Foreign direct investment and income inequality in Southeast Asia: A panel cointegration analysis

This paper examines the relationship between foreign direct investment (FDI) and income distribution in the host country as measured by the Gini coefficient. After reviewing the extant literature and providing background knowledge, this paper undertakes a panel unit root and cointegration analysis that tests whether FDI has a non-linear impact on income inequality in seven selected Southeast Asian countries over the period 1990 to 2013. The paper finds strong evidence for panel cointegration using the Pedroni Augmented Dickey Fuller (ADF) and Phillips-Perron (PP) tests; thus, it proceeds to utilize the group-mean fully modified ordinary least squares (FMOLS) procedure to generate long-run estimates that are unbiased and consistent. The FMOLS estimator is also extremely accurate even in panels with very heterogeneous serial correlation dynamics, fixed effects, and endogenous regressors.

The FMOLS estimates confirm the hypothesis that FDI inflows tend to raise income inequality in the short run, but reduce it in the long run for the seven countries under study. Specifically, the Gini index starts decreasing after FDI inflows as a percentage of GDP reaches 0.56. The fact that the Gini coefficient reaches its maximum at a relatively low level of FDI inflows suggests that the sample countries are endowed with substantial absorptive capacity. In other words, they will shift into the new technological paradigm quickly, thus supporting pro-globalization claims that, on balance, FDI is more beneficial than harmful.

Keywords: Gini coefficient; Foreign direct investment (FDI); Fully modified ordinary least squares (FMOLS); Panel unit roots; Panel cointegration test; Southeast Asian countries.

JEL: C33; O10