International Factor Movements

1
Chapter 7

• International Factor Movements

2
Preview

• Movement of goods and services is one form of
  international integration
• Another form of integration is international
  movements of factors of production

3
Preview

• Main factors of production
• Land (cant move across borders)
• Labor (immigration, emigration)
• Capital (International Capital Markets)
• Note physical capital refers to machines,
  structures, tools, etc. When these cross borders,
  this is considered trade in goods not factor
  movements.
• International capital markets refer to financial
  flows from one country to another that is used to
  finance investment in physical capital.
  (International borrowing and lending)
• Foreign Direct Investment/ Multinational Firms-
  type of financial/capital flow but reasons for
  this type of activity are tied to the fact that
  there is some benefit from owning the facility in
  another country.

4
Preview

• Causes of factor mobility will be much the same
  as causes of trade in goods.
• Example Capital scarce (low savings) country may
  borrow from abroad to finance capital investment
  or could import capital intensive goods
• Example Labor scarce country may import labor
  intensive goods or might employ migrant workers.

5
Preview

• Look at causes and effects of labor migration
• Foreign direct investment and multinational firms
• (Skipping material on international borrowing and
  lending)

6
International Labor Mobility

• Assumptions of factor mobility model
• Two countries (Home and Foreign)
• Both countries produce one good Q (output)
• Both countries have the same technology
• Two factors of production land (T) and labor (L)
• Home is relatively labor abundant and Foreign is
  relatively land abundant
• Perfect competition in all markets.

7
International Labor Mobility

• Concepts needed
• Production function a mathematical expression
  that tells how much output is produced for a
  given amount of inputs.
• Marginal product of labor (MPL)- additional
  output produced by hiring an additional amount of
  labor (MPL?Q/?L)

8
International Labor Mobility

• Example 7.1
• Suppose the production function is given by
  Q(TL).5
• Assume there are initially 100 units of land
  available.
• Draw the production function for T100, for
  varying levels of Labor (L100, 200, 300)
• Calculate the MPL?Q/?L for these different labor
  usages.

9
International Labor Mobility

• Example 7.1 continued
• Now, suppose there are 400 units of land
  available.
• Draw the production function for T200, for
  varying levels of Labor (L100, 200, 300)
• Calculate the MPL?Q/?L for these different labor
  usages.

10
International Labor Mobility

• On a fixed parcel of land, each worker becomes
  less productive as more workers are added.
• The marginal product of labor (MPL) decreases as
  more workers are employed (diminishing marginal
  product of labor)
• Productivity of labor depends on the quantity of
  land currently employed.
• The marginal product of labor will be higher, the
  more land employed.
• Countries with higher land to labor ratios, will
  have a higher level of MPL under full employment.

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International Labor Mobility

• Under perfect competition, firms will hire
  additional units of labor until the marginal
  revenue product of labor (MRPLPMPL) exactly
  equals the cost of a unit of labor (w)
• For example
• If MRPL gtw, this implies that additional revenue
  generated by hiring one more worker is higher
  than additional costs, so the worker should be
  hired.
• If MRPL ltw, this implies that additional revenue
  generated by hiring one more worker is lower than
  additional costs, so the worker should be fired.
• Optimal to hire where PMPL w
• This implies that w/P (the real wage)MPL in
  equilibrium.

12
International Labor Mobility

• Put another way, given perfect competition firms
  will be willing to pay workers a real wage equal
  to MPL.
• If L0 units of labor are hired, each worker will
  be paid a real wage of w/P.
• Total real wage income will be w/PL0

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International Labor Mobility
Real wages, MPL

w/P
Total real income of labor ie the number of goods
paid to labor
MPL
L
L0
14
International Labor Mobility

• Note the area under the MPL curve to the left of
  the quantity of labor hired is equal to total
  output.
• (Shown in Appendix to Chapter 7)

15
International Labor Mobility
16
International Labor Mobility

• Perfect Competition implies that all revenues are
  paid to labor (L0 ) and land (T0 ) where L0 and
  T0 are the levels of labor and land employed.
• PQwL0rT0
• Or QwL0/P rT0/P
• QArea under the MPL curve
• wL0/PArea bounded by MPL curve, real wage, and
  quantity of labor hired
• rT0/PThe rest of the area under the MPL curve.

17
International Labor Mobility
18
International Labor Mobility

• In equilibrium, the real wage paid to workers
  equals their marginal product.
• The area under the marginal product of labor
  curve equals the value of output produced, which
  equals the real value of wages and real rental
  income paid to landowners.

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International Labor Mobility

• Example 7.2
• Suppose the domestic country is relatively labor
  abundant and the foreign country is relatively
  land abundant.
• Example Q(LT).5
• T100
• T400
• LLL
• Q10L.5 Q20L.5
• Draw the MPL curves for the two countries and the
  equilibrium real wages when L units of labor are
  hired.

20
International Labor Mobility

• Example 7.2 continued

21
International Labor Mobility

• If the domestic country is the labor abundant
  country and the foreign country is the land
  abundant country,
• the marginal product of domestic workers is less
  and therefore they earn less than those in the
  foreign country, if technology is the same across
  countries.
• There is an incentive for domestic workers to
  move to the foreign country.

22
International Labor Mobility

• Workers in the domestic country have an incentive
  to move to the foreign country until the real
  wages between the countries are equal.
• Emigration from the domestic country raises the
  real wage of the remaining workers there.
• Immigration to the foreign country, increases the
  quantity of labor and decreases the real wage
  there.
• Model predicts that factor mobility causes
  convergence of real wages.

23
International Labor Mobility

• Income distribution effects of trade in factors
  are similar to those of trade in goods.
• Immigration to the foreign (labor scarce)
  country, increases the quantity of labor and
  decreases the real wage there. Similarly,
  increased imports of labor intensive goods would
  lower real wages of labor in this country.

24
International Labor Mobility
25
International Labor Mobility

• Gains from Free Labor Mobility
• Labor migration between the domestic country and
  the foreign country will also increase world
  output.
• Foreign output rises by the area under its MPL
  curve from OL1 to OL2
• Domestic output falls by the area under its MPL
  curve from OL2 to OL1
• The value of world output is maximized when the
  marginal product of labor is the same across
  countries.

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International Labor Mobility

• Example 7.3

MPL, real wage
MPL, real wage
MPL
20
20
14
14
10
10
MPL
600
400
Original labor endowments L0600 and L0200
800
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International Labor Mobility

• Example 7.3
• What are the original equilibrium real wages in
  each country without factor mobility?
• Who is relatively labor abundant?
• Which way does labor move? How much labor
  migrates?
• What is the final equilibrium real wage in each
  country if labor is fee to migrate?
• Show the area indicating the increase in total
  world output due to labor migration.

28
International Labor Mobility

• The model suggests that
• Labor should move from countries with low real
  wages to countries with high real wages.
• It also suggest that countries with contracting
  labor forces should see increases in real income
  while countries with expanding labor forces
  should see decreases in real income of workers.
• This is consistent with historical evidence
  during periods of mass migration.

29
International Labor Mobility
30
International Labor Mobility

• The Heckscher-Ohlin model predicts that trade in
  goods is an alternative to factor mobility.
• Services from factors of production are
  embodied in goods, so that the value of goods
  reflects the value or productivity of factors of
  production that produced them.
• The HO model as well as the labor mobility model
  predict that factor price equalization should
  occur.

31
International Labor Mobility

• But despite real wage differences across
  countries, complete factor price equalization
  with labor mobility does not really occur for
  reasons that are similar to the reasons given in
  the Heckscher-Ohlin model.

32
International Labor Mobility

• The model assumes that trading countries produce
  the same goods, but countries may produce
  different goods so that marginal product of labor
  in producing a given good are not comparable.
• The model assumes that trading countries have the
  same technology, but different technologies could
  affect the productivities of factors and
  therefore the wages/rates paid to these factors.

33
International Labor Mobility

• Barriers to immigration and emigration and
  transportation costs may prevent factor prices
  from equalizing.
• Barriers to movements for other factors of
  production are also important in the real world
  (e.g., for land and capital).

34
Immigration and the US Economy

• In the past generation, immigration in the US has
  increased substantially, especially among workers
  with the lowest education levels.
• The largest increase in immigration occurred
  among workers with the lowest education levels,
  making less educated worker more abundant,
• possibly causing a widening wage gap between low
  educated workers and high educated workers.
• Is increased immigration in the US of unskilled
  workers behind the increasing skill premium?

35
Immigration and the US Economy
36
Immigration and the US Economy

• But immigration can not wholly explain the
  widening income distribution in the US.
• The fraction of US workers without a high school
  diploma fell, while that with a college education
  rose, during 19801990.
• More highly educated workers became more
  abundant.
• So why did the wage of highly educated workers
  rise relative to that of low educated workers?
• Possibly due to technological changes that made
  education more valuable to employers.

37
Foreign Direct Investment

• What is Foreign Direct Investment (FDI)?
• A firm in one country creates or expands a
  subsidiary in another country (new FDI/ flow)
• Parent firm directly controls or owns a
  subsidiary in another (existing FDI/ stock)
• If a foreign country owns at least 10 of the
  stock in a subsidiary, the two firms are
  typically classified as a multinational
  corporation.
• Multinational firms are active in multiple
  countries.
• 10 or more of ownership in stock is deemed to be
  sufficient for direct control of business
  operations.

38
Foreign Direct Investment

• Ways to serve a foreign market
• Export produce in home market and ship/export to
  the foreign market
• FDI produce in foreign market using a subsidiary
• License produce in foreign market using a
  foreign firm.
• Ways to break up the production process
• Import intermediate goods that are intense in
  scarce factors.
• FDI produce parts of goods in countries that are
  abundant in the intensive factor for these parts
• License produce parts in foreign market using a
  foreign firm.

39
Theory of Multinational Corporations

• Why are multinational corporations created and
  why do they undertake direct foreign investment?
• Why is a good produced in two countries versus
  being produced in one country and then exported
  to the second country? Why break up the
  production process in multiple locations?
  Transportation costs and other barriers to trade
  influence the location of production, as well as
  differences in factor costs (Location advantage)
• Why is the good not produced by a foreign firm?
  (Ownership advantage)
• Why is production in different locations done by
  one firm rather than by separate firms (ie why
  not license out the activity)? Often more
  profitable to conduct transactions within a
  single organization. (Internalization advantage)

40
Theory of Multinational Corporations

• Location Advantage
• Need a reason why production should be located in
  the foreign market
• Must be something that makes production in
  foreign country better than production in
  domestic countryhost country must be special.
• Examples lower factor prices (comparative
  advantage), import restraints (tariffs, quotas)
  which undermine market penetration through trade.
• Location advantage determines how best to attract
  FDI.

41
Theory of Multinational Corporations

• Ownership advantage
• Need a reason why foreign market not served by a
  foreign firm.
• Must be something that domestic firm does better
  than foreign firmsdomestic firm must be special
• Examples technology (unique product design,
  better product, lower cost), superior management
  or organization skills
• Implies possible benefits of FDI for host country

42
Theory of Multinational Corporations

• Internalization Advantage
• Finally need a reason why production should be
  kept within one firm
• Must be something that makes internal
  transactions better than arms length (licensing)
• Examples impossible to write complete contracts
  for every possible event, difficult to enforce
  contracts, risk of opportunistic behavior

43
Theory of Multinational Corporations

• Internalization occurs because it is more
  profitable to conduct transactions and production
  within a single organization than in separate
  organizations. Reasons for this include
• Technology transfers transfer of knowledge or
  another form of technology may be easier within a
  single organization than through a market
  transaction between separate organizations.
• Patent or property rights may be weak or
  non-existent.
• Knowledge may not be easily packaged and sold.

44
Theory of Multinational Corporations

• Vertical integration involves consolidation of
  different stages of a production process.
• Vertical integration would involve consolidation
  of one firm that produces a good that is used as
  an input for another firm.
• This may be more efficient than having production
  operated by separate firms.
• For example, having farms and flour mills
  consolidate into one organization to make flour
  may be more efficient than having farms and flour
  mills as separate organizations.

45
Theory of Multinational Corporations

• What benefits can FDI provide for host countries?
• Benefits from FDI generally stem from the
  existence of ownership advantage
• Any firm that engages in FDI must be special,
  have some dimension of superiority (often
  technology) that offsets the inherent difficulty
  of operating a multinational
• Possible that local firms may be able to gain
  from similar ownership advantages

46
Theory of Multinational Corporations

• Easing Technology Transfer
• Local firms may then have an easier time copying
  technologies from multinationals when they are
  located close by
• For example Workers exposed to technologies may
  leave the multinational and go to work for local
  firms, taking their knowledge of the production
  process with them

47
Theory of Multinational Corporations

• Creating better jobs
• Multinational firms pay higher wages than
  domestically owned firms, even after one controls
  for industry, firm size, etc.
• Could be creaming (hiring best workers) in part
  but also because use more capital
• Better technologies make workers more productive,
  and their output more valuable (raises the MRPL
  and consequently the wage)
• Workers may be trained to use new technologies

48
Theory of Multinational Corporations

• Consumer Benefits
• FDI may bring consumer benefits similar to (but
  beyond) the benefits of opening up to
  international trade.
• Arrival of new varieties or better qualities of
  products to a market
• Lower prices for consumer goods than if imported,
  especially in the case of substantial import
  restrictions

49
Theory of Multinational Corporations

• What government policies increase benefits from
  FDI?
• Policies to attract better FDI generally must
  augment the location advantage, so host country
  is more special relative to other potential
  hosts.
• Important not to tamper with ownership advantage
  (what makes firm special)
• Examples infrastructure (highways, ports,
  airports), education (computers and foreign
  language), national treatment, transparency.

50
Theory of Multinational Corporations

• Vertical FDI
• When locate only part of the production process
  abroad to take advantage of difference in factor
  costs.
• For example locate the unskilled labor intensive
  part of the production process in a country that
  is unskilled abundant and where this type of
  labor is cheap. Locate the skilled intensive part
  in a skilled abundant country where this type of
  labor is cheap.
• Example
• US RD, Marketing, specialized components
• Mexico assembly activities

51
Theory of Multinational Corporations

• Vertical FDI
• Typically expect this type of FDI to increase
  (complement) trade.
• US produces specialized components which are
  assembled and sold in US market (no trade)
• With Vertical FDI specialized components are
  exported to China, assembled, and final goods are
  exported back to the US market for final sale.
• Tariff liberalizations should increase vertical
  FDI activity.

52
Theory of Multinational Corporations

• Horizontal FDI
• When locate all or most of the production
  activities in two countries (duplicate
  activities)
• Example A US firm may open a subsidiary in
  Germany to penetrate the German and other EU
  markets instead of exporting from the US plant.

53
Theory of Multinational Corporations

• Horizontal FDI
• This type of FDI tends to decrease (substitute
  for trade)
• High trade and transportation costs tend to
  increase this type of multinational activity.

54
Multinational Corporations in the US
55
Foreign Direct Investment in the US
56
Summary

• A simple model of international labor mobility
  predicts that labor will migrate to countries
  with higher labor productivity and higher wage
  rates.
• Real wages are predicted to fall due to
  immigration
• Real wages are predicted to rise due to
  emigration
• There are gains from trade in factors as well as
  goods.

57
Summary

• 3. Income distribution effects of trade in
  factors are similar to those of trade in goods.
• 4. International factor movements can substitute
  for trade

58
Summary

• 5. Due to the fact that countries do not produce
  the same goods, due to differences in technology
  and due to immigration barriers real wages
  across countries are far from equal.

59
Summary

• 6. Multinational corporations undertake foreign
  direct investment,
• possibly because locating production in foreign
  countries is efficient,
• possibly because internalizing technology
  transfers is efficient or
• possibly because vertical integration is
  efficient.