Foreign direct investment and wage inequality: is skill upgrading the culprit?

Abstract

This article examines whether inward Foreign Direct Investment (FDI) is a source of wage inequality between skilled and unskilled labour in developing countries. Although the literature has explored wage inequality issues, we studied the impacts of FDI on skill upgrading comprehensively, together with trade and other factors (such as FDI externalities). Specifically, our analysis introduces the origin of FDI, controls for plant heterogeneity and relates the results to the FDI theory on Multinational Enterprises (MNEs). The results show that, on average, FDI caused wage inequality because of FDI-led skill-biased technological change. However, Japanese and Taiwanese investments helped to alleviate the inequality. Japanese and Taiwanese FDI is motivated by cost advantages achieved through vertical FDI and thus increases relative demand for unskilled labour.

Acknowledgements

An earlier draft of this article was prepared while the first author visited the ICSEAD as a visiting scholar. The first author acknowledges financial support from the ICSEAD and the Research Foundation of the City University of New York. The second author acknowledges financial support from the Grants-in-Aid for Scientific Research (No. 18530225). Specifically, we thank Eric Ramstetter for providing the industry survey data of Thailand and Robert Lipsey for his support for this project. We also thank Molly Sherlock and seminar participants at University of Pittsburgh and Waseda University for their helpful comments and suggestions for the earlier draft. All errors are ours.

Notes

¹NSO, various years. Report of the Manufacturing Industry Survey Whole Kingdom, NSO, Ministry of Information and Communication Technology, Thailand.