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Foreign Direct Investment and Income Inequality in Mexico, 1990–2000
Nathan M. Jensen and Guillermo Rosas
International Organization / Volume 61 / Issue 03 / July 2007, pp 467 487 DOI: 10.1017/S0020818307070178, Published online: 26 July 2007
Link to this article: http://journals.cambridge.org/abstract_S0020818307070178 How to cite this article: Nathan M. Jensen and Guillermo Rosas (2007). Foreign Direct Investment and Income Inequality in Mexico, 1990–2000. International Organization,61, pp 467487 doi:10.1017/S0020818307070178 Request Permissions : Click here
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Foreign Direct Investment and Income Inequality in Mexico, 1990 – 2000
Nathan M+ Jensen and Guillermo Rosas
Abstract In this article we explore the relationship between the investments of multinational corporations ~foreign direct investment! and income inequality in Mexico+ We argue that Mexico’s liberalization of foreign direct investment ~FDI! inﬂows in the 1990s provides a natural experiment to test how FDI affects income inequality in a middle-income country+ We use an instrumental variables approach as our identiﬁcation strategy to mitigate problems of endogeneity and omitted variable bias+ In an empirical test of the determinants of changes in income inequality from 1990 to 2000, we ﬁnd that increased FDI inﬂows are associated with a decrease in income inequality within Mexico’s thirty-two states+
Globalization has distributional consequences both within and across societies+ In the areas of international trade and immigration, theoretical and empirical research has explored how the movement of goods and people affect distributions of income+ Although considerable debate remains, existing economic models provide falsiﬁable hypotheses on how trade and migration affect income distributions+ Surprisingly, despite the vast literature on multinational corporations ~MNCs! and their investments and the increasing activity of countries in attempting to woo foreign investment, little research has explored the impact of foreign direct investment ~FDI! on income inequality+ In this article we argue that theoretical predictions regarding the effect of FDI on income distribution within a country are muddled+ Economic models of FDI, usually focused on decisions at the ﬁrm level in response to market imperfections, provide competing predictions of the relationship between FDI and income inequality+ We believe that measuring the net impact of FDI on income inequality becomes
The authors would like to thank Lawrence Broz, John Freeman, Matt Gabel, Geoff Garrett, Quan Li, Eddy Malesky, Layna Mosley, Katie Ridgeway, Pablo Pinto, John Stringer, and Andy Sobel for comments and suggestions+ Jacob Gerber and Mariana Medina provided excellent research assistance+ Thanks also to Patricio Aroca Gonzalez for generously providing us with his data+ We acknowledge the ﬁnancial support of the Weidenbaum Center on the Economy, Government, and Public Policy+ Nate Jensen’s contribution to this article was written as a Global Fellow at UCLA’s International Institute+ International Organization 61, Summer 2007, pp+ 467–87 © 2007 by The IO Foundation+
but one that has to be approached carefully. and Wade 2001+ 2+ Bradley et al+ 2003+ . and omitted variable bias in studies of FDI can lead to spurious results+ We focus on the liberalization of capital ﬂows in Mexico from 1990 to 2000 and on how the ensuing surge of multinational investments changed state-level income inequality+ Thus. we ﬁnd that states that attracted higher levels of FDI enjoyed lesser income inequality relative to states with less FDI+ We believe this strategy mitigates the serious problem of omitted variable bias+ We present our argument as follows+ In the next section. with “distance to the border” as a truly exogenous variable. Sala-i-Martin 2002. we ﬁnd it useful to summarize some of the hypothesized causal connections between globalization and economic inequality+ Following Bradley and colleagues. the decision of most U+S+ MNCs to locate close to one of the six main border routes linking the United States and Mexico also provides spatial variation that allows us to explore how levels of income inequality changed in Mexican states that attracted massive amounts of FDI in contrast with Mexican states that attracted little FDI+ This geographic component of FDI provides us with a natural experiment: using instrumental variables estimation. a lively debate currently rages over whether patterns of economic inequality within and across nations have changed at all during the past two decades. whether these changes can be attributed to globalization+1 Although a full literature review of the determinants of income inequality is beyond the scope of this article. because potential issues of reverse causality. Milanovic 2005. selection bias. we review the extant literature on the international determinants of inequality. we point to potential problems of endogeneity that plague previous ﬁndings in the literature+ We lay out an appropriate research design and focus the discussion of FDI and income inequality on the case of Mexico. especially arguments regarding the effect of FDI on income inequality+ In the second section. we can compare Mexico prior to FDI to Mexico after FDI and assess the effects on the distribution of income of such capital inﬂows+ More importantly. and if so. we distinguish arguments as either emphasizing state institutions or global markets as the main forces driving income inequality+2 1+ See Firebaugh 1999.468 International Organization an empirical question. a middle-income economy that beneﬁted from increased FDI ﬂows during the 1990s+ We then describe the construction of empirical indicators and carry out estimation of a model of FDI and income inequality in the third and fourth sections+ We conclude in the last section by pointing out avenues for further research+ Theory The topic of income inequality has received increasing attention within the ﬁelds of international and comparative political economy+ For starters.
such as party system organization+ In particular. scholars suggest that whether international trade has a positive or negative effect on the demand for unskilled labor depends on a country’s comparative advantage vis-à-vis trading partners+8 Among theorists that build on the premise of comparative advantage. some research suggests that highly unionized labor markets and institutions conducive to centralized wage bargaining allow leftist parties to achieve more egalitarian distributions of opportunity through nontargeted social programs+4 Alternatively. the forces of globalization generate winners and losers within the borders of nation-states+ For example. and Freeman 1995+ . Kenworthy and Pontusson 2005. Garrett 1998. Pontusson. the bargaining power of labor is greatly diminished. Rodrik argues that globalization leads not only to a shift in demand but also increases the elasticity of demand for labor+ As capital can credibly threaten to relocate in a global economy. where this research program has made most inroads. presumably leading to wage concessions across countries+7 Other market-based theories explore how trade or capital mobility can lead to shifts in the demand for different factors of production+ In this vein. and by institutions that regulate the supply of public policy. into different patterns of income inequality+3 The capacity of political parties to achieve more egalitarian distributions of disposable income seems to be constrained by patterns of labor market organization+ For example. government policy can affect individual decisions regarding investment in acquiring different types of skills+6 Most of these studies adopt a decidedly cross-national perspective to explore variation in domestic political institutions as a determinant of distributive outcomes+ In contrast. presumably. Moene and Wallerstein 2001. and Wallerstein 1999+ 5+ See Bradley et al+ 2003. Oatley 1999. Rueda. the common understanding is that while the liberalization of trade and capital ﬂows provides a net gain for all countries.Foreign Investment and Income Inequality in Mexico 469 Many scholars believe that economic distribution is ultimately shaped by domestic factors such as labor market organization and political institutions. several authors have recently argued that similar market pressures derived from globalization will translate into different public policies and. and Iversen and Cusack 2000+ 4+ See Beramendi and Cusack 2004. in one of the classic trade 3+ See Boix 1998. studies argue that patterns of income inequality are determined by political demands for redistribution and safety nets. and Way 2002. although it is a point of debate whether such policies are possible at all under globalization+5 Finally. even if changes in international market conditions are the main cause of demands for redistribution+ At least in countries within the Organization for Economic Cooperation and Development ~OECD!. theoretical arguments that emphasize the role of global markets tend to emphasize similarities across countries+ For example. governments can directly redistribute income through progressive income transfer policies. Esping-Andersen 1990. and Swank 2002+ 6+ Iversen and Soskice 2001+ 7+ Rodrik 1997+ 8+ See Wood 1994. Garrett 1998.
1977. in the developing countries. rather than by factor endowments or differences in rates of return across borders+ Foreign ﬁrms have advantages over domestic ﬁrms. while decreasing the returns to labor ~wages!+ Conversely. free trade will increase wages and decrease proﬁts+ This leads to clear predictions on how trade affects income inequality according to a country’s factor endowments+10 In advanced industrialized countries ~countries rich in capital!. capital and labor. there are clear distributional implications from free trade+ In countries such as the United States that have large endowments of capital. trade liberalization should decrease income inequality by increasing the returns to labor and decreasing the returns to capital+ A second broad research agenda focuses on differences between various types of labor. one has to tread carefully in applying these insights to the study of FDI+ FDI blossomed as a ﬁeld of study when Hymer identiﬁed the differences between FDI and other types of ﬁnancial capital+11 Hymer argued that FDI is driven by market imperfections. free trade will increase the returns to capital ~proﬁts!. Stolper and Samuelson argue that free trade would raise the incomes of the abundant factors of production and lower the returns to the scarce factors of production+9 Assuming a simple model with only two factors of production. MNCs often look quite different from domestic ﬁrms. particularly skilled versus unskilled. employing more skilled workers and using more advanced technologies+ One fairly consistent ﬁnd- 9+ Stolper and Samuelson 1941+ 10+ Wood 1994+ 11+ Hymer 1976+ See also Aliber 1971. and 1981. and these foreign ﬁrms choose to locate in a country to turn this advantage into proﬁts. thus suggesting that trade liberalization decreases the returns to low-skilled labor and increases the returns to high-skilled labor+ These arguments became familiar to noneconomists in the recent debate in the United States over the impact of North American Free Trade Agreement ~NAFTA! on U+S+ workers+ Although debate remains over the distributional impact of trade. Caves 1971. rather than export their goods or services or license domestic ﬁrms to make the product for the MNC+ One of the main explanations for FDI is that MNCs possess intangible assets that are not easily transferred across borders+12 Thus. and Kindleberger 1969+ 12+ Markusen 1995+ . Dunning 1971. and how trade affects income inequality+ A number of scholars have argued that globalization has led to an increased premium for skilled labor. in developing countries with large endowments of labor relative to capital.470 International Organization models. a liberalization of trade should increase income inequality by increasing the returns of capital and decreasing the returns to labor+ Conversely. economic models provide us with theoretical tools to generate hypotheses regarding the effects of trade on income inequality+ While the vast literature on the link between income inequality and trade provides guidance on how globalization affects income inequality.
foreign capital competes with domestic capital for domestic workers. we have little theoretical insight into how this affected income inequality in the United States+ Perhaps more perplexing is the inﬂow of Japanese FDI into the U+S+ auto sector+ Most scholars argue that Japanese auto manufacturers chose to “jump” U+S+ tariffs on imported automobiles and build autos in the United States+ What was the impact of this FDI on income inequality in the United States? Clearly the success of Japanese auto producers has had some impact on Detroit. for a review of the literature+ See Hanson 2004. if MNCs would hire unskilled workers and pay a wage premium for them. Aaron. driving up wages and decreasing the proﬁtability of domestic ﬁrms+ This effect would speed up convergence of the incomes of labor relative to capital. much of the cross-border FDI consists of mergers and acquisitions+ For example. Feenstra and Hanson ﬁnd that FDI into Mexico leads to increased wages of skilled workers relative to unskilled workers and thus probably increases income inequality+17 What does this mean for the relationship between FDI and levels of income inequality? We emphasize two mechanisms through which MNCs may affect income distribution within a country+ First. West. where ﬁerce competition has cost the city numerous highly paid auto production jobs+ In contrast. and South+ Most of these foreign plants are not 13+ 14+ 15+ 16+ 17+ See Moran 1998+ See Klein. foreign car companies have built production facilities that generate highpaying jobs in the Midwest. decreasing the total returns to capital and increasing the returns to labor+ Thus. decreasing income inequality+ Second. MNCs pay a wage premium over domestic ﬁrms+ If MNCs pay a wage premium for skilled workers. and Te Velde 2003+ Feenstra and Hanson 1997+ . although most of this literature is focused on the developed economies+16 Most relevant for this study. or Europe.Foreign Investment and Income Inequality in Mexico 471 ing within the FDI literature is that MNCs pay a wage premium over local ﬁrms+13 Part of this result is attributed to MNCs locating in industries and in urban areas that have higher median wages than the national median wage+14 Yet. this would lead to an increase in the income differential between skilled and unskilled workers but also to diminished income disparity between skilled workers and holders of capital+ Conversely. such as the United States. Japan. MNCs still pay considerably higher wages than local ﬁrms+15 This link between MNCs and the increased demand for skilled workers has been generally supported in the empirical literature on the impact of FDI. and Hadjimichael 2001. FDI would decrease income inequality by raising the incomes of workers that are most likely at the bottom of the income distribution+ The complex relationship between FDI and income inequality becomes clear from an overview of the theoretical determinants of FDI: for the most advanced countries. yet. MNCs bring capital into the country. even after controlling for factors that tend to overstate the MNC wage premium. Europe’s Daimler-Benz purchase of Chrysler led to a massive ﬂow of FDI into the United States. and Moran 1998+ See Te Velde 2003.
for a broad overview on the relationship between globalization and income inequality+ .472 International Organization unionized and pay lower wages than the unionized plants of the Big Three U+S+ car manufacturers+ These foreign car facilities are generally located in poor areas of the United States. such as economic liberalization. FDI is generally treated as an exogenous factor+ Consider. for a review of the literature on FDI and income inequality in Latin America+ See also World Bank 2006. Alderson and Nielsen ﬁnd a positive association between the stock of FDI and income inequality in an unbalanced panel of eighty-eight countries observed at different points in time between 1969 and 1994+19 A complete review of the literature on FDI and income inequality is beyond the scope of this article. generating employment and wage growth. and reverse causation+ The issue of omitted variable bias is the most transparent in the study of FDI+ FDI decisions occur at the ﬁrm level. we can think of studies exploring the link between income inequality and FDI as potentially suffering from omitted variable bias. FDI ﬂows increase the level of income inequality+ Similarly. especially in the South+ In this article we attempt to circumvent the existing empirical pitfalls in the study of links between FDI and income inequality by focusing on a natural experiment in a middle-income country+ We focus on the liberalization of capital inﬂows into Mexico in the mid-1990s to test the impact of FDI on income inequality+ In the following section we discuss the case+ Research Design Few studies have directly tested the impact of FDI ﬂows on income inequality+ One recent study by Reuveny and Li tests the impact of FDI on income inequality in sixty-nine countries from 1960–95+18 They ﬁnd that although democracy and trade decrease income inequality. however. yet most scholars study FDI ﬂows with models that look at country-level variables measured annually+ This is damning if omitted variables are correlated with the error term+ We believe that this bias is especially problematic in countries that enact economic 18+ Reuveny and Li 2003+ 19+ Alderson and Nielsen 1999+ 20+ See Te Velde 2003. selection bias. yet we believe that these studies are representative of the broader literature+20 Although we believe it is important to address cross-national patterns of domestic income inequality. which received little FDI in 1960 but is the leading FDI recipient in recent years and where income inequality has arguably increased during the past decade+ We believe that other factors. we are slightly skeptical about the ability to test the causal link between FDI and the distribution of income with this type of research design+ In this design. have an equally plausible claim to explain the increase in income inequality in China+ More formally. the case of China.
tend to locate their operations near pools of highly trained labor+22 Firms in the textile industry often invest near or in major cities in countries that have low national-level wages and a pool of educated labor+ At the same time. independent of FDI+ Finally. any ﬁndings on the relationship between FDI and income inequality may be capturing the impact of omitted variables on changing patterns of income inequality+ Selection bias can also lead to spurious results on the study of FDI and income inequality+ For example. an excellent study by Moran ﬁnds that MNCs. liberalizing FDI laws at the same time that they privatize stateowned enterprises and implement sweeping trade reforms+21 Unless appropriate indicators are included in the model speciﬁcation. even in the most labor-intensive industries. governments have attracted these labor-intensive operations to export-processing zones+24 In many cases.and low-skilled labor are most likely the countries that will have the most growth in wage inequality anyway. there is an increasing skill premium generated by technological change according to recent economic studies+23 Thus. and strikes+ Even more problematic is the possibility that ﬁrms avoid investments in countries with high levels of income inequality+ As outlined by Alesina and Perotti. and this risk leads to lower levels of FDI+26 Thus. political risk insurers. a 21+ See Biglaiser and DeRouen 2006. higher levels of income inequality can threaten social stability and reduce levels of domestic investment+25 According to Jensen. including the right to collective bargaining. there is an argument for the possibility of reverse causation+ Firms could be purposely locating in countries with high or low levels of income inequality+ The argument for ﬁrms purposely investing in countries with high-income inequality is most probable in the textile or footwear industry+ In numerous countries. studies of the link between FDI and income inequality that fail to control for the possibility of reverse causation may ﬁnd a spurious relationship between higher levels of FDI and lower levels of income inequality+ In this article we explore how FDI affects income inequality within a single country+ To begin with. investors.Foreign Investment and Income Inequality in Mexico 473 reform in a bundle. and Korzeniewicz and Smith 2000. countries with large pools of both high. governments provide exceptions for national labor laws. for emphasis on Latin America+ 22+ Moran 2002+ 23+ Wood 1994+ See also Tuman and Emmert 2004+ 24+ Moran 2002+ 25+ Alesina and Perotti 1996+ 26+ Jensen 2003 and 2006+ . unions. and plant location consultants understand that high levels of income inequality can lead to social conﬂict or the targeting of foreign ﬁrms for redistributive policies+ Income inequality is a risk for ﬁrms. this strategy allows us to more precisely specify our theoretical intuitions on how FDI will affect wages+ We focus on the impact of FDI inﬂows on income inequality in Mexico during the 1990s+ Mexico underwent a rapid process of liberalization starting with the Salinas administration in 1988.
cleaner governance. Coahuila. this pattern becomes even more accentuated+ Average per capita annual ﬂows of FDI from 1994 to 2000 amount to US $1. we can circumvent the pitfalls of endogeneity we identiﬁed above and more persuasively estimate the effect of FDI on income inequality+ Distance to the border is an ideal instrument. but there is no theoretical reason to believe 27+ See Hanson 2005b+ 28+ After controlling for population density. Chihuahua. throughout the 1990s+ National changes in income inequality from 1990 to 2000 could be easily attributed to any of several national-level policy changes or even to statelevel characteristics+ Yet. Mexico carried out major economic reforms. received little FDI+ Comparing the changing pattern of income inequality in states close to the border as opposed to other states in Mexico provides us with a natural experiment+ By using the distance from U+S+ border crossing points as an instrument explaining the decision of MNCs to invest into different Mexican states. or many of the other state-level factors we would normally associate with a good investment environment+ Instead. better infrastructure. as it is highly correlated with FDI. after the 1989 liberalization of controls on capital ﬂows and particularly after the 1994 implementation of NAFTA+ The buildup of FDI throughout the 1990s provides us with temporal variation to explore how the increase in FDI affected the distribution of income in Mexico from 1990 to 2000+ Furthermore. the interesting regional pattern of FDI inﬂows gives us leverage to address the issue of endogeneity of our FDI indicator+ Most of the FDI ﬂowing into Mexico located either in the states bordering the United States or in Mexico City ~see Figure 2!+28 It would be difﬁcult to argue that this pattern of investment close to the U+S+ border was conditional on higher levels of education. the actual location of FDI was determined by an exogenous geographic factor+ States that border the United States received lots of FDI while the rest of Mexico.130 along the six border states ~Baja California. namely. these decisions were largely carried out based on an exogenous factor. we can exploit the regional variation in FDI to address its effect on income inequality+ As in the example of China given earlier. the distance from one of the six major routes linking Mexico to the United States+ Consistent with the typical maquila pattern of FDI. bar Mexico City. including liberalization of the ﬁnancial sector. Sonora. Tamaulipas!. but only US $311 in the rest of the country ~and even this ﬁgure is exaggerated by inclusion of Mexico City!+ . we argue that while the timing of FDI was clearly caused by factors such as Mexican trade and capital liberalizations. Nuevo León. U+S+ ﬁrms located in Mexico to take advantage of lower labor costs and to export ﬁnished or intermediate products back into the United States+ Spatial variation provides leverage to evaluate how FDI inﬂows affected income inequality within Mexico+ Unlike other studies that ignore the endogeneity of FDI ﬂows.474 International Organization process that eventually led to the negotiation and implementation of NAFTA+27 During this period of liberalization Mexico experienced a dramatic increase in FDI inﬂows+ We illustrate this phenomenon in Figure 1+ Note the staggering increase in FDI inﬂows. both as a proportion of gross domestic product ~Panel A! and in dollar terms ~Panel B!.
Foreign Investment and Income Inequality in Mexico 475 FIGURE 1. FDI over time that it is associated with unobserved variables omitted from the model+ We build an instrumental variable model using the minimum distance from one of the six major land routes between the United States and Mexico as an instrument for statelevel FDI+ We then estimate the changing pattern of income inequality that fol- .
most relevant for this study. and Lipsey ﬁnd that foreign ﬁrms pay a 21+5 percent wage premium for skilled workers and only a 3+3 percent wage premium for unskilled workers+30 Finally. and Lipsey 1996+ 31+ Hanson 2005a+ . 2000 lows from the decision of foreign ﬁrms to invest in Mexican states+ We minimize potential concerns about reverse causation by measuring inequality in 1990. four years before our ﬁrst available measure of FDI+ We then gauge the effects of FDI ﬂows on income inequality in 2000+ What are our predictions about the impact of FDI on income inequality in Mexico? As argued before. the distributions of income shifted more to the right in the high exposure states relative to the low exposure states+ These results are mostly driven by a collapse in the incomes of employed males in the lower income states+ 29+ Feenstra and Hanson 1997+ 30+ Aitken. Harrison. Hanson explores the relationship between the wages of working males in states with most exposure to trade and investments ~border states! with those of states with low exposure+31 Hanson ﬁnds that though the Mexican peso crisis led to decreasing wages in all regions. Harrison. the low exposure states were hit much harder+ Also. the relevant literature has explored the differential between skilled and unskilled labor as one causal mechanism linking FDI to inequality+ Feenstra and Hanson ﬁnd that FDI increased the relative demand for skilled workers and was a driver of income inequality from 1975–88+29 Aitken.476 International Organization FIGURE 2. Territorial distribution of FDI stock.
regional wage differences can arise in relation to the location of foreign ﬁrms+ Thus. workers are never perfectly mobile even in the most advanced industrialized economies+ In Mexico. along with wage differentials within the broad categories of skilled and unskilled labor+ This is not a minor point+ The relative scarcity of skilled workers in Mexico makes us skeptical about the impact of changing skilled-labor wages on patterns of income inequality+ According to the 2000 International Labour Organization ~ILO! survey of Mexico. and Rubio 2005 analyze ﬁrm-level 2001 data for Mexico and ﬁnd that 71 percent of employees had no more than lower secondary school education+ 33+ A secondary issue is that most research focuses on the wage differences between low-skilled and high-skilled workers+ One of the motivations for attracting FDI is for the prospects of skill upgrading+ We can imagine a situation where a widening wage difference between skilled and unskilled labor could still lead to a leveling of income inequality if some of the unskilled workers become skilled workers+ 34+ Stolper and Samuelson 1941+ 35+ Stark and Taylor 1991+ This is the same assumption used by Hanson 2005a+ .and semi-skilled workers to increase. MNCs also pay a wage premium for unskilled workers. largely determined by geography. we expect a decrease in levels of income inequality relative to the states with least FDI+ Figure 3 provides a ﬁrst glimpse at the changing patterns of income inequality from 1990 to 2000+ Note that although some states along the U+S+ border have seen improvements in the distribution of income. there is evidence that the lower skilled are signiﬁcantly less mobile both internally ~betweenstates migration! and externally ~migration to the United States!+35 If workers are imperfectly mobile. as we argued above. we believe that the major impact of FDI in Mexico is a changing pattern of income inequality within regions in Mexico+ In the states with the most FDI. it is by no means obvious that FDI ~as portrayed in Figure 2! is driving the process+ 32+ López-Acevedo. leading to a leveling of income inequality across the whole country+ Yet. the fact that the vast majority of workers are classiﬁed as unskilled means that the wage differential between skilled and unskilled workers is probably only a minor determinant of income inequality in Mexico+33 Moreover. we would expect national wages for low. as stated earlier+ We believe instead that the major impact of MNCs will be similar to what Stolper and Samuelson would predict+34 Increased FDI into Mexico will raise the demand for skilled and unskilled workers alike+ Since. a little more than 6 percent of workers in the country are classiﬁed as professional or technical workers+32 Even though this ﬁgure clearly does not include all skilled workers.Foreign Investment and Income Inequality in Mexico 477 While these studies provide important ﬁndings. they focus on explaining the widening gap between skilled and unskilled labor+ Our article is concerned with the broader question of how FDI affects income inequality. we expect reductions in income inequality produced by wage increases for unskilled and semi-skilled workers along the northern states+ If workers were perfectly mobile within Mexico. which is also driven by the relative returns to capital and labor. most FDI goes into regions close to the border. Tinajero. as we know.
census data are publicly available through the Instituto Nacional de Estadística. Geografía e Informática ~INEGI!+36 The actual calculation of Gini indices is based on novel methods proposed by Milanovic and Abounoori and McCloughan+37 These methods allow construction of unbiased Gini coefﬁcients from grouped income data. see Cortés 2003. see Cortés and Rubalcava 1995. 1990–2000 Income Inequality and Foreign Direct Investment Data To test our claim that FDI improves income distribution. Territorial distribution of changes in state Gini indices. we operationalize FDI and state-level inequality+ The income inequality indices are based on information from the 1990 and 2000 Mexican national census. we must construct subnational measures of income inequality and FDI+ In this section. rural families tend to be larger. 142+ A more appropriate measure should consider per capita income. and Cortés 2003+ . such as is available from the Mexican census+38 To construct our measures of 36+ See ^www+inegi+gob+mx&+ Accessed 16 March 2007+ 37+ See Abounoori and McCloughan 2003. but even INEGI routinely reports inequality ﬁgures that are not corrected by family size. and Milanovic 1994+ These data are detailed in Rosas 2006+ 38+ INEGI aggregates the census information at the municipal level and posts frequencies by income group for the purpose of public dissemination+ The data may consider a family to be rich if it reports high income without consideration of family size+ Since poorer. the extent of income inequality is underestimated.478 International Organization FIGURE 3.
we consider the economically active population to comprise all individuals twelve years of age or older+ Second. we have had to impose two minor restrictions to guarantee comparability between the 1990 and 2000 census+ First. we then estimate an instrumental variable two-stage least squares ~IV-2SLS! regression model of the following form: Gini2000 * FDI1993–2000 b0 g0 * b1 FDI1993–2000 b2 Gini1990 b3 GSPpc1990 g3 Education ~1! g1 Gini1990 g4 Distance g2 GSPpc1990 ~2! 39+ Data are available at ^http:00www+economia+gob+mx0?P 1178&. the 1990 census considers individuals “twelve years of age or older. accessed 16 March 2007+ 40+ Aroca Gonzalez and Maloney 2005+ 41+ FDI data are not available at the state level prior to 1993+ Given that the bulk of FDI entered the Mexican economy after the implementation of NAFTA. pointed out by Aroca Gonzalez and Maloney. which we have updated with information from the Dirección General de Inversión Extranjera of the Mexican Ministry of the Economy+39 This data measures the dollar amount of FDI registered in any given Mexican state+ One problem in these data. and retirees!+ For purposes of comparison.” whereas the 2000 version refers to the “economically active population” ~individuals aged twelve years or older. housewives. according to the relative frequency of each category in each municipality+ To measure the amount of FDI at the state level. nonrespondents total about 5 percent of all individuals in the census+ We distributed nonrespondents into the other categories. is that many ﬁrms register their investments in Mexico City. we do not have reason to believe that this will bias our results+ . yet their operations are often located in another state ~usually border states!+40 Aroca Gonzalez and Maloney use an alternative measure of FDI ~although this measure is not collected for all states! and ﬁnd that the results are consistent across FDI measures after including a dummy variable for Mexico City+ Consequently. we draw on two data sources+ Patricio Aroca Gonzalez generously provided his data on state-level FDI. we operationalize FDI as the average dollar value of per capita FDI ﬂows during the period 1993–2000+41 Empirical Results To explore the relationship between FDI and the distribution of income. excluding students. we ﬁrst estimate a cross-sectional ordinary least squares ~OLS! regression to estimate the impact of inﬂows of FDI in the thirty-two Mexican states on levels of income inequality+ Using the OLS results as a benchmark.Foreign Investment and Income Inequality in Mexico 479 inequality.
dropping Mexico City+ Our substantive results remain unchanged+ As highlighted earlier. overidentiﬁcation is necessary to ensure that we can appropriately test the assumption of no correlation between instrument and error process+43 We provide summary statistics for all our indicators in Table 1+ We present our models based on state-level data in Table 2+ Column ~1! of the table suggests that increased levels of FDI are associated with a decrease in income inequality in an OLS model+ As argued earlier. but it is important to note that this method is not a panacea for 42+ Strictly speaking. and even the maximum ~0+58! and minimum ~0+41! values are so far from the theoretical bounds that we are comfortable modeling E~Y6X! as a linear function of effect parameters. we model the level of income inequality in each Mexican state in 2000 as a function of the level of income inequality in 1990. although their production operations are located near the border+ As a check on the robustness of our results. FDI ﬂows may be endogenous. ﬁtted values of a regression of FDI on excluded instruments—distance to the border and education ~average years of schooling!— and all other second-stage independent variables as included instruments+42 Strictly speaking. Summary statistics Variable gini 1990 gini 2000 lgdppc lfdi Minimum distance to border crossing points ~in miles! Education ~schooling average in years for 2000! Mean 0+479 0+471 2+528 2+541 441+3 7+441 Standard deviation 0+045 0+036 0+428 1+969 171+1 0+898 Minimum 0+405 0+417 1+812 2+843 15+02 5+600 Maximum 0+579 0+568 3+589 6+067 749+7 9+700 Thus. in this case. we present in column ~3! of Table 2 the results of an IV-2SLS regression using the minimum distance from one of the six major border crossings and the total number of years of education as instruments for FDI+ IV regressions have become relatively common in political science. and inconsistent+ Foreign investors may select production locations based on factors such as the quality of infrastructure or prevailing state-level wages+ To mitigate these endogeneity concerns. per capita gross state product in 1990. biased. we estimate the impact of FDI inﬂows on income inequality in column ~2! of the table. namely.480 International Organization TABLE 1. many MNCs register their operations in Mexico City. as in OLS or 2SLS+ 43+ Baum. and Stillman 2003+ . making the OLS estimates inefﬁcient. and an instrument for ~log! average FDI inﬂows from 1993–2000 * ~FDI1993–2000 !. the dependent variable is bounded above ~1! and below ~0!+ However. our model is overidentiﬁed through use of education as a second excluded instrument. the cross-state distribution of the Gini indices is unimodal. Schaffer.
* p . indicating that we cannot reject the null that our regressions are appropriately overidentiﬁed+44 The results of the IV regressions. although the magnitude of the impact is substantially increased when compared to the OLS benchmark results+ The impact of FDI on income inequality is negative. both including and excluding Mexico City. 0+01 ~two-tailed test!. meaning that exposure to FDI leads to decreasing levels of income inequality+ Based on coefﬁcients from the IV-2SLS speciﬁcation. Hansen’s J-statistic is not statistically signiﬁcant at even the 0+1 level. we include F-tests for excluded instruments and tests of overidentiﬁcation using Hansen’s J-statistic+ In our IV estimates.Foreign Investment and Income Inequality in Mexico 481 TABLE 2. we ﬁnd that a two standard deviation increase in FDI leads to a 2+4 standard deviation decrease in income inequality from 1990 to 2000+ Figure 4 illustrates uncertainty regarding the effect of FDI on income inequality by displaying a 95 percent conﬁdence interval around expected values+ Despite large estimation 44+ Ibid+ . the F-test for excluded instruments is statistically signiﬁcant at the 0+01 level. are similar to the OLS regressions. the minimum distance to the U+S+ border crossing and the level of education must be correlated with FDI inﬂows. State-level results OLS Constant gini 1990 lgdppc lfdi DF included N R2 F Hansen J Excluded instruments F-test 0+139* ~1+92! 0+724*** ~5+87! 0+010 ~0+47! 0+010** ~ 2+13! Yes 32 0+79 49+82 OLS (excluding Mexico City) 0+182** ~2+35! 0+669*** ~5+55! 0+003 ~0+901! 0+011** ~ 2+11! No 31 0+80 51+54 IV 0+172** ~2+19! 0+586*** ~3+33! 0+030 ~1+31! 0+018** ~ 2+78! Yes 32 0+76 31+65 2+425 7+90*** IV (excluding Mexico City) 0+229*** ~2+99! 0+495*** ~2+81! 0+026 ~1+31! 0+019*** ~ 3+18! No 31 0+76 31+18 1+116 7+21*** Note: All regressions estimated with robust ~Huber-White! standard errors ~t-statistics in parentheses!+ OLS ordinary least squares+ IV instrumental variable two-stage least squares+ *** p . ** p . and they must not be correlated with the error term in equation ~1!+ For our IV speciﬁcations. 0+10+ solving issues of endogeneity+ For our instrument to be valid. indicating that we have valid instruments for the level of FDI inﬂows+ Also. 0+05.
we still ﬁnd that increases in FDI are associated with large reductions in levels of income inequality. it is important to consider the causal mechanism linking FDI and income inequality+ One possible explanation is that FDI has led to a collapse in the incomes of domestic capital in the border states.482 International Organization FIGURE 4. essentially leveling income inequality by reducing the income of individuals at the higher end of the income distribution+ Yet. at the same time that incomes were becoming extremely unequal in the low-exposure states+ 45+ Hanson 2005a+ . all else constant+ Although our study focuses on whether or not FDI affects the distribution of income. Expected Gini index conditional on per capita FDI (95% conﬁdence interval) uncertainty caused by a relatively small set of observations ~thirty-two states!. FDI in Mexico has actually led to lower levels of income inequality in the northern states. Hanson ﬁnds that it is the states with low exposure to FDI where the incomes of workers fell by 10 percent and wage poverty increased 7 percent relative to high FDI states after the Mexican peso crisis+45 Thus.
San Luis Potosí. Breakdown by foreign direct investment (FDI) and income category Average change (% points) in proportions of families in each income group. Baja California Sur. 1990–2000 (1) 0–0. speciﬁcally in the context of a natural experiment. Quéretaro. Baja California Norte. Morelos. Quintana Roo. Jalisco. Coahuila.5 High FDI Low FDI 0+024 ~0+019! 0+017 ~0+030! (2) 0. Puebla. Estado de México. Sonora.Foreign Investment and Income Inequality in Mexico 483 TABLE 3.5 to 1 0+038 ~0+032! 0+034 ~0+029! (3) 1 to 2 0+071 ~0+050! 0+039 ~0+038! (4) 2 to 3 0+026 ~0+044! 0+008 ~0+037! (5) 3 to 5 0+053 ~0+025! 0+045 ~0+022! (6) 5 to 10 0+035 ~0+016! 0+028 ~0+010! (7) 10 0+018 ~0+010! 0+011 ~0+009! Notes: High FDI states are those with above average FDI: Aguascalientes. evidence is consistent with the claim that unskilled workers are beneﬁting the most from increased FDI. Colima. our data allow us to compare growth in the number of families in different income categories+ Table 3 offers a breakdown of change in the percentage of families within each or our seven income categories in high and low FDI states+ First. at least if we consider that unskilled workers are more common in category ~3!+ We believe this evidence. it does not seem to be the case that diminished inequality is driven by a collapse in the number of families at the upper end of the income distribution+ Second. decreases in the number of poor families and increases in the number of well-off families seem to be more pronounced among high FDI states+ We caution the reader that in our small sample only the numbers in income category ~3! ~that is. DF. both types of states show increases in the number of families at the upper tail of the distribution and decreases in the lower categories+ However. illustrates that FDI ﬂows can lead to an increase in the incomes of workers and a leveling of income inequality within states+ Conclusions In this article we explore the relationship between inﬂows of foreign direct investment and changing patterns of income inequality in Mexico from 1990–2000+ Using geographic proximity to major border crossings with the United States as an . Tamaulipas+ Though we cannot speak directly to the issue of income differentials between 1990 and 2000. Nuevo León. those reporting income of one to two minimum wages! are statistically different across FDI categories at the 95 percent level+ Though we cannot conﬁrm which mechanism is most important in tying FDI to diminished income inequality. Chihuahua.
partially attributed to dynamic income growth in the eastern provinces and the lagging performance of the western and central provinces+ Yet.484 International Organization instrument for FDI. we ﬁnd that inﬂows of FDI into Mexican states are associated with a leveling of incomes at the state level+ These results provide new insights and possible directions for future research+ The existing studies on the link between globalization and income inequality have focused on the impact of trade and investment on country-level measures of income inequality+ We argue that these studies suffer from serious econometric problems+ Other studies have discussed rising income inequality across regions+ For example. and Patrick McCloughan+ 2003+ A Simple Way to Calculate the Gini Coefﬁcient for Grouped as Well as Ungrouped Data+ Applied Economics Letters 10 ~8!:505–9+ . Esmaiel. scholars studying China lament the increasing income inequality within that country. the other one including more prosperous and more egalitarian states+ In fact. whereas sixteen states in the poorer south supported a candidate that underscored redistribution and protection from the vagaries of the marketplace+ National-level studies have often linked globalization to increasing income inequality by suggesting that openness increases demand ~and returns! to highskilled labor relative to low-skilled labor+ We ﬁnd this mechanism to be an unlikely candidate for explaining broad changes in the level of income inequality+ This explanation is implausible in our study of Mexico because we ﬁnd that when a MNC invests in a state. diminished withinstate inequality produced by FDI may actually increase national levels of inequality+ This could occur if states that attract FDI not only become more equal. the income distribution becomes ﬂatter within that state+ We speculate that this effect occurs through a localized increased demand for labor relative to that of capital+ Globalization could have complex effects on the distribution of income within a country. as is likely to be the case+ The spread of the national distribution of income could become even wider as Mexican states converge on two different “clubs”: one comprising mostly poor and still extremely unequal states. sixteen states in the prosperous north overwhelmingly favored a candidate that espoused adherence to markets and promised further internationalization of the Mexican economy. many scholars have stressed that the peso crisis led to a further increase in Mexico’s already high levels of income inequality+ More importantly. yet we ﬁnd that ﬂows of FDI can also be associated with a reduction of income inequality for less-developed countries+ References Abounoori. but also more prosperous. in the 2006 presidential election. these studies are limited in their ability to answer the question of how globalization inﬂuences these patterns of income inequality+ In this project we ﬁnd that inﬂows of FDI into a state lead to a leveling of income inequality within the state+ This is not to say that Mexico is becoming a more egalitarian society.
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