Chapter 9

1. Chapter 9 International Factor Movements: Labor and Capital

2. International labor mobility International borrowing and lending Foreign direct investment and multinational firms Preview

3. Movements in factors of production include labor migration, the transfer of financial capital through international borrowing and lending, transactions of multinational corporations involving direct ownership of foreign firms Movements in Factors of Production

4. Like movements of goods and services (trade), movements of factors of production are politically sensitive and are often restricted. Restrictions on immigration Restrictions on financial capital flows (less common today in Europe and US) Restrictions on the activities of multinational corporations Movements in Factors of Production (cont.)

5. To show the effects of labor migration (mobility), let’s build a simple model with only one good (output). Suppose that there are only two important factors of production: land and labor. On a fixed parcel of land, each worker often becomes less productive or efficient as more workers are added to that fixed parcel of land. The marginal product of labor often decreases. International Labor Mobility

6. International Labor Mobility (cont.)

7. International Labor Mobility (cont.)

8. Because of diminishing marginal product, productivity of labor depends on the quantity of labor employed. The marginal product decreases as more workers are employed. Because of competition, the real wage paid to workers equals their marginal product. The area under the marginal product of labor curve equals the value of output produced, which equals the value of wages and rental income paid to factors of production due to competition. International Labor Mobility (cont.)

9. If the domestic country is the labor abundant country and the foreign country is the land abundant country, the marginal product of domestic workers is less and therefore they earn less than those in the foreign country, if technology is the same across countries. There is an incentive for domestic workers to move to the foreign country. International Labor Mobility (cont.)

10. Workers in the domestic country have an incentive to move to the foreign country until the real wages between the countries are equal. Immigration from the domestic country raises the real wage of the remaining workers there. It increases the quantity of labor and decreases the real wage in the foreign country. International Labor Mobility (cont.)

11. International Labor Mobility (cont.)

12. International Labor Mobility (cont.)

13. Labor migration between the domestic country and the foreign country will also increase world output. Foreign output rises by the area under its MPL* curve from OL1 to OL2 Domestic output falls by the area under its MPL curve from OL2 to OL1 The value of world output is maximized when the marginal product of labor is the same across countries. International Labor Mobility (cont.)

14. The Heckscher-Ohlin model predicts that trade in goods is an alternative to factor mobility. Services from factors of production are “embodied” in goods, so that the value of goods reflects the value or productivity of factors of production that produced them. But despite real wage differences across countries, complete factor price equalization with labor mobility does not really occur for reasons that are similar to the reasons given in the Heckscher-Ohlin model. International Labor Mobility (cont.)

15. The model assumes that trading countries produce the same goods, but countries may produce different goods so that marginal product of labor in producing a given good are not comparable. The model assumes that trading countries have the same technology, but different technologies could affect the productivities of factors and therefore the wages/rates paid to these factors. International Labor Mobility (cont.)

16. Barriers to immigration and emigration and transportation costs may prevent factor prices from equalizing. Barriers to movements for other factors of production are also important in the real world (e.g., for land and capital). International Labor Mobility (cont.)

17. In the past generation, immigration in the US has increased substantially, especially among workers with the lowest education levels and the highest education levels. The largest increase in immigration occurred among workers with the lowest education levels, making less educated worker more abundant, possibly causing a widening wage gap between low educated workers and high educated workers. Immigration and the US Economy

18. Immigration and the US Economy (cont.)

19. But immigration can not wholly explain the widening income distribution in the US. The fraction of US workers without a high school diploma fell, while that with a college education rose, during 1980–1990. More highly educated workers became more abundant. So why did the wage of highly educated workers rise relative to that of low educated workers? Possibly due to technological changes that made education more valuable to employers. But also could because of outsourcing Immigration and the US Economy (cont.)

20. Relative Wages

21. Wh/Wl 1970 1980 years

22. Relative Employment

23. H/L 1970 1980 2000

24. 1970-80: relative wage decreases but relative employment between skilled labor and unskilled labor increases. 1980-2000:relative wage increases but relative employment between skilled labor and unskilled labor increases. Wage Premium

25. wh/wl H/L Easy to Explain 1970-1980:More supply of H

26. Difficult Is it possible due to decrease of relative supply of skilled workers? This is contradict with the stylized fact. Only one possibility exists. Relative demand of skilled labor increases due to the outsourcing (Feenstra-Hanson, 1996) It is because the relative demand of unskilled labor decreases. The diagram also applies for the developing country How to explain after 1980?

27. wh/wl H/L Diagrams

28. Facts: Relative Demand for skilled labor occurred within manufacturing industries, and not by shifts in labor between industries. Empirical Studies Berman-Bound-Griliches (1994) found that labor movement between industries are smaller than those within industries. Given that intra-industry trade only accounts for 25% of world trade. Therefore, trade cannot be a dominant explanation for wage & employment shifts. Possible Explanations (I)

30. Price movement cannot explain Wh/Wl and H/L as well. Does Stopler-Samuelson theorem hold? The rise of Ph/Pl leads to an increase of Wh/Wl . The 1970s is the S-S decade. But it does not happen in 1980s. In the U.S., the percentage change of production is higher than the percentage change of the non-production. Lawrence and Slaughter (1994) Possible Explanations (II)

31. Possible Explanations (II)

32. Feenstra-Hanson (1996) Trade is still an important explanation. Outsourcing and Intermediate Input Relative demand of skill labor within industries increases. How important for both technology improvement and outsourcing for wage premium? Acceptable Explanation

34. Figure 8.2 Costs and Fragmentation

35. At low levels of output, production might take place in a single production block exhibiting total costs rising proportionally with output, as in ray 1. An alternative technique fragments the production process into a pair of blocks by placing one of them in a locale more suited to its factor requirement, but this involves service link costs of coordinating the blocks (line 2). Line 3 shows fragmentation that outsources one production block overseas to obtain even lower marginal costs, although the costs of service links become larger (OB). The heavy line show how fragmentation leads to a lowering of average costs as output expands. A Simple Model for Outsourcing

36. International capital mobility usually refers to mobility in financial capital across countries. Financial capital is a source of funds used to build physical capital (e.g., factories and equipment). International capital mobility can be interpreted as intertemporal trade: trade of goods consumed today by borrowers in return for goods consumed in the future by lenders. International Borrowing and Lending

37. For any economy, there is a trade-off (opportunity cost) between consuming today and saving for the future: resources can either be consumed or saved. To save and invest more today typically means that economies need to consume less today. We represent this concept by drawing a special kind of production possibility frontier, an intertemporal production possibility frontier. International Borrowing and Lending (cont.)

38. International Borrowing and Lending (cont.)

42. Some countries will have a comparative advantage in spending current output/income (current consumption). Others will have one in saving current output/ income (future consumption). A comparative advantage in current consumption would mean a lower opportunity cost of spending current income. would be reflected in an intertemporal PPF that is biased toward current consumption. International Borrowing and Lending

43. Suppose that the domestic country has a comparative advantage in (bias towards) current consumption, while the foreign country has a comparative advantage (bias towards) future consumption. In the absence of international borrowing and lending, the relative price of current consumption should be lower in the domestic country. But what is the relative price of current consumption? International Borrowing and Lending (cont.)

44. The price of borrowing 1 unit of output/income today to consume is the output/income that needs to be repaid in the future: principal + interest = 1+r, where r is the interest rate The price of current consumption relative to future consumption is 1/(1+r) The opportunity cost of consuming 1 unit of output/ income today is the output/income that could have be earned by saving it: principal + interest = 1+r, where r is the interest rate International Borrowing and Lending (cont,)

45. If international borrowing and lending are allowed, the domestic country will “export” current consumption (i.e., borrow). The domestic country initially has a lower relative price of current consumption 1/(1+r) The domestic country initially has a higher interest rate r. A higher interest rate r implies a higher return to investment: investment is highly productive/ profitable so that the domestic country borrows from foreign lenders. International Borrowing and Lending (cont.)

46. Foreign direct investment refers to investment in which firm in one country directly controls or owns a subsidiary in another. If a foreign company invests in at least 10% of the stock in a subsidiary, the two firms are typically classified as a multinational corporation. 10% or more of ownership in stock is deemed to be sufficient for direct control of business operations. In addition, international borrowing and lending sometimes occurs between a parent company and its subsidiary. Foreign Direct Investment

47. Table 9.3 Stock of Foreign Direct Investment by Region, 1990 and 2004 ($ billion)

49. Foreign Direct Investment in the US

50. China’ FDI (now is about 3% of GDP)