UC Irvine

How does foreign direct investment (FDI) affect income inequality? We bring evidence from the natural experiment of Central and Eastern Europe (CEE) to bear on a hotly debated topic. We begin by outlining the literature on the effect of FDI on income inequality, and the serious critiques offered by Firebaugh that raised doubt on previous research. We then discuss the ways in which CEE countries provide a natural experiment with which to contribute to this debate. We estimate a series of fixed effects regression models that relate income inequality to foreign investment and a baseline internal development model. We find that foreign investment has a robust positive effect on income inequality, net of unmeasured heterogeneity across cases, the internal development model, additional controls, and the critiques offered by Firebaugh. Further, we show that the effect is observable over the short term, no matter how FDI is measured. We conclude by directing attention to CEE countries as a historically unique opportunity to gauge the effect of exposure to the world economy on many development outcomes. © 2008 SAGE Publications.