreign competition on domestic employment and wages. For this purpose we estimate a structural labour demand equation on UK firm level panel data between 1982-1989. We also estimate several wage equations. We find that intensified foreign competition has a positive effect on wages but does not affect employment. The results suggest a negative effect of UK domestic competition on employment in unionised firms. When we restrict the sample to the manufacturing sector only, we find for the unionised firms that foreign competition has a negative effect on both wages and on employment. However, when UK manufacturing firms face only a few rivals, foreign competition has a positive effect on wages, but no effect on employment. Furthermore the results suggest that increased domestic competition reduces employment in manufacturing firms which face many rivals, but do not alter wages. JEL classification: F2, J3 Address for correspondence: hylke.vandenbussche@econ.kuleuven.ac.be, T: + 32 (0) 16 32 69 20

1 We wish to thank Bruno De Borger, Stefan Késenne, Mathew Tharakan and an anonymous referee for helpful comments and suggestions. All errors are ours.

I. Introduction Fear has grown in the industrialised countries that free trade with low wage developing countries will harm domestic industry and employment. The recent debate in the United States on free trade with Mexico under the NAFTA agreement clearly demonstrates this concern. Lobby groups like trade unions claim to protect domestic industries, in particular the labour intensive ones, to prevent employment loss or real wage declines due to the low wage competition from abroad2. However, there is hardly any empirical research on this important topic and arguments are therefore often put up in an ad hoc manner3. International economists and economic policy makers do not seem to agree on this issue. This paper contributes to the literature and investigates the effect of increased foreign competition on UK employment and wages, by using a unique firm level dataset covering both the manufacturing and non-manufacturing sectors in the UK between 1982-89. The plan of the paper is as follows. In section 2 we briefly review the theoretical debate of trade liberalisation effects on wages and employment. The empirical methodology and the dataset we use, is discussed in section 3, while in section 4 we report and discuss the results. In section 5 we interpret our results and we conclude and summarize the paper in section 6.

Bhagwati (1994) in a recent survey article discusses nicely the current concern about free trade and competition from the "South". 3 Revenga (1992), following Freeman and Katz (1991), investigates empirically the effects of increased import competition for the US, while Grossman (1986) investigates the effects of international competition in the US steel industry.

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II. Theoretical Background The theoretical debate on the effect of foreign competition on employment is still in its early phases despite its practical relevance in trade policy. GATT's article IX and VI, respectively the 'escape clause' and the 'antidumping code', are exceptions to GATT's overall objective to safeguard free trade. Both types of trade regulation allow a member country to take protectionist action when evidence is provided that foreign imports have caused 'material injury' to one or more industries. The effect of foreign imports on domestic employment is only one among several indicators of injury but it is the argument people feel most sympathetically towards and which is consequently often used by policy makers to justify protection (see Vandenbussche