Short-run and Long-run Relationship between Economic Growth, Foreign Direct Investment, Trade Liberalization and Education on Income Inequality: Evidence from Indonesia

Abstract

The aim of this study is to examine the relationship between economic growth (GDP), Foreign Direct Investment (FDI), trade liberalization and education on income inequality in short-run and long-run for Indonesia over the period 1981-2015. Using the Vector Error Correction Model (VECM), this study found that in the long-run, GDP has a positive and significant effect on income inequality. The higher GDP in Indonesia will cause a higher income inequality. In contrast, GDP has a negative effect on income inequality in the short-run. The long-run result supports the Kuznets hypothesis that increasing in income inequality is caused by the initial increase in GDP per capita. Both trade and education have negative and significant effect in the long-run. Meanwhile, in short-run, both have different results. Increasing trade will escalate income inequality significantly, while increasing education will decrease income inequality.