Does FDI lead to a deterioration of income distribution? Evidence from Malaysia

Income inequality has long been a frustrating feature of Malaysian economic development. The country income inequality, represented by the Gini Coefficient has decreased only slightly to 0.41 in 2014 from 0.51 in 1970. This income inequality, however, was accompanied by rapid economic growth. Gross Domestic Product (GDP) has grown by an average of more than 7 percent per year for 25 years or more. The expectations that the high economic growth would accompany low income inequality as hypothesized by the inverted ‘U-shaped’ Kuznets curve have not come true for Malaysia. Why did it occur? Unlike many other conventional studies which look at the relationship between growth and income inequality to explain this phenomenon; this study intent to looks at the foreign direct investment (FDI) relationship with income inequality. Since 1990s, FDI has been an important source of economic growth for Malaysia, bringing in capital investment, technology and management knowledge needed for economic growth. FDI had increased almost thirty-fold during 1970s to 2000s. There is a heated debate on the effects of FDI on income distribution. While FDI may have been good for development this masks the facts that not all types of workers necessarily gain from FDI to some extent. FDI induced skill specific technological change where it can be associated with skill-specific wage bargaining or skill-intensive sectors. This study presents an attempt to evaluate the impact of foreign direct investment (FDI) on income distribution among labors. The Malaysia’s Social Accounting Matrix (SAM) is constructed as a framework for the analysis. In this SAM the detail framework of the component of FDI in various sectors, production sectors and labor groups are essential to analyse different effects from different component of FDI on the labor’s income distribution among different labor group. This structure of SAM would answer the question of either and which component of FDI will benefit the most to the low income. The study finds that the FDI expansion has impacted negatively on the distribution of income across different labor groups, where it has increased the high-low or skilled-unskilled income inequality. It also indicates that there are differences in the composition of the FDI that impacts income distribution among labor. The apparent differences in the magnitude of the effects of the different FDI components suggests that variations in the FDI allocations among sectors should be considered as a possible policy variable to achieve income equality goals.