Foreign Direct Investment and Wage Inequality: Evidence from the People’s Republic of China | Asian Development Bank

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Foreign Direct Investment and Wage Inequality: Evidence from the People’s Republic of China

Publication | May 2017
Foreign Direct Investment and Wage Inequality: Evidence from the People’s Republic of China

The inflow of foreign direct investment creates a wage gap between foreign and domestic firms in the People’s Republic of China.

Based on theoretical analysis of the effects of foreign direct investment (FDI) on the wage gap between foreign firms and domestic firms in the host country, we use data from the Chinese Industrial Enterprises Database to measure these effects. Theoretical results show that the wage gap between foreign firms and domestic firms in the host country caused by the FDI labor transfer effect and technology spillover effect tends to increase then decrease, which implies an inverted U curve track. The empirical results show that FDI has significant effects on the wage gap in the People’s Republic of China (PRC) during the observed period. The contribution of FDI to change the wage gap is above 10%, which is in second position among all observed factors. From the overall point of view, the contribution of FDI tends to decrease. The reason is that the wage gap caused by FDI has stepped into the decreasing stage. This means the wage gap between foreign firms and domestic firms currently has been on the latter part of the inverted U curve. The government should expand fields for FDI to decrease the wage gap between foreign firms and domestic firms. This policy implication should be helpful for the PRC to step over the “middle-income trap”.

WORKING PAPER NO: 734