LABOR AND CAPITAL MOBILITY
CH. 15
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?
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.
INTRODUCTION

TO FACTOR MOBILITY
Concerns about factor mobility:




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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?
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.
CAPITAL MOBILITY - DEFINITIONS

FDI: involves the transfer of capital resources and
the acquisition of control
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
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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)
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
CAPITAL MOBILITY - DEFINITIONS

MNE characteristics
1.
2.
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.
3.
International borrowing and lending sometimes occurs
between a parent company and its subsidiary.
4.
MNEs transfer other "things" to foreign affiliates:

intangible assets: proprietary technology, brand names, marketing
capabilities, trade secrets, managerial practices
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
China
299.2
Sinopec Group
China
294.3
Royal Dutch Shell
Netherlands
272.1
Exxon Mobil
U.S.
246.2
Volkswagen
Germany
236.6
Toyota Motor
Japan
236.5
Apple
U.S.
233.7
BP
United Kingdom
225.9
Source: http://beta.fortune.com/global500/
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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CAPITAL MOBILITY – WHY DO MNE EXIST?
1.
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

2.
firm-specific advantages

ownership of intangible assets


A MNE has expertise it hopes to exploit in larger markets
The question(s) are:
1.
2.
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?
CAPITAL MOBILITY – WHY TO MNE EXIST?
3.
Locational Factors: advantages or disadvantages of
producing in home or foreign country.
key to answering question of "export or FDI“?
 locational factors:

1.
2.
3.
4.
5.
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
CAPITAL MOBILITY – WHY TO MNE EXIST?
4.
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:
1.
2.
3.
Avoiding the transaction costs and risk of licensing an
independent firm
Technology transfers
Vertical integration
CAPITAL MOBILITY – MNE AND TRADE
Does MNE ↑ or ↓ International Trade
 case 1: vertical integration

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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:
1. centralizing production in one or few locations and exporting
to achieve scale economies
2. spreading production to many host countries to reduce
transportation costs and avoid trade barriers.

MIGRATION - DEFINITIONS
1.
Temporary migration

2.
Seasonal workers
Permanent migration

Immigrant permanently moves to another country and
establishes citizenship
CAPITAL MOBILITY – EFFECTS ON HOME
COUNTRY
Extra slides
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

CAPITAL MOBILITY – EFFECTS ON HOME
COUNTRY
3 general effects:
1.
Changes in prices of factors of production – thus income
distribution

If a MNE reduces capital at home and brings it abroad for
investment



2.
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


3.
K/L  r but w 
This implies that wages at home will fall
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
CAPITAL MOBILITY – EFFECTS ON HOME
COUNTRY
Other effects:
1. Introduction of a new technology, management,
training of labor, access to capital markets and sales
networks of MNC1.
2. If MNC raise capital locally
3. Host countries often have 1st opportunity to tax a
MNC
4. Host countries are often concerned about the balance
of payments implications of a MNC
5. Can be conflict on sovereignty, political control, legal
jurisdiction and fairness of contract between host and
MNC
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
1.
2.
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