THE ROLE OF ABSORPTIVE CAPACITY ON THE EFFECTS OF FOREIGN DIRECT INVESTMENT ON INCOME INEQUALITY AND PRODUCTIVITY

Abstract

This dissertation investigates the impacts of foreign direct investment (FDI) inflows on income inequality and productivity growth, emphasizing the role of absorptive capacity. While traditional theories posit that FDI yields favorable outcomes in developing economies by mitigating inequality and enhancing productivity, empirical evidence regarding these relationships is inconclusive. Such disparities may stem from varying responses of income inequality or productivity growth to FDI inflows, attributable to unique characteristics such as absorptive capacity of recipient nations. In order to scrutinize the distributional heterogeneity in FDI-inequality and FDI-productivity associations, this study employs a distinctive empirical approach by utilizing a finite mixture model (FMM) as an unsupervised model-based clustering technique. Then, the study investigates the role of absorptive capacity as a conditioning factor on the heterogeneous effects of FDI on inequality and productivity growth. For this purpose, a country-wise absorptive capacity index is constructed using panel data from 26 developing countries. The first chapter, focusing on FDI-inequality, reveals divergent effects of FDI across three clusters. Meanwhile, the second chapter, centered on FDI-productivity, identifies disparate effects across two clusters. Specifically, our findings indicate that FDI contributes to income inequality improvement in one cluster, exhibits no significant impact in another, and exacerbates it in the third cluster. Moreover, nations with high absorptive capacity, particularly in terms of quality human capital, are better positioned to alleviate the adverse effects of FDI on income distribution. Regarding the productivity impact of FDI, our results indicate a negative effect on productivity growth in one cluster, but a positive effect in the other. Furthermore, countries with high absorptive capacity, characterized by quality human capital, robust institutions, and advanced financial and infrastructural development, are more likely to experience positive FDI effects on productivity growth.