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8.1 INTRODUCTION The level of FDI in China has reached a new record high, US$61 billion, in 2004. The annual average growth rate of utilized FDI in China is remarkable at 34 per cent during the period 1978 to 2004. With this persistent strong growth of FDI inflows, China achieved its highest average annual economic growth rate of about 10 per cent in the same period. Meanwhile, income inequality in China has substantially widened between households in the coastal and the inland regions. In 2004, the per capita annual disposable income of households in the richest coastal region, Shanghai, was CNY16 683 (CNY = Chinese yuan also known as RMB in local Chinese currency), which was almost 10 times as much as the per capita annual disposable income of households in the poorest inland region, Guizhou (CNY1722). 1 In contrast to the inland western regions (for example, Guizhou, Sichun and Guangxi), the coastal regions (for example, Shanghai, Jiangsu and Guangdong,) where most FDI occurs, are relatively well developed. The relationship between FDI and inequality has raised great concern amongst policy makers, and has been an important topic of interest in the areas of international economics and economic development. While some researchers (for example, Mundell 1957, Feenstra and Hanson 1997) argue that FDI generally reduces income inequality in developing countries in particular, others claim (for example Tsai 1995) that FDI contributes to the rise in income inequality. In this chapter, applying time series data for the period 1978 to 2002 to...