Will Foreign Capital Inflow Alleviate Income Inequality?

Abstract

ABSTRACT With the rapid increase in foreign capital inflow, a major concern for policy makers is whether such capital accumulation will help to alleviate a developing country's income inequality or make the rich richer and the poor poorer. This paper points out that more intensive competition in the labor market can be one of the reasons causing China's rising income inequality. This is because of, first, the increase in urban unemployment, especially from the state-owned enterprises, and, second, the rising nominal wage gap between the state-owned enterprises and firms with whole or partial foreign ownership. However, the overall productivity and hence the real wage can increase in both the private sector and the state sector. To reduce income inequality, the government should further enable the state sector to compete on an equal footing with the private sector. This includes both increasing labor mobility and removing the state sector's obligations to provide social welfare to its employees. Moreover, it is essential to build a social safety net to assist the losers in this labor market reform to ensure social stability as China opens both good and financial markets.