FDI inflows and income inequality: A Schumpeterian economic growth

Abstract

It is well documented that inward FDI promotes economic growth and technological progress which are demonstrated to affect income inequality. This paper investigates the distributional effect of FDI inflows. We propose a Schumpeterian economic growth model adopted with the Pareto income distribution. The theoretical model implies that FDI inflows would increase income inequality by promoting economic growth but reduce it by causing creative destruction. The overall distributional effect of FDI inflows is hard to be predetermined. We employ the GLS approach to conduct the empirical test, relying on the dataset taken from 126 countries. The Pareto index constructed based on top income shares indicates that FDI inflows reduce income inequality in emerging market countries but increase income inequality in developed countries. This finding is further confirmed by directly regressing top income shares on FDI inflows. Empirical evidence supports the channels suggested by the theoretical model. The results are found consistent on employing alternative top income shares, proxies of FDI inflows, model specification and estimation approaches.