Academic journal article Journal of Economic Development

Foreign Capital Inflow and Skill Formation: Effects on Skilled-Unskilled Wage Inequality

Academic journal article Journal of Economic Development

Foreign Capital Inflow and Skill Formation: Effects on Skilled-Unskilled Wage Inequality

Article excerpt

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The recent literature on wage inequality between skilled and unskilled workers largely attributes foreign capital inflow as one of the instrumental factors behind the growing incidence of the wage inequality in developing countries. The basic argument is that foreign capital inflow induces skill biased technological change due to capital-skill complementarity and raises the demand for skilled labour and the wage inequality (Behrman, Birdsall, and Szekey, 2000; Pavcnik, 2003; Goldberg and Pavcnik, 2004).

The empirical evidence so far provides mixed results of the impact of increased capital on skilled-unskilled wage gap in developing countries (Anderson, 2005; Goldberg and Pavcnik, 2007). Aitken, Harrison, and Lipsey (1996) in a study of Mexico and Venezuela and Zhang and Zheng (1998) and Wu (2001) in studies of China find evidences of rises in relative wages of skilled labour due to entrance of multinationals. Freeman et al. (2001) find no evidence of any consistent relationship between FDI and wage inequality in a large sample of developing countries. Owen and Yu (2003) find in a study of China that the effect of FDI depends on whether it is export or import oriented. Tomohara and Yokota (2007) find that FDI's distributional effect in Thailand is closely related to the origin of FDI and its motivation, viz, horizontal or vertical FDI. Figini and Gorg (2011) in a study of panel data find the presence of a nonlinear effect in developing countries: wage inequality increases with FDI, but diminishes with further increases in FDI.

It is often argued that if liberalization policies are accompanied by conscious policies enhancing pro-technology adoption environments the wage gap may become markedly reduced (Fuentes et al, 2006). This view finds support in empirical findings that policies promoting FDI inflows towards countries with environments weakly prepared for pro-technology adoption may increase the wage gap between skilled and unskilled workers. (Feenstra and Hanson, 1997; Wood, 1997; Gopinath and Chen, 2003; Beaulieu, et al., 2004).

Since FDI generally entails a higher relative demand for skilled labour (Feenstra and Hanson, 1997), skill formation comprises one of the key mechanisms to provide favourable environment for FDI, resulting in significant impact on the wage gap. In fact, both demand-side factors (like skill biased technology) and supply-side factors (like education and skill) determine the wages and inequality thereof. In a study of five East Asian countries, Te Velde and Morrissey (2002) find that FDI has increased wage inequality in Thailand and Philippines, and reduced inequality in Korea, with less significant effects in Singapore and Hong Kong. While the Asian Tigers stand out as having high enrolment rates in secondary and tertiary education, this is less true for Philippines and Thailand. They suggest that countries wanting to develop on the basis of FDI should invest sufficient resources in good quality and appropriate human resources, or otherwise growth is likely to coincide with rising wage inequality.

A pervasive phenomenon found in developing countries is that FDI induces governments to boost up their allocation on education subsidy so as to induce further FDI flows. Slaughter (2002) shows that foreign capital positively contributes towards investment in human capital. Egger et al. (2005) shows that foreign capital tends to raise participation in higher education, both in cases when public education expenditure is held constant and when optimal adjustment of public education expenditure is allowed for. Zhuang (2013) shows theoretically as well as empirically that the jurisdiction government is willing to provide more education with the inflows of FDI by considering the fact that multinational enterprises will promote more production with higher stock of human capital. The FDI induced rise in the supply of skilled labour is likely to narrow the wage inequality. …

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