INTERNATIONAL TRADE LECTURE 12: International Factor Movements

Contents To research the international capital movements through FDI and MNCs To investigate the labor movements between countries

Introduction In previous theory, it assumes that factors of production are mobile within countries and immobile between countries which seems patently false in today’s world Contents of the lecture  The causes and consequences of capital and labor flows Current nature of international capital movements The principal factors that influence international investment decisions The various effects of international investments  The causes and impacts of labor migration between countries

International Capital Movements through FDI and MNCs Introduction  China experienced rapid economic growth since 1978 The grand view of Chinese economics

The Grand view 30 years of high-speed growth GDP (2000 USD, in billions)157.72,602.6 Annual growth rate9.8% GDP per capita (2000 USD)1651,965 Annual growth rate8.6%

The grand view

The Grad view Living standard substantially improved Urban DPI (current RMB) ,493 Rural DPI (current RMB)223.43,254.9 Poverty ratio ($1.25/day)84%16% Poverty ratio ($2/day)98%36%

The grand view

Industrialization and urbanization in progress OECD GDP decomposition Agriculture28%11%2.6% Industry48%49%27% Service24%40%70% Population Rural81%57%23.3% Urban19%43%76.7%

The grand view

Active participant in international trade and a major destination of FDI Exports (2000 USD, in billions) Annual growth rate11.7% Imports (2000 USD, in billions) Annual growth rate11.9% FDI (current USD, in billions)0148 Annual growth rate26% Foreign exchange (USD, in billions) 0.171,946 Annual growth rate17%

The grand view

International Capital Movements through FDI and MNCs Introduction  China experienced rapid economic growth since 1978 The grand view of Chinese economics Among causes, the economists emphasized on the liberalization has been the permitted entry of more foreign investors into manufacturing, such FDI has increased dramatically which has been especially important in the emergence of the strong export sector (owned or partly owned by foreign investors) China way: political economy approach (policies)

International Capital Movements through FDI and MNCs The nature of international capital flow  Definitions Foreign direct investment: a movement of capital that involves ownership and control  Foreign subsidiary: the firm whose shares were purchased by foreigners more than 50%  Branch plant: the building of a plant in one country which owned by a foreign company  FDI is usually discussed in the context of MNC, or MNE or TNC, or TNE

International Capital Movements through FDI and MNCs Foreign portfolio investment: it does o t involve ownership or control but the flow of what economists call “financial capital” rather than “real capital”  Deposit in foreign banks  Purchase of bond of a foreign company or foreign government

International Capital Movements through FDI and MNCs  Some data on Foreign Direct Investment and Multinational corporations The fast increased stock capital (accumulated FDI) growth rate in recent years (about 15%-20%) outstripped the growth rates of international trade Table 1: the amount of U.S. FDI to other countries (total booked value) Table 2: the size of FID in U.S. Table 3: 10 largest corporations in the world Table 4: 10 largest banks in the world

International Capital Movements through FDI and MNCs Reasons for international movement of capital  Centric view: the mobility of capital across country borders is because the capital is moved in response to the expectation of a higher rate of return in the new location than it earned in the old location

International Capital Movements through FDI and MNCs  Several hypotheses Firms will invest abroad in response to large and rapidly growing markets for their products (positive correlation between GDP of a recipient country and the amount of FDI flowing into that country) Developed-country firms will invest overseas if the recipient country has a high per capita income (China is an exception) The foreign firm can secure access to mineral or raw material deposits in that country To “get behind the tariff wall” and built tariff factories in the host country

International Capital Movements through FDI and MNCs The existence of low wages because of relative labor abundance in the recipient country is an attraction when the production process is labor intensive Firms also argue that they need to invest abroad for defensive purpose to protect market share Firms may want to invest abroad as a means of risk diversification Firms may find they have some firm-specific knowledge (management skills) or assets (patent) and it enables them to outperform the domestic firms, thus huge profit

International Capital Movements through FDI and MNCs Analytical effects of international capital movements  Assume: two country, two factor of production, one homogeneous good  Marginal physical product of capital to production: the additions to output that result from adding one more unit of capital to production when all others inputs are held constant

International Capital Movements through FDI and MNCs  AB->MPP KI, A’B’->MPP KII, 00’->total capital  Initial situation: K 1, r 1 and r 2, GDP, capital and labor’s return  After capital is permitted to move between countries, what happened?

International Capital Movements through FDI and MNCs  The effect of capital flow K 2 K 1 from country II to country I on output Output of country I increase Output of country II decrease World output and thus efficiency of world resource use has increased Free movement of factors can equalize return to factors in the two country

International Capital Movements through FDI and MNCs Potential benefits and costs of Foreign Direct Investment to a host country  Potential benefits of FDI Increased output Increased wages Increased employment Increased exports Increased tax revenues Realization of scale of economies Provision of technical and managerial skills and of new technology Weakening of power of domestic monopoly

International Capital Movements through FDI and MNCs  Potential costs of FDI Adverse impact on the host country’s commodity TOT Transfer pricing Decreased domestic saving Decreased domestic investment Instability in the balance of payments and the exchange rate Loss of control over domestic policy Increased unemployment Establishment of local monopoly Inadequate attention to the development of local education and skills

International Capital Movements through FDI and MNCs  Overview of benefits and costs of foreign direct investment No general assessment can be made regarding whether the benefits outweigh the costs Developed and developing countries often try to institute policies that will improve the ratio of benefits to costs connected with a foreign capital inflow—performance requirements

International Capital Movements through FDI and MNCs There are impacts of FDI on the sending or home country of the investment as well as on the receiving or host country  The sending country experiences a reduction in its GDP, a reduction in total wages, and an increase in the total return to its investors.  International trade could also be affected

Labor Movements Between Countries Labor movements in the world  In both America and Europe, immigration has been the main driver of population growth  Technically, the desire to migrate on the part of an individual depends on the expected costs and benefits of the move, among them, expected wage or income differences are an important factor  In the same time, the movement of labor can influence the average wage in both the old and the new locations, thus has welfare implications

Labor Movements Between Countries Economic effects of labor movements  Assume: homogeneous labor, two country,  Labor should move from areas of abundance and lower wages to areas of scarcity and higher wages and causes the wage rate to rise in the old area and to fall in the new area, until the wage rate is equalized between the two regions

Labor Movements Between Countries  Demand curve D I, D II. Point A, Point B. output. Welfare and productivity of the other factors  Labor loss BDFG, immigrants earn L 1 ADL 2, other factors earn ABFGD

Labor Movements Between Countries  Overall well-being in both countries and the world For country I, output (GDP) falls at a slower rate than the decrease in the labor force, leading to an increase in per capita output For country II, output grows more slowly than the increase in the labor force, leading to a decrease in per capita output The world gains from this migration since the fall in total output in country I is more than offset by the increase in output in country II by the shaded area ABC

Labor Movements Between Countries Immigration and the United States—recent perspectives  Up through the 1970s, based on the stylized facts regarding immigration in the first half of the century, it was widely accepted that although immigrants as a group were initially in an economically disadvantaged position, their earnings soon caught up with the earnings of those domestic workers with similar socioeconomic backgrounds and eventually surpassed them within 10 to 20 years on average, and appeared to have little or no adverse impact on the domestic labor market.

Labor Movements Between Countries  Later analyze indicates that there is a marked increase in the proportion coming from developing countries and a decline in the immigrants’ skill levels. Thus, it is not likely that the more recent wave of immigrants will continue to obtain wage parity with domestic workers of similar socioeconomic backgrounds  It suggests not only the new immigrants will likely have a heavier participation rate in U.S. welfare programs but also that this differential will carry over into second-generation wage and skill differences, which will be reflected in widening ethnic income differences within the overall labor market

Labor Movements Between Countries  There is also weak evidence that the increasing numbers and declining skill levels of immigrants may have contributed to the relative decline of domestic unskilled wages in the 1980s  Countries which are able to effectively control the skill characteristics of the new migrants will be able to negate some of the aforementioned negative effects

Summary To research the international capital movements through FDI and MNCs To investigate the labor movements between countries