Ec 335 International Economics and Finance

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Ec 335 International Economics and Finance

• Lectures 14-15 International Factor Movements
• Giovanni Facchini

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Preview

• International labor mobility
• International borrowing and lending
• Foreign direct investment and multinational firms

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Movements in Factors of Production

• Movements in factors of production include
• labor migration
• the transfer of financial assets through
  international borrowing and lending
• transactions of multinational corporations
  involving direct ownership of foreign firms

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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 asset flows (less
  common today in Europe and U.S.)
• Restrictions on the activities of multinational
  corporations

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International Labor Mobility

• Stylized facts
• Increase in the share of foreign born in OECD
  countries
• Increase in the share of immigrants from low
  income countries in the OCED
• Bimodal skill composition of the immigrant
  population

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  1995 2000 2005 ?1995-2005
Australia 23.0 23.0 23.8 0.8
Austria 10.5 13.5
Belgium 9.7 10.3 12.1 2.4
Canada 16.6 17.4 19.1 2.5
Czech Republic 4.2 5.1 0.9
Denmark 4.8 5.8 6.5 1.7
Finland 2.0 2.6 3.4 1.4
Germany 11.5 12.5
Greece 10.3
Hungary 2.8 2.9 3.3 0.5
Ireland 6.9 8.7 11.0 4.1
Netherlands 9.1 10.1 10.6 1.5
New Zealand 16.2 17.2 19.4 3.2
Norway 5.5 6.8 8.2 2.7
Portugal 5.4 5.1 6.3 0.9
Slovak Republic 2.5 3.9
Spain 5.3
Sweden 10.5 11.3 12.4 1.9
Switzerland 21.4 21.9 23.8 2.4
United Kingdom 6.9 7.9 9.7 2.8
United States 9.3 11.0 12.9 3.6
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Rising share of immigrants from low-income
countries in the OECD
Low Income Sending Region 1990 2000 Change
Mexico, Central America, Caribbean 0.149 0.202 0.053
Southeast Asia 0.086 0.102 0.016
Eastern Europe 0.057 0.099 0.042
Middle East 0.062 0.063 0.001
South Asia 0.041 0.052 0.011
North Africa 0.050 0.044 -0.006
South America 0.031 0.041 0.010
Central, Southern Africa 0.029 0.036 0.007
Former Soviet Union 0.031 0.029 -0.002
Total 0.540 0.672 0.132
High Income Sending Region
Western Europe 0.355 0.244 -0.111
Asia, Oceania 0.065 0.055 -0.010
North America 0.040 0.029 -0.011
Total 0.460 0.328 -0.132
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Educational composition of immigrant population
Share in adult immigrant pop. Share in adult immigrant pop. Share in adult immigrant pop. Share in adult resident pop. Share in adult resident pop. Share in adult resident pop.
    primary education secondry education tertiary education   primary education secondry education tertiary education
1990 EU 8 0.616 0.210 0.174 0.332 0.485 0.183
Canada, US 0.388 0.180 0.433 0.118 0.486 0.397
Australia, N. Zealand 0.303 0.322 0.375 0.311 0.391 0.298
2000 EU 8 0.510 0.240 0.250 0.233 0.541 0.226
Canada, US 0.367 0.181 0.453 0.060 0.427 0.513
  Australia, N. Zealand 0.285 0.267 0.448   0.248 0.425 0.327
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International Labor Mobility

• To show the effects of labor migration
  (mobility), lets build a simple model with only
  one composite good called output.
• Suppose that there are only two important factors
  of production capital and labor.
• On a given stock of capital of land, the
  productivity of workers eventually diminishes as
  each works more hours and as more workers produce
  given that fixed stock of capital .
• The marginal productivity of labor eventually
  decreases.

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Fig. 7-1 An Economys Production Function
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Fig. 7-2 The Marginal Product of Labor
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International Labor Mobility (cont.)

• The productivity of labor depends on the amount
  of work and number or workers.
• In competitive markets, firms can afford to pay
  only wages whose purchasing power equals the
  marginal productivity of the workers earning the
  wages.
• The area under the marginal product(ivity) of
  labor curve equals the value of output produced,
  which equals the value of wages and income paid
  to factors of production when markets are
  competitive.

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International Labor Mobility (cont.)

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

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International Labor Mobility (cont.)

• Workers in the domestic country have an incentive
  to move to the foreign country until the
  purchasing power of wages between the countries
  are equal.
• Emigration from the domestic country raises real
  wages of the remaining workers there.
• It increases the supply of labor services and
  decreases the real wage in the foreign country.

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Solving for General Equilibrium

• Conditions for equilibrium in the labor market
• Wage equals marginal revenue product of labor in
  US
• WUS PUSMPLUS
• Wage equals marginal revenue product of labor in
  Mexico
• WMX PMXMPLMX
• World labor supply
• LUS LMX L

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Solving for General Equilibrium

• Conditions for equilibrium in markets for capital
• Rental price of capital revenue MP of capital
  
• US RUSPUSMPKUS
• MX RMX PMXMPKMX
• We assume capital is immobile between countries
  (or whatever capital will move already has)
• As a result, equilibrium in K markets holds by
  assumption and remains in the background of the
  model
• All action comes from competing national demands
  for labor

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Demand for Labor in the US
W
PUSMPLUS
LUS
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Demand for Labor in Mexico
W
PMXMPLMX
LMX
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Global Supply of Labor
W
? LMX
LUS ?
L
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Labor Market Equilibrium without Labor Mobility
W
WUS
WMX
PMXMPLMX
PUSMPLUS
? LMX
LUS ?
L0MX
L0US
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Labor Market Equilibrium with Labor Mobility
W
WUS
W1
WMX
PMXMPLMX
PUSMPLUS
? LMX
LUS ?
L0MX
L0US
Immigrants
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Labor Market Equilibrium with Labor Mobility
W
WUS
A
B
W1
C
F
D
WMX
PMXMPLMX
E
PUSMPLUS
? LMX
LUS ?
L0MX
L0US
Immigrants
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Welfare Effects of Migration

• US natives
• Loss in labor income A
• Gain in capital income AB
• Gain in GNP B
• Gain in GDP BCDE
• Mexico natives
• Gain in labor income (migrants) CD
• Gain in labor income (non-migrants) F
• Loss in capital income DF
• Gain in GNP C
• Loss in GDP -(DE)
• Global Effects
• Gain in global GNP BC

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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 the factors
  of production that produced them.
• But equalization of factor prices 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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International Labor Mobility (cont.)

1. The model assumes that trading countries produce
   the same goods, but countries may produce
   different goods so that marginal productivities
   of labor 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 and income paid to these
   factors.

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International Labor Mobility (cont.)

• Barriers to immigration and emigration and
  transportation costs may prevent the purchasing
  power of wages from equalizing.
• Barriers to movements for other factors of
  production, like land and capital, are also
  important.

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Immigration and the U.S. Economy

• In the past generation, immigration in the U.S.
  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 workers more abundant,
• possibly causing a widening wage gap between less
  educated workers and highly educated workers.

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Fig. 7-4 Immigrants as a Percentage of the U.S.
Population.
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Immigration and the U.S. Economy (cont.)

• But immigration can not wholly explain the
  widening income distribution in the U.S.
• The fraction of U.S. 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.

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International Borrowing and Lending

• International capital mobility refers to mobility
  of financial assets, or capital, across
  countries.
• Financial capital is a source of funds used to
  build physical capital (ex., 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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Fig. 7-5 The Intertemporal Production
Possibility Frontier
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International Borrowing and Lending

• Some countries will have a comparative advantage
  in spending current output/income (in current
  consumption).
• Others will have one in saving current output/
  income (in 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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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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International Borrowing and Lending (cont.)

• The price of borrowing 1 unit of output/income to
  consume today is the output/income that needs to
  be repaid in the future
• principal interest 1r, where r is the
  interest rate
• The relative price of current consumption
  relative to future consumption is (1r)
• The relative price of future consumption relative
  to present consumption is 1/(1r)
• The opportunity cost of consuming 1 unit of
  output/ income today is the output/income that
  could be earned by saving it
• principal interest 1r, where r is the
  interest rate
• The opportunity cost of current consumption
  relative to future consumption is (1r)

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Intertemporal budget constraint

• The isovalue curve expressed in current
  consumption is given by
• The intertemporal budget constraint of the
  economy when it is allowed to trade is given by

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Fig. 7A2-1 Determining Homes Intertemporal
Production Pattern
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Fig. 7A2-2 Determining Homes Intertemporal
Consumption Pattern
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Fig. 7A2-3 Determining Foreigns Intertemporal
Production and Consumption Patterns
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International Borrowing and Lending (cont.)

• If international borrowing and lending are
  allowed, the domestic country will export
  current consumption (that is, lend).
• The domestic country initially has a lower
  relative price of current consumption (1r)
• Thus the domestic country initially has a
  lowerinterest rate r.
• A lower interest rate r at Home implies a higher
  return to consumption and investment abroad
  investments are highly desirable and profitable
  abroad so that the domestic country should lend
  abroad.

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Foreign Direct Investment

• Foreign direct investment refers to investment in
  which a firm in one country directly controls or
  owns a subsidiary in another country.
• 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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Global FDI Flows
Source UNCTAD, WIR 2008
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FDI in China
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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
• Location Why is a good produced in two countries
  rather than in one country and then exported to
  the second country?
• Internalization Why is production in different
  locations done by one firm rather than by
  separate firms?

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Theory of Multinational Corporations (cont.)

• Why production occurs in separate locations is
  often determined by
• the location of necessary factors of production
• mining occurs where minerals are
• labor intensive production occurs where
  relatively large numbers of workers 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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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
• 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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Theory of Multinational Corporations (cont.)

• Vertical integration involves consolidation of
  different stages of a production process.
• Vertical integration involves consolidation of
  one firm that produces a good which is an input
  for a 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 separate
  organizations.

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Table 7-1 Employment by Foreign-Owned Firms in
the United States
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Fig. 7-6 Flows of Capital to Developing
Countries, as Percentage of Advanced-Country GDP
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Summary

• A simple model of international labor mobility
  predicts that labor will migrate to countries
  with higher labor productivity and higher real
  wages.
• 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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Summary (cont.)

1. 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.
2. The price of current consumption relative to the
   price of future consumption is a function of
   borrowing and saving interest rates.

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Summary (cont.)

• 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.