How Does Globalization Affect Income Inequality? A Panel Data Analysis

Article excerpt

Abstract One of the major issues on the state of income inequality is the effect of globalization through foreign direct investment (FDI). It is well known that FDI inflows create employment opportunities for unskilled labor intensive countries. Hence, during recessionary (expansionary) periods, FDI outflows should cause an increase in a developing (developed) country's unemployment rate, worsening income inequality. This study differs from the previous literature by employing the key variables FDI, trade volume, and GINI coefficient for a panel of three groups of countries (developed, developing, and miracle countries). We estimated panel cointegration coefficients via FM-OLS. Our results show that the effects of trade liberalization and FDI on income distribution differ for different country groups.

Keywords FDI * Income inequality * Globalization * Trade volume * Panel cointegration

JEL C10 * F01 * F15 * J30

Introduction

Globalization has been the magical word used to define the recent episodes of growth and increase in global welfare. With declines in tariffs or creation of free trade areas since the 1990s, globalization has built a set of prospects for mainly large firms around the world with declines in tariffs or creation of free trade areas. Companies have discovered ways to reach out to unchartered markets around the world. Accordingly, companies have also learnt how to decrease their costs further because it became possible for corporations to operate in economies that offer inherent opportunities, such as very low-wage-labor, convenience in tax payments, and lower transaction costs. Hence, globalization has led to broader perspectives and opportunities for many firms, the bulk of which belong to advanced economies. Nevertheless, globalization is beneficial not only for the firms of industrialized countries but also for the ones in developing nations. As a matter of fact, further integration of the developed world would be a bounded one with only fractional benefits. Thus, the steps that the developing economies took through globalization have been significant in their achievement of sustainable development processes. Convincing the developing countries to be more liberalized has also been very crucial, due to creation of additional gains for developed countries.

The globalization-led-international competition has caused firms of developing countries to struggle for market share, get rid of government subsidies and/or protectionist policies, and learn how to stand tall among giant corporations of developed countries. Trade liberalization brought forward low-cost products, making the consumers of the developing economies better off. Through channels of globalization, such as foreign direct investment (FDI), the technological know-how has reached around the globe. Lipsey (2002) argues that the yields of FDI are the contribution to growth by export enhancing developments, increase in revenue for budget through taxation of foreign firms (i.e., Multinational Corporations), and new employment opportunities. (1)

Apart from the economic changes, the interactions among economic and social development is crucial for all governments in the long term. In this respect, income equality arguably could be termed as the one of the most important indicators for social justice. The importance of social justice comes from the fact that achieving sustainable economic growth is necessary but not enough in a globalized world. In order to ensure social cohesion or peace, that is sine qua non for a long run success, social justice should be achieved and maintained. Otherwise, social diversifications and upheavals, which result in social, economic, and politic chaos, are inevitable in the long term. Therefore, this study examines how income distribution is affected by the FDI flows and openness of a country, as proxies for globalization.

Considering previous studies, there is not any common view on the effects of globalization. …