THE ROLE OF INNOVATION IN THE RELATIONSHIP BETWEEN FDI AND INCOME INEQUALITY: EVIDENCE FROM A TRANSITION ECONOMY

Abstract

This study explores the impact of innovation and foreign direct investment (FDI) on income inequality, emphasizing the moderating role of innovation in the relationship between FDI and income inequality, using panel data from 63 Vietnamese provinces from 2005 to 2020. As economic expansion raises concerns about income inequality in Vietnam, understanding the distributional effects of innovation and FDI is essential. While innovation fosters technological progress and job creation, its benefits primarily accrue to skilled labor and capital-intensive sectors, potentially widening income inequality. Similarly, FDI promotes economic expansion, but its effects on inequality depend on absorptive capacity and investment composition, which may exacerbate income gaps. Using the system generalized method of moments (GMM) method on 1,008 observations, the findings reveal a U-shaped relationship between innovation and income inequality, whereas FDI exhibits an inverted U-shaped relationship. Specifically, innovation exacerbates inequality beyond a threshold of 27.63, while FDI reduces inequality once it exceeds 0.76. Moreover, the negative coefficient of the interaction variable between innovation and FDI suggests that innovation weakens the impact of FDI on income inequality. These findings remain robust when substituting the Human Development Index as an inequality proxy and align with modernization and endogenous growth theories. This study contributes novel empirical insights and policy implications for promoting inclusive innovation and sustainable investment, advancing Sustainable Development Goal 10 on inequality reduction.