Chapter 12: International Factor Movements

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Chapter 12 International Factor Movements

• Labour movement migration
• Capital movement Direct investment

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Foreign Direct Investment and Multinational
Corporations

• Foreign direct investment
• movement of capital that involves ownership and
  control
• Foreign portfolio investment
• movement of financial capital - investment that
  involves no ownership or control (bond purchases,
  bank deposits, small stock purchases)

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Example of Foreign Direct Investment

• Foreign investment in China since 1978.
• China allowed foreign partnerships and firms to
  set up
• Large increase in production
• Competition for state-owned firms

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Example of Foreign Direct Investment

• Result (read chapter for more)
• less spending on state firm output
• more spending on independent firm output
• wages higher in independent firms
• consumers and wages earners won, state firms lost
• environment is also losing 60 of Chinas
  waterways are very polluted
• (problem low pricing leading to overuse in
  cities)

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Examples of types of Foreign Direct Investment

• Stock purchases summing to more than 10 of
  common stock
• stock holders have voting power, therefore, if
  investment is significant, the investment moves
  beyond purely financial to having some control

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Examples of types of Foreign Direct Investment

• Investments associated with multi-national
  corporations or transnational corporations
• Purchase to create foreign subsidiary
• if more than 50 of stock is purchased by a
  foreign corporation, the firm becomes a
  subsidiary
• Creation of a branch plant
• firm builds a facility in another country

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Direct Investment

• Direct investment is much bigger than
  International Trade
• In 2003, 7.12 trillion in accumulated foreign
  direct investment in countries
• growth rate high in recent years (7.8 in 2002)
• (note investment accumulates trade is a flow)

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Direct Investment

• Most direct investments flow (in two directions)
  between developed countries. For example,
• the three major host countries for U.S.
  investments are
• United Kingdom (15.5 ), Canada (10.8 ), and the
  Netherlands (10.0 )
• the three major source countries for investments
  into the U.S. are
• United Kingdom (16.7), Japan (11.6 ), and
  Germany (10.8)

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U.S. Direct Investment

• Investment by industry reflects overall economic
  activity

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Worlds Largest Corporations and Banks

• Corporations, largest by revenues
• 1. Wal-Mart (U.S.) 2. BP (UK)
• 3. Exxon (U.S.) 4. Royal Dutch Oil
  (UK/Neth.)
• 5. General Motors (US) 6. Ford Motor (U.S)
• Banks (Bks), largest by assets
• 1. Mizuho Fin. Grp (Japan) 2. Citigroup (US)
• UBS (Switzerland) 4. Credit Agricole (Fr)
• 5. HSBC Holdings (UK) 6. Deutsche Bank
  (Ger)

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Worlds Largest Corporations and Banks last
edition of text

• Corporations, largest by salesition
• 1. Mitsubishi (Japan), 2. Mitsui (Japan),
• 3. Itochu (Japan) 4. General Motors (U.S.)
• Sumitomo (Japan) 6. Marubeni (Japan)
• Banks (Bks), largest by assets
• 1. Sumitomo Bk (Japan) 2. Dai-Ichi Kangyo Bk
  (Japan)
• 3. Sanwa Bk(Japan) 4. Deutsche Bk (Germany)
• 5. Fuji Bank (Japan) 6. Sakura Bk (Japan

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8 Reasons for International Capital Movements

• 1. Markets
• investment to countries where market for product
  is growing
• 2. High per capita income
• production is directed to high income tastes, and
  investment moves to countries with high per
  capita incomes
• 3. Minerals or raw material deposits
• direct investment may be to secure access to raw
  materials

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8 Reasons for International Capital Movements

• 4. Overcome Trade Barriers
• firms may build production facilities in a
  different country to overcome tariff and
  nontariff trade barriers to imports

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8 Reasons for International Capital Movements

• 5. Low Relative Wages (or capital costs)
• production process can be broken up and sent to
  different countries to take advantage of lower
  production costs in those countries, i.e.
  assembly where labour is cheap, machining where
  technological expertise is abundant

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8 Reasons for International Capital Movements

• 6. Protect market share
• produce close to market in order to preserve
  current share of market for the goods v.s. other
  competitors
• 7. Risk Diversification
• production in various industries minimizes risks
  associated with instability, strikes, or market
  downturns

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8 Reasons for International Capital Movements

• 8. Access Firm-Specific Knowledge
• firms may purchase a foreign firm as a subsidiary
  in order to acquire knowledge that will allow
  them to maintain a competitive edge

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Empirical Evidence on Capital Flows4 Studies

• Box 1 Veugelers (1991)
• Significant variables in determining the capital
  flows toward a host country (between developed
  countries)
• higher GDP
• host country participation in international
  integration (openness)
• common language or border
• high labour productivity
• he found a surprising negative relationship
  between level of fixed investment to GDP

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Empirical Evidence on Capital Flows

• Box 1 (Rood and Ahmed 1979)
• Six variables important in determining how much
  capital flows toward a host country (58
  developing countries)
• higher per capita GDP
• higher growth rate of GDP
• host country participation in international
  integration
• greater availability of infrastructure facilities
• greater extent of urbanization (concentration of
  markets)
• greater degree of political stability

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Empirical Evidence on Capital Flows

• Box 1 (Barrell and Pain 1996)
• Influences on US investment abroad in 70s and
  80s
• size of world market
• US cost of labour vs cost of labour in other
  countries (Can, Jap, Ger, Fr, UK)
• US cost of capital vs cost of capital in other
  countries
• US profits (money available)
• expected rise in value of US dollar lowered FDI
  -- postponement

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Empirical Evidence on Capital Flows

• Box 1 (Biswas 2002)
• Influences on US investment in 44 countries from
  1983 to 1990
• higher wages resulted in less FDI in some
  instances (not all perhaps higher wages mean
  higher productivity)
• infrastructure (positive and significant)
• democracies more attractive than other regimes
• greater protection of property rights positive
• longer duration of regime negative (Biswas
  hypothesized that longer lasting regime meant
  that interest groups would gain power)

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Analytical Effects of Capital Movements

• Graph shows the total distribution of capital in
  the 2-country world
• measure capital for country I from left, country
  II from right
• vertical axis shows marginal product of capital
  and rental rate in country I and in country II
• We will first build graph for country I, then add
  country II

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Capital Market Equilibrium-The Two-Country Case
step by step
MPPKI r
The demand for capital by firms equals its
marginal product MPPK The area under the MPPk
line up to K1 represents total product (or
output) in country I
A
The rectangle 0r1CK1 is the total return to
capital.
The triangle r1AC is the total return to labour.
C
r1
MPPKI D (B in book)
0
K1
K
Recall firms pay MPPk r as the price of
capital.
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Analytical Effects of Capital Movements

• International capital flows equalize the price
  for identical capital
• Initially capital in country I earns more (r1)
  than capital in country II (r2)
• capital distribution between the two countries
  moves from K1 to K2 and price (rental rate)
  equalizes

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Capital Market Equilibrium-The Two-Country Case
MPPKI r
Let r2 world equilibrium rental rate of
capital. Demand MPPK Start Capital stock in
country 1 K1 r1 gt r2
A
Capital flows from country II into country I K
K2 r r2
r1
r2
MPPKI D
K1
K2
K
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Capital Market Equilibrium-The Two-Country Case
MPPKI r
Output in country 1 increases by area
K1CEK2 Return to capital owners in country 1 has
fallen from 0r1CK1 to 0r2FK1
A
The area K1FEK2 is paid to country II capital
owners
C
r1
E
r2
F
MPPKI D
0
K1
K2
K
The area r2r1CE is paid to workers.
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Introduce country II

• Country II output and capital will be measured
  from right to left.
• Total capital is represented by the length of the
  horizontal axis.
• K1 shows where capital is used in country I or
  country II, before investment.
• 0K1 is capital in country I before investment
• 0K1 is capital in country II before investment.
• K2 shows where capital is used after the
  investment.

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Introduce country II

• Country II output and capital will be measured
  from right to left.
• Initially, country II has 0K1 capital, and the
  rental rate is r1.
• The total return to capital owners is 0K1Cr1
• The total return to labour is r1AC

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Introduce country II

• Country II output and capital will be measured
  from right to left.
• Initially, country II has 0K1 capital, and the
  rental rate is r1.
• The total return to capital owners is 0K1Cr1
• The total return to labour is r1AC
• Lets see graph then describe movement.

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Capital Market Equilibrium-The Two-Country Case
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Effects of Capital Flows on Output and Income

• Area OACk1 represents output in country 1 without
  capital flows (OACk1) represents output in
  country 2
• Capital flows allow production in country I to
  move to OAEk2 and production in country II falls
  to OAEk2.
• World output therefore increases by area CEC.

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Effects of Capital Flows on Output and Income

• Output in country I increases and output in
  country II decreases
• National income in both countries increase
• country I by FCE, and country II by CEF

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Effects of Capital Flows on Income

• Income of owners of capital in country I falls
• from 0r1Ck1 to 0r2Fk1 -- loss of r1CFr2
• Income of owners of capital in country II rises
• from 0r1Ck1 to 0r2Fk1 -- gain of r1CFr2
  due mainly to the price increase for capital in
  country II
• (note capital has moved to country 1, but
  ownership remains in country 2)

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Effects of Capital Flows on Income

• Income of workers in country I rises
• from r1AC to r2AE -- increase of r2r1CE
• Income of workers in country II decreases
• from r1AC to r2AE -- decrease of r2r1CE
• National incomes in both countries increase
• country I by FCE, and country II by CEF