Chapter 7: International Factor Movements · Chapter 7: International Factor Movements ... In...

Chapter 7: International Factor Movements

• Appleyard, D.R., Field, A.J., Cobb, S.L.:

International Economics, 6th Edition,

McGraw-Hill Irwin, 224-253

• Herzer D., S. Klasen, and F. Nowak-

Lehmann D. (2008) In search of FDI-led

growth in developing countries: The way

forward. Economic Modelling 25(5), 793-810.

1

Preview

• International Capital Movements through Foreign Direct Investment and Multinational Corporations

Reasons for International Movement of Capital

Analytical Effects of International Capital Movements

Potential Benefits and Costs of Foreign Direct Investment

• Host country effects of FDI

• Home country effects of FDI

• Labor movements between countries

Economic Effects of Labor Movements

Additional Considerations Pertaining to International Migration

2

Definitions

• Foreign portfolio investment

• Foreign direct investment (FDI)

• FDI refers to a movement of capital that involves ownership and control.

• World Bank defines FDI as

net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor.

3

Definitions

• FDI is usually discussed in the context of the

multinational corporation (MNC)

multinational enterprise (MNE)

transnational corporation (TNC)

transnational enterprise (TNE)

• 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.

• Foreign portfolio investment does not involve ownership or

control but the flow of “financial capital” rather than “real

capital”.

4

Some Data on Foreign Direct Investment

and Multinational Corporations

• Between 1971 and 1985, real FDI grew at an average yearly rate of 2.6 percent, worldwide real GDP by 3.3 percent and world exports by 5.2 percent.

• In the period 1986-2000 inflows of FDI grew much faster than either trade or GDP: Worldwide real GDP increased at a rate of about 3 percent

per year

Worldwide exports by about 6.4 percent, worldwide real inflows of FDI increased by approximately 18.5 percent.

• Since 2001, the rise of world FDI was reversed, and real world inflows were back to their 1998 level.

• Global FDI recovered in 2004 after a deep three-year slump.

5

Figure 1: Growth Rates of World GDP,

Exports and FDI Inflows, 1971-2006

-.8

-.6

-.4

-.2

.0

.2

.4

.6

1970 1975 1980 1985 1990 1995 2000 2005

EXPORTS GDP FDI

6

Figure 2: World FDI Inflows, 1970-2007

-

200 000

400 000

600 000

800 000

1 000 000

1 200 000

1 400 000

1 600 000

1 800 000

2 000 000

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Source: UNCTAD FDI database:

http://www.unctad.org/templates/Page.asp?IntItemID=3277&lang=1

7

Figure 3: World GDP, Exports, and FDI

Inflows, 1970-2006

0

5E+12

1E+13

1.5E+1

3

2E+13

2.5E+1

3

3E+13

3.5E+1

3

4E+13

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

FDI GDP Exports

8



• The sales of foreign subsidiaries are in many instances much larger than trade flows. Sales of manufacturing products of US subsidiaries in the EU

are approximately 3.8 times larger than EU imports from the US

Sales of EU subsidiaries in the US are 3.6 times larger than EU exports to the US.

• A very large share of world trade is conducted by MNEs. Multinationalsare responsible for 75 percent of the world‟s

commodity trade.

Around one-third of world trade is intra-firm, i.e. between subsidiaries based in different countries or between the subsidiaries and the headquarters of MNEs.

9

Figure 4: Outward FDI Flows as a Share

of Total World FDI in 2007

Developed Economies

Developing Economies

South-East Europe and

the CIS (Transition

Economies)

10

Table 1: The ten largest suppliers of FDI,

2007

Outward FDI stocks

(in millions of US dollars)

Outward FDI stocks

(as percentage of total world outward FDI stocks)

1 United States 2791269 17.89

2 United Kingdom 1705095.25 10.93

3 France 1399036.07 8.97

4 Germany 1235988.65 7.92

5 Hong Kong, China 1026587 6.58

6 Netherlands 851273.8 5.46

7 Spain 636830.158 4.08

8 Belgium 612641 3.93

9 Switzerland 603622.028 3.87

10 Japan 542614.035 3.48

11

Figure 5: FDI Inflows as a Share of Total

World FDI inflows in 2007

Developed economies

Developing economies

South-East Europe and the

CIS (Transition economies)

12

Table 2: The Ten Largest FDI Recipients,

2007

Inward FDI stocks

(in millions of US dollars)

Inward FDI stocks

(as percentage of total world outward FDI stocks)

1 United States 2 093 049 13.76

2 United Kingdom 1 347 688 8.86

3 Hong Kong, China 1 184 471 7.79

4 France 1 026 081 6.75

5 Belgium 748 110 4.92

6 Netherlands 673 430 4.43

7 Germany 629 711 4.14

8 Spain 537 455 3.53

9 Canada 520 737 3.42

10 Italy 364 839 2.40

13



• The establishment of a foreign subsidiary may take place in one of two ways: as a “greenfield investment”, where a new plant is set up

from scratch, or

as a merger with or acquisition of an existing firm (M&A).

• The majority of FDI takes place through M&A activity rather than through greenfield investments,

• The share of M&A has increased steadily since the mid 1980s from 66.3 to 76.2 percent in the period 1998-2001.

• The share of M&A is much smaller in developing than in advanced countries: 35.7 against 89 percent in 1998-2001.

14

Table 3: Cross-Border M&A Investments

as a Percentage of FDI Inflows to the Host

Countries

1987-1991 1992-1994 1995-1997 1998-2001

World 66.29 44.75 60.18 76.23

Developed Countries 77.49 64.93 85.39 88.96

Developing countries and transition economies 21.49 15.49 25.79 35.74

15

Table 4: World FDI Inward Stock by

Industry, 2001

Industry Share of world FDI inward stock (%)

Total 100

Manufacturing 41.6

Services 50.3

Primary sector 8.1

16

Table 5: Comparing Average Size and

Labor Productivity of Foreign Affiliates and

All Firms in Manufacturing for the G5

Countries

France Germany Japan UK USA

Year 1997

Foreign

affiliates

All

firms

Foreign

affiliates

All

firms

Foreign

affiliates

All

firms

Foreign

affiliates

All

firms

Foreign

affiliates

All

firms

Number of

employees per firm

256.6

130.9

288.9

172.5

313.8

49.1

301.9

25.4

782.5

52.9

Turnover per firm*

61.1

25.8

105.6

33.8

184.1

11.5

94.5

4.5

234.6

10.7

Value added per

firm*

18.0

7.7

6.0

34.6

3.4

32.2

1.9

66.2

3.8

Turnover per

employee*

0.23

0.197

0.366

0.169

0.587

0.234

0.313

0.177

0.3

0.202

Value added**

0.068

0.059

0.0035

0.110

0.068

0.107

0.073

0.085

0.072

* millions US$; ** millions US$/number of employees

17



• Table 5:

Foreign subsidiaries of MNEs are on average larger than national firms in host economies.

Labor productivity of foreign subsidiaries is above average, both when measured by turnover and value added per employee.

• Empirical studies:

Foreign-owned subsidiaries are more productive than firms with no foreign affiliates

Home activities of MNEs are more productive than those of national firms

18


and Multinational Corporations • Multinational firms are increasingly engaged in international

production networks Example: the “American” car

• 30 percent of the car‟s value goes to Korea for assembly

• 17.5 percent to Japan for components and advanced technology

• 7.5 percent to Germany for design

• 4 percent to Taiwan and Singapore for minor parts

• 2.5 percent to the UK for advertising and marketing services and

• 1.5 percent to Ireland and Barbados for data processing.

• Only 37% of the production value is generated in the United States.

• vertical specialization / fragmentation / disintegration of production / intra-product specialization

• Reflects countries‟ production of different stages of a good and the consequent trade in intermediate products.

19

Reasons for International Movement of

Capital

• 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.

Rapidly growing markets

Per capita income

Access to mineral or raw material deposits

Tariffs and nontariff barriers

Low relative wages

Defensive purpose to protect market shares

Risk diversification

Enter new markets

Source the foreign technology base

20


Capital: The Evidence • Veugelers (1991):

Significant positive effects: GDP of the recipient country weighted by the degree of openness, common language, common borders

Insignificant effects: labor productivity in the recipient country, distance, tariff rates

• Root and Ahmed (1997) find six variables to be most important:

per capita GDP

GDP growth

participation in economic integration projects such as customs unions and free-trade areas

infrastructure facilities

Urbanization

political instability

21


Capital: The Evidence

• Biswas (2002):

infrastructure contributes positively and significantly to the recipient of FDI

democracies are more attractive to FDI than autocracies.

Greater protection of property rights enhances FDI.

Curiously a longer duration of a regime significantly reduces FDI.

22

Analytical Effects of International Capital

Movements • Two factors of production—capital and labor

• Two countries

• Both countries produce a single, homogeneous good that represents the aggregate of all goods produced in the countries.

• A marginal physical product of capital schedule plots the additions to output that result from adding one more unit of capital to production (when all other inputs are held constant).

• With constant prices, this schedule constitutes the demand for capital inputs derived from the demand for the product.

• Schedule AB in Figure 6 shows the marginal physical product of capital in country I (MPPkI)

• Schedule A’B’ indicates the MPPk in country II (MPPkII)

23

Figure 6: Capital Market Equilibrium—the

Two-Country Case

MPKKI MPKKII

A’

A

MPKKI MPKKII

r1 C

E

r2 F r’2

C’

r’1

0 B’ B 0’

k1 k2

Capital

24

Initial Situation

• Capital stock in country I: 0k1

• Capital stock in country II: 0‟k1.

• Capital in country I will be paid at the rate equal to its marginal product (0r1) point C

• Capital in country II will be paid at the rate equal to its marginal product (0‟r’1) point C’

• Total output (GDP) in country I: area 0ACk1

• Total output (GDP) in country II: area 0‟A’C’k1.

• Total return of capital in country I: 0r1Ck1 / workers receive r1AC.

• Total return of capital in country II: 0‟r’1C’k1 / workers receive r’1A’C’

MPKKI MPKKII

A’

A

MPKKI MPKKII

r1 C

E

r2 F r’2

C’

r’1

0 B’ B 0’

k1 k2

Capital

25

Capital Flow

Situation

• The rate of return to capital in country I (0r1) exceeds that in country II (0‟r’1).

• The amount of capital k2k1 in country II moves to country I

• The rate of return in country I decreases from 0r1 to 0r2.

• The rate of return in country II rises from 0‟r’1 to 0‟r’2.

• Equilibrium point E

• At this equilibrium, the rate of return to capital is equalized between the countries: at 0r2 = 0‟r’2

MPKKI MPKKII

A’

A

MPKKI MPKKII

r1 C

E

r2 F r’2

C’

r’1

0 B’ B 0’

k1 k2

Capital

26

Output

Effects

• Output of country I increases from 0ACk1 to 0AEk2

• An increase by area k1CEk2.

• Output of country II decreases from 0‟A’C’k1 to 0‟A’Ek2

• A decrease by area k1C’Ek2

• The increase in output in country I (k1CEk2) is greater than the decrease in country II (k1C’Ek2)

• World output increases by area C’CE.

MPKKI MPKKII

A’

A

MPKKI MPKKII

r1 C

E

r2 F r’2

C’

r’1

0 B’ B 0’

k1 k2

Capital

27

Changes in

Total Return

• Total return to country I‟s owners of capital before the capital movement: 0r1Ck1

• Total return to country I‟s owners of capital after the capital movement: 0r2Fk1

• A decline by the amount r2r1CF.

• Total return to country II‟s owners of capital before the capital movement: 0‟r’1C’k1

• Total return to country II‟s owners of capital after the capital movement: 0‟r’2Fk1

• An increase by the amount r’1r’2FC’.

MPKKI MPKKII

A’

A

MPKKI MPKKII

r1 C

E

r2 F r’2

C’

r’1

0 B’ B 0’

k1 k2

Capital

28

Changes in

Total Return

• Before-capital-flow wages in country I: r1AC

• After-capital-flow wages in country I: r2AE

• An increase by the amount r2r1CE

• Before-capital-flow wages in country II: r’1A’C’

• After-capital-flow wages in country II: r’2A’E

• A decrease by the amount r’1 r’2E C’

MPKKI MPKKII

A’

A

MPKKI MPKKII

r1 C

E

r2 F r’2

C’

r’1

0 B’ B 0’

k1 k2

Capital

29

Effects on

National

Income

• Gross national income (GNP) consists of total wages plus total profits.

• Total wage increase in country I: r2r1CE

• Total returns decline: r2r1CF

• GNP increase: FCE

• Decrease in total wages in country II: r’1r’2EC’

• Increase in total returns: r’1r’2FC’

• Increase in GNP: C’FE

MPKKI MPKKII

A’

A

MPKKI MPKKII

r1 C

E

r2 F r’2

C’

r’1

0 B’ B 0’

k1 k2

Capital

30

Potential Benefits and Costs of Foreign

Direct Investment

• Host-country effects of FDI

• Home-country effects of FDI

31

Host country effects of FDI

• Potential benefits of FDI

Increased 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

32

Host country effects of FDI

• Potential costs of FDI

Adverse impact on the host country‟s commodity terms of trade.

Decreased domestic investment.

Instability of 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.

33

FDI and Economic Growth

• Neoclassical growth models

FDI increases the capital stock and thus growth in the host economy by financing capital formation.

• Endogenous growth models

FDI encourages the incorporation of new technologies in the production function of the host economy.

FDI augments the existing stock of knowledge in the host economy through labour training and skill acquisition, on the one hand, and through the introduction of alternative management practices and organisational arrangements on the other.

Through capital accumulation and knowledge spillovers, FDI may play an important role for economic growth.

34

FDI and Economic Growth

• Mergers and acquisitions do not necessarily increase the capital stock in capital-scarce economies.

• The positive effect of FDI on growth through capital accumulation requires that FDI does not “crowd out” equal amounts of investment from domestic sources.

• No knowledge spillovers in developing countries.

1. Multinationals may be able to effectively protect their firm-specific knowledge.

2. Domestic firms using very backward production technology and low skilled workers may be unable to learn from multinationals.

3. Knowledge spillovers are realised only if local firms have the ability to invest in absorbing foreign technologies, which may be restricted by underdeveloped local financial markets.

4. Foreign firms may reduce the productivity of domestic firms through competition effects.

35

Empirical Evidence

• Cross-country studies

• Panel studies

• Cointegration studies

Studies based on time series data

Studies based on panel data

36

Cross-country studies

• Blomström et al. (1994)

Threshold level of development

• Balasubramanyam et al. (1996)

Trade openness

• Borensztein et al. (1998)

Human capital

• Alfaro et al. (2004)

Financial market development

• Problems:

Omitted Variables (Heterogeneity)

Endogeneity

37

Panel studies

• Carkovic and Levine (2005) GMM

FDI has no robust effect on growth

• Problem: Slope heterogeneity

• Nair-Reichert and Weinhold (2001) MFR approach

FDI has, on average, a positive causal effect on economic growth, but this growth effect is highly heterogeneous.

• Problem with both cross-country and panel studies is the use of the growth rate of output as the dependent variable, while either the level or the growth rate of the FDI-to-GDP ratio is used as the explanatory variable.

38

Cointegration studies

• Investigate the long-run level relationship between output and FDI using time-series data for individual developing countries.

• Most studies find a positive long-run relationship with Granger-causality running from FDI to output or in both directions.

• Problem: These studies are focused on analyzing a limited number of major FDI recipients.

• Herzer et al. (2008)

They investigate the FDI-led growth hypothesis for 28 developing countries

Their main result is that there is a long-run positive causal relationship from FDI to GDP in only four countries.

For one of the 28 countries (Ecuador), they actually find evidence of a long-run negative growth effect of FDI.

Problem: Low power inherent in individual country cointegration tests.

39

Cointegration studies

• Hansen and Rand (2006)

Panel cointegration tests, which have higher power, by exploiting both the time-series and cross-sectional dimensions of the data.

Using heterogeneous panel estimators in a sample of 31 developing countries for the period 1970 to 2000 they find that FDI has a positive long-run effect on GDP, whereas GDP has no long-run effect on FDI.

Also, they find large differences in the growth effect of FDI across countries.

The overall picture that emerges from these studies is that FDI tends to have a positive effect on economic growth in developing countries, but this growth effect is very heterogeneous.

40

Home country effects of FDI

• Effects of foreign investment activities

on the domestic production activities of

multinational firms.

• Output effects of outward FDI on the

domestic economy as a whole.

• Empirical evidence on the effects of

outward FDI on domestic economic

activity.

41

Outward FDI and multinational firms

• Q(D, F, θ) where D is the level of domestic input, F denotes

foreign input, and θ is vector of all other factors that influence Q.

Foreign and domestic production of the multinational firm can be related either through the cost of inputs (and thus the cost of capital) or through the production process.

In the following, we discuss these two types of interdependence in more detail.

42

Interactions through the financial side

• Fixed financial resources

This scenario is characterized by investments in different locations competing for scarce funds due to increasing costs of external financing.

Outward FDI necessarily substitutes foreign production activities for domestic production activities.

• Evidence:

Desai et al. (2004): Multinational affiliates substitute internal borrowing for costly external finance stemming from adverse capital market conditions.

Desai et al. (2008): Multinationals receive equity capital from their parent companies to finance profitable investment opportunities during currency crises.

• Conclusion: Possible interactions between domestic and foreign activities are less likely to occur through the financial side, but the production process acts as the main source of interdependence.

43

Interactions through the production side

• Horizontal or market-seeking FDI is motivated by market access. It occurs when a firm decides to serve foreign markets through local production rather than exports

Domestic production decreases to the extent that foreign output substitutes for domestically produced exports.

• In reality, there is rarely a pure case of horizontal production

Services related to firm-specific assets are generally produced at company headquarters and supplied to foreign plants

Multinational firms combine home production with foreign production to reduce costs and to raise the returns to domestic production, which stimulates domestic factor demand and thus domestic output.

The initial export loss in terms of finished goods can be more than compensated for by an increase in the export of intermediate goods and services to the affiliate.

• Horizontal FDI allows the multinational firm to raise its competitiveness by accessing new markets or successfully penetrating already existing markets.

44


• Vertical FDI is driven by international factor-price differences. It takes place when firms fragment their production process internationally, locating each stage of production in the country where it can be done at the lowest cost.

Such relocations lead to reductions in home output, at least in the short run.

In the long run, vertical investment may allow firms to import intermediate goods from foreign affiliates at lower prices and/or to produce a greater volume of final goods abroad at lower cost, thereby stimulating exports of intermediate used by foreign affiliates.

The new structure of the production chain is associated with increased efficiency.

• Through vertical outward FDI, firms are able to improve their competitive position and hence raise domestic output in the long run.

45


• Technology-sourcing FDI occurs when a firm intends to copy or to source the foreign technology base by either purchasing foreign firms or establishing R&D facilities in „foreign centers of excellence‟.

If foreign affiliates then acquire new knowledge in terms of technological know-how, management techniques, knowledge of consumer tastes, etc., this can be transferred back to the parent company, which positively affects home country productivity and thus output.

46

Outward FDI and the domestic economy

• It may be that the above described positive effects accrue not only to the investing firms but also to local producers, thereby benefiting the economy as a whole.

Copying of technology

Diffusion of new technology through labor turnover

Increased competition in the home country

Cheaper intermediate goods

Economies of scale

• Outward FDI is likely to increase the competitiveness of the host economy as well.

Outward FDI may enable foreign competitors to attract demand away from domestic or domestically owned firms

47

Empirical evidence

• Stevens and Lipsey (1992)

analyze the domestic investment behavior of seven US multinational companies.

find that outward investment and domestic investment are substitutes.

• Desai et al. (2005)

use time series data for US firms

find a positive relationship between domestic and foreign investment.

• Lipsey (1994)

reports a positive correlation between foreign production and domestic employment levels by US firms.

48

Empirical evidence

• Braconier et al. (2001)

examine the question of whether domestic productivity is affected by outward FDI.

find no evidence of FDI-induced productivity gains using firm- and industry-level panel data for Sweden

• Barba Navaretti and Castellani (2004)

find that in Italian firms, outward investment increases domestic output and productivity growth.

• Problem: The studies are based on firm- or industry level data for manufacturing.

49

Empirical evidence

• Herzer (2008) examines the long-run impact of aggregate outward FDI on total domestic output.

• Country-level panel data for fourteen industrialized countries over the period 1971-2005 to estimate the following model

• Yit = ai + βOFDIit + eit

• where Y is the real GDP of country i in year t, OFDI stands for outward foreign direct investment, and eit is the usual error term summarizing the influence of all other factors.

• GDP is measured in logarithms, while outward foreign direct investment is represented by the ratio of net FDI outflows to GDP.

50

Table 6: Estimated Effect of Outward FDI on Domestic Output

Coefficient on outward FDI

Country results

Australia 0.341*** (5.66)

Austria 0.238*** (6.38)

Canada 0.167*** (7.63)

Denmark 0.054*** (6.57)

Finland 0.051*** (5.62)

France 0.074*** (6.68)

Germany 0.182*** (6.42)

Italy 0.461*** (9.68)

Japan 0.754*** (4.45)

Netherlands 0.052*** (8.65)

Spain 0.098*** (7.80)

Sweden 0.056*** (9.79)

UK 0.066*** (6.12)

US 0.501*** (5.42)

Panel results

Group-mean estimator (Pedroni, 2001) 0.221*** (25.90)

Fixed effects estimator (Kao and Chiang,

2000)

0.079*** (16.48)

*** indicate significance at the 1% level. t-statistics in parentheses. 51

Labor movements between countries

• Between 1989 and 1998, about 1 million people per year entered the United States legally and 500,000 per year did so illegally

• For the European Union, the figures were 1.2 million per year legally and perhaps 500,000 entering illegally.

• In both America and Europe, immigration has been the main driver of population growth.

In 2004, the number of foreign-born people in the United States was more the 30 million, with Mexican immigrants totaling 10.5 million.

52


• The labor force of both countries is represented by the length of the horizontal axis.

• The demand (the marginal physical product) for labor in each country is denoted by demand curves DI and DII.

• If markets are working perfectly and labor is mobile, the wage in both countries should settle at 0Weq, and 0L1 labor will be employed in country I and 0‟L1in country II.

53

Figure 7: Labor Market Equilibrium—the

Two-Country Case

WI, MPPLI WII, MPPLII

MPPLI = DI MPPLII = DII

WII F

B

A D

Weq G

C

WI

0 0’

L1 L2

Labor

54

Economic

Effects of

Labor

Movements

• Initial situation: Labor in country I: 0L2

• Initial situation: Labor in country II: 0‟L2

• Labor responds to the wage difference: it moves from country I to country II.

• The wage in country I rises while that in country II should fall until 0Weq exists in both countries.

• Output falls in country I and rises in country II.



WII F

B

A D

Weq G

C

WI

0 0’

L1 L2

55

Economic

Effects of

Labor

Movements

• The remaining laborers in country I are better off absolutely (due to the higher wage) and relatively, as the productivity of the other factors falls with the reduced labor supply.

• In country II, with the fall in the wage rate, labor is less well-off. Productivity of the other factors, however, rises with the increased use of labor, so owners of the other factors are better off.

• The other factors in country II gain area ABFGD, while country II‟s labor loses area DBFG. The amount of income earned by the new migrants is L1ADL2.



WII F

B

A D

Weq G

C

WI

0 0’

L1 L2

56

Economic

Effects of

Labor

Movements

• Given the existence of diminishing marginal productivity of labor in production, output (GDP) in country I falls at a slower rate than the decrease in the labor force, leading to an increase in per capita output.

• In country II, output (GDP) grows more slowly than the increase in the labor force, leading to a decrease in per capita output.

• The world as a whole gains since the fall in total output in country I (area L1ACL2) is more than offset by the increase in output in country II (area L1ABL2) by the area ABC.



WII F

B

A D

Weq G

C

WI

0 0’

L1 L2

57


• An even clearer case of world gains from migration occurs if it is assumed that market imperfections within country I lead to an initial excess supply of labor.

• Now Not only do wages differ between country I and country II, but some labor remains unemployed in country I at the institutional or traditional wage rate.

• This excess supply is often called surplus labor in the economic development literature.

58

Figure 8: The Effects of Labor Migration in

the Case of Surplus Labor


DI DII

WII WII

B

W’II

Weq A Weq

WI D

C W’Ieq

0 0’

Leq L1 L2

Labor

59

The Effects of

Labor

Migration in the

Case of

Surplus Labor

• L20‟ = amount of labor available in country II

• 0L2 = amount of labor in country I.

• 0‟WII = wage in country II

• 0WI = wage in country I instead of the lower, market-clearing 0W’Ieq

0L1 = employment; L1L2 = unemployment

• Migration of unemployed workers L1L2 from country I to country II leads to an expansion of output in country II without any reduction of output in country I.


DI DII

WII WII

B

W’II

Weq A Weq

WI D

C W’Ieq

0 0’

Leq L1 L2

60

The Effects of

Labor

Migration in the

Case of

Surplus Labor

• Complete equalization of wages requires that additional LeqL1 workers move from country I to country II so that Leq0‟ workers are employed in country II.

• Output in country I declines because previously employed labor, LeqL1, leaves the country.

• Compared to full-employment case, the gain in per capita output in country I caused by the migration is greater because the loss of unemployed workers, L1L2, does not affect country I‟s total output.

• The increase in total output and the decline in per capita output in country II is the same as before, and the net world gain (area ABC plus L1DCL2—the shaded area) is larger by L1DCL2.


DI DII

WII WII

B

W’II

Weq A Weq

WI D

C W’Ieq

0 0’

Leq L1 L2

61

Additional Considerations Pertaining to

International Migration • Remittances

Remittances are transfers of money by foreign workers to their home countries

According to a World Bank study, remittances to developing countries amounted to $93 billion in the year 2003.

Remittances more than exceed the amount of foreign aid received by these countries.

Remittances are equivalent to more than a quarter of GDP for several countries and more than 5 percent for many others.

• The reduction in income (from home production) in country I is at least partly offset by the amount of the transfer

• The increase in income resulting from the increased employment in country II is reduced be the amount of the transfer.

• Labor income in country I is enhanced and total income (and per capita income) available to the labor force in country II is further reduced.

62


International Migration

• Skilled and unskilled labor

The traditional migrant responding to economic forces tend to be the low-skilled worker who is unemployed or underemployed in the home country and who seeks employment in the labor-scarce country with the higher wage.

The movement of low-skilled workers based on expected income differentials has effects on the two counties that are consistent with our previous analysis.

63


International Migration • Skilled and unskilled labor

The movement of skilled labor, especially between developing and industrialized countries, is a relatively recent phenomenon. Brain drain

If markets are working and labor is paid its marginal product in both countries, the analysis of skilled-labor movements is similar to that of unskilled labor

However: skilled labor is typically associated with positive externalities

• Negative effects for the home country

• Positive effects for the recipient country

64

Chapter 7: International Factor Movements · Chapter 7: International Factor Movements ... In...

Documents

Transcript of Chapter 7: International Factor Movements · Chapter 7: International Factor Movements ... In...