Geographical Location of Foreign Direct Investment and Wage Inequality in China

This paper examines the relationships between distance and the transportation costs of international trade on the location‐specific effects of foreign direct invest‐ment and provincial per capita income in China. Applying the economic geography model proposed by Redding and Venables (2004), it traces the increasing wage inequality among the coastal and inland provinces by focusing on the distance of foreign‐owned firms from access to international markets and to suppliers of intermediate inputs. First, a gravity‐type equation is used to construct the ‘market access’ and ‘supplier access’ variables. Then, the effect of market and supplier access on provincial wage rates is estimated. The results indicate that distance does affect international trade and geography explains roughly one‐third of the wage differential. Greater market access increases the provincial wage gap, while larger supplier access increases the wage difference in trade destined for the foreign market but decreases the wage difference in trade targeted for the domestic market. Similar findings also result from applying the estimations to two local firm types: state‐owned enterprises and collective‐owned enterprises.