1. International Factor Movements
Chapter 7
International Factor Movements

2. Movements in Factors of Production
Movements in factors of production include
labor migration (discussion skipped here)
the transfer of financial capital through international borrowing and lending,
transactions of multinational corporations involving direct ownership of foreign firms (Foreign Direct Investment; FDI).
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3. Movements in Factors of Production (cont.)
Movements of factors of production are politically sensitive and are often restricted.
More sensitive than the movements of goods and services (trade).
Restrictions on immigration
Restrictions on financial capital flows (less common today in Europe and US)
Restrictions on the activities of multinational corporations
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4. International factor Mobility (in the context of H.-O. model)
The Heckscher-Ohlin model predicts that (free) trade in goods is an alternative to factor mobility.
Services from factors of production are “embodied” in goods, so that the value of goods reflects the productivity of factors of production that produced them.
(Relative) prices will be equalized across the countries.
Wages (factor prices) will be equalized across the countries in the H-O Model.
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5. International Borrowing and Lending
International capital mobility usually refers to mobility in financial capital across countries.
Financial capital is a source of funds used to build physical capital (e.g., factories and equipment).
International capital mobility can be interpreted as inter-temporal trade:
International borrowing & lending can be interpreted as a kind of international trade between today’s consumption and future consumption.
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6. International Borrowing and Lending (cont.)
For any economy, there is a trade-off between consuming today and consuming in the future (saving for the future):
To save and invest more today typically means that economies need to consume less today.
(Build a model to explain the above phenomenon).
Imagine an economy that consumes only one good and will exist for only two periods (called present and future).
There exists trade-off between present and future production of the good.
We can represent this by drawing a special kind of production possibility frontier, an intertemporal PPF.
Different shape across the countries.
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7. International Borrowing and Lending (cont.)
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8. International Borrowing and Lending
Some countries will have a inter-temporal PPF biased toward current production.
Others will have a bias toward future production.
Let’s assume that Home’s PPF biased toward current production, while Foreign’s PPF biased toward future production.
What could the cases (examples) for Home & Foreign in real world?
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9. International Borrowing and Lending (cont.)
In the absence of inter-temporal trade, the relative price of future consumption would be higher in Home than in Foreign.
(Equivalently) relative price of current consumption would be lower in Home (in the absence of international borrowing and lending).
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11. International Borrowing and Lending (cont.)
If inter-temporal trade is open between the two countries, Home would export current consumption, importing future consumption.
The relative price will be equalized for the two countries.
What is the relative price of current consumption to future consumption?
How does one country trade over time with another country?
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12. International Borrowing and Lending (cont’d): Real Interest Rate
A country can trade over time by borrowing or lending.
Borrowing implies buying current consumption by sacrificing future consumption (via repayment).
The price of (borrowing) 1 unit of today’s consumption is the income that needs to be repaid in the future:
That is, 1 unit of current consumption is exchanged for (1+r) unit of future consumption, where r is the real interest rate.
In the absence of international borrowing and lending, the real interest rate will be lower in Home.
(i.e.) lower relative price of current consumption in Home .
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13. International Borrowing and Lending (cont.)
If international borrowing and lending are allowed, the Home will “export” current consumption (lend now) & “import” future consumption (get repayment in the future).
As the relative price is equalized between the two countries due to inter-temporal trade, the relative price of current consumption will increase in Home.
So the Home will reduce current consumption (lend), and will be able to consume more in the future.
The opposite change would occur in Foreign.
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14. Inter-temporal Comparative Advantage
We assumed that Home’s inter-temporal PPF is biased toward current production.
Foreign’s inter-temporal PPF is biased toward future production.
A country that has a comparative advantage in future production is one that would have a low relative price of future consumption (i.e., high real interest rate), in the absence of international borrowing and lending .
High interest rate corresponds to a high return on investment.
In our example, the Foreign has a comparative advantage in future production.
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17. Foreign Direct Investment
Foreign direct investment refers to investment in which firm in one country directly controls (or owns) a subsidiary in another country.
If a foreign company invests in at least 10% (15%) of the stock in a subsidiary, the firms are typically classified as a multinational corporation.
10% (15%) or more of ownership in stock is deemed to be sufficient for direct control of business operations.
In addition, international borrowing and lending sometimes occurs between a parent company and its subsidiary.
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18. Theory of Multinational Corporations
Why are multinational corporations created or why do they undertake foreign direct investment?
We rephrase these questions into those dealing with
Location: why is a good produced in two (or more) countries rather than in one country?
(eg) GM (Ford, Toyota, Hyundai) sell their car in Europe (China) by producing in Europe (China).
Internalization: why is production in different locations done by one firm rather that by separate firms?
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19. Theory of Multinational Corporations (cont.)
Why production occurs in separate locations is often determined by
the location of necessary factors of production:
mining occurs where minerals are;
labor intensive production occurs where relatively large pools of labor available.
transportation costs and other barriers to trade may also influence the location of production.
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20. Theory of Multinational Corporations (cont.)
Internalization occurs because it is more profitable to conduct transactions and production within a single organization than in separate organizations.
Reasons for this include:
Technology transfers: transfer of knowledge or another form of technology may be easier within a single organization (than through a market transaction between separate organizations).
Patent or property rights may be weak or non-existent.
Knowledge may not be easily packaged and sold.
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21. Theory of Multinational Corporations (cont.)
Vertical integration involves consolidation of different stages of a production process.
Vertical integration would involve consolidation (M&A) of a firm that produces a good used as an input for the acquiring firm.
This may be more efficient than having production operated by separate firms.
(eg) Having farms and flour mills consolidate into one organization may be more efficient that have farms and flour mills as separate organizations.
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22. Summary
A simple model of international labor mobility predicts that labor will migrate to countries with higher labor productivity and higher wage rates.
Real wages are predicted to fall due to immigration
Real wages are predicted to rise due to emigration
Due to the fact that countries do not produce the same goods, due to differences in technology and due to immigration barriers; real wages across countries are far from equal.
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23. Summary (cont.)
International borrowing and lending can be described as intertemporal trade, where countries with profitable investment opportunities borrow funds today and repay lenders in the future, benefiting both borrowers and lenders.
The price of current consumption relative to the price of future consumption is a function of the interest rate.
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24. Summary (cont.)
Multinational corporations undertake foreign direct investment,
possibly because locating production in foreign countries is efficient,
possibly because internalizing technology transfers is efficient or
possibly because vertical integration is efficient.
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