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BA 187 – International Trade

BA 187 – International Trade. Krugman & Obstfeld, Chapter 7 International Factor Movements. International Capital Flows. Foreign Direct Investment (FDI). International Capital Mobility. Two Types of Capital Movements possible Foreign Direct Investment (FDI):

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BA 187 – International Trade

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  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 nation’s production or income. • Foreign Portfolio Investment: • Capital flows that do not involve ownership or control. • Flow of “financial” capital primarily affects nation’s Balance of payments or exchange rate.

  4. FDI Positions By Industry, Dec 31, 1995 Source: U.S. Dept. of Commerce, Survey of Current Business, 1996

  5. FDI Positions By Region, Dec 31, 1995 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.

  9. MPK* MPK Capital Flows from Home to Foreign r*0 req req r0 Final Home Capital Final Foreign Capital Initial Home Capital Initial Foreign Capital 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 LDC’s, hence large potential benefit. • Potential to weaken existing domestic monopolies.

  11. Potential Disadvantages of FDI • Adverse impact of host’s 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 gov’t policies. • Increased unemployment. • If FDI in capital-intensive industries, then possible fall in employment. • Inadequate attention to development of local skills. • MNC’s may reserve skill positions for home country head office.

  12. International Labor Mobility Wages and Migration of Labor

  13. 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.

  14. MPL* MPL Migration from Home to Foreign w*0 weq weq w0 Final Home Labor Final Foreign Labor Initial Home Labor Initial Foreign Labor 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.

  16. Migration from Home to Foreign w*0 weq weq w0 Final Home Labor Final Foreign Labor Initial Home Employed U0H Home Unemployment & Labor Mobility Home MPL Foreign MPL* MPL* MPL O* O Initial Foreign Labor Total Home Labor Force

  17. 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).

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