Income inequality, development, and dependence: A reconsideration

We reconsider the role of foreign investment in income inequality in light of recent critiques that question the results of quantitative cross-nationa l research on foreign capital penetration. We analyze an unbalanced cross-n ational data set in which countries contribute different numbers of observa tions, with a maximum of 88 countries and 488 observations, dated from 1967 to 1994. Random-effects regression models that control for unmeasured coun try heterogeneity are used to investigate effects of foreign capital penetr ation on inequality (measured as the Gini coefficient) against the backgrou nd of an internal-developmental model of inequality. We adapt Firebaugh's ( 1992, 1996) critique of the literature on the effect of foreign investment on economic growth to the study of income inequality and find that the stoc k of foreign direct investment has an effect on inequality that is independ ent of the mechanisms identified by Firebaugh. We explore Tsai's (1995) cla im that the effect of foreign capital penetration is spurious and find that foreign stock has a significant positive effect on inequality net of regio n-specific differences. An alternative interpretation of the findings of th e foreign investment/inequality literature is discussed in light of the dis covery of an inverted-U shaped relationship between income inequality and f oreign investment stock per capita. We conclude that thinking on the relati onship between income inequality and investment dependence should be revise d in light of an investment-development path relating the inflow and outflo w of foreign capital to economic development.