Lecture 4

INTERNATIONAL FACTOR MOVEMENTS

By Carlos Llano,References for the slides:• Krugman y Obsfeld: International Economics. Pearson. 2006.• UNCTAD (2011). WORLD INVESTMENT REPORT.• Paul Antràs:

http://ocw.mit.edu/OcwWeb/Economics/14-54Fall-2006/DownloadthisCourse/index.htm

“The extension and use of railroads,

steamships, telegraphs, break down

nationalities and bring peoples geographically

remote into close connection commercially and

politically. They make the world one, and

capital, like water, tends to a common level.”

David Livingstone, reflecting on his experiences in Africa in the 1850s.

Motivación

1. Introduction2. International Labor Mobility3. Foreign Direct Investment and Multinational Firms

4. Extensions.

Index

Balance of Payments

• International Trade: movement of goods and services. – The easiest way of economic integration.

• Other ways of integration: mobility of factors of production:– Immigration (labor mobility).– Capital transferences through international lending.– International Investments with the aim of permanence:

FDI and multinational firms.

1. Introduction

One-Good Model Without Factor Mobility• Hypothesis of the model:

– 2 countries (Home, Foreign).– 2 factors of production: Land (T) and Labor (L).–Both countries produce only one good.–Both countries have the same technology but different

overall land-labor endowments (T/L ratios).–Home is abundant in L, Foreign is abundant in T.–Perfect competition in all markets.

2. International Labor Mobility

Labor: L

Production: Q

Q (T, L)

An Economy’s Production Function

2. International Labor Mobility

Rents

Wages

Real Wage

MPL

L

MPL

The Marginal Product of Labor (MPL)

2. International Labor Mobility

www.youtube.com/watch?v=gurlpLOyubA

2. International Labor Mobility

Rivane Neuenschwander | Contingent - YouTube In Contingent (2008), a time-lapse film follows a single meal, as a world map – daubed in honey on blotting paper – is consumed by ants, the land masses becoming first emaciated then completely disconnected. Pitching a rational (and of course stubbornly Eurocentric) chart against an unpredictable system, Neuenschwander’s dynamic territories refer back to when terra incognita spaces – visual representations of what is not known2– had yet to disappear from maps, when the distinction between pictorial and cartographic representation was less certain.

2. International Labor Mobility

http://blip.tv/frieze/rivane-neuenschwander-pangaea-s-diaries-2008-1897430

Rivane Neuenschwander, Pangaea's Diaries (2008)Pangaea’s Diaries (2008), shown at the 2008 Carnegie International, is a microcosmic account of massive shift: a stop-motion projection of ants shuffling a beef carpaccio around a white oval plate, glimpses of a world map occasionally caught amidst the flux. The vertiginous compression through which a 250 million-year-old supercontinent is collapsed into a two-minute projection is matched by the title, which refers to both the vast land mass that preceded the separation of the continents and the three-month period that the work’s painstaking frame-by-frame production required. Time spent simply living – or perhaps just eating carpaccio at a restaurant – is casually placed alongside the rhythms of vast geological processes, as though the significances of both weren’t so far apart.

• Migration: workers are able to move between the two countries.

• Nationals will want to move to Foreign until the MPL (wage) equals the one at Home.– This movement will reduce the Home’s Labor Force, and

thus raises the real wage in Home.– This movement rises the labor force and reduces the real

wage in Foreign.

2. International Labor Mobility

L2

Causes and effects of International Labor Mobility

MPL

MPL MPL*

MPL*

Home Employment

O Foreign Employment

O*

AB

C

L1

Migration of labor from Home to Foreign

Total world labor force

Marginal Product of Labor

2. International Labor Mobility

• Effects of the re-distribution of the world labor force:– It leads to a convergence of real wage rates.– It increases the world’s output as a whole …… but it produces loses in some groups:

• Which groups?– Those who would originally have worked in Home receive higher real

wages (because of less competition and a higher MPL). Inversely in Foreign.

– The “land-owners” in Home are hurt since they have to pay higher wages, while the land-owners in Foreign will benefit from the larger labor supply (+ competition, - W).

2. International Labor Mobility

• Extension: we could modify the model by adding some complications:

• We assume that the 2 countries produce 2 goods, 1 is labor intensive (L) and the other is Land intensive (T).

• In this case, “trade” offers an alternative to factor mobility: – Home and Foreign could specialize according to its factor endowment (H-

O)

– Home could export Labor (L) and import land (T), just by exporting the good “intensive in L” and “importing the good intensive in T.

2. International Labor Mobility

• Doubt: Then, is factor mobility an obstacle for trade?– In theory it is, but in practice there is space for both of them.– Trade is not a perfect substitutive of factor mobility.– Why? The HOV Model does not work perfectly:

• The equalization of factor prices is not produced in the real world: countries are very different and they tend to specialize.

• There are barriers to trade: natural and artificial.• There are many differences in technology as long as in natural resources.• Many “services” can’t move and/or be commercialized. • Trade produced by “economies of scale” implies factor mobility “between

regions” or “between industries”.

2. International Labor Mobility

Foreign Direct Investment (FDI):• It refers to international capital flows in which a firm in

one country expands or creates a subsidiary in another.• It involves not only a transfer of resources but also the

acquisition of control.• The subsidiary does not simply have a financial obligation to

the “related” company (Ex: interests) but a “political” relationship of being part of the same organizational structure.

3. Foreign Direct Investment (FDI) and Multinationals

Multinational Firms:• They are a vehicle for international borrowing and lending.

Differences between FDI and multinationals (Lipsey, 2003)• MNE borrow in local markets.• FDI does not always involves taking the control.

Why choosing FDI vs. other ways of internationalization? Two theories:– Location theory– Internalization theory

3. Foreign Direct Investment (FDI) and Multinationals

Location theory• A good can be produced in more than a country because of

different factors:– Natural resources; transportation cost (metallurgy; refinery); trade

barriers (pharmaceuticals).

Internalization theory• The same good is produced in different locations by the

same firm instead of different firms, making use of intra-firm technology transfer, management and finance ( and taxes).– Technology transfer; – Vertical Integration.

3. Foreign Direct Investment (FDI) and Multinationals

What is the relative importance of the multinationals?

• They play an important role in world trade and investment.10% of the world GDP is produced by foreign subsidiaries½ of the U.S. imports are transactions between “related

parties” (intra-firm flow)24% of U.S. Assets abroad consists of the value of foreign

subsidiaries of U.S. firms.

3. Foreign Direct Investment (FDI) and Multinationals

• TNCs’ production generated value-added = $16 trillion in 2010, (1/4 of global GDP.

• Foreign affiliates of TNCs:

• > 10% of global GDP.

• 1/3 world exports.

FDI UNCTAD’S REPORT 2011.

International production is expanding, with foreign sales, employment and assets of transnational corporations (TNCs) all increasing.

• Global FDI flows rose moderately to $1.24 trillion in 2010, but were still 15% below their pre-crisis average. In contrast, global industrial output and trade, are back to pre-crisis levels. (FDI is more volatile than trade)

• UNCTAD estimates that global FDI will recover to its pre-crisis level in 2011, increasing to $1.4–1.6 trillion, and approach its 2007 peak in 2013.

• In 2010, developing and transition economies together attracted more than half of global FDI flows.

• Outward FDI from those economies also reached record highs, with most of their investment directed towards other countries in the South (South-South FDI).

• FDI inflows to developed countries continued to decline.• The poorest regions continued to see declines in FDI flows:

Flows to Africa, least developed countries, landlocked developing countries and small island developing States fell, as did flows to South Asia.

• Major emerging regions, such as East and South-East Asia and Latin America experienced strong growth in FDI inflows.

FDI TRENDS AND PROSPECTS (UNCTAD’S WORLD INVESTMENT REPORT 2011.

FDI TRENDS AND PROSPECTS (UNCTAD’S WORLD INVESTMENT REPORT 2011)

Fragmentation the production chain: an example

• State-owned TNCs are an important emerging source of FDI. – There are at least 650 State-owned TNCs, with 8,500

foreign affiliates across the globe. – While they represent less than 1 % of TNCs, their outward

investment accounted for 11 % of global FDI in 2010. – The ownership and governance of State-owned TNCs have

raised concerns in some host countries.

FDI TRENDS AND PROSPECTS (UNCTAD’S WORLD INVESTMENT REPORT 2011).

The relevance of Sovereign wealth funds (SWFs)

• Trade, productivity and foreign market entry decisions:– Export vs. FDI: (Head and Ries, 2003, Helpman, 2004,

Girma and Kneller, 2003)– Export vs. FDI with symmetric countries: Markusen

and Venables (2000)– Export vs. FDI with heterogeneous firms: (Melitz,

2003; Helpman, Melitz y Yeaple, 2004)

4. Extensions

Vertical vs Horizontal FDI:• Horizontal FDI:

–Trade and FDI are substitutive.–References: (Brainard, 1997…).

• Vertical FDI:–Trade and FDI are complementary.–References: (Helpman, 1984; Antràs, 2003;

Hanson et al, 2003; Yeaple, 2003).

4. Extensions