Chapter 12: International Factor Movements

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Chapter 12 International Factor Movements
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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
• Result
• 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

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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
• (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 five major host countries for U.S.
  investments are
• United Kingdom (15.5 ), Canada (10.8 ), and the
  Netherlands (10.0 )
• the five 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 sales Last edition
• 1. Mitsubishi (Japan), 2. Mitsui (Japan),
• 3. Itochu (Japan) 4. General Motors (U.S.)
• 5. 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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Worlds Largest Corporations and Banks

• Corporations, largest by revenues
• 1. Wal-Mart 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. Deutche Bank

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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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Reasons for International Capital Movements
(continued)

• 4. Overcome Trade Barriers
• firms may build production facilities in a
  different country to overcome tariff and
  nontariff trade barriers to imports
• 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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Reasons for International Capital Movements
(continued)

• 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
• 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 Flows

• Case Study 1
• The most significant variables in determining the
  capital flows toward a host country are
• 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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Analytical Effects of Capital Movements

• Graph on next slide shows the total distribution
  of capital in the 2-country world
• measure capital for country 1 from left, country
  2 from right
• vertical axis shows marginal product of capital
  and rental rate in country 1 and in country 2
• International capital flows equalize the price
  for identical capital
• Initially capital in country 1 earns more (r1)
  than capital in country 2 (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
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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 to move to OAEk2
  and OAEk2.
• World output therefore increases by area CEC.
• Output in country 1 increases and output in
  country 2 decreases
• National income in both countries increase
• country 1 by FCE, and country 2 by CEF

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Effects of Capital Flows on Income

• Income of owners of capital in country 1 falls
• from 0r1Ck1 to 0r2Fk1 -- loss of r1CFr2
• Income of owners of capital in country 2 rises
• from 0r1Ck1 to 0r2Fk1 -- gain of r1CFr2
  (note capital has moved to country 1, but
  ownership remains in country 2)
• Income of workers in country 1 rises
• from r1AC to r2AE -- increase of r2r1CE
• Income of workers in country 2 decreases
• from r1AC to r2AE -- decrease of r2r1CE
• National income in both countries increase
• country 1 by FCE, and country 2 by CEF