Foreign Investment, Democracy and Income Inequality: Empirical Evidence

Abstract

I empirically investigate the impact of Foreign Direct Investment (FDI) inflows and democracy on income inequality. Under the assumption that the effect of FDI inflows depends on the magnitude of the level of democracy in the host country, I also assess the interaction between the level of democracy and FDI inflows effect on inequality. Using a panel dataset of 153 developing and developed countries from 1995 to 2010, I use fixed effect method to fix for heterogeneity and the system Generalized Method of Moments by Arello and Bond (1998) to control for eventual endogeineity issues. This study concludes that FDI inflows and democracy level reduce income inequality. Moreover, robust and significant results are consistent on the assumption that FDI inflows alleviate income inequality in countries with higher level of democracy. Among the control variables used, consistent and robust results of the education attainment variable show that an increase in human capital reduces income inequality.