Chapter 7
? International Factor Movements
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? Introduction
? International Labor Mobility
? International Borrowing and Lending
? Direct Foreign Investment and Multinational Firms
? Summary
? Appendix,More on Intertemporal Trade
Chapter Organization
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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
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? 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
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International Labor Mobility
Labor,L
Output,Q
Q (T,L)
Figure 7-1,An Economy’s Production Function
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Rents
Wages
Real
wage
MPL
Labor,L
Marginal Product of
labor,MPL
International Labor Mobility
Figure 7-2,The Marginal Product of Labor
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? 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
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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
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? 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
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? 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
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? 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
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Figure 7-4,The Intertemporal Production Possibility Frontier
Present
consumption
Future
consumption
International Borrowing and Lending
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? 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
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? 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
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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.
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? 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
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? 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
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? 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
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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)
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Direct Foreign Investment
and Multinational Firms
Figure 7-5,Foreign Direct Investment in the United States
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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.
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? Two elements explain the existence of a multinational:
? A location motive.
? An internalization motive.
Summary
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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
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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
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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
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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)