Do Foreign Firms Thrive in Immigrant Enclaves? O Da!

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Wharton’s Exequiel (Zeke) Hernandez discusses his research on how foreign firms benefit when they move into areas inhabited by immigrants from their home countries.

Studies have shown that foreign companies tend to move into areas where immigrants from their home countries live, and they have also suggested that doing so could boost performance. But new research coauthored by Wharton management professor Exequiel (Zeke) Hernandez and Elena Kulchina, a strategic management professor at North Carolina State University, looks closely at why, and under what circumstances, that boost happens. Their paper is titled “Immigrants and Firm Performance: Effects on Foreign Subsidiaries versus Foreign Entrepreneurs.” Hernandez spoke with Knowledge@Wharton about their research and its implications for companies wanting to do business abroad. (Listen to the podcast at the top of this page.)

An edited transcript of the conversation follows.

Knowledge@Wharton: When foreign firms establish businesses in places where immigrants from their home countries reside, how do these firms benefit?

Exequiel “Zeke” Hernandez: What studies have suggested is that there are three classes of benefits, or reasons, that would attract a firm to where immigrants from their home countries live. The first one would be what I’ll call demand. That is, there is a new market there. You sell a product that the immigrants like. I’m a Mexican firm. I sell tacos. Here is a new market for tacos. But it’s not just that you get a bigger demand among the immigrant population; the natives of the receiving country would also want to start eating tacos, for example, so you just get a bigger market.

The other benefit is more on the supply side, meaning you can go there and get benefits that help you operate more efficiently or at lower costs. For example, if I’m a firm from China and I move into Russia, I might be able to hire Chinese workers and use them more effectively or more efficiently. It could also be that the immigrant community helps me find suppliers. It’s anything on the supply side of business.

The third kind of mechanism is what we typically [label] knowledge. I can get knowledge or information about an opportunity to invest in a certain foreign market, and the immigrant community helps me learn about that opportunity for the first time. Or I decided to invest in a country like the United States, but I don’t really know how the United States works, so the immigrant community can help me get information about how to do business there.

Demand, supply and knowledge would be the three categories that researchers have speculated are beneficial and why we see this pattern of firms moving into places where immigrants live.

Knowledge@Wharton: What was the main question you set out to answer with this research?

“Studies hadn’t really shown if setting up a business where these co-national immigrants live affects profits, so that was the broad question we wanted to ask.”

Hernandez: What previous papers had shown, including some of our own work, was that firms locate in the same places where immigrants of the same nationality live. But the research had been a little bit unclear as to whether this really affects performance. For example, you could imagine that a firm from Korea likes to be where Koreans are [for a variety of reasons]. But studies hadn’t really shown if setting up a business where these co-national immigrants live affects profits, so that was the broad question we wanted to ask. Does it affect profits?

Knowledge@Wharton: In your study, you look at the performance of firms owned by individual foreigners and those that are subsidiaries of multinational firms. Does one type have an advantage over the other when it comes to setting up a business in an immigrant community?

Hernandez: That’s a great question and a really important one to understand what we’re doing in this study. I answered your previous question by saying that the broad question we’re trying to answer is does it affect performance? But as we dug into what’s really going on here, we realized that there are two types of foreign firms. There are subsidiaries of multinational firms, and there are foreign firms that are started by foreign individuals. Let’s just call [the second type] foreign startups or foreign entrepreneurial firms.

What we suspected is that perhaps the benefits of being close to these co-national immigrants differ if you’re one of these two types of firms. Think of a restaurant like Shake Shack moving abroad versus an American entrepreneur starting a hamburger restaurant abroad. A lot of us know Shake Shack. We like to eat there. That’s a pretty different position [to be in] in a foreign market [compared to the entrepreneur selling hamburgers].

Let me tell you what we found and then I’ll go back to these two firms. What we found is that, on average, both types of firms profit from co-national immigrants. The more immigrants of the same nationality there are in the foreign location, the higher the profits of both types of firms. But the mechanism or the means by which they get those profits is a little bit different.

If it’s a foreign startup — I’m an individual and I own my hamburger restaurant — what we found is that type of firm will profit from the immigrant community, but only if the firm is managed by an immigrant CEO. That is, a CEO that is of the same nationality as the target immigrant community. Let’s say in this case it’s the expat U.S. community. If the firm had a local CEO, it did not get that benefit.

If I’m Shake Shack, I’m the subsidiary of a big multinational, so I benefit from the immigrant community regardless of the nationality of the CEO. Why would that happen?

I think the Shake Shack versus hamburger startup example is useful. If I’m Shake Shack, what do I have? I have a reputation among the immigrant community abroad. I have a brand. People might have already eaten in my restaurant. In the eyes of the immigrant community, they can relate to me through these mechanisms, these brands, reputation, marketing channels that I already have established as a multinational firm.

In contrast, if I’m the entrepreneur who is starting the new hamburger restaurant, I don’t have all of those resources, all of that organization, reputation and history. What do I need to do to connect to the immigrant community? I need to develop a personal connection to them. And that’s why it’s so important for a foreign startup to have an immigrant CEO to benefit from the immigrant community. But it doesn’t seem to be that important for the subsidiary of a multinational firm.

Knowledge@Wharton: Why did you choose Russia as the context for this study?

Hernandez: The data came from thousands of foreign firms operating in Russia. Russia was convenient for two very important empirical reasons. One is that because of Russian law, local businesses have to report financial statements at the subsidiary level, at the level of the local establishment. Why does that matter? Besides perhaps nerdy empirical reasons, we were able to observe profitability at the level of the local business. And that’s not available in all countries.

But there’s a second reason that’s very important to the research design. If you think of trying to establish an empirical relationship between immigrants and the performance of firms that are of the same nationality as those immigrants, that could be just a spurious correlation. It could be that, for example, both immigrants and firms choose places that have a good economy. In fact, it’s very likely that they both do because there are jobs for the immigrants and a good market for the firm trying to set up a business there. It’s very hard to know which one causes which. Is it the immigrants that cause profits, or is it other spurious [reasons] like the one I just mentioned?

Russia offered us a historically convenient situation where, if we were trying to run an ideal experiment, we would do the following: We would have firms of a certain nationality in a certain place, and then we’d randomly assign immigrants from the same nationality to either show up or not show up in that place. And then we could see the performance of those firms.

It turns out that Russia kind of offered a setting like that in the lead-up to two big events — the Sochi Olympics in 2014 and the Asia-Pacific Economic Cooperation Conference, which is a big event, in 2012. Russia had to build a lot of infrastructure in Vladivostok, which is on the eastern side of Russia, and then in Sochi, which is on the western side. Two very different provinces. And because Russian construction labor couldn’t keep up with the demands, Russia lifted the quota on foreign construction workers in those two places.

“Immigration plays a very important role in the diffusion and attraction and movement of foreign capital around the world.”

All of a sudden, in those two places, we had firms of certain nationalities who saw this huge influx of construction workers from their home countries…. Those countries tended to be places like Turkey and China — countries that were nearby Russia. But then there were other foreign firms that didn’t see immigrants from their home countries come in.

What does all of that do? It allows us to have something of a natural experiment where we can compare the performance of firms that unexpectedly saw an increase of immigrants from their home countries coming into where they were, and firms that did not. We can set up that comparison and have some claims at causality. That’s why we chose Russia. To go back to the results, what we can observe is that the performance of these firms that unexpectedly received an influx of co-national immigrants performed significantly better than the firms that didn’t.

Knowledge@Wharton: Can you explain the concept of social embeddedness and how that plays out?

Hernandez: Social embeddedness is a concept that, unsurprisingly by the name, comes from the field of sociology. It’s a concept that we rely on to explain what’s going on here in our study. It’s the idea that economic transactions aren’t driven purely by cold, hard economic calculus, although they are partially driven by that. But they are often embedded or surrounded by social considerations. For example, if you’re my friend, I might give you a good deal or help you out a little bit. This concept of social embeddedness has been applied to the way immigrant communities do business with each other. Being of the same nationality creates these bonds. This common nationality bond creates a situation in which economic transactions are smoothed a little bit because of certain mechanisms. And what this literature shows is there are two mechanisms in particular that are very unique to immigrant communities.

There is one mechanism called bounded solidarity. It’s just the fact that, “Hey, we’re in this together. We’re foreigners. We’re outsiders in this receiving country. Let’s help each other out. Let’s do each other some favors.” Perhaps they prefer to transact with each other. “If I have to do my dry cleaning, I’ll do it with you, and not with somebody else.” It’s just kind of a preference for doing business and helping each other out.

The other one is what’s called enforceable trust, which is the idea that we don’t want to act badly with each other in economic transactions because [of our social connections]. “I know your cousin,” or “We go to the same ethnic church,” or something like that. It’s not kind of a Mafia thing. It’s more like, “Hey, let’s play nice with each other in business because we interact in these other settings. We have this commonality of being of the same ethnicity or nationality.”

This is a concept that we use in the paper to explain why it is that a community of immigrants would be beneficial for a firm of the same nationality. It’s for these two reasons. There’s a commonality. “Hey, we’re both American,” or “We’re both Korean,” or “We’re both Chinese. Let’s go give the benefit of the doubt to this business.” If I work for you and we’re of the same nationality, I’m going to behave well towards you because we might go to church together or our kids might go to the same school. These are reasons why one could explain the benefits of doing business within the immigrant community, especially when you’re a foreign firm in a foreign, sometimes hostile location.

Knowledge@Wharton: What are some of the key takeaways of your research for both multinational companies and independent companies looking to establish a presence in immigrant communities?

“Economic transactions aren’t driven purely by cold, hard economic calculus…. [They] are often embedded or surrounded by social considerations.”

Hernandez: I think the advice comes directly from the results. One is that you are likely to benefit from picking a place that has a high number of co-national immigrants. Of course, you have to take into account the economics and the other things. But say two places are relatively comparable — give the nod to the place that has an immigrant community because you’ll get these benefits that I’ve been talking about.

But understand the type of firm you are. Understand that if you don’t have a pre-existing reputation, brand, marketing channels, if you’re not part of a multinational firm, of a parent firm, you’re going to need to appoint an immigrant manager to relate to the immigrant community, whereas you don’t necessarily have to do that if you’re the subsidiary of a multinational firm.

Knowledge@Wharton: On the whole, what does your study indicate about the economic value of immigrants?

Hernandez: This study is one in a series of papers on related topics that I’ve done. But the broader implication here is that immigration plays a very important role in the diffusion and attraction and movement of foreign capital around the world. In this particular paper, what we’re adding is that immigration doesn’t just help explain where capital is moving across the world, but that that capital is going to be used more productively by the firms that are making those capital investments. In that sense, immigration is a leading indicator of where capital is going to flow and where it’s most likely to be productive. Immigration is a very powerful attractor of firms, but it also seems to help those firms be more profitable.

Knowledge@Wharton: What question would you explore next in this area?

Hernandez: The thing that really stood out to us from this study is just the importance of individuals, particularly managers, in helping firms connect with these immigrant communities and benefit from these immigrant communities.

Something we’re actively studying in a follow-up paper is how multinational firms allocate managers depending on the sizes of immigrant populations in foreign countries. Let’s use Korean multinationals as an example. The Korean diaspora is spread out across many parts of the world. If I’m Samsung, am I more likely to appoint a Korean manager in places where there are lots of Koreans versus fewer Koreans? It’s not obvious in which direction that’s going to go, but this study has suggested that it’s important to understand why something like that might happen.

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