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Chapter 9
International Factor
Movements: Labor
and Capital
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All rights reserved
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• International labor mobility
• International borrowing and lending
• Foreign direct investment and multinational firms
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9-2
Movements in Factors of Production
• Movements in factors of production include
– labor migration,
– the transfer of financial capital through international
borrowing and lending,
– transactions of multinational corporations involving direct
ownership of foreign firms
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9-3
Movements in
Factors of Production (cont.)
• Like movements of goods and services (trade),
movements of factors of production are politically
sensitive and are often restricted.
– Restrictions on immigration
– Restrictions on financial capital flows (less common
today in Europe and US)
– Restrictions on the activities of multinational
corporations
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9-4
International Labor Mobility
• To show the effects of labor migration (mobility),
let’s build a simple model with only one good
(output).
• Suppose that there are only two important factors
of production: land and labor.
• On a fixed parcel of land, each worker often
becomes less productive or efficient as more
workers are added to that fixed parcel of land.
– The marginal product of labor often decreases.
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9-5
International Labor Mobility (cont.)
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9-6
International Labor Mobility (cont.)
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9-7
International Labor Mobility (cont.)
• Because of diminishing marginal product, productivity of
labor depends on the quantity of labor employed.
– The marginal product decreases as more workers are employed.
• Because of competition, 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 value of
wages and rental income paid to factors of production due
to competition.
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9-8
International Labor Mobility (cont.)
• 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.
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9-9
International Labor Mobility (cont.)
• Workers in the domestic country have an incentive to
move to the foreign country
until the real wages between the countries
are equal.
– Immigration from the domestic country raises the real wage
of the remaining workers there.
– It increases the quantity of labor and decreases the real
wage in the foreign country.
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9-10
International Labor Mobility (cont.)
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9-11
International Labor Mobility (cont.)
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International Labor Mobility (cont.)
• 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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9-13
International Labor Mobility (cont.)
• 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.
• 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.
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9-14
International Labor Mobility (cont.)
1. 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.
2. 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.
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9-15
International Labor Mobility (cont.)
3. 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).
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9-16
Immigration and the US Economy
• In the past generation, immigration in the US has
increased substantially, especially among workers
with the lowest education levels and the highest
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.
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9-17
Immigration and the US Economy (cont.)
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9-18
Immigration and the US Economy (cont.)
• 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 1980–1990.
– 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.
– But also could because of outsourcing
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9-19
Relative Wages
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Wh/Wl
1970
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1980
years
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Relative Employment
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H/L
1970
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1980
2000
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Wage Premium
• 1970-80: relative wage decreases but relative employment
between skilled labor and unskilled labor increases.
• 1980-2000:relative wage increases but relative employment
between skilled labor and unskilled labor increases.
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Easy to Explain 1970-1980:More supply of H
• wh/wl
•
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H/L
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How to explain after 1980?
• Difficult
• Is it possible due to decrease of relative supply of skilled
workers?
• This is contradict with the stylized fact.
• Only one possibility exists.
• Relative demand of skilled labor increases due to the
outsourcing (Feenstra-Hanson, 1996)
• It is because the relative demand of unskilled labor decreases.
• The diagram also applies for the developing country
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9-26
Diagrams
• wh/wl
•
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H/L
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Possible Explanations (I)
• Facts: Relative Demand for skilled labor occurred within
manufacturing industries, and not by shifts in labor between
industries.
• Empirical Studies
• Berman-Bound-Griliches (1994) found that labor movement
between industries are smaller than those within industries.
• Given that intra-industry trade only accounts for 25% of world
trade.
• Therefore, trade cannot be a dominant explanation for wage &
employment shifts.
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9-28
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9-29
Possible Explanations (II)
• Price movement cannot explain Wh/Wl and H/L as well.
–
–
–
–
–
Does Stopler-Samuelson theorem hold?
The rise of Ph/Pl leads to an increase of Wh/Wl .
The 1970s is the S-S decade.
But it does not happen in 1980s.
In the U.S., the percentage change of production is higher than the
percentage change of the non-production.
– Lawrence and Slaughter (1994)
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9-30
Possible Explanations (II)
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Acceptable Explanation
•
•
•
•
•
Feenstra-Hanson (1996)
Trade is still an important explanation.
Outsourcing and Intermediate Input
Relative demand of skill labor within industries increases.
How important for both technology improvement and
outsourcing for wage premium?
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9-32
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9-33
Figure 8.2 Costs and Fragmentation
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A Simple Model for Outsourcing
• At low levels of output, production might take place in a single
production block exhibiting total costs rising proportionally
with output, as in ray 1.
• An alternative technique fragments the production process into
a pair of blocks by placing one of them in a locale more suited
to its factor requirement, but this involves service link costs of
coordinating the blocks (line 2).
• Line 3 shows fragmentation that outsources one production
block overseas to obtain even lower marginal costs, although
the costs of service links become larger (OB).
• The heavy line show how fragmentation leads to a lowering of
average costs as output expands.
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9-35
International Borrowing and Lending
• International capital mobility usually refers to
mobility in financial capital across countries.
– Financial capital is a source of funds used to build physical
capital (e.g., factories and equipment).
• International capital mobility can be interpreted as
intertemporal trade:
– trade of goods consumed today by borrowers
in return for goods consumed in the future
by lenders.
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International
Borrowing and Lending (cont.)
• For any economy, there is a trade-off (opportunity
cost) between consuming today and saving for the
future: resources can either be consumed or saved.
– To save and invest more today typically means that
economies need to consume less today.
• We represent this concept by drawing a special kind
of production possibility frontier, an intertemporal
production possibility frontier.
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9-37
International
Borrowing and Lending (cont.)
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9-40
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International Borrowing and Lending
• Some countries will have a comparative advantage in spending
current output/income (current consumption).
• Others will have one in saving current output/ income (future
consumption).
• A comparative advantage in current consumption
– would mean a lower opportunity cost of spending current
income.
– would be reflected in an intertemporal PPF that is biased
toward current consumption.
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9-42
International
Borrowing and Lending (cont.)
• Suppose that the domestic country has a comparative
advantage in (bias towards) current consumption, while the
foreign country has a comparative advantage (bias towards)
future consumption.
• In the absence of international borrowing and lending, the
relative price of current consumption should be lower in the
domestic country.
• But what is the relative price of current consumption?
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9-43
International
Borrowing and Lending (cont,)
• The price of borrowing 1 unit of output/income today to
consume is the output/income that needs to be repaid in the
future:
– principal + interest = 1+r, where r is the interest rate
– The price of current consumption relative to future consumption is
1/(1+r)
• The opportunity cost of consuming 1 unit of output/ income
today is the output/income that could have be earned by saving
it:
– principal + interest = 1+r, where r is the interest rate
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9-44
International
Borrowing and Lending (cont.)
• If international borrowing and lending are allowed,
the domestic country will “export” current
consumption (i.e., borrow).
– The domestic country initially has a lower relative price
of current consumption 1/(1+r)
– The domestic country initially has a higher
interest rate r.
– A higher interest rate r implies a higher return to
investment: investment is highly productive/ profitable
so that the domestic country borrows from foreign
lenders.
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9-45
Foreign Direct Investment
• Foreign direct investment refers to investment in which firm
in one country directly controls or owns a subsidiary in another.
• If a foreign company invests in at least 10% of the stock in a
subsidiary, the two firms are typically classified as a
multinational corporation.
– 10% or more of ownership in stock is deemed to be sufficient for direct
control of business operations.
– In addition, international borrowing and lending sometimes occurs
between a parent company and its subsidiary.
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Table 9.3 Stock of
Foreign Direct
Investment by
Region, 1990 and
2004 ($ billion)
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Foreign Direct Investment in the US
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China’ FDI (now is about 3% of GDP)
FDI
1800
1600
1400
FDI (0.1 billion USD)
1200
1000
800
600
400
200
0
1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Year
FDI
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9-50
Theory of Multinational Corporations
•
Why are multinational corporations created and
why do they undertake direct foreign investment?
•
We rephrase these questions into those dealing
with the OLI framework
1. Location: why is a good produced in two countries
rather than in one country and then exported to the
second country?
2. Internalization: why is production in different
locations done by one firm rather that by
separate firms?
3. Ownership of an asset
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9-51
Theory of
Multinational Corporations (cont.)
• Why production occurs in separate location is often
determined by
– the location of necessary factors of production:
• mining occurs where minerals are;
• labor intensive production occurs where relatively large pools of
labor live.
– transportation costs and other barriers to trade may also
influence the location of production.
– These factors also influence the pattern of trade.
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9-52
Theory of
Multinational Corporations (cont.)
•
Internalization occurs because it is more profitable to
conduct transactions and production within a single
organization than in separate organizations. Reasons for this
include:
1. 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.
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9-53
Theory of
Multinational Corporations (cont.)
2. 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 that have farms and flour mills as
separate organizations.
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9-54
Multinational Corporations
in the US (cont.)
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9-55
Capital Flow in a One-Sector Economy
• Y=f(L, K)
• R=fk(L, K), fkk<0
• The equilibrium rental in the absence of the foreign capital is
shown by r0,
• In the presence of the capital inflow by r1.
• The foreign capital earns the amount r1K*, which is taken out
of the country.
• The increase in GDP due to the capital inflow is:
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9-56
Capital Flow in a One-Sector Economy
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Capital Flow in a One-Sector Economy
• The net welfare gain to the home is the area A.
• What is the source of this gain?
• When capital enters, it depresses the rental, so that the
payment to foreign capital (B) are less than the total area under
the demand curve (A+B).
• Or,
• The capital inflow raises marginal product of labor and wages.
• Increase of wages= A+C
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9-58
•
•
•
•
•
•
Y0=w0L+r0K0
Y1=w1L+r1(K0+K*)
Change of Y=(A+B)
=(W1-W0)L+(r1-r0)K0+r1K*
A+B =(W1-W0)L- C+B
(w1-w0)L=A+C
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9-59
Summary
1.
A simple model of international labor mobility predicts that
labor will migrate to countries with higher labor productivity
and higher wage rates.
–
–
2.
Real wages are predicted to fall due to immigration
Real wages are predicted to rise due to emigration
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.
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9-60
Summary (cont.)
3. International borrowing and lending can be
described as intertemporal trade, where countries
with profitable investment opportunities borrow
funds today and repay lenders in the future,
benefiting both borrowers and lenders.
4. The price of current consumption relative to the
price of future consumption is a function of the
interest rate.
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9-61
Summary (cont.)
5. 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.
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9-62
Table 9.1 Average Ratios of Wages to Land
Rent, 1870 and 1910
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9-63
Table 9.2 Total Foreign Capital Stock Placed
in Developing Countries, 1980 and 2000
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9-64