Foreign Direct Investment and Income Inequality in Southeast Asia: A Panel Unit Root and Panel Cointegration Analysis, 1990-2013

By Cho, Hyungsun Chloe; Ramirez, Miguel D. | Atlantic Economic Journal, December 2016 | Go to article overview

Foreign Direct Investment and Income Inequality in Southeast Asia: A Panel Unit Root and Panel Cointegration Analysis, 1990-2013


Cho, Hyungsun Chloe, Ramirez, Miguel D., Atlantic Economic Journal


Introduction

FDI and Economic Growth in Southeast Asia

For several decades, southeast Asian countries have exhibited remarkable annual growth rates second only to those of China (Coxhead 2014). Economic globalization has been a vital factor, with its abundant labor and natural resources southeast Asia has not only become an important base for multinational corporation (MNC) operations and international trade, but also a popular destination of foreign direct investment (FDI) flows, especially in the manufacturing sector UNCTAD (2014) and Pedroni (2000). Several empirical studies have found that increased flows of FDI into high-value added sectors have contributed to industrialization and rapid economic growth in Southeast Asia (Sjoholm 2014).

Yet, this popular view has been challenged by critics such as Chang (2003), Cypher and Dietz (2004), and Wade (1990). They argue that neoliberal policies have failed in generating faster growth and that the experience of states like South Korea, praised as an exemplary case of liberalization-led growth, has actually involved significant government intervention. Moreover, they contend that it is likely that the causality runs in the opposite way, viz., economic growth builds prior conditions and generates pressure for liberalization, by accumulating capital, improving technological capacity, and growing markets (Chang 2003).

Impact of FDI on Wage and Income Inequality

The issue of whether FDI flows have contributed to greater or diminishing income and wage inequality in emerging nations is a contentious one in the extant literature. Although wage inequality is an incomplete proxy for income inequality (Lindert and Williamson 2001), high wage inequality is likely to correlate with high income inequality unless the government mitigates the wage differentials with appropriate welfare programs. This correspondence is especially likely to be present in countries where a large proportion of the population makes a living through wages and salaries, which tends to be the case in most recipient countries of FDI. Hence, wage inequality and income inequality will be used interchangeably in this paper.

Bhandari (2007) hypothesizes that, in a host country where wage earners outnumber capital owners, the introduction of FDI will reduce income inequality. When FDI is added to domestic capital, the returns to capital are reduced, but the returns to labor are increased. Hence, income inequality within the economy decreases, ceteris paribus. Bhandari's hypothesis that FDI will reduce inequality in the host country has been supported by other prominent economists, including Obstfeld (1998) who contends that the effects of FDI on income distribution are similar to those of trade as predicted by the Heckscher-Ohlin-Stolper-Samuelson (HOSS) model.

This optimistic outcome has been challenged by the more recent experience of other countries that underwent trade liberalization, especially those in Latin America (Feenstra and Hanson 1995; and Wood 1997). In the case of Brazil, Arbache et al. (2004) report findings that trade liberalization introduced skill-biased technology to the country, hurting the low-skilled workers. Similarly, Latin American structuralist theorists such as Cypher and Dietz (2004) contend that FDI increases income inequality. Reuveny and Li (2003) discuss additional ways in which FDI (undertaken by MNCs) may exacerbate income inequality within the host country. For example, they often enjoy sufficient political power to pressure host governments to guarantee cheap labor costs. Second, they can decrease the workers' bargaining power through the threat of leaving. Third, MNCs push domestic firms to also pay low wages to keep their costs down. Their empirical analysis of 69 selected countries from 1960 to 1996 finds a statistically significant and positive relationship between FDI inflows and income inequality, in support of their conjecture. …

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