Does trade openness and FDI reduce inequality? Evidence from South Asia

This study seeks to examine whether trade openness and inward FDI may affect income distribution in an unbalanced panel of five South Asian countries over the period of 1990–2016. The analysis of the model involves the examination of likely non‐linear effect of both trade and FDI on income distribution. Therefore, dynamic panel system‐generalized method of moments (SYS‐GMM) estimator has been applied to mitigate the problem of non‐linearity and possible endogeneity. In the second stage, the model is extended to test the impact of education on income inequality. The hypothesis was that secondary school enrolment speeds up the process of adoption of contemporary technology and decreases inequality. The results reveal that trade and FDI have significant effects on income inequality, however, inverted U‐shaped curve holds for trade as purposed by the trade theory. The component wise effect of trade was also held, except imports from advanced countries. The joint effect of trade and FDI through education has produced mixed results. South Asia needs to invest in social infrastructure and swifter the process of openness to achieve the desired goal of equitable prosperity.