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Using a rich data set of the Dutch manufacturing sector between 1995 and 2010, we investigate the effect of foreign direct investment (FDI) on domestic new firm entry. The emerging empirical literature has focused on the direct relationship between FDI and entry, but has not explored the mechanisms behind the observed effect. Drawing on a simultaneous equations model, our analysis features both the direct effect of FDI as well as indirect effects through two channels: industry competition and wages. We estimate the parameters through 3SLS and take into account the endogeneity of competition and wages with respect to entry. Our results show that there is a significant negative direct effect of FDI on entry. At the same time, FDI decreases competition and increases wage levels, which then impact entry positively and negatively, respectively. The total effect of FDI is negative, but small and virtually disappears after one year. Policy implications are discussed.

Wage and competition channels of foreign direct investment and new firm entry