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International Economics
Chapter 11
International Factor Movements
and Multinational Enterprises
Chapter 11 International Factor Movements
and Multinational Enterprises

11.1 International Movement of Labor

11.2 International Movement of Capital

11.3 Multinational Enterprises and Foreign
Direct Investment Theories
11.1 International Movement of Labor

Motives for International Labor Movement
 Most
international labor migration, particularly since the end of
World War II, has been motivated by the prospect of earning
higher real wages and income abroad.
 The decision to migrate for economic reasons can be analyzed
in the same manner and with the same tools as any other
investment decision.
 The costs include the expenditures for transportation and the
loss of wages during time spent relocating and searching for
a job in the new nation.
 The economic benefits of international migration can be
measured by the higher real wages and income.
11.1 International Movement of Labor

Economic Effects of Labor Movement
Assuming
that Country A is labor-abundant, that
Country B is capital-abundant, and that trade between
the two follows the Heckscher-Ohlin pattern.
the movement of labor from Country A to Country B is
indicated by the outward shift of the Production
Possibilities Frontier (PPF) for Country B and the
inward shift of the PPF for Country A.
Assume that Country A is labor-abundant and exports
the labor-intensive good X and imports the capitalintensive good Y prior to the labor migration and that
the two countries are small ones.
11.1 International Movement of Labor
 This
change in relative labor supplies will lead Country A to
contract production of X from t0 to t1 and expand production of
Y from a0 to a1. Country B, on the other hand, will expand
production of X from T0 to T1 with the newly acquired labor and
reduce the production of Y from A0 to A1.
 Workers will move from the home country to the foreign
country. This movement will reduce the home labor force and
thus raise the real wage in the home country, while increasing
the labor force and reducing the real wage in the foreign country.
11.1 International Movement of Labor
Y
(PX /PY )
Y
(PX /PY )
A0
A1
a1
a0
O
t1
Country A
t0
X
O
T0
T1
Country B
The Relation Between Labor Movement and International Trade
X
11.1 International Movement of Labor
The
causes and effects of international labor mobility
 Given
this allocation, the real wage rate would be lower in
Country A than in Country B.
 If workers can move freely to whichever country offers the
higher real wage, they will move from Country A to Country
B until the real wage rates are equalized.
 The eventual distribution of the world’s labor force will be
one with OAL2 workers in Country A, L2OB workers in
Country B.
 As these adjustments occur, output falls in Country A and
rises in Country B.
11.1 International Movement of Labor
 With
the fall in the wage rate in Country B, labor is less
well-off since its wage rate has fallen.
 Productivity of the other factors has risen with the increased
use of labor, so owners of these factors are better off.
 The other factors in Country B gain Area ABFG, while
Country B’s labor loses Area DBFG. The amount of income
earned by the new migrants is L1L2AD.
 Finally, the world as a whole gains from this migration since
the fall in total output in Country A (Area ACL1L2) is more
than offset by the increase in output in Country B (Area
ABL1L2) by the shaded area ABC.
11.1 International Movement of Labor
WB, MPLB
wA, MPLA
MPLB
MPLA
B
A
D
F
G
C
OA
L2
L1
OB
The Economic Effect of International Labor Movement
11.1 International Movement of Labor
 Three
points should be noted about this redistribution of the
world’s labor force.
 It leads to a convergence of real wage rates. Real wages rise
in Country A and fall in Country B.
 Country B’s output rises by the area under its marginal
product curve from L1 to L2, while Country A’s output falls
by the corresponding area under its marginal product curve.
 Those who would originally have worked in Country A
receive higher real wages, but those who would originally
have worked in Country B receive lower real wages.
11.1 International Movement of Labor

Other Welfare Effects of International Labor Movement
The new immigrant might transfer some income back
to the home country.
The nature of the immigration.
The movement of skilled labor between developing
and industrialized countries.
The countries of origin of skilled migrants charge that
they incur a great cost in educating and training these
workers.
The brain drain is often encouraged by developed
countries.
Chapter 11 International Factor Movements
and Multinational Enterprises

11.1 International Movement of Labor

11.2 International Movement of Capital

11.3 Multinational Enterprises and Foreign
Direct Investment Theories
11.2 International Movement of Capital
U.S. Foreign Long-Term Private International Investment Position
in Selected Years, 1950-2001 (billions of U.S. dollars)
Year
1950
1960
1970
1980
1990
2000
2001
4.3
9.5
20.9
62.4
342.3
2,389.4
2,110.5
11.8
31.9
75.5
214.5
421.5
1,239.4
1,381.7
369.2
616.7
1,515.3
1,623.1
731.8
2,674.2
2,289.9
U.S. assets abroad
Foreign securities
Direct investments at
Historical cost
Current cost
Market value
Foreign assets in the U.S.
U.S. assets
2.9
9.3
34.8
74.1
460.6
2,623.6
2,856.7
3.4
6.9
13.3
83.0
403.7
1,214.3
1,321.1
125.9
505.3
1,374.8
1,498.9
539.6
2,766.0
2,526.7
Direct investments at
Historical cost
Current cost
Market value
11.2 International Movement of Capital
 Both
the stock of U.S. direct investments abroad and foreign
direct investments in the United States also increased very
rapidly from 1950 to 2001 and were similar in amount at the
end of 2001 when measured at market value.
11.2 International Movement of Capital
U.S. Direct Investments Abroad by Area in Selected Years, 1950-2001
(billions of U.S. dollars, at historical cost, at year end)
Year
Total
Canada
Europe
Latin
America
Asia and
Pacific
of which
Japan
Others
1950
11.8
3.6
1.7
4.6
0.3
0.0
1.6
1960
31.9
11.2
7.0
8.4
1.2
0.3
4.1
1970
78.2
22.8
24.5
14.8
8.3
1.5
7.8
1980
215.6
45.0
96.5
38.9
25.3
6.2
9.9
1990
421.5
68.4
204.2
72.5
63.6
21.0
12.8
2000
1,293.4
128.8
679.5
251.9
205.3
59.4
27.9
2001
1,381.7
139.0
725.8
269.6
216.5
64.1
30.8
11.2 International Movement of Capital
 From
1950 to 2001, the stock of U.S. direct investments in
Europe grew much more rapidly than the stock of U.S. direct
investments in Canada and Latin America. This was due to the
rapid growth of the European Union and the United States’
desire to avoid the common external tariff imposed by the EU
on imports from outside the EU.
11.2 International Movement of Capital

Motives for International Capital Movement
Firms will invest abroad in response to large and
rapidly growing markets for their products.
 Tariffs and nontariff barriers in the host nation also
can induce an inflow of foreign direct investment
(FDI).
It has also suggested that firms may want to invest
abroad as a means of risk diversification.
11.2 International Movement of Capital

Economic Effects of Capital Movement

OAA belongs to Country A and OBA belongs to Country B. The
MPKA and MPKB curves give the value of the marginal product of
capital in Country A and Country B, respectively.
 Assume in the initial situation that Country A invests its entire
capital stock OAA domestically at a yield of OAC.
 The total product is thus OAFGA, of which OACGA goes to
owners of capital in Country A and the remainder of CFG goes
to other cooperating factors, such as labor and land.
 Country B in isolation invests its entire stock OBA domestically
at a yield of OBH. Total product is OBJMA, of which OBHMA
goes to owners of capital in Country B and the remainder of
HJM goes to other cooperating factors.
11.2 International Movement of Capital
F
MPKB
MPKA
M
H
E
R
N
T
G
C
OA
J
B
A
OB
The Economic Effect of International Capital Movement
11.2 International Movement of Capital
 Since
the returns on capital are higher in Country B
(OBH) than in Country A (OAC), AB of capital flows
from Country A to Country B so as to equalize at BE
(=OAN=OBT) the rate of return on capital in the two
countries.
 Total domestic product in Country A is now OAFEB, to
which must be added ABER as the total return on foreign
investments, giving a total national income of OAFERA
(with ERG greater than before foreign investments).
 With free international capital flows, the total return on
capital in Country A increases to OANRA, while the total
return on other cooperating factors decreases to NFE.
11.2 International Movement of Capital
 The
inflow of AB of foreign capital into Country B lowers the
rate of return on capital from OBH to OBT.
 Total domestic product in Country B grows from OBJMA to
OBJEB. Of the increase in total product of ABEM, ABER goes
to foreign investors, so that ERM remains as the net gain in total
product accruing to Country B.
 The total return to domestic owners of capital falls from
OBHMA to OBTRA, while the total return to other cooperating
factors rises from HJM to TJE.
 Total product increased from OAFGA+OBJMA to
OAFEB+OBJEB, or by ERG+ERM=EGM. Thus, international
capital flows increase the efficiency in the allocation of
resources internationally and increase the world output and
welfare.
11.2 International Movement of Capital
Other
effect on international capital movement
 The total and average return on capital increases,
whereas the total and average return to labor
decreases in the investing country.
 International capital transfers also affect the balance
of payments of investing and host countries.
 Foreign investments, by affecting output and the
volume of trade of both investing and host countries,
are also likely to affect the terms of trade.
Chapter 11 International Factor Movements
and Multinational Enterprises

11.1 International Movement of Labor

11.2 International Movement of Capital

11.3 Multinational Enterprises and Foreign
Direct Investment Theories
11.3 Multinational Enterprises and Foreign Direct
Investment Theories

Multinational Enterprises
 One
of the most significant international economic
developments of the postwar period is the proliferation of
multinational enterprises (MNEs). These are firms that own,
control, or manage production facilities in several countries.
 Operating in many host countries, MNEs often conduct research
and development (R&D) activities in addition to manufacturing,
mining, extraction, and business-service operations.
 MNE cuts across national borders and is often directed from a
company planning center that is distant from the host country.
Both stock ownership and company management are typically
multinational in character.
11.3 Multinational Enterprises and Foreign Direct
Investment Theories
 MNEs
may diversify their operations along vertical, horizontal,
and conglomerate lines within the host and home countries.
 Vertical integration often occurs when the parent MNE
decides to establish foreign subsidiaries to produce
intermediate goods or inputs that go into the production of
the finished good.
 Horizontal integration occurs when a parent company
producing a commodity in the home country sets up a
subsidiary to produce the identical product in the host
country.
 Besides making horizontal and vertical foreign investments,
MNEs may diversify into unrelated markets, in what is
known as conglomerate integration.
11.3 Multinational Enterprises and Foreign Direct
Investment Theories
The
reasons for the existence of MNEs
 The
basic reason for the existence of MNEs is the
competitive advantage of a global network of production and
distribution. This competitive advantage arises in part from
vertical and horizontal integration with foreign affiliates.
 The competitive advantage of MNEs is also based on
economies of scale in production, financing, research and
development (R&D), and the gathering of market
information.
 MNEs and their affiliates usually have greater access, at
better terms, to international capital markets than do purely
national firms, and this puts MNEs in a better position to
finance large projects.
11.3 Multinational Enterprises and Foreign Direct
Investment Theories
Some
of the problems they create for the home and
host countries.
 The
most controversial of the alleged harmful effects of
MNEs on the home country is the loss of domestic jobs
resulting from foreign direct investments.
 Another possible harmful effect of MNEs on the home
country can result from transfer pricing and similar practices.
 Host countries have even more serious complaints against
MNEs because of their domination of economies.
11.3 Multinational Enterprises and Foreign Direct
Investment Theories

Foreign Direct Investment Theories
 FDI
is real investments in factories, capital goods, land, and
inventories where both capital and management are involved
and the investor retains control over use of the invested capital.
 Any purchase of 10 percent or more of the stock of a firm,
however, is defined as direct investment by the U.S. government.
 In the international context, FDI is usually undertaken by
multinational enterprise engaged in manufacturing, resource
extraction, or services.
11.3 Multinational Enterprises and Foreign Direct
Investment Theories
FDI Flows to the U.S. in Selected Years, 1980-2001
(billions of U.S. dollars)
Year
FDI
Year
FDI
1980
12.2
1991
25.5
1981
23.2
1992
15.3
1982
10.8
1993
26.2
1983
8.1
1994
45.6
1984
15.2
1995
57.2
1985
23.1
1996
79.9
1986
39.2
1997
69.7
1987
40.3
1998
215.3
1988
72.7
1999
275.0
1989
71.2
2000
335.6
1990
65.9
2001
132.9
11.3 Multinational Enterprises and Foreign Direct
Investment Theories
FDI
typically occurs when:
 The
parent company obtains sufficient common stock in a
foreign company to assume voting control.
 The parent company acquires or constructs new plants and
equipment overseas.
 The parent company shifts funds abroad to finance an
expansion of its foreign subsidiary.
 Earnings of the parent company’s foreign subsidiary are
reinvested in plant expansion.
11.3 Multinational Enterprises and Foreign Direct
Investment Theories
Potential Benefits
 Increased
of Foreign Direct Investment
output
 Increased wages
 Increased employment
 Increased exports
 Increased tax revenues
 Realization of scale economies
 Provision of technical and managerial skills and of new
technology
 Weakening of power of domestic monopoly
11.3 Multinational Enterprises and Foreign Direct
Investment Theories
Potential Disadvantages
 Adverse
of Foreign Direct Investment
impact on the host country's commodity terms of
trade
 Decreased domestic savings
 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