Foreign Direct Investment and Inequality: Evidence from China’s Policy Change

In this paper, we examine the impact of foreign direct investment (FDI) on local urban inequality in China. Specifically, we consider the FDI policy change as an exogenous shock on the local labour markets. We find that cities that have experienced a bigger policy change in promoting FDI between 1997 and 2002 are significantly more unequal in 2005. This pattern is mainly driven by the positive association between FDI liberalisation and skill premia. The result holds after we control for other policy changes, such as privatisation of state‐owned enterprises, infrastructure and trade liberalisation. We then turn to investigate the mechanisms using firm and individual‐level information. Our firm‐level evidence shows that FDI firms not only hire relatively more high‐skilled workers but also provide relatively higher wages to high‐skilled workers compared to domestic firms. Moreover, the individual‐level analysis shows that FDI has a significantly positive spillover effect on wages received by skilled workers employed by state‐owned enterprises, but not wages of unskilled workers.