Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin International Factor Movements

12-2 Factors of Production: Capital  Types of capital foreign investment Foreign Direct Investment (FDI) Foreign Portfolio Investment (FPI)  FDI: Can involve individuals but the bulk is done by firms. known as: multinational corporations (MNCs), Multinational Enterprise (MNE), Transnational Corporation (TNC), or Transnational Enterprise (TNE)

Global FDI Flows  In 2011, the accumulated stock of global FDI was over $20 trillion. (UNCTAD data)  This stock is growing each year but the growth has slowd down since 2008 due to the impact of global crisis.  65% of FDI flows is in developed economies and remaining 35% in developing economies. 12-3

U.S. Direct Investment Position Abroad by Industry, 2007 IndustryValue ($, billions) Share Finance and Insurance$ % Manufacturing % Wholesale Trade % Mining % Information % Depository Institutions % Other Industries1, % Total2, % 12-4

U.S. Direct Investment Position Abroad by Region or Country, 2007 Region or Country Value ($, billions Share Europe$1, % Latin America % Asia/Pacific % Canada % Middle East % Africa % Total2, % 12-5

World’s Largest Corporations, 2008 (billions of $) CompanyHome CountryRevenues Wal-MartU.S.$378.8 Exxon MobilU.S.$372.8 Royal Dutch ShellNetherlands$355.8 BPU.K.$291.4 Toyota MotorJapan$230.2 ChevronU.S.$210.8 ING GroupNetherlands$201.5 TotalFrance$187.3 GMU.S.$182.3 Conoco PhillipsU.S.$

Reasons for International Movement of Capital  To access growing markets.  To secure access to raw materials.  To avoid tariffs and NTBs.  To take advantage of low wages.  Defensive purposes to prevent loss of market share.  Risk diversification.  MNC efficiency over local suppliers. 12-7

Capital Market Equilibrium MPP KI k1k1 0 MPP KII MPP KI MPP KII 0' Initially, suppose Country I has 0k 1 as its capital stock. This means Country II will have 0'k

Capital Market Equilibrium MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r1'r1' The price of capital will be r 1 in Country I and r 1 ’ in Country II. 12-9

Capital Market Equilibrium MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r1'r1' Output in Country I 12-10

Capital Market Equilibrium MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r1'r1' Payment to Labor Payment to Capital 12-11

Capital Market Equilibrium MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r1'r1' Output in Country II 12-12

Capital Market Equilibrium MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r1'r1' Payment to Labor Payment to Capital 12-13

Capital Market Equilibrium K MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r2r2 k2k2 r2'r2' r1'r1' If capital can flow freely across international borders, k 2 k 1 units of capital will flow from II to I because r 1 > r 1 ’. Eventually, r will fall in I and rise in II until r = r 2 = r 2 ’ in both countries

Capital Market Equilibrium K MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r2r2 k2k2 r2'r2' r1'r1' What happens to output in Country I? It rises due to the capital inflow. Increase in output 12-15

Capital Market Equilibrium K MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r2r2 k2k2 r2'r2' r1'r1' What happens to output in Country II? It falls because of the loss of capital

Capital Market Equilibrium K MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r2r2 k2k2 r2'r2' r1'r1' What happens to output in Country II? It falls because of the loss of capital. Output after capital outflow Loss in output 12-17

Capital Market Equilibrium K MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r2r2 k2k2 r2'r2' r1'r1' Overall, world output rises

Economic Effects of International Capital Flows On Incomes  Output rises in country I (the country to which the capital flows), BUT: Returns fall for capitalists, since their rate of return decreases. Returns rise for laborers.  Capitalists are hurt; labor benefits.  Therefore, per capita income rises in Country I

Economic Effects of Int’l Capital Flows On Incomes K MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r2r2 k2k2 r2'r2' r1'r1' Loss by capitalists in Country I 12-20

Economic Effects of Int’l Capital Flows On Incomes K MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r2r2 k2k2 r2'r2' r1'r1' Gain by laborers in Country I 12-21

Economic Effects of Int’l Capital Flows On Incomes K MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r2r2 k2k2 r2'r2' r1'r1' Net income gain in Country I 12-22

Economic Effects of Int’l Capital Flows On Incomes  Output falls in country II (the country from which the capital flows), BUT: Returns rise for capitalists, since their rate of return increases. Returns for laborers fall.  Capitalists are better off; labor is worse off.  Because overall incomes rise, per capita income rises

Economic Effects of Int’l Capital Flows On Incomes K MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r2r2 k2k2 r2'r2' r1'r1' Income gain by capitalists in Country II 12-24

Economic Effects of Int’l Capital Flows On Incomes K MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r2r2 k2k2 r2'r2' r1'r1' Lost labor income 12-25

Economic Effects of Int’l Capital Flows On Incomes K MPP KI r1r1 k1k1 0 MPP KII MPP KI MPP KII 0' r2r2 k2k2 r2'r2' r1'r1' Overall gain in income in Country II 12-26

International Capital Flows: A Summary  Both countries’ incomes rise as a result of capital flows.  World output rises.  Capitalists in inflow country (Country I) and Laborers in outflow country (Country II).  Capitalists in outflow country (Country II) and Laborers in inflow country (Country I) are better off

Potential Benefits of FDI to Host Country  Increased output  Increased wages  Increased employment  Increased exports  Increased tax revenues  Realization of economies of scale  Import of technical and managerial skills  Weakening power of domestic monopoly 12-28

Potential Costs of FDI to Host Country  Adverse impact in the country’s commodity terms of trade  Transfer pricing  Decrease in domestic savings  Decrease in domestic investment  Instability in the balance of payments  Loss of control over domestic policy 12-29

Potential Costs of FDI to Host Country (cont’d)  Increase in Unemployment  Establishment of Local Monopoly  Inadequate attention to the development of local education and skills  Loss of natural resources 12-30

Why Migrate?  Simply put, migration occurs when the expected costs of migrating are less than the expected benefits

Economic Effects of Labor Migration MPP LI W I L2L2 MPP LI wIwI MPP LII W II 0 0'0' GDP in Country I is given by the shaded area: w II wIwI Income of capitalists Income of laborers 12-32

Economic Effects of Labor Migration MPP LI W I L2L2 MPP LI wIwI MPP LII W II 0 0'0' GDP in Country II is given by the shaded area: w II wIwI Income of capitalists Income of laborers 12-33

Economic Effects of Labor Migration MPP LI W I L2L2 MPP LI wIwI MPP LII W II 0 0'0' If migration is possible, 0L 1 workers will work in Country I and 0'L 1 in Country II. The wage will be the same: W eq. w II wIwI L1L1 w eq 12-34

Economic Effects of Labor Migration MPP LI W I L2L2 MPP LI wIwI MPP LII W II 0 0'0' What happens to Country I? GDP falls because of out-migration: w II wIwI L1L1 w eq Lost GDP 12-35

Economic Effects of Labor Migration  GDP falls in country I (the country from which the migrants come), BUT: Wages rise for remaining workers. It can be shown that the decrease in the Country I labor force is greater than the decrease in GDP, so per capita income rises.  Capitalists are hurt; labor benefits

Economic Effects of Labor Migration MPP LI W I L2L2 MPP LI wIwI MPP LII W II 0 0'0' What happens to Country II? GDP rises because of in-migration: w II wIwI w eq Increase in GDP II 12-37

Economic Effects of Labor Migration  GDP rises in country II (the country to which migrants go), BUT: Wages fall. It can be shown that the increase in the Country II labor force is greater than the increase in GDP, so per capita income falls.  Labor is worse off; capitalists are better off

Economic Effects of Labor Migration MPP LI W I L2L2 MPP LI wIwI MPP LII W II 0 0'0' Country I’s loss in GDP is smaller than Country II’s gain, so world GDP rises. w II wIwI w eq Increase in GDP II 12-39

Economic Effects of Labor Migration MPP LI W I L2L2 MPP LI wIwI MPP LII W II 0 0'0' Country I’s loss in GDP is smaller than Country II’s gain, so world GDP rises. w II wIwI w eq Decrease in GDP I 12-40

Economic Effects of Labor Migration MPP LI W I L2L2 MPP LI wIwI MPP LII W II 0 0'0' Country I’s loss in GDP is smaller than Country II’s gain, so world GDP rises. w II wIwI w eq Increase in Total GDP 12-41

International Migration: Other Considerations  Migrants now in Country II may send remittances back to Country I So I’s per capita income rises by even more, and II’s per capita income falls by even more.  If the migrants are “guest workers” and they can be paid a lower wage, it may be possible for capitalists in Country II to be better off without domestic labor being worse off

International Migration: Other Considerations  If the immigrants are low-skill workers, the host country may experience rising social costs.  If the immigrants are high-skill workers, the host country may benefit, and the migrants’ home countries may suffer. This is called the “brain drain.” 12-43