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Abstract
Distributional implications of capital account regulation is eminently context-specific. This paper examines the distributional effects of the openness of foreign direct investment (FDI) flows across 27 European countries in different economic environments around the Great Recession, covering the period 2007–2013. Our multi-level approach allows us to combine country-level variables and sociodemographic characteristics of individuals. The results highlight that the openness of FDI flows heterogeneously affects the income share of individual groups, favouring in particular the highest income classes. This finding seems to be driven by the educational level. We argue that even though highly educated individuals are present along the entire distribution, the highest income classes are especially favoured by the openness of FDI flows. This biased distributional effect of the openness of FDI flows persists throughout the years examined, regardless of the economic environment; this is due, in part, to the fact that the distribution of highly educated people is not sensitive to the business cycle.
Acknowledgements
The authors gratefully acknowledge the financial support provided by the University of Malaga and the Regional Government of Andalusia (UMA18-FEDERJA-005).
Disclosure statement
No potential conflict of interest was reported by the authors. The views expressed are those of the authors and do not necessarily represent the views of the European Central Bank and the Eurosystem.
Data
In this paper we made use of the European Union Statistics on Income and Living Conditions (EU-SILC) data. This data is public and can be freely accessed by contacting EUROSTAT, but we cannot provide it due to the privacy clause signed in the contract with EUROSTAT.
Notes
1 Although financial intermediaries’ vulnerability to bank runs and financial panic are heavily influenced by mismatches between short-term liabilities and long-term assets, this problem reaches a new level of severity in cross-border transactions, where there is no international lender of last resort (Radelet et al., Citation1998; Sachs, Citation1995). Besides, it is usually argued that financial liberalisation is typically followed by pronounced boom-bust cycles: bank credit expands rapidly during the booms, and excessive credit risk tends to be assumed, which, in turn, makes the economy more fragile and more prone to financial crises (Jaumotte et al., Citation2013; Jaumotte & Osorio Buitron, Citation2015; Rancière et al., Citation2006). Lately, these dynamics have been reaching previously unheard-of levels due to financial innovation.
2 IMF’s Annual Report on Exchange Arrangement and Exchange Restrictions (AREAER) database reports the restrictions on cross-border financial transactions; Chinn and Ito (Citation2008) provide details on the relevant methodology. Based on these data, the KAOPEN index develops de jure measures to assess a country’s degree of capital account openness.
3 Although the middle class ‘suffers’ from a liberalising reform while the upper quintile gains, this statement is true for income shares. Das and Mohapatra (Citation2003) found that income levels in liberalising nations almost universally rose after liberalisation.
4 Our sample includes advanced economies with a similar level of development. While this homogeneity allows us to control for the potential differential effect related to economic development, we do not address the analysis of low- versus middle- or high-income countries.
5 Bernard (Citation1995) and Revenga (Citation1994) show that more capital-intensive plans, involve hiring a larger proportion of skilled workers and offer higher wages.
6 This argument is especially important in the current global context, where income growth rates of low and middle classes in advanced economies are fairly stagnated, as revealed by the elephant graph in Lakner and Milanovic (Citation2013). The supply and price of skilled labour relative to unskilled labour have changed dramatically over the last decades, and the skill premium has grown significantly since 1980. In fact, one of the most studied questions arising from these facts is why the skill premium has risen during a period of significant growth in the relative supply of skilled labour. Skill-biased technological change has been the immediate answer, although there is no widely accepted standard economic theory for interpreting this change.
7 Trade openness might also be a channel for inducing income inequality, as trade flows may cause sudden changes in the relative demand of highly skilled workers as well as in relative wages, thus increasing income inequality (Anderson, Citation2005). Similarly, Cragg and Epelbaum (Citation1996) find that current account liberalisation and reduced costs of capital goods, due to trade liberalisation reforms, may increase relative demand for skilled labour and thus increase the college premium due to a special relationship between capital and skilled labour.
8 The threshold that distinguishes portfolio from direct investments is officially defined as an investment amounting to 10% or more of an entity’s equity. However, in practice, most FDI holdings reflect a majority control on the side of the holder.
9 Some authors have evidenced that FDI tends to flow into sectors that are more likely to employ high-skilled workers, hence increasing inequality (see e.g., Acharyya, Citation2011; Wu & Hsu, Citation2012; and Jaumotte et al., Citation2013).
10 The number of upper level units in the sample limit the number of country-level variables.
11 Data on capital account is available for both Great Britain and Ireland, while EU-SILC database offers microdata on the UK, on the one hand, and Ireland, on the other. Due to this mismatch, the UK is left outside our sample, but we do include Ireland.
12 Even though the IMF makes data on capital account liberalization available from 2000 up to 2013, as EU-SILC provides data for the pre-crisis period only for a reduced number of countries, we start our study in 2007. Otherwise, the reduced number of countries would undermine our analysis.
13 A value of 1 is assigned to the first adult in the household, 0.5 to each remaining adult and 0.3 to each member younger than 14.
14 Defined as the person owning or renting the accommodation.
15 We perform a robust check using an alternative definition of the income class, where individuals located between the second and eighth deciles constitute the middle class. See the Robustness section.
16 We have performed a robust check in which Model 2 does not control the income class. We obtain those potential drivers of income share gain explanatory power once dropping the income classes. Thus, all household level variables are significant, except the age of the household head. The results are available from the authors upon request.
17 We have checked the robustness of this result against an alternative definition of higher education. See the Robustness Section.