Effects of International Capital Flows on Income Inequality: Bilateral Approach

ABSTRACT This paper examines the influence of cross‐border capital flows on income inequality in both origin and recipient countries. Using bilateral flow data and a panel dataset spanning 63 countries from 2005 to 2018, we employ panel regression analysis to investigate the effects of different types of capital. Our findings indicate that FDI inflows reduce income inequality in advanced countries by creating jobs and raising wages in sectors that employ lower‐income individuals. Conversely, in developing countries, FDI often targets capital‐intensive and high‐skilled industries, increasing inequality. Portfolio investments generally increase inequality by driving up asset prices and creating instability, but can decrease inequality in emerging markets by supporting financial inclusion and reducing government financing costs. Specific scenarios, such as investments in tax havens or differences in human capital, show distinct results. Policymakers should regulate international capital flows through financial regulations, progressive taxation and international cooperation to mitigate their impact on income inequality.