Trade Openness and the Distributional Effects of Foreign Direct Investment Cross-Country Evidence on Income Inequality

Abstract

This study investigates the connections between trade openness, income inequality and foreign direct investment (FDI), with a specific focus on the moderating effect of trade openness on national economies. The analysis method of the study was a quantitative longitudinal research design, with country-years totaling 992 for 58 countries from 1990 to 2024. The World Bank Gini Index was used to measure income inequality, whereas FDI, trade openness, and some macroeconomic indicators were used as explanatory variables. Descriptive statistics, Pearson correlation analysis and pooled and fixed-effects panel regressions were used, with an interaction term between FDI and trade openness. The results showed that trade openness had a moderate negative correlation with income inequality (r = −0.463), while FDI had a weak negative correlation (r = −0.096). The pooled regression found a significant negative relationship between trade openness and inequality (β = −0.074, p<0.001). This relationship, however, was not significant statistically when controlling for country and year effects. In a similar fashion, fixed-effects estimation revealed no significant relationship between FDI and inequality. There was not enough evidence of moderation as the interaction coefficient was negative and not significant (β = −0.00038, p = 0.629). The results indicate that the differentials in distributional outcomes are significant and the extent of the differences depends on the country-specific economic conditions. The study highlights the need to link trade and investment policies with inclusive employment, financial development and institutional strengthening, in order to foster equitable economic development.