Do Foreign Investors Care about Labor Market Regulations? Beata Smarzynska Javorcik and Mariana Spatareanu World Bank, Washington, D.C. Abstract: This study investigates whether labor market flexibility affects foreign direct investment (FDI) flows across 19 Western and Eastern European countries. The analysis uses firm level data on new investments undertaken in the period 1998–2001. The study employs a variety of proxies for labor market regulations reflecting the flexibility of individual and collective dismissals, the length of the notice period and the required severance payment along with controls for busi- ness climate characteristics. The results suggest that greater flexibility in the host country’s labor market in absolute terms or relative to that in the investor’s home country is associated with larger FDI inflows. JEL no. F21, F23, J0 Keywords: Foreign direct investment; labor market regulation; firm level data 1 Introduction While the existing empirical literature on foreign direct investment (FDI) has examined the effect of various regulatory determinants on investment flows, 1 no attention has been paid to one key aspect of government regula- tions, namely the flexibility of labor markets, despite the fact that both the anecdotal evidence and the theoretical literature suggest it ought to be im- portant. For instance, a recent article in the Financial Times carried a head- line stating that “Archaic Labor Laws Stop Europe Working” and argued that Remark: The authors would like to thank Mathias Busse, Holger Görg, Jan Rutkowski, Maurice Schiff and an anonymous referee for helpful comments and suggestions and Simeon Djankov for providing an index of labor market flexibility. The views expressed in the paper are those of the authors and should not be attributed to the World Bank or its Executive Directors. Please address correspondence to Beata Smarzynska Javorcik, The World Bank, Development Economics Research Group, 1818 H St, NW, MSN MC3-303, Washington D.C. 20433, USA; e-mail: bjavorcik@worldbank.org 1 Wei and Schleifer (2000) examine the consequences of FDI incentives and restrictions on investment flows, Hines (1996) and Devereux and Griffith (1998) the effect of taxation, Javorcik (2004) the impact of intellectual property protection, Keller and Levinson (2002) and Javorcik and Wei (2004) the effect of environmental standards.  2005 Kiel Institute for World Economics DOI: 10.1007/s10290-005-0035-7