International Journal of Comparative Sociology-2008-Mahutga-429-54, artykuły, papers
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//-->International Journal of ComparativeSociologyForeign Investment and Income Inequality : The Natural Experiment of Central andEastern EuropeMatthew C. Mahutga and Nina BandeljInternational Journal of Comparative Sociology2008 49: 429DOI: 10.1177/0020715208097788The online version of this article can be found at:Published by:Additional services and information forInternational Journal of Comparative Sociologycan be found at:Email Alerts:Subscriptions:Reprints:Permissions:Citations:>>Version of Record- Nov 14, 2008What is This?Downloaded fromcos.sagepub.comby Anna Dom on October 30, 2012429International Journal of Comparative Sociology 49(6)International Journal of Comparative SociologyCopyright © 2008 SAGE PublicationsLos Angeles, London, New Delhi and SingaporeVol 49(6): 429–454DOI: 10.1177/0020715208097788Foreign Investment and Income InequalityThe Natural Experiment of Central and Eastern EuropeMatthew C. MahutgaUniversity of California, Riverside, USANina BandeljUniversity of California, Irvine, USAAbstractHow does foreign direct investment (FDI) affect income inequality? We bring evidence fromthe natural experiment of Central and Eastern Europe (CEE) to bear on a hotly debatedtopic. We begin by outlining the literature on the effect of FDI on income inequality, and theserious critiques offered by Firebaugh that raised doubt on previous research. We thendiscuss the ways in which CEE countries provide a natural experiment with which tocontribute to this debate. We estimate a series of fixed effects regression models that relateincome inequality to foreign investment and a baseline internal development model. We findthat foreign investment has a robust positive effect on income inequality, net of unmeasuredheterogeneity across cases, the internal development model, additional controls, and thecritiques offered by Firebaugh. Further, we show that the effect is observable over the shortterm, no matter how FDI is measured. We conclude by directing attention to CEE countriesas a historically unique opportunity to gauge the effect of exposure to the world economyon many development outcomes.Key words:Central and Eastern Europe • development • foreign direct investment• inequality • post-socialist transitionINTRODUCTIONOne foundational orienting question for the social sciences has been the sourceof various forms of inequality (e.g. Alderson and Nielsen, 1999; Mahutga, 2006;Milanovic, 2005; Morris and Western, 1999; Nielsen, 1994). One of the standardapproaches to the explanation of cross-national variation in income inequality isoffered by the foreign investment dependence (PEN) – the percentage of a nationaleconomy owned by foreign actors – literature, which suggests that a high level offoreign ownership in a domestic economy increases the level of inequality for thecountry as a whole (e.g. Beer and Boswell, 2002; Bornschier and Ballmer-Cao, 1979;Downloaded fromcos.sagepub.comby Anna Dom on October 30, 2012430International Journal of Comparative Sociology 49(6)Bornscheir et al., 1978). Indeed, the purported impact of PEN is not limited toinequality trends, but also affects many development outcomes, such as economicgrowth and urbanization (Bornscheir and Chase-Dunn, 1985; Dixon and Boswell,1996; Evans and Timberlake, 1980; Kentor, 1998, 2001). Further, a large and grow-ing body of literature finds that PEN affects an economy’s impact on the environ-ment by generating higher pollution rates (Jorgenson, 2006a, 2006b; Jorgenson andKick, 2006; Kentor and Grimes, 2006).However, the literature finding deleterious PEN effects was subject to a seri-ous critique by Firebaugh (1992). This was followed by a fairly convincing rebut-tal (Dixon and Boswell, 1996), and subsequent findings that tended to supportthe inequality increasing effects of penetration across a rather heterogeneoussample of countries (Alderson and Nielsen, 1999). Nevertheless, the debateabout the developmental effects of PEN is far from settled. In particular, therecontinues to be some debate over whether or not it ‘makes sense’ to conceptual-ize the effects of foreign direct investment as the delayed consequences of thehistorical penetration of a national economy that leads to long-term ‘disarticu-larion’, or rather that the effects of FDI can only truly be assessed over the shortterm – and studies taking the latter view tend to contradict the hypotheses ofthe PEN literature (e.g. de Soysa and Oneal, 1999, cf. Dixon and Boswell, 1996;Kentor, 1998).We argue that the recent experience of post-socialist transition countries fromCentral and Eastern Europe (CEE) provides a natural experiment with which toassess the effect of foreign investment dependence on income inequality. Thesecountries had almost zero foreign investment prior to the fall of the communistregimes, after which they increasingly opened up to foreign investment to vary-ing degrees (Bandelj, 2008). Thus, this case provides a window through whichto view changes in the distribution of income as economies that were isolatedfrom Western political and economic practices, fairly advanced in terms of theirindustrial infrastructure and egalitarian in terms of their political orientation,become exposed to foreign investment.This article begins by outlining the debate on the effect of inequality fromthe dependency/world-systems perspective and the subsequent critique offeredby Firebaugh (1992). We then discuss the various ways in which CEE provides anatural experiment with which to assess the role FDI plays in income inequality,and discuss the mechanisms through which FDI likely impacts income inequal-ity in CEE. We continue by discussing control variables that should be includedin order to isolate the effect of FDI on inequality: a) the internal developmentmodel (Alderson and Nielsen, 1999; Nielsen, 1994), and b) additional factorsproposed by the literature: rising unemployment, the retrenchment of govern-ment spending and the relative level of privatization. We then estimate a seriesof fixed effects models that control for unmeasured time-invariant unit-specificheterogeneity. We find that PEN significantly increases income inequality, net ofthe internal development model, the critiques suggested by Firebaugh (1992),Downloaded fromcos.sagepub.comby Anna Dom on October 30, 2012Mahutga and BandeljForeign Investment and Income Inequality431and other potential suspects. Further, we show that both yearly inflow and accumu-lated stock have substantively identical effects, indicating that the effect of FDI inthese CEE cases is significant over the fairly short term. We conclude by suggest-ing that transition countries will continue to provide an important research siteallowing researchers to assess the effect of FDI and globalization on inequality, aswell as other outcomes over the course of these countries’ long-term change.FOREIGN INVESTMENT AND INCOME INEQUALITYThose approaching the problem of development from the world-systems/dependency perspectives suggest that PEN has deleterious consequences forhost economies. In particular, PEN contorts the composition of a nation’s forcesof production to rely on low wage and unskilled labor to produce goods atlow levels of technological sophistication. This creates few opportunities forbeneficial ‘spill-over’ effects such as research and development activities, indus-trial services or differentiation (Bornschier and Ballmer-Cao, 1979; Bornschierand Chase-Dunn, 1985; Galtung, 1971; Hirschman, 1945). Furthermore, heavydependence on foreign capital promotes an uneven distribution of capitalintensity across sectors and geographical regions in the receiver economy. Thisconcentrates income in (typically more productive) outward oriented sectors,increasing overall income inequality (Frank, 1967; Stack, 1980). In addition, PENconstrains the development of bureaucratic skills necessary for a highly function-ing business sector. This increases inequality because it delimits the productionof human capital within the receiver economy (Bornschier and Ballmer-Cao,1979; Bornschier and Chase-Dunn, 1985; Evans and Timberlake, 1980).Scholars also argue that foreign capital penetration encourages inequality byinfluencing the distributive capacity of nation-states. Increases in global capitalflows tend to produce a ‘race to the bottom’ in which governments in devel-oping nations seek to attract foreign investment by implementing policies thatlower the bargaining power of labor, eliminate provisions that encourage fullemployment and wage enhancement, such as job training and local purchas-ing requirements, and thus remove institutional constraints on rising incomeinequality (Beer and Boswell, 2002; DeMartino, 1998; McMichael, 1996; Ranney,1998). In sum, the dependency and world-systems perspectives suggest that PENis associated with higher levels of inequality.While many studies in the world systems/dependency literature report thedeleterious effect of PEN on economic growth and income equality (Alderson andNielsen, 1999; Bornschier and Ballmer-Cao, 1979; Bornschier and Chase-Dunn,1985; Bornschier et al., 1978; Dixon and Boswell, 1996; Evans and Timberlake,1980; Kentor, 1998; Tsai 1995), early studies were subject to a major critique byFirebaugh (1992). In the context of economic growth, PEN researches estimatedmodels that contained both FDI flow (the yearly inflow) and FDI stock (thecumulated inflow) in the same equation, and interpreted a positive coefficientDownloaded fromcos.sagepub.comby Anna Dom on October 30, 2012432International Journal of Comparative Sociology 49(6)on the former as a short-term beneficial effect, and a negative coefficient onthe latter as a long-term deleterious one. Firebaugh countered that the negativesign on the stock variable could also be interpreted as a beneficial effect of theforeign investment rate: the faster the yearly inflow of foreign investment, thefaster the economic growth. This argument stems from the fact that the foreigninvestment rate is calculated as the ratio of flow/stock, so that including bothflow and stock as separate regressors is equivalent to estimating the effect of thenumerator while holding the denominator constant in the case of flow, and viceversa in the case of stock. Thus, ‘a negative effect of foreign investment stockin such a model would indicate a positive effect of the foreign investment rateon growth because, keeping flow constant, the larger the stock the smaller therate’ (Alderson and Nielsen, 1999: 612). Firebaugh concludes by arguing thatthe correct interpretation for the findings from PEN studies is that the foreigninvestment rate (the ratio of flow/stock) benefits developing countries, but thatit doesn’t benefit them as much as domestic investment.We should note that Firebaugh’s main critique was directed at interpretationsof the effects of foreign investment on economic growth rather than on incomeinequality. Nevertheless, Firebaugh (1992) argues that the logic holds in thecontext of ‘non-economic’ outcomes (pp. 123–4), and as Alderson and Nielsen(1999) emphasized, studies measuring the effect of investment dependence oninequality should also avoid misinterpretation due to denominator effects. Wefollow previous analyses (Alderson and Nielsen, 1999; Dixon and Boswell, 1996)and use a variety of model specifications to avoid misinterpreting any results forforeign capital penetration.FOREIGN INVESTMENT AND TRANSITION FROM SOCIALISM: THE NATURALEXPERIMENT OF CENTRAL AND EASTERN EUROPEPost-socialist countries in Central and Eastern Europe present a naturalexperiment with which to study the effects of FDI on inequality because privateforeign investment was practically non-existent prior to the collapse of com-munist regimes, after which the barriers to liberalization were lifted (Bandelj,2008). It is important to acknowledge that some intra-regional investmentactivities occurred within the Council of Mutual Economic Assistance (CMEA),the economic organization of communist states that existed from 1949 to 1991 –the so-called COMECON countries (which included the Soviet Union and itssatellite states) – forming ‘a handful of joint enterprises’ and ‘joint investmentprojects’ (McMillan, 1987: 4). However, such efforts did not involve direct equityinvestment of one COMECON state into another, and thus, as McMillan speci-fies, would not qualify as FDI proper. Moreover, de facto liberalization startedbefore 1989 in Hungary, Poland and former Yugoslavia. Consistent with theirsocialist reform efforts, these countries put in place laws that allowed formationof joint ventures with foreign firms after 1985. By 1988 these states legalizedfull foreign ownership of firms as did the Baltic states of Estonia, Latvia andDownloaded fromcos.sagepub.comby Anna Dom on October 30, 2012
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