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te Velde, Dirk Willem
Year of Publication:
Documento de Trabajo No. 04/03
There is a heated debate on the effects of Foreign Direct Investment on development. Proponents argue that FDI is good for development, and hence the rapid expansion of FDI in Latin America in the past decade and a half is manna from heaven. In some cases, it is indeed difficult to imagine whether the same development level could have been achieved without FDI. Critics, however, contend that FDI leads to more poverty, isolation and a neglect of local capabilities. Recent difficulties with privatization in Latin America, which involved FDI, appear to tell us that not all share in the benefits. The paper positions Foreign Direct Investment (FDI) in the debate on income inequality in Latin America. It argues that: • Income inequality is persistently and relatively high in almost all Latin American countries. Labor income inequality plays an important role in total income inequality. It is therefore instructive to examine developments in labor income inequality, both by occupation and education. We review different data sources. All support the conclusion that in most countries the relative position of skilled workers has improved over much of the late 1980s and early 1990s. In many, but not all, countries this has manifested itself in an increase in relative wages. Most countries have also experienced an increase in the relative employment of skilled workers (which should have caused a drop in relative wages) (Section 2). • Many researchers have examined the causes of income inequality in Latin America. Income inequality can be determined by at least three factors: the distribution of factors of production, the demand for those factors, and the supply. Labor or human capital, i.e., the distribution of education and the returns to skill, are the factors of production that are driving income inequality (Section 3). • While FDI may have been good for development (e.g. we find positive correlations between FDI and GDP, or productivity, or wages) this masks the fact that different countries with different policies and economic factors tend to derive different benefits and costs of FDI. In addition, not all types of workers necessarily gain from FDI to the same extent. The reasons for this include: FDI induces skill-specific technological change; it can be associated with skill-specific wage bargaining; it may locate in skill-intensive sectors; and it provides more training to skilled than unskilled workers. A review of micro and macro evidence shows that, at a minimum, FDI is likely to perpetuate inequalities. This is in contrast to what traditional trade and FDI theories would predict. Nevertheless, because there are so many opposing effects, empirical research is required (Section 4). • When FDI is measured as stock as a share of GDP, almost all countries experienced substantial growth in FDI over the past decade and a half (with the exception of the last two years). However, growth rates and sector distribution vary markedly by country. New preliminary empirical evidence shows that FDI did not have an inequality-reducing effect in Latin America. There are possible exceptions, such as Colombia, but even here FDI may still have played a relatively minor role in reducing inequality. On the contrary, there are indications that in countries such as Bolivia and Chile FDI may have increased wage inequality. While this does not imply that FDI was or was not good for development and poverty reduction in these countries, it does imply that most of the gains of FDI have benefited skilled and educated workers. FDI tends to raise wages of both types of labor, although for Bolivia the results suggested that FDI lowered wages of less-skilled workers more than wages of skilled workers (Section 5). • Government and business policies affect the link between FDI and income inequality. A government may use education, training, infrastructure, trade and investment promotion policies to improve the developmental impact of FDI. Similarly, businesses can use pay, training, industrial relations and supplier development. There are areas in which both a business and development case can be made for improving the social impact of FDI, and hence where co-ordination is required to realize win-win situations. These include: training, health, supplier development, infrastructure and transparency, security and reputation (Section 6). The main conclusion of the paper is that while FDI may have been good for development, more can be done to improve its impact on income distribution and the poor in Latin America, either through appropriate government policies in the area of education, training and infrastructure (i.e. a general development policy), or through working directly with TNCs through incentives or partnerships. Determining which policies are most appropriate and relevant will depend on country characteristics as well as FDI characteristics, and hence will require further discussion and in-depth studies.
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