BA 187

1
BA 187 International Trade

• Krugman Obstfeld, Chapter 7
• International Factor Movements

2
International Capital Flows

• Foreign Direct Investment (FDI)

3
International Capital Mobility

• Two Types of Capital Movements possible
• Foreign Direct Investment (FDI)
• Movement of capital that involves ownership and
  control.
• Generally involves foreign subsidiary of
  Multi-National corporation (MNC)
• Flow of real capital primarily affects nations
  production or income.
• Foreign Portfolio Investment
• Capital flows that do not involve ownership or
  control.
• Flow of financial capital primarily affects
  nations Balance of payments or exchange rate.

4
FDI Positions By Industry, Dec 31, 1995
U.S. Direct Investment Abroad U.S. Direct Investment Abroad Foreign Direct Invest. in U.S. Foreign Direct Invest. in U.S.
By Industry Value bill Share Value bill Share
Manufacturing 257.6 36.2 210.3 37.5
Finance except banking 212.1 29.8 47.9 8.6
Wholesale trade 71.4 10.0 71.7 12.8
Petroleum 69.7 9.8 35.6 6.4
Banking 30.4 4.3 41.8 7.5
Services 27.8 3.9 37.9 6.8
Other 42.7 6.0 114.9 20.5
Total 711.6 100 560.1 100
Source U.S. Dept. of Commerce, Survey of Current
Business, 1996
5
FDI Positions By Region, Dec 31, 1995
U.S. Direct Investment Abroad U.S. Direct Investment Abroad Foreign Direct Invest. in U.S. Foreign Direct Invest. in U.S.
By Country or Region Value bill Share Value bill Share
Europe 363.5 51.1 360.8 64.4
Asia and Pacific 126.0 17.7 124.6 22.2
Latin South America 122.8 17.3 22.7 4.1
Canada 81.4 11.4 46.0 8.2
Middle East 8.0 1.1 5.1 0.9
Africa 6.5 0.9 0.9 0.2
Intl Organizations 3.5 0.5
Total 711.6 100 560.1 100
Source U.S. Dept. of Commerce, Survey of Current
Business, 1996
6
Reasons for International Capital Flows

• Considerable international capital mobility
  today.
• Capital should flow to areas where expectation of
  higher return.
• Specific rationales for International Capital
  Flows
• Firms invest as response to large and growing
  international demand for their products.
• Developed country firms invest in countries with
  similar per-capita incomes, and so similar
  demands for products.
• Firms invest to secure access to mineral or raw
  material supplies.
• Firms invest abroad to access markets with high
  tariff or non-tariff barriers. EU Tariff
  factories to get behind the tariff wall.
• Firms invest in countries with low relative
  wages.
• Firms invest abroad as defensive measure to
  protect market share.
• Firms invest abroad as means of risk
  diversification against economic or exchange rate
  fluctuations.

7
International Capital Mobility

• World Capital Market Equilibrium

8
Model of Capital Mobility

• Two countries, two factors of production (Capital
  and Labor), single good sold in perfectly
  competitive market.
• Demand for capital equals its marginal physical
  product, MPK, in each country ( influenced by
  amount labor).
• Assume total world capital stock fixed.
• Distribution of capital initially based on
  historical accident.
• Initially return to capital less in Home than
  Foreign country.
• Capital assumed to move to highest rate of return
  over time.
• Capital moves from Home to Foreign, equalizing
  returns.
• Results of Capital Flow from Home to Foreign
• Output rises by more in Foreign, than it falls in
  Home.
• World output resource efficiency increase.
• Capital owners in Home gain, Labor in Home loses.
  Opposite occurs for Foreign factors of production.

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International Capital Mobility
Home MPK
Foreign MPK
O
O
Total World Capital Stock
10
Potential Benefits of FDI to Host

• Increased output.
• Increased wages.
• Increased employment.
• Increased exports.
• Assumes foreign capital produces goods with
  export potential.
• Increased tax revenues.
• Realization of Scale economies.
• Transfer of technical managerial skills to host
  nation.
• Often scarcest resources in LDCs, hence large
  potential benefit.
• Potential to weaken existing domestic monopolies.

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Potential Disadvantages of FDI

• Adverse impact of hosts Terms of Trade.
• Either through export promotion or transfer
  pricing effects.
• Decreased domestic saving or domestic investment.
• If FDI partly financed in host capital market,
  crowds out domestic investment. If not, allows
  for less domestic saving (public or private).
• Instability in Balance of Payments or Exchange
  rate.
• Loss of control over domestic govt policies.
• Increased unemployment.
• If FDI in capital-intensive industries, then
  possible fall in employment.
• Inadequate attention to development of local
  skills.
• MNCs may reserve skill positions for home
  country head office.

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International Labor Mobility

• Wages and Migration of Labor

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Model of Labor Mobility

• Two countries, two factors of production (Capital
  and Labor), single good sold in perfectly
  competitive market.
• Demand for labor equals its marginal physical
  product, MPL, in each country ( influenced by
  amount labor).
• Assume total world labor force fixed.
• Distribution of labor initially based on
  historical accident.
• Initially return to capital less in Home than
  Foreign country.
• Labor assumed to move to highest wage over time.
• Labor moves from Home to Foreign, equalizing
  wages.
• Results of Immigration from Home to Foreign
• Output rises by more in Foreign, than it falls in
  Home.
• World output resource efficiency increase.
• Labor in Home gains, Capital in Home loses.
  Opposite occurs for Foreign factors of production.

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International Labor Mobility
Home MPL
Foreign MPL
O
O
Total World Labor Force
15
Unemployment Labor Mobility

• Same model as before except that Home initially
  has unemployed workers due to wage above
  equilibrium.
• Might be result of minimum wage, or efficiency
  wages, or labor market imperfections.
• Unemployed often termed surplus labor in econ.
  Development.
• Labor again assumed to move to highest wage over
  time.
• Labor moves from Home to Foreign, equalizing
  wages.
• Results of Immigration from Home to Foreign
• Output rises by much more in Foreign than it
  falls in Home.
• World output resource efficiency increase is
  larger.
• Labor in Home gains, Capital in Home loses but by
  less than previous example. Opposite occurs for
  Foreign factors.

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Home Unemployment Labor Mobility
Home MPL
Foreign MPL
MPL
MPL
O
O
Initial Foreign Labor
Total Home Labor Force
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Additional Considerations for Labor

• Income Transfers
• New immigrants may transfer income back to Home
  country.
• This offsets income loss to Home and income
  increase to Foreign.
• Temporary vs. Permanent Immigration
• Temporary (guest) workers may be subject to
  two-tier wage scheme.
• Capital owners in Foreign pay guest workers lower
  wage, than domestic labor. Note both domestic
  labor capital win, guest labor also wins but by
  less than if not discriminated against.
• Less domestic opposition to temporary vs.
  permanent immigration.
• Characteristics of Migrant Labor
• If typical migrant labor unskilled, then return
  to both capital skilled labor likely to rise
  with immigration BUT maybe greater social costs.
• If typical migrant labor skilled (brain drain)
  potential for large gains to nation gaining this
  labor (positive externalities, lower social
  costs).