FDI and inequality in Sub-Saharan Africa: does democracy matter?

Abstract

PurposeThis paper investigates whether democracy plays a mediating role in the relationship between foreign direct investment (FDI) and inequality in Sub-Saharan Africa (SSA).Design/methodology/approachThe empirical analysis is conducted using fixed effects and system GMM (Generalised Method of Moments) on a panel of 38 Sub-Saharan African countries covering the period of 1990–2018.FindingsThe results find that FDI has no direct effect on inequality whereas democracy reduces inequality directly in both the short run and the long run. The sensitivity analyses find that democracy improves equality regardless of the magnitude of FDI, resource endowment or democratic deepening whereas FDI only reduces inequality once a moderate level of democracy has been achieved.Social implicationsThe results discussed above thus have four policy implications. First, these results show that although democracy has inequality reducing benefits, SSA is unlikely to significantly reduce inequality unless the region purposefully diversifies its trade and FDI away from natural resources. Second, the region should continue to expand credit access to reduce inequality and attract FDI. Third, policymakers should undertake reforms that will reduce youth inequality. Lastly, the region should focus on long-run democratic reforms rather than on short-run democratization to improve governance and investor confidence.Originality/valueAlthough there are existing studies that examine the association between FDI and inequality, FDI and democracy and democracy and inequality, this is the first study to explicitly examine the effect of democracy on the association between FDI and inequality in SSA, and the first study to separately consider the possible varied effects of contemporaneous democratization versus the long-run accumulation of democratic capital. In addition, rather than measure inequality by income alone, this study uses the more appropriate Human Development Index to account for SSA's sociological, education and income disparities.

Effects of Foreign Direct Investment on Wage Inequality in Developing Countries: Do recipient sectors matter?

“…However, this pattern of inward vertical FDI cannot guarantee lowering wage inequality in developing countries even in countries that are relatively dependent on labor intensive sectors (Herzer et al, 2014;Nguyen, 2021). The reason is that despite these processes of production are low-skilled labor intensive from the perspective of MNCs, it is still high-skilled labor intensive from the perspective of developing host countries (Gossel, 2022;Huang et al, 2020). Hence, relying on attracting inward vertical FDI in developing countries will raise wage inequality (Couto, 2018;Le et al, 2021;Li and Su, 2021).…”

“…The global economic system is shaped so that this dependency is increasing. According to this theory, labor in the FDI-recipient sectors isolates themselves from the rest of labor in the traditional sectors in the receiving country (Gossel, 2022). This leads to increase the wage inequality between both (Hemmer et al, 2005).…”

“…Following the model, the presence of firms internationally is divided into three categories: least-productive-firms exit totally from foreign markets, relatively more-productive-firms choose to export and most-productive-firms prefer FDI (Helpman et al, 2004). Considering search frictions result from labor market imperfections, inward FDI redistributes income leading to increase wage inequality at first stages of development then decrease it later with deepening development (Gossel, 2022;Redding, 2011). According to the model, this does not differ from one sector to another.…”

“…The following is a number of recent studies those differ in terms of countries used in application, measures of inequalities, and technique used in estimation. Gossel (2022) investigated the distributional effect of inward FDI in 38 Sub-Saharan African countries from 1990 to 2018 using both of FE and S-GMM techniques. Human Development Index was used instead of Gini referring to inequalities and the stock of inward FDI as a ratio of GDP was used referring to inward FDI.…”

The Dynamics of Economic Globalization and Income Inequality in Sub-Saharan African Countries: An Empirical Insight from Two Stage Least Square and Fixed Effect Approach

“…In addition, the [26,27] technological change hypothesis posits that there is a rapid demand for skilled labour and new technology in the early stage of development, which increases inequality but when low-skilled workers develop more skills, there is a reduction in income inequality over time as the supply of skilled labour equates demand [28].…”