Chapter 7
International Factor Movements
Copyright? 2003 Pearson Education,Inc,Slide 7-2
Introduction
International Labor Mobility
International Borrowing and Lending
Direct Foreign Investment and Multinational Firms
Summary
Appendix,More on Intertemporal Trade
Chapter Organization
Copyright? 2003 Pearson Education,Inc,Slide 7-3
Introduction
Movement of goods and services is one form of
international integration,
Another form of integration is international
movements of factors of production (factor
movements).
Factor movements include:
Labor migration
Transfer of capital via international borrowing and
lending
International linkages involved in the formation of
multinational corporations
Copyright? 2003 Pearson Education,Inc,Slide 7-4
A One-Good Model Without Factor Mobility
Assumptions of the model:
– 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.
International Labor Mobility
Copyright? 2003 Pearson Education,Inc,Slide 7-5
International Labor Mobility
Labor,L
Output,Q
Q (T,L)
Figure 7-1,An Economy’s Production Function
Copyright? 2003 Pearson Education,Inc,Slide 7-6
Rents
Wages
Real
wage
MPL
Labor,L
Marginal Product of
labor,MPL
International Labor Mobility
Figure 7-2,The Marginal Product of Labor
Copyright? 2003 Pearson Education,Inc,Slide 7-7
International Labor Movement
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.
International Labor Mobility
Copyright? 2003 Pearson Education,Inc,Slide 7-8
L2
International Labor Mobility
Figure 7-3,Causes and Effects of International Labor Mobility
MPL
MPL MPL*
MPL*
Home
employment
O Foreign
employment
O*
A
B
C
L1
Migration of labor
from Home to Foreign
Total world labor force
Marginal product
of labor
Copyright? 2003 Pearson Education,Inc,Slide 7-9
The redistribution of the world’s labor force:
Leads to a convergence of real wage rates
Increases the world’s output as a whole
Leaves some groups worse off
Extending the Analysis
Modifying the model by adding some complications:
– 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.
International Labor Mobility
Copyright? 2003 Pearson Education,Inc,Slide 7-10
International movements of capital
Refer to borrowing and lending between countries
–Example,A U.S,bank lends to a Mexican firm.
Can be interpreted as intertemporal trade
–Refers to trade of goods today for goods in the
future
International Borrowing and Lending
Copyright? 2003 Pearson Education,Inc,Slide 7-11
Intertemporal Production Possibilities and Trade
Imagine an economy that consumes only one good and
will exist for only two periods,which we will call
present and future.
Intertemporal production possibility frontier
– It represents a trade-off between present and future
production of the consumption good.
– Its shape will differ among countries:
– Some countries will be biased toward present output.
– Some countries will be biased toward future output.
International Borrowing and Lending
Copyright? 2003 Pearson Education,Inc,Slide 7-12
Figure 7-4,The Intertemporal Production Possibility Frontier
Present
consumption
Future
consumption
International Borrowing and Lending
Copyright? 2003 Pearson Education,Inc,Slide 7-13
The Real Interest Rate
How does a country trade over time?
– 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,where r is the real interest rate
on borrowing.
– The relative price of future consumption is 1/(1 + r),
International Borrowing and Lending
Copyright? 2003 Pearson Education,Inc,Slide 7-14
Intertemporal Comparative Advantage
Assume that Home’s intertemporal production
possibilities are biased toward present production.
– A country that has a comparative advantage in future
production of consumption goods is one that in the
absence of international borrowing and lending would
have a low relative price of future consumption (i.e.,
high real interest rate),
– High interest rate corresponds to a high return on investment.
International Borrowing and Lending
Copyright? 2003 Pearson Education,Inc,Slide 7-15
Direct Foreign Investment
and Multinational Firms
Direct foreign investment
Refers to international capital flows in which a firm in
one country creates or expands a subsidiary in another
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.
Copyright? 2003 Pearson Education,Inc,Slide 7-16
Multinational firms
A vehicle for international borrowing and lending
They provide financing to their foreign subsidiaries
Why is direct foreign investment rather than some
other way of transferring funds chosen?
To allow the formation of multinational organization
(extension of control)
Why do firms seek to extend control?
The answer is summarized under the theory of
multinational enterprise.
Direct Foreign Investment
and Multinational Firms
Copyright? 2003 Pearson Education,Inc,Slide 7-17
The Theory of Multinational Enterprise
Two elements explain the existence of a multinational:
– Location motive
– A good is produced in two (or more) different countries rather
than one because of:
Resources
Transport costs
Barriers of trade
– Internalization motive
– A good is produced in different locations by the same firm rather
than by separate firms because it is more profitable to carry
transactions on technology and management.
Technology transfer
Vertical integration
Direct Foreign Investment
and Multinational Firms
Copyright? 2003 Pearson Education,Inc,Slide 7-18
Multinational Firms in Practice
Multinational firms play an important part in world
trade and investment.
– Example,Half of U.S,imports can be regarded as
transactions between branches of multinational firms,
and 24% of U.S,assets abroad consist of the value of
foreign subsidiaries of U.S,firms.
Multinational firms may be either domestic or foreign-
owned.
– Foreign-owned multinational firms play an important
role in most economies,especially in the United States,
Direct Foreign Investment
and Multinational Firms
Copyright? 2003 Pearson Education,Inc,Slide 7-19
Direct Foreign Investment
and Multinational Firms
Table 7-1,France,United Kingdom,and United States,Shares of
Foreign-Owned Firms in Manufacturing Sales,Value
Added,and Employment,1985 and 1990 (percentages)
Copyright? 2003 Pearson Education,Inc,Slide 7-20
Direct Foreign Investment
and Multinational Firms
Figure 7-5,Foreign Direct Investment in the United States
Copyright? 2003 Pearson Education,Inc,Slide 7-21
Summary
International factor movements can sometimes
substitute for trade.
International borrowing and lending can be viewed
as a kind of international trade of present
consumption for future consumption rather than
trade of one good for another.
Multinational firms primarily exist as ways of
extending control over activities taking place in two
or more different countries.
Copyright? 2003 Pearson Education,Inc,Slide 7-22
Two elements explain the existence of a multinational:
A location motive.
An internalization motive.
Summary
Copyright? 2003 Pearson Education,Inc,Slide 7-23
Present
consumption
Future
consumption
QP
QF
Intertemporal
production
possibility
frontier
Isovalue lines with slope – (1 + r)
Investment
Appendix,
More on Intertemporal Trade
Figure 7A-1,Determining Home’s Intertemporal Production Pattern
Q
Copyright? 2003 Pearson Education,Inc,Slide 7-24
QP
QF
Indifference curves
Exports
D
Intertemporal budget constraint,
DP + DF/(1 + r) = QP +QF/(1 + r)
Imports
Present
consumption
Future
consumption
Appendix,
More on Intertemporal Trade
Figure 7A-2,Determining Home’s Intertemporal Consumption Pattern
DP
DF
Q
Copyright? 2003 Pearson Education,Inc,Slide 7-25
D*P
D*F
Imports
Q*
Q*P
Q*F
Intertemporal budget constraint,
D*P + D*F/(1 + r) = Q*P +Q*F/(1 + r)
Exports
Present
consumption
Future
consumption
D*
Appendix,
More on Intertemporal Trade
Figure 7A-3,Determining Foreign’s Intertemporal Production and
Consumption Patterns
Copyright? 2003 Pearson Education,Inc,Slide 7-26
P
F
(QP – DP) = (D*P – Q*P)
(Q*F– D*F) =
(DF – QF)
Appendix,
More on Intertemporal Trade
Figure 7A-4,International Intertemporal Equilibrium in Terms of Offer
Curves
E
Home exports of present consumption
(QP – DP) and Foreign imports of future
consumption (D*P – Q*P)
Foreign exports of future
consumption (Q*F – D*F) and Home
imports of future consumption (DF – QF)
O
slope = (1 + r1)
International Factor Movements
Copyright? 2003 Pearson Education,Inc,Slide 7-2
Introduction
International Labor Mobility
International Borrowing and Lending
Direct Foreign Investment and Multinational Firms
Summary
Appendix,More on Intertemporal Trade
Chapter Organization
Copyright? 2003 Pearson Education,Inc,Slide 7-3
Introduction
Movement of goods and services is one form of
international integration,
Another form of integration is international
movements of factors of production (factor
movements).
Factor movements include:
Labor migration
Transfer of capital via international borrowing and
lending
International linkages involved in the formation of
multinational corporations
Copyright? 2003 Pearson Education,Inc,Slide 7-4
A One-Good Model Without Factor Mobility
Assumptions of the model:
– 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.
International Labor Mobility
Copyright? 2003 Pearson Education,Inc,Slide 7-5
International Labor Mobility
Labor,L
Output,Q
Q (T,L)
Figure 7-1,An Economy’s Production Function
Copyright? 2003 Pearson Education,Inc,Slide 7-6
Rents
Wages
Real
wage
MPL
Labor,L
Marginal Product of
labor,MPL
International Labor Mobility
Figure 7-2,The Marginal Product of Labor
Copyright? 2003 Pearson Education,Inc,Slide 7-7
International Labor Movement
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.
International Labor Mobility
Copyright? 2003 Pearson Education,Inc,Slide 7-8
L2
International Labor Mobility
Figure 7-3,Causes and Effects of International Labor Mobility
MPL
MPL MPL*
MPL*
Home
employment
O Foreign
employment
O*
A
B
C
L1
Migration of labor
from Home to Foreign
Total world labor force
Marginal product
of labor
Copyright? 2003 Pearson Education,Inc,Slide 7-9
The redistribution of the world’s labor force:
Leads to a convergence of real wage rates
Increases the world’s output as a whole
Leaves some groups worse off
Extending the Analysis
Modifying the model by adding some complications:
– 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.
International Labor Mobility
Copyright? 2003 Pearson Education,Inc,Slide 7-10
International movements of capital
Refer to borrowing and lending between countries
–Example,A U.S,bank lends to a Mexican firm.
Can be interpreted as intertemporal trade
–Refers to trade of goods today for goods in the
future
International Borrowing and Lending
Copyright? 2003 Pearson Education,Inc,Slide 7-11
Intertemporal Production Possibilities and Trade
Imagine an economy that consumes only one good and
will exist for only two periods,which we will call
present and future.
Intertemporal production possibility frontier
– It represents a trade-off between present and future
production of the consumption good.
– Its shape will differ among countries:
– Some countries will be biased toward present output.
– Some countries will be biased toward future output.
International Borrowing and Lending
Copyright? 2003 Pearson Education,Inc,Slide 7-12
Figure 7-4,The Intertemporal Production Possibility Frontier
Present
consumption
Future
consumption
International Borrowing and Lending
Copyright? 2003 Pearson Education,Inc,Slide 7-13
The Real Interest Rate
How does a country trade over time?
– 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,where r is the real interest rate
on borrowing.
– The relative price of future consumption is 1/(1 + r),
International Borrowing and Lending
Copyright? 2003 Pearson Education,Inc,Slide 7-14
Intertemporal Comparative Advantage
Assume that Home’s intertemporal production
possibilities are biased toward present production.
– A country that has a comparative advantage in future
production of consumption goods is one that in the
absence of international borrowing and lending would
have a low relative price of future consumption (i.e.,
high real interest rate),
– High interest rate corresponds to a high return on investment.
International Borrowing and Lending
Copyright? 2003 Pearson Education,Inc,Slide 7-15
Direct Foreign Investment
and Multinational Firms
Direct foreign investment
Refers to international capital flows in which a firm in
one country creates or expands a subsidiary in another
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.
Copyright? 2003 Pearson Education,Inc,Slide 7-16
Multinational firms
A vehicle for international borrowing and lending
They provide financing to their foreign subsidiaries
Why is direct foreign investment rather than some
other way of transferring funds chosen?
To allow the formation of multinational organization
(extension of control)
Why do firms seek to extend control?
The answer is summarized under the theory of
multinational enterprise.
Direct Foreign Investment
and Multinational Firms
Copyright? 2003 Pearson Education,Inc,Slide 7-17
The Theory of Multinational Enterprise
Two elements explain the existence of a multinational:
– Location motive
– A good is produced in two (or more) different countries rather
than one because of:
Resources
Transport costs
Barriers of trade
– Internalization motive
– A good is produced in different locations by the same firm rather
than by separate firms because it is more profitable to carry
transactions on technology and management.
Technology transfer
Vertical integration
Direct Foreign Investment
and Multinational Firms
Copyright? 2003 Pearson Education,Inc,Slide 7-18
Multinational Firms in Practice
Multinational firms play an important part in world
trade and investment.
– Example,Half of U.S,imports can be regarded as
transactions between branches of multinational firms,
and 24% of U.S,assets abroad consist of the value of
foreign subsidiaries of U.S,firms.
Multinational firms may be either domestic or foreign-
owned.
– Foreign-owned multinational firms play an important
role in most economies,especially in the United States,
Direct Foreign Investment
and Multinational Firms
Copyright? 2003 Pearson Education,Inc,Slide 7-19
Direct Foreign Investment
and Multinational Firms
Table 7-1,France,United Kingdom,and United States,Shares of
Foreign-Owned Firms in Manufacturing Sales,Value
Added,and Employment,1985 and 1990 (percentages)
Copyright? 2003 Pearson Education,Inc,Slide 7-20
Direct Foreign Investment
and Multinational Firms
Figure 7-5,Foreign Direct Investment in the United States
Copyright? 2003 Pearson Education,Inc,Slide 7-21
Summary
International factor movements can sometimes
substitute for trade.
International borrowing and lending can be viewed
as a kind of international trade of present
consumption for future consumption rather than
trade of one good for another.
Multinational firms primarily exist as ways of
extending control over activities taking place in two
or more different countries.
Copyright? 2003 Pearson Education,Inc,Slide 7-22
Two elements explain the existence of a multinational:
A location motive.
An internalization motive.
Summary
Copyright? 2003 Pearson Education,Inc,Slide 7-23
Present
consumption
Future
consumption
QP
QF
Intertemporal
production
possibility
frontier
Isovalue lines with slope – (1 + r)
Investment
Appendix,
More on Intertemporal Trade
Figure 7A-1,Determining Home’s Intertemporal Production Pattern
Q
Copyright? 2003 Pearson Education,Inc,Slide 7-24
QP
QF
Indifference curves
Exports
D
Intertemporal budget constraint,
DP + DF/(1 + r) = QP +QF/(1 + r)
Imports
Present
consumption
Future
consumption
Appendix,
More on Intertemporal Trade
Figure 7A-2,Determining Home’s Intertemporal Consumption Pattern
DP
DF
Q
Copyright? 2003 Pearson Education,Inc,Slide 7-25
D*P
D*F
Imports
Q*
Q*P
Q*F
Intertemporal budget constraint,
D*P + D*F/(1 + r) = Q*P +Q*F/(1 + r)
Exports
Present
consumption
Future
consumption
D*
Appendix,
More on Intertemporal Trade
Figure 7A-3,Determining Foreign’s Intertemporal Production and
Consumption Patterns
Copyright? 2003 Pearson Education,Inc,Slide 7-26
P
F
(QP – DP) = (D*P – Q*P)
(Q*F– D*F) =
(DF – QF)
Appendix,
More on Intertemporal Trade
Figure 7A-4,International Intertemporal Equilibrium in Terms of Offer
Curves
E
Home exports of present consumption
(QP – DP) and Foreign imports of future
consumption (D*P – Q*P)
Foreign exports of future
consumption (Q*F – D*F) and Home
imports of future consumption (DF – QF)
O
slope = (1 + r1)
