## wpiea2021004-print-pdf

## Source details

**Canonical URL:** [wpiea2021004-print-pdf](https://www.imf.org/-/media/files/publications/wp/2021/english/wpiea2021004-print-pdf.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/wp/2021/english/wpiea2021004-print-pdf.pdf.md)
- [Structured JSON version](/-/media/files/publications/wp/2021/english/wpiea2021004-print-pdf.pdf.json)

---

### I. Introduction — key premises and findings
- Focus: relationship of financial globalization to income inequality and implications for policy.
- Point of departure: contrast between trade liberalization and financial liberalization.
- Trade theory: Stolper-Samuelson theorem predicts trade opening will increase relative incomes of a country’s abundant factors of production; implication:
  - In high-income countries, income inequality will increase.
  - In low-income countries, income inequality will fall.
- Mundell (1957) theorem: suggests trade flows and capital flows have the same distributional effects; empirical evidence indicates this does not hold in practice.
- Recent empirical finding: inequality, as measured by the Gini Coefficient, has risen with financial globalization in both advanced and developing countries.
- Key policy dilemma: financial globalization can raise living standards but can also be unequalizing; international financial liberalization should be coupled with social and economic policies to promote more equal sharing of gains.

### Distributional impacts depend on initial conditions
- Relevant conditions affecting distributional outcomes:
  - Level of human capital.
  - Depth of financial markets.
  - Strength of institutional and policy frameworks.
- Higher educational attainment, stronger creditor rights, and more effective rule of law help realize growth benefits while minimizing adverse distributional effects.

### Heterogeneous effects by type of financial flow
- FDI
  - Distributional effects depend on sectoral composition, labor intensity, and skill intensity across sectors.
  - Adverse distributional effects greatest when FDI flows into sectors with strong complementarities between capital and skill.
  - Better-educated labor forces facilitate wider sharing of FDI benefits.
  - Over the long term, the inequality increasing effect of FDI tends to diminish with rising educational levels.
  - Outward FDI (sourced mainly from high-income countries and increasingly from middle-income countries such as China) tends to be associated with a decline in demand for less-skilled labor in the source country and may reduce labor bargaining power via relocation threat.
- Portfolio financial capital flows
  - May accentuate macroeconomic volatility, which disproportionately hurts the poor.
  - Can be vehicles for tax avoidance and illicit flows that disproportionately benefit high earners.
  - Can reduce inequality if they deepen and develop financial markets, boosting financial inclusion and entrepreneurial opportunities for the poor.
  - Strong institutions, policies to manage capital flow surges and reversals, and well-developed financial markets are important to mitigate inequality-raising effects.
- Remittances
  - Affect inequality through direct income effects.
  - Empirical studies show remittances have accrued increasingly to lower-income households over time.
  - Inequality-reducing effects more pronounced in countries with longer migration histories, lower fixed costs of migration, and greater accessibility of migration and remittances to poorer households.
  - Remittances can facilitate business setup and employment creation, which tends to be pro-poor.
- Official development assistance (ODA) and other official flows
  - ODA can reduce inequality where institutions are sufficiently strong.
  - Risks: aid may induce rent-seeking by officials and well-connected private actors where institutional checks are lacking.
  - Donor allocation may deviate from pro-poor rhetoric toward politically-motivated self-interest.
  - Official flows tend to be procyclical, amplifying volatility that disproportionately hurts the poor.
  - Reserve accumulation: higher reserves could reduce macroeconomic and financial volatility, mitigating disproportionate impacts on low-income households; but reserve accumulation is costly because opportunity cost of funds (typical government funding costs) are a multiple of interest income from holding U.S. treasury bonds or other similar “safe assets”.

### Policy implications (overview)
- Couple international financial liberalization with social and economic policies that level the distributional playing field.
- Strengthen human capital development (education).
- Strengthen institutions and the rule of law, and improve creditor rights.
- Implement policies and regulatory frameworks to manage capital flow surges and reversals.
- Target and time ODA appropriately and ensure recipient institutional capacity.
- Weigh costs and benefits of reserve accumulation given opportunity costs.

---

### Overview and historical facts about capital flows (Section IV)
- Cross-border investment rose tenfold between 1970 and 2015, from 20 to 200 percent of global GDP.
- In the early 1990s capital flows accelerated, rising faster than global trade and output.
- Of 135 episodes of capital account liberalization over the last five decades, 95 took place in EMDCs (69 in emerging markets (EMs) and 26 in low-income developing countries (LIDCs)).
- Gross foreign assets rose markedly over the period shown.
- Technological and market-structure changes (electronic trading, submarine fiber-optic cables, advances in computer technology) and liberalization of domestic financial markets facilitated globalization of finance.
- Regulatory changes broadened cross-border intermediation to include mutual funds, hedge funds, and insurance companies, contributing to reduced home bias.

### Composition and magnitudes of capital flows
- FDI stock rose from about 6-10 percent of world GDP in the 1970s-1980s to nearly 60 percent of global GDP in 2015.
- In 2015, FDI assets amounted to 37 and 4 percent of GDP in AEs and EMCDs, respectively.
- Some 80 percent of the stock of global FDI is held by investors in AEs; increase in EMDC FDI assets since the 1990s driven by increased outward FDI by China.
- Chinese cross-border FDI accounts for fully 25 percent of total outward FDI by EMDCs.
- Foreign official holdings of U.S. Treasuries rose from about US$200 billion in the early 1990s to US$4 trillion in the mid-2010s (around 30 percent of total marketable U.S. Treasury debt securities).
- In the 1970s, cross-border bank loans constituted more than half of all capital flows to emerging markets in 1973-82.
- Remittances: in 2017 remittances accounted for less than 1 per cent of global GDP, but they had more than doubled relative to global GDP since 1995; remittances exceed 10 percent of GDP in 31 countries and account for over one third of GDP in some countries.

### Facts about inequality and liberalization
- Capital account liberalization episodes identified: 135 episodes across 173 countries; inequality data available for 111 episodes.
- Median change in the average market Gini index during the 10-year periods before and after liberalization shows newly liberalized countries experienced higher increases in Gini than closed countries.
- Rise in inequality following liberalization was pronounced among AEs that liberalized; EMDCs showed mixed results (about 40 percent of newly liberalized EMDCs experienced a decline in inequality).
- Inequality appears to have risen following liberalization episodes in both creditor and debtor countries; no clear relationship between net international investment position sign and inequality.

---

### Distributional channels — Foreign Direct Investment (FDI)
- Empirical findings and magnitudes
  - 14 episodes since 1995 when EMDCs reduced restrictions on inward FDI were identified; inequality and investment data available for 12 and 13 episodes, respectively.
  - Increased openness to inward FDI was followed by rising income inequality in the sample, both absolutely and relative to countries that maintained restrictions.
  - FDI can raise capital-labor ratios and increase returns to capital versus labor.
  - If capital substitutes for unskilled labor or complements skilled labor, FDI raises the skill premium and increases inequality.
  - Vertical FDI (outsourcing segments) has stronger effects on the skill premium than horizontal FDI.
  - Outward FDI can raise inequality in source countries by lowering demand for less skilled workers.
  - FDI can facilitate tax avoidance via “phantom FDI” (investments with no real links to the local economy), estimated at 40 percent of global FDI; phantom investments amount to US$15 trillion.
  - The inequality-increasing impact of inward FDI is mitigated in countries with higher levels of educational attainment: EMDCs that observed a decline in inequality had more than 6 percent of the population complete tertiary education between 1995 and 2015, versus slightly more than 2 percent in those with an increase in inequality.
- Other sectoral effects
  - FDI-driven “de-fragmentation” of retail can lower prices for goods consumed by poor households but can crowd out local stores and depress wages in low-skilled retail (example: Mexico — real wages in retail fell by 18 percent between 1994 and 2003 after Walmart entry).

### Distributional channels — Non-FDI private capital flows (portfolio, bank, other)
- Findings and episodes
  - Portfolio capital flows affect inequality via investment impacts and macroeconomic volatility.
  - Identified 22 episodes of liberalization followed by crisis; data available for 16 episodes.
  - Portfolio inflows in EMDCs are procyclical: net flows rise in good times and fall in bad times.
  - Gross flows are more procyclical than net flows; gross inflows and outflows both decline during crises.
- Channels raising inequality during downturns
  - Recessions disproportionately affect wages and employment of poorer households.
  - Credit rationing in downturns disproportionately restricts poor borrowers.
  - Education interruptions for poorer households can have long-term human capital costs.
- Positive effects and other mechanisms
  - Portfolio equity can promote financial inclusion (example: foreign equity investment enabled Safaricom and M-PESA in Kenya, which spread to 30 million users and significantly boosted financial inclusion).
  - Portfolio flows can affect asset prices (housing booms, equity prices) increasing wealth inequality if assets are concentrated among the rich.
  - Exchange rate movements tied to portfolio flows can change net wealth of households with foreign-currency liabilities (evidence from Central/Eastern Europe with euro/Swiss franc mortgages).
  - Portfolio flows can facilitate tax evasion and illicit financial flows; evidence that the top 0.01 percent evaded around 25 percent of their taxes via offshore accounts in certain country comparisons.

### Distributional channels — Official capital flows (ODA and reserve accumulation)
- ODA
  - Evidence on ODA and inequality is mixed: some studies find no robust effect; others find aid reduces inequality or increases it depending on institutional quality.
  - Calderón et al. (2006): aid reduces inequality if institutional quality exceeds a critical threshold.
  - Weak institutions increase the risk that aid is diverted, benefiting elites and increasing inequality.
  - Aid is often procyclical, which can exacerbate volatility rather than stabilize it.
- Reserve accumulation
  - Reserve buildup by EMDCs (pre-GFC and post-GFC waves) can mitigate volatility via insurance against reversals and through foreign exchange interventions to promote export-led growth.
  - The distributional impact of reserve-driven export-led growth depends on whether gains are distributed across skilled and unskilled labor and capital owners.

### Distributional channels — Remittances
- Findings and empirical patterns
  - Literature on remittances and inequality is mixed; earlier studies compared Gini coefficients with and without remittances, while more recent studies construct counterfactual income distributions.
  - Remittances are relatively stable and co-move less with recipient-country GDP than portfolio flows and FDI; they smooth disposable income and cushion shocks, often benefiting poorer households.
  - Given remittances’ magnitude in some countries (exceed 10 percent of GDP in 31 countries and can be over one third of GDP), remittances can have visible effects on within-country inequality.
- Mechanisms
  - Pioneer migrants often come from wealthier households due to higher migration costs; later migrants often come from poorer households as fixed costs fall — implying remittances may initially increase and later reduce inequality.
  - Counterfactual estimation that accounts for behavioral adjustments (e.g., propensity score matching) provides more accurate estimates than simple income-with/without comparisons.

### Cross-cutting mechanisms and empirical regularities
- Crises following liberalization magnify distributional harms: newly liberalized countries followed by crisis show larger increases in Gini than liberalized countries not followed by crisis.
- No major difference in outcomes by creditor versus debtor status in many instances.
- Financial globalization impacts inequality via multiple channels: labor market effects (skill premium, bargaining power), asset-price and wealth effects, volatility and crisis exposure, tax avoidance and illicit flows, and financial inclusion.

---

### Policy implications and recommendations (drawn from analysis)
- Strengthen financial regulation and supervision to manage risks associated with cross-border flows.
- Deploy capital flow measures (CFMs) where appropriate to shape the composition of inflows and reduce volatility, while not substituting for warranted macroeconomic adjustment.
- Use macroprudential policies to mitigate impact of global financial shocks.
- Improve access to financial services to broaden financial inclusion and help households smooth income shocks.
- Promote strong institutions to ensure ODA and other official flows reach intended beneficiaries and do not get diverted to elites.
- Shape capital account openness and domestic policies to favor more stable, long-term flows (e.g., FDI and portfolio equity) over volatile debt flows where possible.
- Address tax avoidance and phantom FDI through multilateral and domestic tax-policy measures.
- Manage reserve accumulation and exchange-rate policies with attention to distributional implications.

### Detailed policy sets (Section 6)
- 6.1. Macroeconomic policies
  - Use countercyclical macroeconomic policies to limit volatility associated with capital flows.
  - Use fiscal policy to lean against capital-flow-induced demand pressures.
  - Strengthen automatic fiscal stabilizers and fiscal institutions (e.g., independent agencies for fiscal forecasts).
  - Note: monetary policy has limited usefulness in this context.
- 6.2. Capital-flow management policies (CFMs)
  - CFMs can limit risk of capital-flow reversals and crises that hurt the poor, but should not substitute for warranted macroeconomic adjustment.
  - Consider distributional and social objectives explicitly (e.g., housing-related restrictions on non-resident investments).
  - Advanced-economy examples since 2011: Australia, Canada, Hong Kong SAR, New Zealand, and Singapore have adopted or tightened measures discriminating between residents and non-residents for domestic real estate.
- 6.3. Education
  - Higher educational attainment in EMDEs reduces adverse distributional effects by enabling wider sharing of increases in the skill premium.
  - Align the pace of educational attainment improvements with the education system’s capacity to avoid quality declines.
- 6.4. Business climate
  - Reliable contract enforcement and business-enabling regulation attract FDI and shift capital inflows toward forms with more favorable distributional consequences.
  - Promote competition in product markets, streamline regulation, reduce bureaucratic discretion, increase transparency.
  - Investment-promotion agencies can assist in attracting FDI; political visibility and private-sector involvement can strengthen their credibility.
- 6.5. Financial sector policies, including macroprudential policies
  - Ensure prudent use of external funds by banks through sound micro- and macro-prudential policies to enhance banking-sector resilience and financial stability.
  - Foster competition in banking and finance to facilitate credit access.
  - Some macroprudential tools (e.g., LTV and DTI limits) have direct distributional effects and may restrict access for low-income households; balance stability and inclusion.
  - Consider macroprudential levies on bank flows to manage bank risk-taking in bank-led flows contexts.
- 6.6. Redistributive policies and social safety nets
  - Redistribution mitigated some adverse effects of capital account liberalization: inequality in disposable incomes increased less than inequality in market incomes following liberalization episodes.
  - Financial globalization shifts tax burden toward less mobile factors (low-skilled labor); proactive tax and transfer policy adjustments may be needed.
  - Strengthen social safety nets to support consumption smoothing and protect the poor during crises.
- 6.5. Remittance-related policies (remittances subsection numbering retained)
  - Given broadly favorable distributional impact of remittances, focus policy on reducing remittance costs.
  - Policies: reduce transaction costs, increase competition, help migrants compare providers, leverage mobile technology to lower costs.

---

### Remittances, migration, and inequality — heterogeneous, time-varying effects
- Empirical findings are mixed:
  - Möllers and Meyer (2014) find remittances increase inequality in Kosovo.
  - Mughal and Anwar (2012) and Koczan and Loyola (2018) find remittances lower inequality in Pakistan and Mexico, respectively.
- Mechanism: pioneer migrants (higher migration costs) often come from wealthier households; later migrants (benefiting from migrant networks and lower costs) often come from poorer households — implying time-varying effects that can shift from inequality-increasing to inequality-reducing as migration history lengthens.
- Supporting evidence cited from Acosta et al. (2008); Brown and Jimenez (2007); Margolis et al. (2013); McKenzie and Rapoport (2007); Acharyaa and Leon-Gonzalez (2012); Möllers and Meyer (2014).

### The case of Mexico: interaction of remittances, FDI, migration history, and inequality
- Historical periods and drivers
  - Three inequality periods since the 1970s:
    - 1970s: inequality fell from high initial levels.
    - Mid-1980s to mid-1990s: inequality increased.
    - Mid-1990s through late 2000s: inequality declined (especially disposable income) coincident with NAFTA implementation.
  - 1970s Shared Development and oil discovery in 1978 financed public investment and were equalizing; external debt rose and culminated in the 1982 debt servicing crisis, leading to recession and worsening inequality.
  - Post-1990 debt restructuring and FDI pick-up contributed to skill-biased technological change and rising skill premium.
  - 1994-95 peso crisis: devaluation, spike in interest rates, economic contraction, rise in unemployment; top 10 percent hardest hit, leading to a fall in inequality between 1994 and 1996.
  - Post-NAFTA decline in wage inequality possibly driven by increase in college enrollment starting in 1995 and rise in low-skilled wages due to expansion of assembly activities by foreign investors.
- FDI and regional inequality
  - Jensen and Rosas (2007): Mexican states with larger FDI inflows had larger declines in inequality between 1990 and 2000.
  - Waldkirch (2008): FDI into maquiladora industry benefited unskilled workers disproportionately.
  - Authors’ data (2003-10) indicate inequality decreased more in regions receiving higher FDI inflows.
- Remittances in Mexico — key numeric and survey points
  - Mexico is one of the world’s largest recipients of remittances.
  - In early years remittance-receiving households were typically in the middle of the income distribution; as migration costs fell, remittances became increasingly pro-poor.
  - Remittance-receiving households are on average poorer than non-receiving households, even when remittances are included; remittances constitute a larger share of income for poorer households.
  - Empirical counterfactual result: the Gini coefficient of households’ “no-migration” counterfactual income is higher than that of actual income, suggesting inequality would be higher in the absence of remittances after accounting for behavioral adjustments (counterfactuals estimated via propensity score matching using 2002, 2008 and 2014 surveys).
  - During the Global Financial Crisis, the likelihood of receiving remittances and remittances’ share of income fell for top income deciles but increased for lower income deciles — contrasting with the peso crisis when lower deciles’ remittance receipts remained largely unchanged.
- Key numeric and survey points for Mexico (preserve original figures):
  - In 2014, households received on average about US$290 per month (US$140 median).
  - Poverty: a 24 percent increase in the poverty headcount during the 1994-95 crisis.

### Overall conclusion
- Financial globalization tends to foster economic growth but can raise inequality.
- Neither outcome is inevitable: benefits of capital flows are likely when countries strengthen policies and institutions to limit volatility and guide flows to appropriate sectors.
- The inequality-increasing tendency of capital flows can be limited by policies shaping composition and timing of flows, by raising educational attainment ex ante, and by ex post redistributive measures to support the disadvantaged.

*Source: wpiea2021004-print-pdf — Sections I–IV and Conclusions*

### References .............................................................................................................

### References

### I. Introduction — key premises and findings
- Focus: relationship of financial globalization to income inequality and implications for policy.
- Point of departure: contrast between trade liberalization and financial liberalization.
- Trade theory: Stolper-Samuelson theorem predicts trade opening will increase relative incomes of a country’s abundant factors of production; implication:
  - In high-income countries, income inequality will increase.
  - In low-income countries, income inequality will fall.
- Mundell (1957) theorem: suggests trade flows and capital flows have the same distributional effects; empirical evidence indicates this does not hold in practice. Footnote references: 2, 3, 4, 5.
- Recent empirical finding: inequality, as measured by the Gini Coefficient, has risen with financial globalization in both advanced and developing countries. (Reference to Gini use: footnote 2.)
- Key policy dilemma: financial globalization can raise living standards (make the pie larger) but can also be unequalizing; thus, international financial liberalization should be coupled with social and economic policies to promote more equal sharing of gains.

### Distributional impacts depend on initial conditions
- Relevant conditions affecting distributional outcomes:
  - Level of human capital.
  - Depth of financial markets.
  - Strength of institutional and policy frameworks.
- Higher educational attainment, stronger creditor rights, and more effective rule of law help realize growth benefits while minimizing adverse distributional effects.

### Heterogeneous effects by type of financial flow
- FDI:
  - Distributional effects depend on sectoral composition, labor intensity, and skill intensity across sectors.
  - Adverse distributional effects greatest when FDI flows into sectors with strong complementarities between capital and skill.
  - Better-educated labor forces facilitate wider sharing of FDI benefits. Footnote 6: Over the long term, the inequality increasing effect of FDI tends to diminish with rising educational levels; see for example Mihaylova (2015).
  - Outward FDI (sourced mainly from high-income countries and increasingly from middle-income countries such as China) tends to be associated with a decline in demand for less-skilled labor in the source country.
  - Outward FDI may reduce labor bargaining power via relocation threat, further reducing labor income share.
- Portfolio financial capital flows:
  - May accentuate macroeconomic volatility, which disproportionately hurts the poor.
  - Can be vehicles for tax avoidance and illicit flows that disproportionately benefit high earners.
  - Can reduce inequality if they deepen and develop financial markets, boosting financial inclusion and entrepreneurial opportunities for the poor.
  - Strong institutions, policies to manage capital flow surges and reversals, and well-developed financial markets are important to mitigate inequality-raising effects.
- Remittances:
  - Affect inequality through direct income effects.
  - Empirical studies show remittances have accrued increasingly to lower-income households over time.
  - Inequality-reducing effects more pronounced in countries with longer migration histories, lower fixed costs of migration, and greater accessibility of migration and remittances to poorer households.
  - Remittances can facilitate business setup and employment creation, which tends to be pro-poor.
- Official development assistance (ODA) and other official flows:
  - ODA can reduce inequality where institutions are sufficiently strong.
  - Risks: aid may induce rent-seeking by officials and well-connected private actors where institutional checks are lacking (Svensson, 2000; Hodler, 2007; Economides et al., 2008).
  - Donor allocation may deviate from pro-poor rhetoric toward politically-motivated self-interest.
  - Official flows tend to be procyclical, amplifying volatility that disproportionately hurts the poor.
  - Reserve accumulation: higher reserves could reduce macroeconomic and financial volatility, mitigating disproportionate impacts on low-income households; but reserve accumulation is costly because opportunity cost of funds (typical government funding costs) are a multiple of interest income from holding U.S. treasury bonds or other similar “safe assets” (Rodrik 2006).

### Policy implications and recommendations
- Couple international financial liberalization with other social and economic policies that level the distributional playing field.
- Strengthen human capital development (education) to ensure broader sharing of gains from FDI and other capital inflows.
- Strengthen institutions and the rule of law, and improve creditor rights to capture growth benefits while limiting unequal outcomes.
- Implement policies and regulatory frameworks to manage capital flow surges and reversals to limit macroeconomic volatility and protect low-income households.
- Target and time ODA appropriately and ensure recipient institutional capacity to limit diversion and appropriation.
- Weigh costs and benefits of reserve accumulation given opportunity costs.

*Source: wpiea2021004-print-pdf - References*

### Section IV probes deeper with a discussion of the main channels through which different types

### wpiea2021004-print-pdf - Section IV probes deeper with a discussion of the main channels through which different types

### Overview and historical facts about capital flows
- Cross-border investment rose tenfold between 1970 and 2015, from 20 to 200 percent of global GDP.
- In the early 1990s capital flows accelerated, rising faster than global trade and output.
- Of 135 episodes of capital account liberalization over the last five decades, 95 took place in EMDCs (69 in emerging markets (EMs) and 26 in low-income developing countries (LIDCs)).
- Gross foreign assets rose markedly over the period shown (figures and series provided in source).
- Technological and market-structure changes (electronic trading, submarine fiber-optic cables, advances in computer technology) and liberalization of domestic financial markets facilitated globalization of finance.
- Regulatory changes broadened cross-border intermediation to include mutual funds, hedge funds, and insurance companies, contributing to reduced home bias.

### Composition and magnitudes of capital flows
- FDI stock rose from about 6-10 percent of world GDP in the 1970s-1980s to nearly 60 percent of global GDP in 2015.
- At that point (2015), FDI assets amounted to 37 and 4 percent of GDP in AEs and EMCDs, respectively.
- Some 80 percent of the stock of global FDI is held by investors in AEs; there has been an increase in EMDC FDI assets since the 1990s, driven by increased outward FDI by China.
- Chinese cross-border FDI accounts for fully 25 percent of total outward FDI by EMDCs.
- Foreign official holdings of U.S. Treasuries rose from about US$200 billion in the early 1990s to US$4 trillion in the mid-2010s (around 30 percent of total marketable U.S. Treasury debt securities).
- In the 1970s, cross-border bank loans constituted more than half of all capital flows to emerging markets in 1973-82.
- Remittances: in 2017 remittances accounted for less than 1 per cent of global GDP, but they had more than doubled relative to global GDP since 1995; remittances exceed 10 percent of GDP in 31 countries and account for over one third of GDP in some countries.

### Facts about inequality and liberalization
- Capital account liberalization episodes identified: 135 episodes across 173 countries; inequality data available for 111 episodes.
- Median change in the average market Gini index during the 10-year periods before and after liberalization shows that newly liberalized countries experienced higher increases in Gini than closed countries (figure-based evidence).
- The rise in inequality following liberalization was pronounced among AEs that liberalized; EMDCs showed mixed results (about 40 percent of newly liberalized EMDCs experienced a decline in inequality).
- Inequality appears to have risen following liberalization episodes in both creditor and debtor countries; there is no clear relationship between net international investment position sign and inequality.

### Distributional channels — Foreign Direct Investment (FDI)
Findings:
- 14 episodes since 1995 when EMDCs reduced restrictions on inward FDI were identified; data availability: inequality and investment data available for 12 and 13 episodes, respectively.
- Increased openness to inward FDI was followed by rising income inequality in the sample, both absolutely and relative to countries that maintained restrictions.
- Mechanisms:
  - FDI can raise capital-labor ratios and increase returns to capital versus labor (potentially reducing inequality if capital ownership is broad, but often not).
  - If capital substitutes for unskilled labor or complements skilled labor, FDI raises the skill premium and increases inequality.
  - Distinction between horizontal FDI (same activities abroad) and vertical FDI (outsourcing segments): vertical FDI has stronger effects on the skill premium; effects vary by context.
  - Outward FDI can raise inequality by lowering capital/labor ratios and reducing demand for less skilled workers.
  - FDI can facilitate tax avoidance via “phantom FDI” (investments with no real links to the local economy), estimated at 40 percent of global FDI; phantom investments amount to US$15 trillion.
  - The inequality-increasing impact of inward FDI is mitigated in countries with higher levels of educational attainment: EMDCs that observed a decline in inequality had more than 6 percent of the population complete tertiary education between 1995 and 2015, versus slightly more than 2 percent in those with an increase in inequality.
- Other sectoral effects:
  - FDI-driven “de-fragmentation” of retail can lower prices for goods consumed by poor households (distributional benefit) but can also crowd out local stores and depress wages in low-skilled retail (e.g., Mexico: real wages in retail fell by 18 percent between 1994 and 2003 after Walmart entry).

### Distributional channels — Non-FDI private capital flows (portfolio, bank, other)
Findings:
- Portfolio capital flows can affect inequality via investment impacts and macroeconomic volatility.
- Capital account liberalization that increases macroeconomic volatility—especially when followed by crisis—has pronounced negative distributional consequences.
- Identified 22 episodes of liberalization followed by crisis; data available for 16 episodes.
- Procyclicality:
  - Portfolio inflows in EMDCs are procyclical: net flows rise in good times and fall in bad times.
  - Gross flows are more procyclical than net flows; gross inflows and outflows both decline during crises, making gross flows a better indicator of financial vulnerabilities.
- Channels raising inequality during downturns:
  - Recessions disproportionately affect wages and employment of poorer households.
  - Credit rationing in downturns disproportionately restricts poor borrowers.
  - Education interruptions for poorer households can have long-term human capital costs.
- Positive effects:
  - Portfolio equity can promote financial inclusion (example: foreign equity investment enabled Safaricom and M-PESA in Kenya, which spread to 30 million users and significantly boosted financial inclusion).
- Other mechanisms:
  - Portfolio flows can affect asset prices (housing booms, equity prices) increasing wealth inequality if assets are concentrated among the rich.
  - Exchange rate movements tied to portfolio flows can change net wealth of households with foreign-currency liabilities; evidenced in Central/Eastern Europe with euro/Swiss franc mortgages.
  - Portfolio flows can facilitate tax evasion and illicit financial flows; evidence that the top 0.01 percent evaded around 25 percent of their taxes via offshore accounts in certain country comparisons.
- Aggregate implication: portfolio capital flows may raise inequality via volatility, tax avoidance, illicit flows, and asset-price effects; they may reduce inequality when they improve financial inclusion.

### Distributional channels — Official capital flows (ODA and reserve accumulation)
Findings:
- Evidence on ODA and inequality is mixed:
  - Some studies find no robust effect of aid on inequality; others find aid reduces inequality or increases it depending on institutional quality.
  - Calderón et al. (2006): aid reduces inequality if institutional quality exceeds a critical threshold.
  - Weak institutions increase the risk that aid is diverted, benefiting elites and increasing inequality.
- Aid is often procyclical, which can exacerbate volatility rather than stabilize it.
- Reserve accumulation:
  - Reserve buildup by EMDCs (pre-GFC and post-GFC waves) can mitigate volatility via insurance against reversals and through foreign exchange interventions to promote export-led growth.
  - The distributional impact of reserve-driven export-led growth depends on whether gains are distributed across skilled and unskilled labor and capital owners.

### Distributional channels — Remittances
Findings:
- Literature on remittances and inequality is mixed.
- Earlier studies simply compared Gini coefficients with and without remittances; more recent studies construct counterfactual income distributions to estimate what migrants’ incomes would have been at home absent migration.
- Remittances are relatively stable and co-move less with recipient-country GDP than do portfolio flows and FDI; they smooth disposable income and cushion shocks, often benefiting poorer households (pro-poor).
- Given their magnitude in some countries (remittances exceed 10 percent of GDP in 31 countries and can be over one third of GDP), remittances can have visible effects on within-country inequality.

### Cross-cutting mechanisms and empirical regularities
- Crises following liberalization tend to magnify distributional harms: newly liberalized countries followed by crisis show larger increases in Gini than liberalized countries not followed by crisis.
- There is no major difference in outcomes by creditor versus debtor status in many instances (examples: Germany vs U.S.; China vs Mexico).
- Financial globalization impacts inequality via multiple channels: labor market effects (skill premium, bargaining power), asset-price and wealth effects, volatility and crisis exposure, tax avoidance and illicit flows, and financial inclusion.

### Policy implications and recommendations (drawn from analysis)
- Strengthen financial regulation and supervision to manage risks associated with cross-border flows.
- Deploy capital flow measures (CFMs) where appropriate to shape the composition of inflows and reduce volatility, while not substituting for warranted macroeconomic adjustment.
- Use macroprudential policies to mitigate impact of global financial shocks.
- Improve access to financial services to broaden financial inclusion and help households smooth income shocks.
- Promote strong institutions to ensure ODA and other official flows reach intended beneficiaries and do not get diverted to elites; institutional strength is a pre-condition for aid to reduce inequality.
- Shape capital account openness and domestic policies to favor more stable, long-term flows (e.g., FDI and portfolio equity) over volatile debt flows where possible.
- Address tax avoidance and phantom FDI through multilateral and domestic tax-policy measures to limit inequality-amplifying profit-shifting and offshore evasion.
- Manage reserve accumulation and exchange-rate policies with attention to distributional implications of export-led strategies.

*Source: IMF Working Paper (wpiea2021004-print-pdf) — Sections II–IV (as provided).*

### conclusions. For example, Möllers and Meyer (2014) find that remittances increase inequality in

### wpiea2021004-print-pdf - conclusions. For example, Möllers and Meyer (2014) find that remittances increase inequality in

### Remittances and inequality: heterogeneous, time-varying effects
- Empirical findings are mixed: Möllers and Meyer (2014) find remittances increase inequality in Kosovo; Mughal and Anwar (2012) and Koczan and Loyola (2018) find remittances lower inequality in Pakistan and Mexico, respectively.
- Mechanism proposed:
  - Pioneer migrants (lacking migrant networks, facing higher migration costs) often come from wealthier households.
  - Later migrants (benefiting from expanding migrant networks and lower costs) often come from poorer households.
  - Implication: migration and remittances may initially increase inequality and later reduce it as migration history lengthens and fixed costs fall.
- Supporting evidence:
  - Acosta et al. (2008): different effects across Latin American countries depending on migration histories, migrant networks, and proximity to destinations.
  - Brown and Jimenez (2007): larger poverty- and inequality-reducing effects of remittances and migration in Tonga (long migration history, high remittances) than in Fiji (more recent migration history).
  - Margolis et al. (2013): larger inequality-reducing effects in Algerian regions with more migrants and remittance-receiving households.
  - McKenzie and Rapoport (2007): migration and remittances reduce inequality in rural Mexican communities with high levels of past migration.
  - Acharyaa and Leon-Gonzalez (2012): remittances from India reduce inequality in Nepal due to greater participation of the poor in the Nepal-India migration process.
  - Möllers and Meyer’s (2014) finding for rural Kosovo attributed to recent migration history and high migration costs.
- Net inference: inequality-reducing effects of remittances are more pronounced in countries with longer migration histories where fixed costs of migration are lower and migration/remittances are more accessible to poorer households.
- Methodological note: simple comparisons of income distributions with and without remittances are misleading because they ignore behavioral adjustments; counterfactual income estimation that accounts for behavioral changes (e.g., via propensity score matching) provides more accurate estimates.

### The case of Mexico: interaction of remittances, FDI, migration history, and inequality
- Historical context:
  - Mexico described historically as “a country of inequality.”
  - Long history of out-migration to the United States; migration flows influenced by push factors (economic crises in the 1970-80s) and pull factors (U.S. industrial demand and family reunification programs in the 1970-80s).
- Three inequality periods since the 1970s:
  - 1970s: inequality fell from high initial levels.
  - Mid-1980s to mid-1990s: inequality increased; both gross and disposable-income Ginis rose.
  - Mid-1990s through late 2000s: inequality declined (especially disposable income) coincident with NAFTA implementation.
- Drivers and episodes:
  - 1970s Shared Development (Desarrollo Compartido) and oil discovery in 1978 financed public investment and were equalizing; external debt rose and culminated in the 1982 debt servicing crisis, leading to recession and worsening inequality.
  - Post-1990 debt restructuring and FDI pick-up contributed to skill-biased technological change and rising skill premium, increasing inequality in the early transition.
  - 1994-95 peso crisis: devaluation, spike in interest rates, economic contraction, rise in unemployment; top 10 percent (high-skilled in non-tradable sectors) hardest hit, leading to a fall in inequality between 1994 and 1996.
  - Post-NAFTA decline in wage inequality possibly driven by:
    - Increase in college enrollment starting in 1995 (Campos-Vázquez 2013).
    - Rise in low-skilled wages due to expansion of assembly activities by foreign investors (Robinson 2007), with larger increases in states closer to the U.S. border (Chiquiar 2008).
- FDI and regional inequality:
  - Jensen and Rosas (2007): Mexican states with larger FDI inflows had larger declines in inequality between 1990 and 2000.
  - Waldkirch (2008): FDI into maquiladora industry benefited unskilled workers disproportionately.
  - Authors’ data (2003-10) indicate inequality decreased more in regions receiving higher FDI inflows.
- Remittances in Mexico:
  - Mexico is one of the world’s largest recipients of remittances.
  - In early years remittance-receiving households were typically in the middle of the income distribution; as migration costs fell, remittances became increasingly pro-poor.
  - Remittance-receiving households are on average poorer than non-receiving households, even when remittances are included; remittances constitute a larger share of income for poorer households.
  - Empirical counterfactual result: the Gini coefficient of households’ “no-migration” counterfactual income is higher than that of actual income, suggesting inequality would be higher in the absence of remittances even after accounting for behavioral adjustments (counterfactuals estimated via propensity score matching using 2002, 2008 and 2014 surveys).
  - Koczan and Loyola (2018): during the Global Financial Crisis, the likelihood of receiving remittances and remittances’ share of income fell for top income deciles but increased for lower income deciles — a contrast with the peso crisis when lower deciles’ remittance receipts remained largely unchanged. Possible explanations: falling fixed costs of migration (making migration accessible to poorer households) and migrants’ better integration in the United States (higher incomes, more stable jobs, regularized status) enabling an insurance effect during a common shock.

- Key numeric and survey points for Mexico (preserve original figures):
  - In 2014, households received on average about US$290 per month (US$140 median).
  - Poverty: a 24 percent increase in the poverty headcount during the 1994-95 crisis (Pereznieto 2010).

### Policy implications: seven sets of measures to harness financial globalization while limiting adverse distributional effects
- 6.1. Macroeconomic policies
  - Use countercyclical macroeconomic policies to limit macroeconomic volatility associated with capital flows, since volatility disproportionately hurts the poor.
  - Practically, use fiscal policy to lean against capital-flow-induced demand pressures.
  - Strengthen automatic fiscal stabilizers and fiscal institutions (e.g., independent agencies for fiscal forecasts) to support discretionary fiscal policy.
  - Note: monetary policy has limited usefulness in this context (raising rates when capital flows in attracts more capital; lowering rates to dampen inflows aggravates excess demand).
- 6.2. Capital-flow management policies (CFMs)
  - CFMs can be part of a package to limit risk of capital-flow reversals and crises that hurt the poor, but should not substitute for warranted macroeconomic adjustment.
  - Consider distributional and social objectives explicitly (e.g., housing-related restrictions on non-resident investments where housing affordability is an issue).
  - Advanced-economy examples since 2011: Australia, Canada, Hong Kong SAR, New Zealand, and Singapore have adopted or tightened measures discriminating between residents and non-residents for domestic real estate (stamp duties, transaction taxes, prohibitions, quotas).
- 6.3. Education
  - Higher educational attainment in EMDEs reduces adverse distributional effects of liberalization by enabling wider sharing of increases in the skill premium.
  - Avoid skill mismatch; align the pace of educational attainment improvements with the education system’s capacity to avoid quality declines.
- 6.4. Business climate
  - Reliable contract enforcement and business-enabling regulation attract FDI and shift capital inflows toward forms with more favorable distributional consequences.
  - Promote competition in product markets, streamline regulation, reduce bureaucratic discretion, increase transparency (e.g., information portals).
  - Investment-promotion agencies can assist in attracting FDI; political visibility and private-sector involvement can strengthen their credibility (Morisset 2003).
- 6.5. Financial sector policies, including macroprudential policies
  - Ensure prudent use of external funds by banks through sound micro- and macro-prudential policies to enhance banking-sector resilience, financial stability, and reduce adverse distributional effects from volatility.
  - Foster competition in banking and finance to facilitate credit access and broadly share benefits from more abundant credit (examples: abolishing credit and interest-rate controls, strengthening banking supervision).
  - Some macroprudential tools (e.g., LTV and DTI limits) have direct distributional effects and may restrict access for low-income households; design must balance stability and inclusion.
  - Consider measures such as macroprudential levies on bank flows to manage bank risk-taking in bank-led flows contexts.
- 6.6. Redistributive policies and social safety nets
  - Redistribution mitigated some adverse effects of capital account liberalization: inequality in disposable incomes increased less than inequality in market incomes following liberalization episodes.
  - Financial globalization shifts tax burden toward less mobile factors (low-skilled labor); proactive tax and transfer policy adjustments may be needed to achieve redistributional objectives.
  - Strengthen social safety nets to support consumption smoothing and protect the poor during crises.
- 6.5. Remittance-related policies (remittances subsection numbering retained as in source)
  - Given broadly favorable distributional impact of remittances, focus policy on reducing remittance costs.
  - Remittance costs are high in certain corridors and providers (small markets, little competition, bank intermediated).
  - Policies: reduce transaction costs, increase competition, help migrants compare providers, and leverage mobile technology to lower costs.

### Overall conclusion
- Financial globalization tends to foster economic growth but can raise inequality.
- Neither outcome is inevitable: benefits of capital flows are likely when countries strengthen policies and institutions to limit volatility and guide flows to appropriate sectors.
- The inequality-increasing tendency of capital flows can be limited by policies shaping composition and timing of flows, by raising educational attainment ex ante so more workers benefit from capital-skill complementarities, and by ex post redistributive measures to support the disadvantaged.

*Source: conclusions section of wpiea2021004-print-pdf.*

### References

### wpiea2021004-print-pdf - References

### Remittances, Migration, and Inequality
- Acharyaa, Chakra. P., and Robert Leon-Gonzalez (2012), “The Impact of Remittances on Poverty and Inequality: A Micro-Simulation Study for Nepal.” GRIPS Discussion Paper 11–26, National Graduate Institute for Policy Studies, Tokyo, Japan
- Acosta, Pablo, Cesar Calderon, Pablo Fajnzylber and Humberto Lopez (2008), “What is the Impact of International Remittances on Poverty and Inequality in Latin America?” World Development 36 (1): 89–114
- Adams, Richard, Alfredo Cuecuecha, and John Page (2008), "The Impact of Remittances on Poverty and Inequality in Ghana." World Bank Policy Research Working Paper 4732, World Bank, Washington, DC
- Barham, Bradford and Stephen Boucher (1998), “Migration, Remittances, and Inequality: Estimating the Net Effects of Migration on Income Distribution.” Journal of Development Economics 55: 307–31
- Brown, Richard P. C. and Eliana Jimenez (2007), “Estimating the Net Effects of Migration and Remittances on Poverty and Inequality: Comparison of Fiji and Tonga.” UNU-WIDER Research Paper 2007/23
- Margolis, David, Luis Miotti, El Mouhoub Mouhoud, Joël Oudinet (2013), “To Have and Have Not”: Migration, Remittances, Poverty and Inequality in Algeria.” IZA Discussion Paper 7747
- McKenzie, David and Hillel Rapoport (2007), “Network effects and the dynamics of migration and inequality: Theory and evidence from Mexico.” Journal of Development Economics 84 (1): 1-24
- Taylor, J. Edward, Richard Adams, Jorge Mora and Alejandro López-Feldman (2009), “Remittances, Inequality and Poverty: Evidence from Rural Mexico.”

### Capital Flows, Financial Globalization, and Distributional Effects
- Araujo, Juliana D., Antonio C. David, Carlos von Hombeeck, and Chris Papageorgiou (2015a), “Non-FDI Capital Inflows in Low-Income Developing Countries: Catching the Wave?”, IMF Working Paper 15/86
- Araujo, Juliana D., Antonio C. David, Carlos von Hombeeck, and Chris Papageorgiou (2015b), “Joining the Club? Procyclicality of Private Capital Inflows in Low Income Developing Countries”, IMF Working Paper 15/163
- Ananchotikul, Nasha, and Longmei Zhang (2014), “Portfolio Flows, Global Risk Aversion and Asset Prices in Emerging Markets”, IMF Working Paper 14/156
- Bluedorn, John, Rupa Duttagupta, Jaime Guajardo, and Petia Topalova (2013), “Capital Flows are Fickle: Anytime, Anywhere”, IMF Working Paper 13/183
- Broner, Fernando, Tatiana Didier, Aitor Erce, and Sergio L. Schmukler (2013), “Gross capital flows: Dynamics and crises”, Journal of Monetary Economics 60 (2013): 113-133
- Calvo, Guillermo A., and Carmen M. Reinhart (1999), “When Capital Inflows Come to a Sudden Stop: Consequences and Policy Options”
- Eichengreen, Barry (2004), “Capital Flows and Crises”, MIT Press
- Forbes, Kristin J., and Francis E. Warnock (2011), “Capital Flow Waves: Surges, Stops, Flight, and Retrenchment”, NBER Working Paper 17351
- Rey, (not included in list) — note: only supplied references used.

### Foreign Direct Investment (FDI), Trade, and Income Distribution
- Amendolagine, Vito, Andrea F. Presbitero, Roberta Rabellotti, Marco Sanfilippo, and Adnan Seric (2017), “FDI, Global Value Chains, and Local Sourcing in Developing Countries”, IMF Working Paper 17/284
- Amighiani, Alessia A., Margaret S. McMillan, and Marco Sanfilippo (2017), “FDI and Capital Formation in Developing Economies: New Evidence from Industry-Level Data”, NBER Working Paper 23049
- Basu, Parantap, and Alessandra Guariglia (2007), “Foreign Direct Investment, Inequality, and Growth”, Journal of Macroeconomics 29 (2007) 824-839
- Choi, Changkyu (2006), “Does foreign direct investment affect domestic income inequality?”, Applied Economics Letters, 13:12, pp 811-814
- Feenstra, Robert C., and Gordon H. Hanson (1997), “Foreign direct investment and relative wages: Evidence from Mexico’s maquiladoras”, Journal of International Economics 42 (1997) pp. 371-393
- Herzer, Dierk, Philipp Hühne, and Peter Nunnenkamp (2014), “FDI and Income Inequality – Evidence from Latin American Economies”, Review of Development Economics, 18(4), 778-793
- Suanes, Macarena (2016), “Foreign direct investment and income inequality in Latin America: a sectoral analysis”, CEPAL Review 118, April 2016
- Te Velde, Dirk (2003), “Foreign Direct Investment and Income Inequality in Latin America”, Overseas Development Institute, April 2003

### Financial Crises, Banking, and Macroprudential Policy
- Agnello, Luca, and Ricardo Sousa (2012), “How do banking crises impact on income inequality?”, Applied Economics Letters, Vol. 19, Issue 15, pp 1425-1429
- Laeven, Luc, and Fabián Valencia (2012), “Systemic Banking Crises Database: An Update”, IMF Working Paper 12/163
- Reinhart, Carmen M., and Vincent R. Reinhart (2008), “Capital Flow Bonanzas: An Encompassing View of the Past and Present”, NBER Working Paper 14321
- Reinhart, Carmen M., and Kenneth S. Rogoff (2009), “The aftermath of financial crises”, American Economic Review 99, no. 2, pp 466-472
- Frost, Jon and Rene van Stralen (2018), “Macroprudential Policy and Income Inequality,” Journal of International Money and Finance, Vol. 85, pp. 278-290
- Bergant, Katharina, Francesco Grigoli, Niels-Jakob Hansen, and Damiano Sandri (2020), “Dampening Global Financial Shocks: Can Macroprudential Regulation Help (More than Capital Controls)?”, IMF Working Paper 20/106

### Technology, Trade Shocks, and Labor Market Effects
- Autor, David, David Dorn and Gordon Hansen (2016), “The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade,” Annual Review of Economics 8.
- Berman, Eli, John Bound, and Stephen Machin (1998), “Implications of skill-biased technological change: international evidence”, The Quarterly Journal of Economics, Vol 113, No 4, pp 1245-1279
- Blinder, Alan. S. (2009), “How Many US Jobs Might be Offshorable”, World Economics Vol 10, No 2, pp 41-78
- Feenstra, Robert C., and Gordon H. Hanson (1997), “Foreign direct investment and relative wages: Evidence from Mexico’s maquiladoras”
- Pavcik, Nina (2017), “The Impact of Trade on Inequality in Developing Countries,” NBER Working Paper no.23878
- Chiquiar, Daniel (2008), “Globalization, regional wage differentials and the Stolper-Samuelson Theorem: Evidence from Mexico”, Journal of International Economics 74(2008) pp 70-93

### Aid, Public Policy, Institutions, and Inequality
- Calderón, María Cecilia, Alberto Chong, and Mark Gradstein (2006), “Foreign Aid, Income Inequality, and Poverty”, Inter-American Development Bank Working Paper 547
- Chong, Alberto, and Mark Gradstein (2007), “Inequality and Institutions”, The Review of Economics and Statistics, Vol. 89, No. 3, pp. 454-465
- Chong, Alberto, Mark Gradstein, and Cecilia Calderon (2009), “Can foreign aid reduce income inequality and poverty?”, Public Choice 140, 59-84
- Economides, George, Sarantis Kalyvitis, and Apostolis Philippopoulos (2008), “Does foreign aid distort incentives and hurt growth? Theory and evidence from 75 aid-recipient countries”, Public Choice 134(3) pp 463-488
- Hodler, Roland (2007), “Rent seeking and aid effectiveness”, International Tax and Public Finance 14(5), pp 525-541
- Svensson, Jakob (2000), “Foreign aid and rent-seeking”, Journal of International Economics, Vol 51, Issue 2, pp 437-461

### Measurement, Datasets, and Methodological Contributions
- Barro, Robert, and Jong-Wha Lee (2013), “A New Data Set of Educational Attainment in the World, 1950-2010”, Journal of Development Economics, Vol 104, pp. 184-198
- Bertaut, Carol C., and Ruth Judson (2014), “Estimating U.S. Cross-Border Securities Positions: New Data and New Methods”, International Finance Discussion Papers No. 1113
- Bertaut, Carol C., and Ralph W. Tryon (2007), “Monthly Estimates of U.S. Cross-Border Securities Positions”, International Finance Discussion Papers No. 910
- Damgaard, Jannick, Thomas Elkjaer, and Niels Johannesen (2019), “What is Real and What Is Not in the Global FDI Network?”, IMF Working Paper 19/274
- Laeven, Luc, and Fabián Valencia (2012), “Systemic Banking Crises Database: An Update”, IMF Working Paper 12/163
- Piketty, Thomas, Emmanuel Saez, and Gabriel Zucman (2018), “Distributional National Accounts: Methods and Estimates for the United States”, The Quarterly Journal of Economics 131(2), pp 519-578

*References section from wpiea2021004-print-pdf*

---


_Source: https://www.imf.org/-/media/files/publications/wp/2021/english/wpiea2021004-print-pdf.pdf_