Foreign direct investments and income inequality: an empirical investigation within Europe

Abstract

Most research on the effect on foreign direct investments (FDI) focuses on the influence on economic growth and productivity. Much less attention is paid to the possible effects of FDI on income inequality. In order to get a better understanding of the effect of FDI on income inequality and if all people in a country benefit to the same extent, it is necessary to fill this gap. This research analyses the relationship between FDI and income inequality in a panel of 15 European countries from 2003 to 2012. In particular, it estimates the effect of FDI from a sectoral perspective, identifying two major sectors: the manufacturing and services sector. This research uses a panel fixed effects model (FEM) to control for all time-invariant unmeasured (or latent) variables that influence the relationship between FDI and inequality. This paper finds that there is a negative association between FDI and changes in income inequality. However, this paper did not find evidence for a non-linear relationship between FDI and inequality. In fact, only empirical evidence is found that FDI inflows in the manufacturing sector tend to reduce income inequality. This paper argues that the relationship between FDI and income inequality is (sub)sector specific and employments patterns associated with these sector investments can help explain these findings.