International Economics

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International Economics
NB! Due to a crash in B3, the lecture hall is
changed to G-salen 8/12 and 15/12

• Lecture 6. International Factor Mobility

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Outline

• Introduction
• International Labor Mobility
• Standard Analysis
• Regulated Markets
• International Borrowing and Lending
• Foreign Direct Investment and Multinational Firms

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Introduction

• Up to now only focused on international
  integration in the form of movement of goods and
  services.
• Another form of integration is international
  movements of factors of production.
• Factor movements include
• Labor migration
• Transfer of capital via international borrowing
  and lending
• Transactions of multinational corporations
  involving direct ownership/control of foreign
  firms

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Introduction (cont.)

• Factor proportions explanations for trade imply
  that trade in goods and services is a substitute
  for factor mobility
• Instead of labor migrating from labor abundant
  country to capital abundant country, wage
  differentials are reduced by trade according to
  comparative advantages
• Movements of factors of production are
  politically sensitive and often restricted.
• Most countries have restrictions on immigration.
• Restrictions on financial capital flows in many
  developing countries.
• Restrictions on the activities of multinational
  corporations (less common today than in the 60s
  and 70s).

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International Labor Mobility

• Standard analysis shows that labor migration
  generates welfare gains, but just as with free
  flows of goods and services, some groups are
  likely to lose.
• A One-Good Model
• Assumptions
• There are two countries (Home and Foreign).
• There are two factors of production Land (T) and
  Labor (L).
• Both countries produce only one good (refer to it
  as output).
• Both countries have the same technology but
  different overall land-labor ratios.
• Home is the labor-abundant country and Foreign is
  the land-abundant country.
• Perfect competition prevails in all markets.

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An Economys Production Function
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The Marginal Product of Labor

• area under the marginal product(ivity) of labor
  curve value of output produced total income
  (provided markets are competitive)

Real wage
Wages
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International Labor Mobility (cont.)

• The assumption that countries differ in terms of
  land-labor ratios imply that wage rates differ in
  the absence of labor mobility
• The real wage is lower in Home than in Foreign
• Suppose that workers are able to move between the
  two countries.
• Home workers would like to move to Foreign until
  the marginal product of labor is the same in the
  two countries.
• This movement will reduce the Home labor force
  and thus raise the real wage in Home.
• This movement will increase the Foreign labor
  force and reduce the real wage in Foreign.

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International Labor Mobility (cont.)
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Causes and Effects of International Labor Mobility
Marginal product of labor
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International Labor Mobility (cont.)

• The redistribution of the worlds labor force
• Leads to a convergence of real wage rates
• Increases the worlds output as a whole
• Each worker who moves is more productive in
  Foreign than in Home.
• Leaves some groups worse off
• The owners of immobile factors in labor exporting
  country and workers in labor importing country
  tend to lose.
• Suppose the countries produce two goods, one
  labor- intensive and one land-intensive.
• Trade offers an alternative to factor mobility
  Home can export labor and import land by
  exporting the labor-intensive good and importing
  the land-intensive good.
• Labor migration between small countries need not
  have an effect on income distribution (but may
  affect production pattern instead)

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International Labor Mobility with Regulated
Markets

• In reality, wages are negotiated rather than
  determined in market with perfect competition in
  most high-wage countries.
• More plausible setup is to have trade unions set
  wages and employers employment.
• Unless immigrant workers are able to undercut
  negotiated wages, small incentives to migrate in
  spite of large wage differentials.
• Exception may be for specialist jobs for which it
  is difficult to hire domestic labor
• Small scope for undercutting in many European
  countries.
• Labor immigration varies strongly with business
  cycle
• Poor integration of immigrants in labor market
• Larger scope for undercutting in the US.

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Capital Mobility

• Large increase in the volume of transactions in
  international capital market since 1960s.
• They can be divided into
• Portfolio investments, e.g.
• A U.S. bank lends to a Swedish firm
• A U.S. pension fund invests in equity issued by a
  Swedish corporation
• A Swedish bank buys U.S. Treasury bonds
• Direct investment, e.g.
• A Swedish firm is taken over by a U.S. firm
• The U.S. firm uses internal funds to finance the
  takeover
• The U.S. firm borrows from a U.S. bank to finance
  to takeover

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Capital Mobility (cont.)

• Both types imply a movement of capital between
  countries
• Funds financed by residents of one country are
  being used for investments in another country
• International movements of capital are associated
  with international borrowing and lending
• Residents of one country give up consumption
  today to finance investments in another country,
  which will generate consumption in the future
• The borrowing country gets to consume more today
  by giving up some larger quantity of consumption
  in the future.
• Aggregate movements are reflected in the current
  account
• Surplus ? Production gt Absorption ? international
  lending
• Deficit ? Production lt Absorption ? international
  borrowing

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International Borrowing and Lending

• Can be interpreted as intertemporal trade
• Trade of goods today for goods in the future
• Gains of trade if countries trade according to
  comparative advantage
• Borrowing if comparative advantage in future
  production.
• E.g. emerging economies
• Capital importing countries benefit from being
  able to finance investment at a lower price.
• Lending if comparative advantage in current
  production,
• E.g. industrialized countries
• Capital exporting countries benefit from earning
  a higher return on savings.

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International Borrowing and Lending, cont.

• Imagine an economy that consumes only one good
  and will exist for only two periods, present and
  future.
• Intertemporal production possibility frontier
• Represents a trade-off between present and future
  production of the single consumption good.
• Its shape will differ among countries
• Some countries will be biased toward present
  output.
• Some countries will be biased toward future
  output.

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The Intertemporal Production Possibility Frontier
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International Borrowing and Lending, cont.

• The difference between present production and
  present consumption is investment in future
  production.
• In order to give up consumption of one unit
  today, (1r) units are required in future
  consumption, where r is the real interest rate on
  borrowing.
• The relative price of future consumption is
  1/(1r).
• The relative price of present consumption is 1r.
• With perfect competition, production will take
  place where the slope of the intertemporal
  production possibility frontier is equal to the
  relative price between present and future
  consumption.

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Determining Homes Intertemporal Production
Pattern
Isovalue lines with slope (1 r)
Q
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International Borrowing and Lending, cont.

• A country can trade over time by borrowing or
  lending.
• When a country borrows, it gets the right to
  purchase some quantity of consumption at present
  in return for repayment of some larger quantity
  in the future.
• The quantity of repayment in future will be (1
  r) times the quantity borrowed in present.
• Assume that Home has a comparative advantage in
  present production (so that its production
  possibilities are biased toward present
  production).
• In the absence of international borrowing and
  lending Foreign would have a high relative price
  of future consumption (i.e., low r).
• Low interest rate corresponds to a low return on
  investment.

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Homes Intertemporal Trade
Indifference curves
D
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International Borrowing and Lending, cont.

• Production and consumption patterns
• Period 1 (present)
• Homes production is greater than its consumption
  ? current account surplus
• Period 2 (future)
• Reversal of current account
• Gains from intertemporal trade
• Home benefits from earning a higher return on
  savings and from a better allocation between
  present and future consumption.

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Foreign Direct Investment

• Foreign direct investment (FDI) refers to
  investment in which a firm directly controls or
  owns a subsidiary in another country.
• Involves not only a transfer of resources but
  also the acquisition of control.
• The subsidiary does not simply have a financial
  obligation to the parent company it is part of
  the same organizational structure.
• If a foreign company invests in at least 10 of
  the stock of a subsidiary, the two firms are
  typically classified as a multinational
  corporation.
• A multinational firm is a vehicle for
  international borrowing and lending
• They provide financing to their foreign
  subsidiaries

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Why do firms seek to extend control outside their
country?

• Rephrase question into questions dealing with
• Location why is a good produced in two countries
  rather than in one country and then exported to
  the other country?
• Internalization why is production in different
  locations carried out by the same firm rather
  than by separate firms?

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Why production in more than one location?

• Activities attracted to where necessary factors
  of production are located.
• Mining occurs where minerals are.
• Labor intensive production occurs where
  relatively large pools of labor live.
• Transport costs and other barriers to trade make
  local production relatively cheap compared to
  exports.
• With economies of scale in production there is a
  trade-off between locating production close to
  factors and/or consumers and the disadvantage of
  spreading out production.

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Why activities within the same organization?

• Because it is more profitable than carrying out
  activities in separate organizations.
• Reasons for this include
• Technology transfers transferring technology may
  be easier within an organization than through the
  market.
• Patent or property rights may be weak or
  non-existent.
• Knowledge may not be easily packaged and sold.
• Vertical integration involves consolidation of
  different stages of a production process.
• May be more efficient than having different
  stages being operated by separate firms.
• E.g. having compressor and refrigerator producers
  consolidating into one organization may be more
  efficient than having them as separate
  organizations.

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Multinational Corporations in the U.S.
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Multinational Corporations in Sweden (cont.)
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Employment by Swedish Multinational Corporations
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Summary

• A simple model of labor migration 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.
• Collective agreements reduce the scope for
  migration and serve as an impediment to real wage
  equalization.
• International borrowing and lending can be
  described as intertemporal trade.
• Countries with profitable investment
  opportunities borrow funds today and repay
  lenders in the future.
• Multinational corporations undertake foreign
  direct investment when there are location and
  internalization advantages associated with the
  foreign activities.

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Summary (cont.)

• It happens when the advantages of local
  production outweigh the disadvantages of
  spreading out production, provided that it is
  more efficient to carry out activities within the
  same organization.
• Internalization advantages may arise because
  internalizing technology transfers or vertical
  integration is efficient.