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
U.S. Direct Investment Abroad
Foreign Direct Invest. in U.S.
By Industry
Value $ bill
Share
Manufacturing
$257.6
36.2%
$210.3
37.5%
Finance except banking
212.1
29.8
47.9
8.6
Wholesale trade
71.4
10.0
71.7
12.8
Petroleum
69.7
9.8
35.6
6.4
Banking
30.4
4.3
41.8
7.5
Services
27.8
3.9
37.9
6.8
Other
42.7
6.0
114.9
20.5
Total
$711.6
100%
560.1
Source: U.S. Dept. of Commerce, Survey of Current Business, 1996

5. FDI Positions By Region, Dec 31, 1995
U.S. Direct Investment Abroad
Foreign Direct Invest. in U.S.
By Country or Region
Value $ bill
Share
Europe
$363.5
51.1%
$360.8
64.4%
Asia and Pacific
126.0
17.7
124.6
22.2
Latin & South America
122.8
17.3
22.7
4.1
Canada
81.4
11.4
46.0
8.2
Middle East
8.0
1.1
5.1
0.9
Africa
6.5
0.2
Int’l Organizations
3.5
0.5
Total
$711.6
100%
560.1
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

9. International Capital Mobility
MPK*
Initial Foreign Capital
Home MPK
Foreign MPK*
MPK
Initial Home Capital
Capital Flows from
Home to Foreign r0
r*0
req
Final Home Capital
Final Foreign Capital 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

14. Marginal Product of Labor
MPL
Rents
Real
Wage
Wages
MPL
Labor, L

16. International Labor Mobility
MPL*
Initial Foreign Labor
Home MPL
Foreign MPL*
MPL
Initial Home Labor
Migration from
Home to Foreign w0
w*0
weq
Final Home Labor
Final Foreign Labor O* O
Total World Labor Force

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