1. Labor and Capital Mobility ch. 15

2. Introduction to factor mobility
Where we’ve been: goods are mobile across countries, factors (labor and capital) are not.
Now: labor and capital mobility: factors freely move across international boarders.
Why? Countries differ in factor abundance.
What does HO predict: Factor Price Equalization
These theories require free trade…we know it is not.
Question: Would countries trade goods/services or trade factors of production?

3. Introduction to factor mobility
Why does international mobility of labor and capital occur?
Factor mobility results from arbitrage in capital and labor markets
Suppose US is capital abundant and Mexico is labor abundant
⇒ Wus>Wm and rus <rm
⇒ abundant capital in US moves to Mexico
⇒ abundant labor in Mexico moves to the US.
⇒ this can equalize factor prices, eliminating the basis for HO
Point: HO and international factor mobility are substitutes.

4. Introduction to factor mobility
Concerns about factor mobility:
Owners of scarce factors: support trade protection and limits on factor movement (AFL-CIO)
Owners of abundant factors: support free trade and more factor mobility.
Multinational Enterprises: do their global activities conflict with the well-being of individual countries? Do they have the power to circumvent national sovereignty?
LDC’s: worry that foreign firms will invest in them ⇒fear of being exploited
LDC: worry that foreign firms will not invest in them ⇒fear of limited access to foreign capital, technology, marketing and management skill needed to grow
What is the impact of foreign direct investment on exports/imports?
What are the benefits /risks of migration?

5. Capital Mobility - definitions
foreign direct investment (FDI)
international capital flows in which a firm in one country creates or expands a subsidiary into another country
flow of funding provided by an investor or lender (usually a firm) to establish or acquire a foreign company or expand finance to an existing foreign company that the investor owns and controls
key distinction is the degree to which an investor can control or influence the management of the company
a rule of thumb (intl standard) : if someone owns at least 10% of a firm, they can have the ability to influence management
FDI is any flow of lending to, or purchase of ownership in, a foreign firm in which the investor (usually a firm) has (or gains) ownership of 10% or more of the foreign firm.

6. Capital Mobility - definitions
FDI: involves the transfer of capital resources and the acquisition of control
Foreign subsidiary: If US company purchases more than 50% of the shares outstanding in a French company -- US company has controlling interests
Branch plant: If US builds a plant in France -- there is ownership and control over this facility
Note:
FDI is usually discussed in the context of the multinational corporation (MNC)

7. Capital Mobility - definitions
Multinational corporation (MNC) or Multinational enterprise (MNE)
a firm that owns and controls operations in more than one country is an MNE
Ex: production is taking place in plants located in two or more countries, but under the supervision and general direction of the headquarters located in one country.
parent firm: in the MNE is the headquarters or base firm located in the "home" country
foreign affiliates (subsidiary or branch): parent firm has one or more located in the "host" country

8. Capital Mobility - definitions
MNE characteristics
MNE operates in 2 or more countries via branches or subsidiaries over which it has effective control
10% or more of ownership in stock is deemed to be sufficient for direct control of business operations.
International borrowing and lending sometimes occurs between a parent company and its subsidiary.
MNEs transfer other "things" to foreign affiliates:
intangible assets: proprietary technology, brand names, marketing capabilities, trade secrets, managerial practices

9. Fortune 500’s list of world’s largest corporations in 2016
Company
Country
Revenue
( billions)
Wal-Mart Stores
U.S.
482.1
State Grid
China
329.6
China National Petroleum
299.2
Sinopec Group
294.3
Royal Dutch Shell
Netherlands
272.1
Exxon Mobil
246.2
Volkswagen
Germany
236.6
Toyota Motor
Japan
236.5
Apple
233.7 BP
United Kingdom
225.9
Source:

10. Capital Mobility - definitions
MNEs diversify their operations
Vertical integration: a parent MNE establishes foreign subsidiaries to produce intermediate goods or inputs that go into the production of the finished good.
Backward integration: includes the extraction and processing of raw materials.
Forward integration: in the direction of the final consumer market.
Horizontal integration: parent MNE produces commodity in the source country sets up a subsidiary to produce the identical product in the host country
Conglomerate integration: firms that have diversified in non-related markets

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12. Capital Mobility – Why do MNE Exist?
inherent disadvantages
lack of knowledge of local laws, customs, procedures, practices and relationships
extra cost of initially managing from a distance
lack of initial connection to political leaders - could face some hostility
firm-specific advantages
ownership of intangible assets
A MNE has expertise it hopes to exploit in larger markets
The question(s) are:
Should a firm sell to foreign buyers by exporting from "home" country? Or set up local production in the foreign country to produce and sell locally?
Should a firm license products to local firms in foreign country (foreign firms use their local operations to produce/sell)? Or should the firm set up foreign production operations that it owns and controls?

13. Capital Mobility – Why to MNE Exist?
Locational Factors: advantages or disadvantages of producing in home or foreign country.
key to answering question of "export or FDI“?
locational factors:
Comparative advantage
Scale economies
Ex: High plant-specific costs but low transportation cost encourage exports.
Ex: High plant-specific costs but high transportation cost encourage FDI.
Host country gov. polices: trade barriers or domestic taxes/subsidies.
Existence of a PTA
Transportation costs

14. Capital Mobility – Why to MNE Exist?
Internalization advantages: The advantages of using an asset within the firm rather than finding other firms to buy, rent or license the asset
key to answering question of "license or FDI“?
license: an agreement for one firm to use another firm's assets, with restrictions on how the asset can be used, and with payments for the right to use the asset.
Benefit: more profitable to conduct transactions and production within a single organization than in separate organizations. Why:
Avoiding the transaction costs and risk of licensing an independent firm
Technology transfers
Vertical integration

15. Capital Mobility – MNE and Trade
Does MNE ↑ or ↓ International Trade
case 1: vertical integration
FDI and trade are complements
low transportation costs and low trade barriers → FDI can reduce total cost by locating different stages of production in different countries.
FDI thus leads to more trade
case 2: horizontal integration
FDI and trade are substitutes
Need to find a balance between:
centralizing production in one or few locations and exporting to achieve scale economies
spreading production to many host countries to reduce transportation costs and avoid trade barriers.

16. Migration - definitions
Temporary migration
Seasonal workers
Permanent migration
Immigrant permanently moves to another country and establishes citizenship

18. Capital Mobility – Effects on Home Country
Extra slides

19. Capital Mobility – Why to MNE Exist?
5. Oligopolistic Rivalry
Basic idea:
MNE are often large firms that have some monopoly power (economies of scale and thus very large or have some intangible asset).
They also compete with each other for market share and turf
Thus: make their decisions about FDI as part of their strategies for competing

20. Capital Mobility – Effects on Home Country
3 general effects:
Changes in prices of factors of production – thus income distribution
If a MNE reduces capital at home and brings it abroad for investment
K/L  r but w 
This implies that wages at home will fall
If a MNC raises capital from host country (borrows locally) – no change in K/L ratio – so no distributional effect
If a MNC reduces home production & exports to foreign countries
Reduced demand for factors used intensively in production at home
Foreign plants complement the production process benefiting production produced abroad and production produced at home
Home govt. may benefit from MNC if it collects tax revenue for foreign sales

21. Capital Mobility – Effects on Home Country
Other effects:
Introduction of a new technology, management, training of labor, access to capital markets and sales networks of MNC1.
If MNC raise capital locally
Host countries often have 1st opportunity to tax a MNC
Host countries are often concerned about the balance of payments implications of a MNC
Can be conflict on sovereignty, political control, legal jurisdiction and fairness of contract between host and MNC

22. Capital Mobility – Taxation of MNE profit
Host countries tax the profits of local affiliates of the multination
Home countries tax the parent company's "local" profits.
Should the home country also tax profits earned by foreign affiliates?
Foreign affiliates is usually only subjected to tax rates of host country.
2 issues
MNE can shop among countries for an affiliate location to find country w/ lowest tax rate.
MNE can use "transfer pricing" and other devices to report more of their profits at the low-tax country
transfer pricing: the setting by a company of prices (or monetary values) for things that move between units of the company
shifting location of costs and profits to avoid taxes governments try to police this