Chapter Ten

1
Chapter Ten

• Growth, Immigration, and Multinationals

2
Chapter Ten Outline

• Introduction
• Economic Growth I More Inputs
• Economic Growth II More Productivity
• What if Factors Can Move?

3
Introduction

• Basic trade model will be extended to consider
  issues related to economic growth and factor
  mobility.
• Factor flows between countries represent another
  way in which countries can use economic
  interaction to benefit from their differences.
• Study of economic growth has become a growth
  industry within economics.
• Economic growth defined as any shift outward in a
  countrys production possibilities frontier.

4
Introduction

• Major sources of economic growth
• Increases in quantities of inputs or resources
  available to the country and
• Technical progress, or improvements in available
  production technology.
• Empirical evidence suggests that increases in
  resources have accounted for a little less than
  half of economic growth in the modern
  eratechnical progress accounted for the
  remainder.
• Endogenous growth theory
• New approaches to growth recognize knowledge and
  ideas as inputs.

5
Introduction

• Growth rates among countries differ dramatically.
• Assumption that factors of production move more
  freely within than among countries seems
  realistic.
• Inter-country factor movement remains small
  relative to intra-country movement because
• Most governments maintain some restrictions on
  flows of both capital and labor across their
  national boundaries.
• Differences in costs would produce a differential
  rate of movement.

6
Economic Growth I More Inputs

• More labor and capital
• Countrys balanced growth proportional increase
  in country's endowments of both capital and
  labor.
• Figure 10.2 depicts the effects of balanced
  growth
• Increases production and consumption of each
  good, imports, exports, and volume of trade in
  same proportion as the factor endowments.
• Subscript p refers to production, c to
  consumption, 0 to pre-growth, and 1 to
  post-growth.

7
Figure 10.2 What Are the Effects of Balanced
Growth?
Y
Slope

(P
)
tt
/P
X
Y
Y
1
c
U
Y
0
1
c
U
0
Y
1
p
Y
0
p
0
X
0
X
1
X
0
X
1
X
c
c
p
p
8
Economic Growth I More Inputs

• More labor and capital (cont.)
• Two components of growths effect on welfare
• Income effect of growth growths effect on per
  capita consumption at unchanged terms of trade.
• Terms-of-trade effect Captures the effect of
  changes in relative output prices.
• Equals the price of its exports relative to the
  price of its imports.
• Figure 10.3 illustrates the effects of a
  deterioration in a countrys terms of trade.

9
Figure 10.3 What Are the Effects of
Deterioration in a Countrys Terms of Trade?
Y
U
1
U
2
tt
Slope

(P
/P
)
X
Y
1
U
0
tt
Slope

(P
/P
)
X
Y
0
0
X
10
Economic Growth I More Inputs

• More labor and capital (cont.)
• Net effect of balanced growth on per capita
  income in a large country depends on
• Source of growth in labor endowment (population
  vs. labor-force participation) and
• Relative magnitudes of income and terms-of-trade
  effects.

11
Economic Growth I More Inputs

• Just more labor
• Increase in labor endowment with a constant
  capital endowment shifts production possibilities
  frontier asymmetrically.
• Figure 10.4 Good X is labor-intensive. Out put
  of X rises more than proportionally with the
  labor endowment and output of the
  capital-intensive good falls.
• Provides example of Rybczynski theorem.
• When terms of trade are constant, an increase in
  endowment of one factor with the other factor
  endowment held constant increases production of
  the good intensive in the increased factor, and
  decreases production of the good intensive in the
  constant factor.

12
Figure 10.4 What Are the Effects of Labor
Endowment Growth?
Y
Slope

(P
)
tt
/P
X
Y
Y
II
I
0
Y
1
X
X
X
0
0
1
13
Economic Growth I More Inputs

• Just more capital
• Overall effects are ambiguous (as in the case of
  labor-based growth).
• Major change is a positive income effect
• Total consumption rises because the population
  does not change, a rise in per capita consumption
  follows.
• Small country growth has no effect on its
  trading partners.
• Large country if growth is import replacing, the
  terms of trade improve and effect on welfare is
  positive if growth is export expanding, terms
  of trade deteriorate and welfare effect is not
  clear (see Table 10.3).

14
Economic Growth I More Inputs

• Extreme Case Immiserizing Growth
• In some cases, increased production may lower
  welfare through its deteriorating effect on the
  terms of trade.
• Implication that growth may lower per capita
  consumption even if population remains constant.
• Fig. 10.5 shows that with unrestricted trade,
  growth at unchanged terms of trade shifts out the
  production possibilities curve, allowing the
  country to reach U1, rather than the pre-growth
  U0.
• If increased volume of trade significantly
  worsened the terms of trade, the country could
  end up on U2, which lies below U0.

15
Figure 10.5 Immiserizing Growth
Y
tt
Slope

(P
)
/P
X
1
Y
tt
Slope

(P
)
/P
X
0
Y
U
1
U
0
U
2
X
0
16
Economic Growth II More Productivity

• Increase in productivity is Technical Progress.
• Types of technical progress
• Neutral technical progress leaves firms chosen
  capital-labor ratio unchanged.
• Fig. 10.6 represents neutral technical progress
  in production of good X.
• Shifts the isoquant that represents production
  level X0 in toward the origin firms
  capital-labor ratio is unchanged at the old
  relative factor prices.

17
Figure 10.6 Neutral Technical Progress in the X
Industry
K
X
(K/L)
before
(K/L)
after
X
X
Slope

(w/r)
X
(before technical progress)
0
X
(after technical progress)
0
L
0
X
18
Economic Growth II More Productivity

• Capital-saving technical progress raises the
  marginal productivity of labor relative to that
  of capital.
• Fig. 10.7 indicates that at unchanged factor
  prices, firms use a lower capital-labor ratio.
• Along any ray from the origin (for any given
  K/L), the new isoquant is steeper than the old
  one.

19
Figure 10.7 Capital-Saving Technical Progress
K
X
(K/L)
before
X
(K/L)
after
X
Slope

(w/r)
X
(before technical progress)
0
X
(after technical progress)
0
L
0
X
20
Economic Growth II More Productivity

• Labor-saving technical progress involves an
  increase in the marginal product of capital
  relative to that of labor.
• The cost-minimizing capital-labor ratio rises.
• How does increased productivity affect welfare?
• Small country income effect constitutes only
  component of welfare effect, and overall impact
  is favorable.
• Large country Depends on relative strength of
  positive income effect and the negative
  terms-of-trade effect, identical to that in the
  case of balanced growth.

21
Economic Growth II More Productivity

• Figure 10.8 illustrates the effects of neutral
  technical progress in the X industry in a small
  country
• The country reduces production of good Y and
  increases production of good X.

22
Figure 10.8 What Are the Effects of Neutral
Technical Progress in the X Industry?
Y
Slope

(P
)
tt
/P
X
Y
Y
0
Y
1
0
X
X
X
0
1
23
What if Factors Can Move?

• Welfare analysis of factor movements involves
  four questions
• How does factor movement affect total world
  output?
• How does factor movement affect the division of
  welfare between the two countries?
• How does factor movement affect the distribution
  of income within each country?
• How does the movement affect the factors that
  move?
• assuming factor movements occur voluntarily,
  owners of the factors must expect to be better
  off, or they would not move

24
What if Factors Can Move?

• Inter-country labor mobility
• Labor generally flows less easily than capital
  across national boundaries.
• Incentives for labor migration
• Economic desire to better themselves and to
  improve conditions for their children.
• Text focuses on these motivations and assumes
  that an individual moves when the reward paid to
  labor is higher in the destination country.
• Noneconomic desire for religious and political
  freedom.

25
What if Factors Can Move?

• Inter-country labor mobility (cont.)
• Fig. 10.9 provides a convenient guide for
  analyzing labor mobilitys effects.
• Labors ability to move from country B to country
  A in response to a wage differential raises total
  world output by an amount represented by area of
  triangle EGJ.
• Country A gains, and country B loses.
• In A, capital owners gain relative to labor and
• In B, workers gain relative to capital owners.

26
Figure 10.9 What Are the Effects of Labor
Mobility?
A
w
B
w
E
A
w
0
G
F
B
w
A
w
1
1
B
w
0
J
H
B
VMP
L
A
VMP
L
A
B
0
L
L
0
0
1
Native labor in A
Migration
from B to A
27
What if Factors Can Move?

• Inter-country labor mobility (cont.)
• Labor migrations effects Gains are not divided
  equally among all countries.
• Country A as a whole gains from immigration.
• Net gain is sum of gains by capital owners in A,
  losses by native country-A workers, and gains by
  the immigrants themselves.
• Country B as a whole loses from its emigration.
• But workers in B gain relative to owners of
  capital.

28
What if Factors Can Move?

• Inter-country labor mobility (cont.)
• Opposition to immigration policies
• Open immigration can lower wages of domestic
  workers (including earlier immigrants) who
  compete with new immigrants in labor markets.
• Many countries have adopted strong social laws
  guaranteeing residents minimal levels of food,
  housing, medical care, education, and income
  they fear influx of immigrants who will not work
  and produce.
• Fear of a Brain Drain tendency of most highly
  skilled, trained, and educated individuals from
  developing countries to migrate to industrialized
  countries.

29
What if Factors Can Move?

• Inter-country labor mobility (cont.)
• Theory, evidence, and politics an important
  caveat
• Assume that country produces at least two goods,
  a labor-intensive one and a capital-intensive
  one, and that these goods can be traded
  internationally.
• An inflow of labor makes a country more labor
  abundant and causes it to shift toward more
  labor-intensive goods and away from
  capital-intensive ones.
• Result is an increase in the demand for labor to
  match the increased supply.

30
What if Factors Can Move?

• Inter-country labor mobility (cont.)
• Labor mobility without immigration?
• Recently firms have begun to use several
  arrangements that amount to labor mobility
  without immigration
• Outsourcing offshore assembly in which a firm
  performs each step in a manufacturing process in
  a country with a comparative advantage in that
  particular stage.
• Use of electronic means to allow work like
  software programming to be outsourced to places
  like India and Russia finished work
  retransmitted back to U.S.
• No brain drain and earnings remain in developing
  country.

31
What if Factors Can Move?

• Inter-country capital mobility
• Two major classes of capital mobility
• International portfolio investment flow across
  national boundaries of funds for financing
  investments in which the lender does not gain
  operating control over the borrower.
• U.S. firm issues bonds (borrows) and sells some
  to German resident (makes loan to U.S. firm).
• From German perspective equals capital outflow
  (international purchase of assets).
• From U.S. perspective equals capital inflow
  (international sale of assets)
• Direct investment gives the lender operating
  ownership of and control over the borrower.

32
What if Factors Can Move?

• Inter-country capital mobility (cont.)
• Recent patterns of international capital
  mobility.
• Two main trends
• Rapid and erratic growth.
• Diversification of source and host countries.
• Figure 10.10 illustrates the top 20 host
  countries for cumulative foreign direct
  investment during the 1985-95 period.
• Figure 10.11 indicates the regional allocation of
  U.S. outward and inward direct foreign investment
  for 1996.

33
Figure 10.10 Top Source and Host Countries for
Foreign Direct Investment, 1999
34
Figure 10.11a, b Destination and Sources of U.S.
Outward and Inward FDI, 1999 ( of Total)
35
What if Factors Can Move?

• Inter-country capital mobility (cont.)
• Incentives for international capital movements
• Opportunity to earn higher rate of return or
  reward.
• Desire to diversify assets to reduce risk.
• Diversification refers to holding a variety of
  assets, chosen such that when some perform
  poorly, others are likely to perform well.
• Mobility is a way of trading goods across time,
  called intemporal trade.
• Intemporal exchange in assets can be mutually
  beneficial in much the same way as ordinary trade
  in goods and services.

36
What if Factors Can Move?

• Inter-country capital mobility (cont.)
• Capital mobilitys effects
• Analysis of the effects of capital mobility is
  very similar to that for labor mobility.
• Fig. 10.12 points out that beginning at point E,
  capital flows, in response to the higher rate of
  return in country A, improve efficiency and
  increase output by EGJ.
• Both countries gain because ownership of the
  migrant capital remains with country B.
• In A, workers gain relative to capital owners,
  and in B capital owners gain relative to workers.

37
Figure 10.12 What Are the Effects of Capital
Mobility?
r
A
r
B
E
r
A
G
0
F
r
A
r
B
1
1
J
r
B
0
H
VMP
A
VMP
B
K
K
0
A
K
K
0
B
0
1
38
What if Factors Can Move?

• Taxation and factor mobility
• Rates of taxation vary widely from country to
  country.
• Hong Kong corporate rate 16 Germany 56.
• Factor mobility increases world efficiency by
  drawing resources to those locations where they
  can be most productive.
• This conclusion does not apply to mobility
  motivated solely by countries differing tax
  rates and rules.
• Such mobility clearly benefits migrant labor or
  capital, but does not increase efficiency of the
  world economy.

39
What if Factors Can Move?

• Taxation and factor mobility (cont.)
• Taxation of wages and capital income have similar
  effects.
• Figure 10.13 examines the effects of wage
  taxation by Country A
• Beginning with an efficient allocation of labor
  between A and B, taxation of wages by A reduces
  total output by EGJ.
• Workers between L1 and L0 migrate to B in
  response to a differential in wages net of taxes.
  Immigration harms workers in B. Workers in A
  are better off than they would be in the presence
  of the tax and with no labor mobility.

40
Figure 10.13 What Are the Effects of Wage
Taxation by Country A?
w
A
w
B
E
w
A
G
1
w
A
w
B
0
0
)
w
A
(1

t
A
w
B
H
1
1
J
)
w
A
(1

t
A
0
M
VMP
A
L
VMP
A
)
(1

t
A
VMP
B
L
L
L
L
0
B
0
A
0
1
41
What if Factors Can Move?

• Taxation and factor mobility (cont.)
• Double taxation, or taxation on the same income
  by two governments, creates a strong disincentive
  for factor mobility.
• Most governments agree, through tax treaties, to
  reduce, if not eliminate, double taxation by
  granting either tax credits or tax reduction for
  taxes paid to foreign governments.

42
Multinational Enterprises and the World Economy

• One of the major economic trends of the postwar
  period has been the growth of firms across
  national boundaries.
• Definition of Multinational Enterprises (MNEs)
• Firms that manage facilities in at least 2
  countries.
• Classified into three groups
• Horizontally integrated MNEs Produce basically
  the same or identical goods in several countries.
• Vertically integrated MNEs Produce inputs in
  one country that they use to produce another good
  in another country.
• Diversified or Conglomerate MNEs Production of
  different goods in various countries.

43
Multinational Enterprises and the World Economy

• Why go multinational?
• Capital arbitrage theory of multinationals
  perspective of analysts who view MNEs as vehicles
  for spreading capital from one country to
  another.
• Capital arbitrage view appears inconsistent with
  at least 3 aspects of observed MNE behavior
• MNE capital does not necessarily flow from
  capital-abundant to capital-scarce countries.
• In many countries, inflows and outflows of MNE
  capital occur simultaneously.
• Although MNEs often do move capital form one
  country to another, such movements are not
  necessary because MNEs can borrow funds locally
  for their subsidiaries.

44
Multinational Enterprises and the World Economy

• Why go multinational?
• Studies have confirmed that trade barriers
  encourage MNE development.
• Tactic by host country involves imposing import
  restrictions high enough to force foreign firms
  that want to sell in the market to establish
  local production facilities.
• Called tariff-jumping foreign direct investment.
• Foreign direct investment can also defuse
  political sentiment in the host country.
• Called quid pro quo investment.

45
Multinational Enterprises and the World Economy

• Why go multinational?
• Deliberate use of high trade barriers to attract
  inward FDI can work, but has some negative
  consequences
• Investment attracted tends to be simply
  production units to service the domestic market
  not technology transfer or export-oriented
  production.
• High trade barriers can make the domestic MNE
  affiliate less competitive by raising the cost of
  imported inputs.

46
Multinational Enterprises and the World Economy

• Why go multinational? (cont.)
• Due to lack of adequate intellectual property
  protection in developing countries, firms in
  technologically innovative or RD-intensive
  industries tend to choose multinationalism over
  licensing.
• By forming an MNE, the firm can maintain control
  over its technology while using it to serve
  foreign markets.
• Fig. 10.14 reveals that U.S. FDI tends to be
  higher in industries that involve high levels of
  RD.

47
Figure 10.14 U.S. FDI and RD, 1994 ( Billions)
48
MNEs Effects

• As MNEs help move production to least-cost
  locations and contribute to the spread of
  technological improvements, total world output
  increases.
• Makes possible increases in total world welfare.
• MNEs facilitate achievement of economies of scale
  by handling some functions centrally while
  continuing to adapt to local conditions in
  relevant areas of operation.

49
MNEs Effects

• Claims by labor that shifting production to other
  countries constitutes the export of jobs that
  rightfully belong to U.S.
• Once short-term adjustment and relocation costs
  are overcome, movement of production maximizes
  total world output and income.
• Often, firm faces a choice between moving abroad
  or stopping production completely.
• If foreign production makes inputs cheaper for
  U.S. producers, their competitive positions
  improve.
• More foreign production raises foreign incomes,
  demand for U.S. exports increase, and employment
  in export-oriented industries increases.

50
MNEs Effects

• MNEs tend to spread the technology developed in
  parent countries to the rest of the world.
• Developing countries sometimes charge that the
  sheer size and economic strength of MNEs allow
  them to exploit their host countries.
• Bargaining with host government for excessive tax
  concessions
• Paying unfairly low prices for raw materials
  removed from the host country.
• Issuing deceptive financial statements to
  repatriate all the benefits from the operation to
  the parent country.
• MNEs general domination of hosts economy and
  culture causes loss of indigenous values and
  damage to local companies.

51
Note for Case Three Saving, Investment, and
Intertemporal Trade

• Figure 10.15 shows that despite increased capital
  mobility, countries with low (high) rates of
  saving tend to also have low (high) rates of
  investment expenditure.

52
Figure 10.15 Saving and Investment Rates,
19701992 Averages
35
Japan
1
1
Switzerland
2
Gross Saving
Norway
3
Austria
4
Portugal
5
as Percent
2
30
Finland
6
Holland
7
of GDP
Italy Spain
8
France
9
3
4
10
Germany
11
Greece
5
25
12
Australia
7
6
13
Iceland New Zealand
8
9
10
11
12
15
14
13
20
18
17
16
20
19
21
15
15
25
30
35
20
Gross Investment as Percent of GDP
53
Key Terms in Chapter 10

• Economic growth
• Endogenous growth theory
• Balanced growth
• Income effect
• Terms-of-trade effect
• Rybczynski theorem
• Immiserizing growth

54
Key Terms in Chapter 10

• Technical progress
• Neutral technical progress
• Capital-saving technical progress
• Labor-saving technical progress
• Brain drain
• Outsourcing
• Portfolio investment
• Capital outflow

55
Key Terms in Chapter 10

• International purchase of assets
• Capital inflow
• International sale of assets
• Direct investment
• Diversification
• Intertemporal trade
• Multinational enterprise (MNE)

56
Key Terms in Chapter 10

• Capital arbitrage theory of multinationals
• Total factor productivity