Available online at www.sciencedirect.com Structural Change and Economic Dynamics 19 (2008) 17–37 Labour costs and FDI flows into Central and Eastern European Countries: A survey of the literature and empirical evidence Christian Bellak ∗ , Markus Leibrecht, Aleksandra Riedl Department of Economics, Augasse 2-6, A-1090 Vienna, Austria Received December 2006; accepted March 2007 Available online 24 March 2007 Abstract We analyse the determinants of Foreign Direct Investment (FDI) across selected Central and Eastern European Countries (CEECs) focusing on labour costs. We propose a labour cost measure which is relevant for the location decisions of Multinational Enterprises. A panel-gravity model approach is used to empirically assess the impact of market-related and cost-related location factors. Our dataset comprises bilateral net-FDI flows between seven home and eight host countries for the period of 1995–2003. Results suggest that higher unit labour costs as well as higher total labour costs affect FDI negatively, whereas higher labour productivity impacts positively on FDI. Our results support the choice of unit labour costs as the proper measure of labour costs, not least to avoid an omitted variable bias resulting from the exclusion of labour productivity. Standardised beta coefficients imply that all cost factors taken together (distance, taxes, labour costs) exert a considerable influence upon the decision to invest in the CEECs. In order to compensate for the rising wage costs in many CEECs, future public policy should contribute to improvements in labour productivity via investments in production-related infrastructure. © 2007 Elsevier B.V. All rights reserved. JEL classification: F15; F21; F23 Keywords: Foreign Direct Investment; Transition economies; Gravity model; Unit labour costs 1. Introduction We explain the pattern of Foreign Direct Investment (FDI) across selected Central and Eastern European Countries (CEECs) focusing on the role of labour costs 1 as a determinant of FDI. Labour costs are frequently considered to be among the key economic variables in the discussion of the determinants of investment location decisions of firms (e.g. Havlik, 2005a). In order to assess the FDI decisions of Multinational Enterprises (MNEs) properly, one has to consider a range of determining factors. The literature on the determinants of FDI has been influenced by theories of ∗ Corresponding author. Tel.: +43 1 31 336 4505. E-mail address: christian.bellak@wu-wien.ac.at (C. Bellak). 1 Throughout the paper the term labour costs is used as a generic term covering different types of labour costs like unit labour costs, total labour costs and gross wages. 0954-349X/$ – see front matter © 2007 Elsevier B.V. All rights reserved. doi:10.1016/j.strueco.2007.03.001