Assume that Mexico receives an inflow of FDI. Suppose two factors (labor and capital) are used in the production in two industries (food and televisions). Further assume that televisions are capital-intensive, as compared with food. Use the long-run specific-factors model to answer the following questions.
a.Show the impact of the inflow of FDI on Mexico in an illustration using a graph (you can upload your graph as an attachment), with the output of food (televisions) on the vertical (horizontal) axis. What happens to the output of each good?
b. How has wage changed in terms of food and televisions?
PowerPoint Presentation Week 05 | Movement of Labour and Capital between Countries Reading: Chapter 5 1. Does immigration lower wages? 2. Which industries expand because of immigration? 3. Who gains when foreign companies move in? 4. Does the world gain from international factor movements? 1ECON847 INTERNATIONAL TRADE Introduction • So far, we have kept production factors within their countries of origin. • This week, we will let them cross borders: migration and FDI. • And we will see what happens to the economy--factor prices and output level. 2ECON847 INTERNATIONAL TRADE International Movement of Labour: Migration • International migration is movement of people from one country to another, where they spend a noticeable period of time. – Know your vocab: migration, immigration, emigration. • Let’s take a poll. Does immigration lower the wage? • First, we use the specific-factors model, the short run model from week 3, where some factors are specific and others are mobile between industries. • Next, we use the Heckscher-Ohlin model, the long-run model from week 4, where all factors are mobile. 3ECON847 INTERNATIONAL TRADE Migration | Short Run (1) • Let’s start with the short run case using the specific factors model. – Recall that land and capital are specific to agriculture and manufacture, respectively, and labour is mobile across two industries. 4ECON847 INTERNATIONAL TRADE • Recall the diagram below. Due to labour’s mobility between industries, the equilibrium wage (W) is determined when wages in both industries are equal at point A. – This is before immigration. Migration | Short Run (2) • Let’s assume that the equilibrium wage in Foreign is less than Home’s. This means that Foreign workers would want to immigrate to Home. – Recall from week 1 that the primary motivation for migration is an economic one. 5ECON847 INTERNATIONAL TRADE • The migration leads to an increase in Home’s workforce. This expands the horizontal axis by the amount of L, moving the right-side origin OA to OA’. Migration | Short Run (3) • As the origin moves rightwards, the MPLA curve is also carried along by the amount of L. • The new equilibrium wage (W’) in Home is determined at point B. This is lower than before migration. – The wage decreases due to diminishing returns as more labour is working on fixed amount of capital and land. 6ECON847 INTERNATIONAL TRADE • Note that the extra labour L is shared between agriculture and manufacturing. – Manufacturing hires (L’−L); and agriculture hires the rest, L −(L’−L). • How about Foreign? DIY. ☺ Migration | Short Run (4) • Does migration affect earnings on other factors, capital and land? We use the same measurement for their earnings: Rent on capital: RK = PM • MPKM Rent on land: RT = PA • MPTA • As more labour is hired in each industry (due to lower wage), the marginal products of capital and land both increase. – How about prices of goods? Let’s not worry about them now. Assume them unchanged. • And so do the rentals for capital and land. • Owners of capital and land often support more open borders, which provides them with foreign workers. • How about Foreign? DIY. ☺ 7ECON847 INTERNATIONAL TRADE Migration | Short Run (5) • Does migration affect the industry outputs? • This one is easy. More workers mean more production. • This can be visualised with an expansion of a PPF via increased production capabilities in both industries. • How about Foreign? DYI. ☺ 8ECON847 INTERNATIONAL TRADE Migration | Long Run (1) • Now we turn to the long run using the HO setup, where all factors are mobile across industries. Now recall the followings: – Only consider labour and capital to make things simple. – Shoe production is labour-intensive and computer production is capital-intensive: LS/KS > LC/KC. • Also, assume that the relative price between the two goods do not change to keep things simple. • Again, we analyse Home. – How about Foreign? DIY. ☺ 9ECON847 INTERNATIONAL TRADE Migration | Long Run (2) • In order to analyse the long-run effect of migration, we use a box diagram to keep track of the amount of L and K used in each industry. • Before immigration, Home uses OsL and OsK in shoe industry; and OcL and OcK in computer industry. 10ECON847 INTERNATIONAL TRADE • Note that the line OsA is flatter than the line AOc: the K-L ratio is lower in shoe industry than in computer industry. – This is the same assumption we made on factor intensity. Migration | Long Run (3) • Now let Home receive immigrants: its labour endowment increases by L. – This expands the horizontal axis. • Will the extra labour decrease the relative wage? – Intuitively, it sounds likely, as occurred in the short-run model. 11ECON847 INTERNATIONAL TRADE – That is, the extra labour could be allocated into both industries, which will reduce the MPL and lower the wage. – But this does not need to occur because capital is also mobile, if both industries keep their L-K ratios constant. Migration | Long Run (4) • So let’s keep the L-K ratio constant and see what happens. – Keep the slopes OsA and AOc unchanged, and allocate all L and K into two industries. • Point B will be the new equilibrium: shoe industry expands; and computer industry shrinks. 12ECON847 INTERNATIONAL TRADE • The extra labour is employed in shoe industry. • Some labour and capital move from computer to shoe. Migration | Long Run (5) • What happens to the wage and rental? • Because the L-K ratio is unchanged in both industries, the marginal products of labour and capital are also unchanged. • That is, the wage and rental are also unchanged. • That is, it is possible that immigration does not decrease the wage level. – This result differs from the short-run model. • That is, in the HO model with two goods and two factors, an increase in the amount of a factor found in an economy can be absorbed by changing the outputs of the industries, without any change in the factor prices. This is the factor price insensitivity theorem. 13ECON847 INTERNATIONAL TRADE Migration | Long Run (6) • What happens to the industry outputs? • The PPF shifts with an increase in labour at Home. • Keeping the relative price equal, we can illustrate the change in production point from A to B. – Shoe output rises; computer output falls. 14ECON847 INTERNATIONAL TRADE Migration | Long Run (7) • That is, in the HO model with two goods and two factors, an increase in the amount of a factor found in an economy will increase the output of the industry using that factor intensively and decrease the output of the other industry. This is the Rybczynski theorem. 15ECON847 INTERNATIONAL TRADE – Later we will show that the same theorem holds when capital in the economy grows. International Movement of Capital: FDI • We turn now to look at how capital can move across countries through foreign direct investment (FDI). • FDI occurs when a firm or individual from one country owns 10% or more of a firm in another country. – Building a new plant in a foreign country is called ‘greenfield FDI’. – Buying an existing foreign company is called ‘brownfield FDI’. • We will consider here the effect of greenfield FDI (an increase in capital stock) on the earnings of labour and capital and industry outputs in the receiving country. – It will be very similar to the immigration analysis. 16ECON847 INTERNATIONAL TRADE FDI: Short Run (1) • Let’s start with short run using the specific-sectors model: – Capital is specific to manufacturing. • As capital flows into the country, there is more capital to work with for each worker. So the MPL in manufacturing increases. – This shifts up the manufacturing wage curve. 17ECON847 INTERNATIONAL TRADE • This increases the equilibrium wage in the country. • Labour shifts from agriculture to manufacturing. FDI: Short Run (2) • How does FDI affect rentals of capital and land? • In agriculture, fewer workers work on the same amount of land, which decreases MPTA , and the rental for land. • In manufacturing, there are more workers (which leads to higher MPK) as well as more capital (which leads to lower MPK). That is, this is not helpful. • So, we use a different method. Consider the rental on capital as: the total revenue made in manufacturing minus the payment to labour. • We know that payment to labour increased. • Keeping the manufacturing price constant, the rental on capital should decrease. 18ECON847 INTERNATIONAL TRADE FDI: Short Run (3) • Does FDI affect industry output? • With FDI, the PPF expands but only on the manufacturing side. Why? • Labour has been drawn out of agriculture, which decreases the output in agriculture, and increases the output in manufacturing. 19ECON847 INTERNATIONAL TRADE FDI: Long Run (1) • Now we turn to the long run using the HO setup. – Consider only labour and capital. • Again, we use the box diagram. • FDI expands computer industry; and shrinks shoe industry (i.e. Rybczynski theorem). – The extra capital is employed in computer industry. – Some labour and capital move from shoes to computer. 20ECON847 INTERNATIONAL TRADE FDI: Long Run (2) • What happens to the wage and rental? • Because the L-K ratio is unchanged in both industries, the wage and rental are also unchanged (the factor price insensitivity theorem). 21ECON847 INTERNATIONAL TRADE Overall Gains from Labour and Capital Flows • Foreign investment and immigration are both controversial policy issues. • Most countries impose limits on FDI at some time in their development but later become open. • But, nearly all countries restrict the inflow of people. • Previously, we saw that immigration and FDI can create both gains and losses for different groups in both Home and Foreign. • But, do immigration and FDI provide an overall gain to the world? 22ECON847 INTERNATIONAL TRADE Overall Gains from Immigration (1) • To measure gains from immigration, we use the setup of the specific-factors model. • Consider a world labour market in the diagram. The horizontal axis represents the total world labour stock.