This paper discusses policy options available to government policy makers in developing countries to attract foreign direct investment (FDI) and influence the behaviour of transnational corporations (TNCs), and it focuses on the effects these corporations have on human capital formation and income inequality in host countries. While the central role of human capital formation in development is increasingly recognised in the literature, less is known about the relationship between FDI and human capital formation and the questions whether and how policy should address this remain unanswered. This paper first reviews the effects of TNCs on human capital using a simple supply and demand framework of the market for skills. It then reviews different types of FDI policy and their effectiveness. Finally, it discusses how FDI policy may have affected the interaction between FDI and human capital formation in developing countries. The paper concludes with suggestions for further research ...