chapter  5
20 Pages

Foreign Direct Investment and Income Inequality

WithXiaodong Wu

This chapter provides an analysis that helps policymakers to design policies to boost economic growth without aggravating income inequality. It contributes to the rich literature by deriving a rule-of-thumb prediction for the effect of inward Foreign Direct Investment (FDI) on a host country's relative wage of skilled versus unskilled labor when there is product differentiation. The chapter explores some policy implications for China's labor market reform so as to accommodate China's accession to the World Trade Organization in its ongoing fight against poverty. It addresses whether all FDI into China, a relatively labor abundant country, will indiscriminately lead to an increase in the relative return to skill, regardless of whether the FDI source country is a newly developed or a well developed country. The chapter argues that the huge FDI inflow started in 1993 can be one of the driving forces and that the theoretical predictions are consistent with empirical evidence.