Foreign Direct Investment and International Skill Inequality

Abstract

This paper focuses on the effects of foreign direct investment (FDI) on skill inequality amongst countries. New growth models and international business studies predict that when countries liberalize their trade and investment regime in an environment of imperfect technology transfers, they will specialize in activities depending on the initial conditions such as skill endowments. Countries with few skills tend to specialize in low-skill intensive production, while countries with a high innovation rate and skill endowment tend to specialize in the production of high-skill intensive goods. The econometric evidence, based on an unbalanced panel for 111 countries over seven 5-year time periods from 1970 to 2000, confirms that FDI enhances skill development (particularly secondary and tertiary enrolment) in countries that are relatively well endowed with skills to start with. There are important policy conclusions for national governments when FDI tends to raise international skill inequalities. In particular, developing countries with low-skill endowments that attract investors would do well to co-ordinate actively their human resources policies with investor needs in order to bring the country to a higher skill path.

Notes

¹ There is a rapidly emerging literature that deals with the relationship between openness to trade and the demand for skills and education. The determinants of increased wage inequality include openness to globalization processes and technical progress and the associated organizational change. The evidence for the effects of trade on the structure of labour markets has emerged, see, for example, Wood (1997), though there is still comparatively little on the link between FDI and the structure of the labour market. Te Velde (2004) includes a survey of a handful of existing studies on FDI, and provides new evidence for Latin America..

² See Ashton et al. (1999) and Galhardi (1999) for how Asian governments were able to co-ordinate skill needs with (local and foreign) production for the global market.

Additional information

Notes on contributors

Dirk Willem Te Velde

The UK Department for International Development (DFID) supports policies, programmes and projects to promote international development. DFID provided funds for this study as part of that objective but the views and opinions expressed are those of the author(s) alone. We are grateful to an anonymous referee for helpful comments.

Theodora Xenogiani

Theodora Xenogiani, Economist, OECD Development Centre; Xenogiani worked on this paper when employed as a Research Officer at the Overseas Development Institute.