International factor movements
Encyclopedia
In international economics
, international factor movements are movements of labor, capital
, and other factors of production
between countries. International factor movements occur in three ways: immigration
/emigration
, capital transfers through international borrowing and lending, and foreign direct investment
. International factor movements also raise political and social issues not present in trade in goods and services. Nations frequently restrict immigration, capital flows, and foreign direct investment.
, or the 2x2x2 model, wherein there are two-countries, two-commodities, and two factors of production. While the assumptions of that model are unlikely to hold true in reality, the model is still informative as to how prices of factors and commodities react as trade barriers are erected or removed.
International labor mobility is a politically contentious subject, particularly when considering the illegal movements of people
across international borders to seek work. For example, a number of European countries saw the rise in the 1990s of a number of anti-immigrant political parties such as the National Front in France, the National Alliance in Italy, and the Republikaner in Germany. The subject is equally contentious among academics who have espoused numerous theories for the effects of immigration, both illegal and legal, on foreign and domestic economies. Traditional international economic theory maintains that reducing barriers to labor mobility results in the equalization of wages across countries.
This can be demonstrated easily with a graphical model. First, the wage rate in a particular country can be shown graphical by looking at the marginal product of labor
(MPL). The MPL curve demonstrates the real wage rate at any given level of employment in an economy.
Now, consider a model where there are two countries: Home and Foreign. Each country is represented by a MPL curve.
Initially, Home's labor force is at point C and Foreign's labor force is at point B. In the absence of labor mobility, these points would stay the same. However, when you allow labor to move between countries, assuming the costs of movement are zero, the real wage converges on point A, and workers in Home move to Foreign where they will earn a higher wage.
A number of scholars who study the effects of international labor mobility have argued that complementary immigration, which deviates from the outcome predicted by the above model, is a common phenomena. Illegal immigration in the United States provides one useful example of this critique. The above model would predict that illegal immigration in the United States would cause the wages of domestic unskilled workers to fall. Illegal immigrants would move to the United States seeking higher wages than in their home countries. The influx of foreign laborers willing to work for wages below the pre-immigration market price in the United States would cause wages for U.S. domestic unskilled workers to fall and cause U.S. domestic unskilled workers to lose their jobs to the new foreign workers.
However, there is both theoretical and empirical evidence that this may not always be the case. The idea behind this critique is that immigrant unskilled labor differs in certain fundamental qualities from the domestic unskilled labor force. The central difference may be immigrants willingness to work in particular occupations that are shunned by domestic unskilled workers. The occupations that foreign unskilled workers fall into may in some cases actually be complements to the occupations of domestic unskilled workers, and, therefore, the work of the foreign unskilled workers could raise the marginal productivity of domestic laborers, rather than reduce their wages and employment rates as the traditional model predicts.
A great deal of empirical research has been done to assess the impact of certain groups of foreign workers. Most of these empirical studies attempt to measure the impact of immigration by looking at a cross-section of cities or regions in a country and using variations in immigrant or foreign worker density to determine how immigrants effect a particular variable of interest. Wages of domestic and foreign workers are obviously a common variable of interest. There are problems with this approach, however. In open economies with free trade, factor price equalization is likely to occur, so even if immigrants affect native national wages, the uneven distribution of immigrants across the nation may not result in long run cross-sectional wage differences. In the short run though, wage differences could indeed be present. Another issue is that immigrants may selectively move to cities that are experiencing high growth and an increase in wages. It has been suggested, however, that this issue can be resolved if wage data is examined over a period of time. In Friedburg and Hunt's survey of empirical immigration studies in 1995, they authors found that while some cross-sectional studies showed a slight decrease in domestic worker wages as a result of immigration, the effect was only slight, and not particularly detrimental. Pischke and Velling came to similar conclusions in a cross-sectional German immigration study.
Studies have also been done using "natural experiments" and time series data, which had findings similar to the cross-sectional studies. However, George Borjas, of Harvard University, and several other economists have used time series studies and looked at wage inequality data and found that immigration does have a significant effect on domestic laborers. There are several factors, however, that might lead to the overestimation of the effects of immigration using the wage inequality methodology. The primary problem in past studies was the limitiations on available data. The wage inequality studies may therefore represent an upper boundary for what the real effect of immigration is on domestic wages.
. International lending takes place through both private, commercial banks and through international, public banks, like multilateral development banks. It can be classified as a type of intertemporal trade, i.e., the exchange of resources over time. Intertemporal trade represents a tradeoff of goods today for goods tomorrow, and it can be contrasted with intratemporal trade, an exchange of goods taking place immediately. Intertemporal trade is measured by the current account
of the balance of payments.
According to the time value of money
, the present value of money is not equal to its future value (e.g., $1000 today is worth more than $1000 a year from now). Those wishing to borrow money from a lender must provide a measure of compensation above the value of the principal being borrowed. This compensation usually happens in the form of an interest rate
payment. People do not all have the same demand for present and future consumption, so if borrowing and lending are allowed the "price of future consumption", i.e., the interest rate, will emerge. For the purposes of international economics, countries can be thought of in the same way as people. If a country has a relatively high interest rate, that would mean it has a comparative advantage
in future consumption—an intertemporal comparative advantage. Countries that borrow from the international market are, therefore, those that have highly productive current investment opportunities. Countries that lend are in the opposite situation.
(FDI) is the ownership of assets in a country by foreigners where the ownership is intended to provide control over those assets. The foreign owner is often a firm. FDI is one way in which factors of production, specifically capital, move internationally. It is distinct from international borrowing and lending of capital because the intent of FDI is not simply to transfer resources; FDI is also intended to establish control.
Two aspects of the above definition are often debated due to their inherent ambiguity. First, if a firm acquires an ownership interest in another firm, how do we determine the "nationality" of either the acquiring or acquired firms? Many companies operate in multiple countries, making it difficult to assign them a nationality. For example, Honda has factories in multiple countries, including the United States, but the firm began in Japan. How, therefore, should we assign a nationality to Honda? Should it be on the basis of where the company was founded, where it primarily produces, or some other metric? Assigning a nationality is particularly problematic for firms founded countries with very small domestic markets and for companies that specifically focus on selling goods on the international market.
The second problem with FDI's definition is the meaning of "control." The U.S. Department of Commerce has defined FDI as when a single foreign investor acquires an ownership interest of 10% or more in a U.S. firm. The number 10%, however, is somewhat arbitrary, and it is easy to see how the Commerce Department's definition might not capture all instances of actual foreign control. For example, a group of investors in a foreign country could buy 9% of a U.S. firm and still use that ownership to exercise some measure of control. Alternatively, a foreign investor that purchases 10% of a U.S. firm may have no intention of exercising control over the company.
One important question economists have preoccupied themselves with regarding FDI is why ownership of domestic resources could be more profitable for foreign firms than for domestic firms. This questions rests on the assumption that, all things being equal, domestic firms should have an advantage over foreign firms in production in their in own country. There are many explanations for why foreign firms acquire control over businesses in other countries. The foreign firm may simply have greater knowledge and expertise regarding productions methods, which gives it an advantage over domestic firms. The acquisition of a foreign firm could be based on a global business strategy. Finally, foreign firms might use a different discount rate
or return on investment
, which are essentially "cost of capital" considerations, when evaluating investment opportunities. However, Krugman and Graham, through a survey of the relevant literature, concluded that industrial organization considerations are more likely than cost of capital concerns to be the driving force for FDI.
(MNEs) manage production or deliver services in more than one country. According to the United Nations Conference on Trade and Development's World Investment Report from 2007, as of 2005 there were over 77,000 parent company MNEs and 770,000 foreign affiliates. From an international economics viewpoint, there are two central questions about why MNEs exist. The first question is why goods and services are produced in multiple countries, instead of a single country. The second central question regarding MNEs is why certain firms decide to produce multiple products—why they internalize other areas of production. The first question can be answered rather simply. Different countries have different resources that companies may need for production. Also, transport costs and barriers to trade often mean the MNEs are necessary to access a particular market. The short answer to the second question it that firms internalize because it is more profitable for them to do so, but the exact reasons behind why it is more profitable to internalize are a more difficult issue. One possible reason for internalization is to insulate MNEs from opportunistic business partners through vertical integration. Technology transfer (here defined as any kind of useful economic knowledge) is also posited as a reason for internalization. A detailed discussion of these issues, however, is outside the scope of this article.
International economics
International economics is concerned with the effects upon economic activity of international differences in productive resources and consumer preferences and the institutions that affect them...
, international factor movements are movements of labor, capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
, and other factors of production
Factors of production
In economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...
between countries. International factor movements occur in three ways: immigration
Immigration
Immigration is the act of foreigners passing or coming into a country for the purpose of permanent residence...
/emigration
Emigration
Emigration is the act of leaving one's country or region to settle in another. It is the same as immigration but from the perspective of the country of origin. Human movement before the establishment of political boundaries or within one state is termed migration. There are many reasons why people...
, capital transfers through international borrowing and lending, and foreign direct investment
Foreign direct investment
Foreign direct investment or foreign investment refers to the net inflows of investment to acquire a lasting management interest in an enterprise operating in an economy other than that of the investor.. It is the sum of equity capital,other long-term capital, and short-term capital as shown in...
. International factor movements also raise political and social issues not present in trade in goods and services. Nations frequently restrict immigration, capital flows, and foreign direct investment.
Substitutability of factors and commodities
Trade in goods and services can to some extent be considered a substitute for factor movements. In the absence of trade barriers, even when factors are not mobile, there is a tendency toward factor price equalization. In the absence of barriers to factor mobility, commodity prices will move toward equalization, even if commodities may not freely move. However, complete substitution between factors of production and commodities is only theoretical, and will only be fully realized under the economic model called the Heckscher-Ohlin modelHeckscher-Ohlin model
The Heckscher–Ohlin model is a general equilibrium mathematical model of international trade, developed by Eli Heckscher and Bertil Ohlin at the Stockholm School of Economics. It builds on David Ricardo's theory of comparative advantage by predicting patterns of commerce and production based...
, or the 2x2x2 model, wherein there are two-countries, two-commodities, and two factors of production. While the assumptions of that model are unlikely to hold true in reality, the model is still informative as to how prices of factors and commodities react as trade barriers are erected or removed.
International labor mobility
International labor migration is a key feature of our international economy. For example, many industries in the United States are heavily dependent on legal and illegal labor from Mexico and the Caribbean. Middle Eastern economic development has been fueled by laborers from South Asian countries, and several European countries have had formal guest-worker programs in place for years. The United Nations estimated that more than 175 million people, roughly 3 percent of the world’s population, live in a country other than where they were born.International labor mobility is a politically contentious subject, particularly when considering the illegal movements of people
Illegal immigration
Illegal immigration is the migration into a nation in violation of the immigration laws of that jurisdiction. Illegal immigration raises many political, economical and social issues and has become a source of major controversy in developed countries and the more successful developing countries.In...
across international borders to seek work. For example, a number of European countries saw the rise in the 1990s of a number of anti-immigrant political parties such as the National Front in France, the National Alliance in Italy, and the Republikaner in Germany. The subject is equally contentious among academics who have espoused numerous theories for the effects of immigration, both illegal and legal, on foreign and domestic economies. Traditional international economic theory maintains that reducing barriers to labor mobility results in the equalization of wages across countries.
This can be demonstrated easily with a graphical model. First, the wage rate in a particular country can be shown graphical by looking at the marginal product of labor
Marginal product of labor
In economics, the marginal product of labor also known as MPL is the change in output that result from employing an added unit of labor. More generally, in defining marginal product, other inputs to production are held constant...
(MPL). The MPL curve demonstrates the real wage rate at any given level of employment in an economy.
Now, consider a model where there are two countries: Home and Foreign. Each country is represented by a MPL curve.
Initially, Home's labor force is at point C and Foreign's labor force is at point B. In the absence of labor mobility, these points would stay the same. However, when you allow labor to move between countries, assuming the costs of movement are zero, the real wage converges on point A, and workers in Home move to Foreign where they will earn a higher wage.
Substitutability and complementarity of foreign and domestic labor
Some have argued that guest workers, including perhaps illegal workers in some instances, help insulate domestic populations from economic fluctuations. In times of economic prosperity more guest workers may be needed. While during economic downturns guest workers may be required to return to their country of origin. However, it is often simultaneously argued that cheaper foreign labor may be necessary for the preservation of import-competing industries. Looking at those two arguments together presents a contradiction between these two alleged benefits. When migrant workers are sent home during economic downturns and native workers take their place, the assumption is that the two types of labor are substitutes, but if cheap labor is necessary to make domestic industries competitive, this requires migrant labor to be complementary. Different types of labor (e.g., skilled and unskilled) may be complements and substitutes at the same time. For example, skilled laborers may need unskilled laborers to work in the factories skilled laborers design, but at the same time an influx of unskilled labor may make capital intensive production less economically attractive than labor intensive production, reducing the competitiveness of skilled laborers that design high-tech goods. However, the same type of labor, cannot be both a complement and substitute. For example, foreign unskilled workers will either be a substitute or complement to domestic unskilled workers; they cannot be both. The economic well being of domestic workers will tend to rise if complementary foreign labor enters the market, but their economic well being, a function of their wage, will fall if substitute foreign labor enters the market.A number of scholars who study the effects of international labor mobility have argued that complementary immigration, which deviates from the outcome predicted by the above model, is a common phenomena. Illegal immigration in the United States provides one useful example of this critique. The above model would predict that illegal immigration in the United States would cause the wages of domestic unskilled workers to fall. Illegal immigrants would move to the United States seeking higher wages than in their home countries. The influx of foreign laborers willing to work for wages below the pre-immigration market price in the United States would cause wages for U.S. domestic unskilled workers to fall and cause U.S. domestic unskilled workers to lose their jobs to the new foreign workers.
However, there is both theoretical and empirical evidence that this may not always be the case. The idea behind this critique is that immigrant unskilled labor differs in certain fundamental qualities from the domestic unskilled labor force. The central difference may be immigrants willingness to work in particular occupations that are shunned by domestic unskilled workers. The occupations that foreign unskilled workers fall into may in some cases actually be complements to the occupations of domestic unskilled workers, and, therefore, the work of the foreign unskilled workers could raise the marginal productivity of domestic laborers, rather than reduce their wages and employment rates as the traditional model predicts.
A great deal of empirical research has been done to assess the impact of certain groups of foreign workers. Most of these empirical studies attempt to measure the impact of immigration by looking at a cross-section of cities or regions in a country and using variations in immigrant or foreign worker density to determine how immigrants effect a particular variable of interest. Wages of domestic and foreign workers are obviously a common variable of interest. There are problems with this approach, however. In open economies with free trade, factor price equalization is likely to occur, so even if immigrants affect native national wages, the uneven distribution of immigrants across the nation may not result in long run cross-sectional wage differences. In the short run though, wage differences could indeed be present. Another issue is that immigrants may selectively move to cities that are experiencing high growth and an increase in wages. It has been suggested, however, that this issue can be resolved if wage data is examined over a period of time. In Friedburg and Hunt's survey of empirical immigration studies in 1995, they authors found that while some cross-sectional studies showed a slight decrease in domestic worker wages as a result of immigration, the effect was only slight, and not particularly detrimental. Pischke and Velling came to similar conclusions in a cross-sectional German immigration study.
Studies have also been done using "natural experiments" and time series data, which had findings similar to the cross-sectional studies. However, George Borjas, of Harvard University, and several other economists have used time series studies and looked at wage inequality data and found that immigration does have a significant effect on domestic laborers. There are several factors, however, that might lead to the overestimation of the effects of immigration using the wage inequality methodology. The primary problem in past studies was the limitiations on available data. The wage inequality studies may therefore represent an upper boundary for what the real effect of immigration is on domestic wages.
International borrowing and lending
International borrowing and lending is another type of international factor movement; however, the "factor" being moved here is not physical, as it is with labor mobility. Instead, it is a financial transaction. It is also known as portfolio investmentPortfolio investment
The purchase of stocks, bonds, and money market instruments by foreigners for the purpose of realizing a financial return, which does not result in foreign management, ownership, or legal control.Some examples of portfolio investment are:...
. International lending takes place through both private, commercial banks and through international, public banks, like multilateral development banks. It can be classified as a type of intertemporal trade, i.e., the exchange of resources over time. Intertemporal trade represents a tradeoff of goods today for goods tomorrow, and it can be contrasted with intratemporal trade, an exchange of goods taking place immediately. Intertemporal trade is measured by the current account
Current account
In economics, the current account is one of the two primary components of the balance of payments, the other being the capital account. The current account is the sum of the balance of trade , net factor income and net transfer payments .The current account balance is one of two major...
of the balance of payments.
According to the time value of money
Time value of money
The time value of money is the value of money figuring in a given amount of interest earned over a given amount of time. The time value of money is the central concept in finance theory....
, the present value of money is not equal to its future value (e.g., $1000 today is worth more than $1000 a year from now). Those wishing to borrow money from a lender must provide a measure of compensation above the value of the principal being borrowed. This compensation usually happens in the form of an interest rate
Interest rate
An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for...
payment. People do not all have the same demand for present and future consumption, so if borrowing and lending are allowed the "price of future consumption", i.e., the interest rate, will emerge. For the purposes of international economics, countries can be thought of in the same way as people. If a country has a relatively high interest rate, that would mean it has a comparative advantage
Comparative advantage
In economics, the law of comparative advantage says that two countries will both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods...
in future consumption—an intertemporal comparative advantage. Countries that borrow from the international market are, therefore, those that have highly productive current investment opportunities. Countries that lend are in the opposite situation.
Foreign direct investment
Foreign Direct InvestmentForeign direct investment
Foreign direct investment or foreign investment refers to the net inflows of investment to acquire a lasting management interest in an enterprise operating in an economy other than that of the investor.. It is the sum of equity capital,other long-term capital, and short-term capital as shown in...
(FDI) is the ownership of assets in a country by foreigners where the ownership is intended to provide control over those assets. The foreign owner is often a firm. FDI is one way in which factors of production, specifically capital, move internationally. It is distinct from international borrowing and lending of capital because the intent of FDI is not simply to transfer resources; FDI is also intended to establish control.
Two aspects of the above definition are often debated due to their inherent ambiguity. First, if a firm acquires an ownership interest in another firm, how do we determine the "nationality" of either the acquiring or acquired firms? Many companies operate in multiple countries, making it difficult to assign them a nationality. For example, Honda has factories in multiple countries, including the United States, but the firm began in Japan. How, therefore, should we assign a nationality to Honda? Should it be on the basis of where the company was founded, where it primarily produces, or some other metric? Assigning a nationality is particularly problematic for firms founded countries with very small domestic markets and for companies that specifically focus on selling goods on the international market.
The second problem with FDI's definition is the meaning of "control." The U.S. Department of Commerce has defined FDI as when a single foreign investor acquires an ownership interest of 10% or more in a U.S. firm. The number 10%, however, is somewhat arbitrary, and it is easy to see how the Commerce Department's definition might not capture all instances of actual foreign control. For example, a group of investors in a foreign country could buy 9% of a U.S. firm and still use that ownership to exercise some measure of control. Alternatively, a foreign investor that purchases 10% of a U.S. firm may have no intention of exercising control over the company.
One important question economists have preoccupied themselves with regarding FDI is why ownership of domestic resources could be more profitable for foreign firms than for domestic firms. This questions rests on the assumption that, all things being equal, domestic firms should have an advantage over foreign firms in production in their in own country. There are many explanations for why foreign firms acquire control over businesses in other countries. The foreign firm may simply have greater knowledge and expertise regarding productions methods, which gives it an advantage over domestic firms. The acquisition of a foreign firm could be based on a global business strategy. Finally, foreign firms might use a different discount rate
Discount rate
The discount rate can mean*an interest rate a central bank charges depository institutions that borrow reserves from it, for example for the use of the Federal Reserve's discount window....
or return on investment
Return on investment
Return on investment is one way of considering profits in relation to capital invested. Return on assets , return on net assets , return on capital and return on invested capital are similar measures with variations on how “investment” is defined.Marketing not only influences net profits but also...
, which are essentially "cost of capital" considerations, when evaluating investment opportunities. However, Krugman and Graham, through a survey of the relevant literature, concluded that industrial organization considerations are more likely than cost of capital concerns to be the driving force for FDI.
Multinational enterprises
Multinational enterprisesMultinational corporation
A multi national corporation or enterprise , is a corporation or an enterprise that manages production or delivers services in more than one country. It can also be referred to as an international corporation...
(MNEs) manage production or deliver services in more than one country. According to the United Nations Conference on Trade and Development's World Investment Report from 2007, as of 2005 there were over 77,000 parent company MNEs and 770,000 foreign affiliates. From an international economics viewpoint, there are two central questions about why MNEs exist. The first question is why goods and services are produced in multiple countries, instead of a single country. The second central question regarding MNEs is why certain firms decide to produce multiple products—why they internalize other areas of production. The first question can be answered rather simply. Different countries have different resources that companies may need for production. Also, transport costs and barriers to trade often mean the MNEs are necessary to access a particular market. The short answer to the second question it that firms internalize because it is more profitable for them to do so, but the exact reasons behind why it is more profitable to internalize are a more difficult issue. One possible reason for internalization is to insulate MNEs from opportunistic business partners through vertical integration. Technology transfer (here defined as any kind of useful economic knowledge) is also posited as a reason for internalization. A detailed discussion of these issues, however, is outside the scope of this article.
Further reading
- Paul Krugman (2005). International Economics Theory and Policy. Addison Wesley. ISBN 978-0321278845.
- Paul Krugman (1995). Foreign Direct Investment in the United States. Institute for International Economics. ISBN 0-88132-204-0
- Simon Collinson & Glenn Morgan (2009). Images of the Multinational Firm. John Wiley & Sons. ISBN 978-1405-14700-2
- Giorgio Barba Navaretti & Anthony J. Venables (2004). Multinational Firms in the World Economy. Princeton University Press. ISBN 9780691119205
- Charles P. Kindleberger (1969). American Business Abroad. Yale University Press. ISBN 0300010850
- Mats Foresgren (2008). Theories of the Multinational Firm. Edward Elgar Publishing. ISBN 978 1 84844 117 0
- Michael Rauscher (1997). International Trade, Factor Movements, and the Environment. Clarendon Press. ISBN 0-19-829050-0
- Irving Fisher (1961). The Theory of Interest. ISBN 0678000034