International Economics

International Economics Li Yumei Economics & Management School of Southwest University

International Economics Chapter 12 International Resource Movements and Multinational Corporations

Organization • 12.1 Introduction • 12.2 Some Data on International Capital Flows • 12.3 Motives for International Capital Flows • 12.4 Welfare Effects of International Capital Flows • 12.5 Multinational Corporations • 12.6 Motives for and Welfare Effects of International Labor Migration • Chapter Summary • Exercises

12.1 Introduction • Main Contents • Up to now, the international trade only involves with the commodity trade; In this chapter, the international trade involves with the international resource movement; The international trade and movements of productive resources can be regarded as substitutes for one another • This chapter examines the motives and effects (costs and benefits) of international movement of productive resources • Multinational Corporations (important vehicle of international movements of productive factors)

12.1 Introduction • Main Types of Foreign Investments • Portfolio Investments Portfolio investments are purely financial assets, such as bonds, denominated in a national currency • Direct Investments Direct investments are real investments in factories, capital goods, land, and inventories where both capital and management are involved and the investor retains control over use of the invested capital

12.2 Some Data on International Capital Flows • US Data on International Capital Flows • Table 12.1 (page 397) It shows that both the stock of US direct investments abroad and foreign direct investments in the United States also increased very rapidly from 1950 to 2001 and were similar in amount at the end of 2001 when measured at market value • Table 12.2 (page 398) It shows that from 1950 to 2001, the stock of US direct investments in Europe grew much more rapidly than the stock of US direct investments in Canada and Latin America

12.2 Some Data on International Capital Flows • Table 12.3 (page 398) It shows that direct investments in manufacturing, finance, and other categories grew much more rapidly than direct investments in petroleum since 1985 • Table 12.4 (page 399) It shows the yearly inflows of foreign direct investments into US from 1980-2001

Capital Inflows into US and US Interest Rates

12.3 Motives for International Capital Flows • Motives for International Portfolio Investments • Motives for Direct Foreign Investments • Conclusion

Motives for International Portfolio Investments • Higher Returns Abroad • Two-way International Capital Investors are not only interested in the rate of return but also in the risk associated with a particular investment • Portfolio Theory It tells that by investing in securities with yields that are inversely related over time, a given yield can be obtained at a smaller risk or a higher risk yields can be obtained for the same level of risk for the portfolio as a whole. • Risk Diversification It explains the two-way international portfolio investments (different countries)

Motives for Direct Foreign Investments • Motives • To Obtain the Higher Returns Higher growth rate, favorable tax treatment, greater availability of infrastructures • To diversify Risks Export, foreign production or sales facilities • Reasons • Unique production knowledge or managed skill to retain the direct control in foreign countries (horizontal integration) • The control of a needed raw material to ensure an uninterrupted supply at the lowest possible costs (vertical integration)

Motives for Direct Foreign Investments • To avoid tariffs and other restrictions • Two-way direct investments • It can be explained by some industries being more advanced in one nation, while other industries are more efficient in other nations • Regional distribution of foreign direct investments around the world also seems to depend on geographical proximity or established trade relations Case Study 12-2 (page 403)

12.4 Welfare Effects of International Capital Flows • Effects on the Investing and Host Countries • Other Effects on the Investing and Host Countries • Conclusion

Conclusion The basic motives for international portfolio investments are yield maximization and risk diversification. The latter is also required two-way capital movements. Direct foreign investment require additional explanations. These are : • To exploit abroad some unique production knowledge or managerial skill (horizontal integration) • To gain control over a foreign source of a needed raw material or a foreign marketing outlet (vertical integration) • To avoid import tariffs and other trade restrictions or take advantage of production subsidies • To enter a foreign oligopolistic market • To acquire a foreign firm in order to avoid future competition • The unique ability of obtain financing

Effects on the Investing and Host Countries • Figure 12.1 (page 404) • World of two nations, the world total capital OO’, OA belongs to nation 1’s capital, O’A belongs to nations 2’s capital • Value of the marginal production of capital (VMPK) represents the return, or yield on capital • In isolation, nation 1’s capital return is OC (total production OFGA) with the total investment of capital OA; nation 2’s capital return is O’H (total production O’JMA). Nation 2’ capital return is higher than nation 1’s • Under free international capital movements, AB capital flows from nation 1 to nation 2 so as to equalize at BE (ON=O’T)

FIGURE 12-1 Output and Welfare Effects of International Capital Transfers.

Effects on the Investing and Host Countries • Conclusion International capital flows increase the efficiency in the allocation of resources internationally and increase world output (GEM=GRE + REM) and welfare (nation 1 higher return GRE while nation 2 higher return ERM)

Other Effects on the Investing and Host Countries • Redistribution of domestic income from labor to capital • The effect of payments of the investing and host countries • The initial capital transfer and increased expenditures abroad of the investing country are likely to be mitigated by increased exports of capital goods, spare parts, and other products of the investing country • Different rates taxation and foreign earnings in investing and host countries • The effect of the trade volume and terms of trade in both investing and host countries

Conclusion International capital transfers increase the national income of both the investing and host countries, but in the investing nation the relative share going to capital rises and the share going to labor falls, while the opposite occurs in the host or receiving nation. Thus, the level of employment tends to fall in the investing nation and rise in the host nation. In the short run, the balance of payments tends to worsen in the investing nation and improve in the host nation. In the long run, the balance-of- payments effects of foreign investments on the investing and host nations are less clear-cut. Nations with high corporate tax rates encourage investments abroad and thereby lose tax revenues. The terms of trade are also likely to be affected by foreign investments

12.5 Multinational Corporations • Reasons for the Existence of Multinational Corporations • Problems Created by Multinational Corporations in the Home Country • Problems Created by Multinational Corporations in the Host Country • Conclusion

Reasons for the Existence of Multinational Corporations • Multinational Corporations (MNCs) • These are firms that own, control or manage production facilities in several countries. • Intra-firm trade: trade among the parent firm and its foreign affiliates • Most international direct investment are undertaken by MNCs

Reasons for the Existence of Multinational Corporations • Reasons for MNCs Existence • The competitive advantage of a global network of production and distribution • Economies of scale in production, financing, R&D • Higher returns (differentiated products, technological gap, product cycle models) • Much better position to control or change to their advantage the environment in which they operate than are purely national firms • Transfer pricing (by artificially overpricing components shipped to an affiliate in a higher tax nation and under-pricing products shipped from the affiliate in the high-tax nation, an MNC can minimize its tax bill

Problems Created by Multinational Corporations in the Home Country • The loss of domestic jobs ( unskilled and semiskilled production jobs) • The loss of technological superiority • The erosion of domestic tax system • To circumvent domestic monetary policies and make government control over the economy more difficult

Problems Created by Multinational Corporations in the Host Country • To dominate the economy • To siphon off of R&D funds to the home nation • To absorb local savings and entrepreneurial talent • To extract most of the benefits resulting from their investments, either through tax and tariff benefits or through tax avoidance • Developing countries’ complaints: Low prices paid to the host countries, inappropriate techniques, lack of training local labor, overexploitation of natural resources, creating highly dualistic “enclave” economies

Conclusion Multinational corporations have grown to be the most prominent form of private international economic organization today. The basic reason for their existence is the competitive advantage of a global network of production and distribution. Some of the alleged problems created by multinational corporations in the home country are the export of domestic jobs, erosion of the home nation’s technological advantage, avoidance of domestic taxes through transfer pricing, and reduced

Conclusion government control over the domestic economy. On the other hand, host countries complain of loss of sovereignty and domestic research activity, tax avoidance, inappropriate technology, and most benefits flowing to the home nation. As a result, most host nations have adopted policies to reduce these alleged harmful effects and increase the possible benefits

12.6 Motives for and Welfare Effects of International Labor Migration • Motives for International Labor Migration • Welfare Effects of International Labor Migration • Other Welfare Effects of International Labor Migration • Conclusion

Motives for International Labor Migration • Economic Reasons In the nineteenth century and earlier in Europe, labor migration due to the desire to escape political/ and religious Oppression. Since the end of World War, labor migration due to higher real wages and income abroad • Non-economic Reasons The decision to migrate can be analyzed in the same manner and with the same tools as any other investment decision (costs and benefits). Here the labor migration refers to unskilled workers

Motives for International Labor Migration • Costs: expenditures for transportation and the loss of wage for relocating and searching for a job in the new nation, many other quantifiable costs (new customs, language, risk to find the new job, housing) • Benefits: it can be measured by the higher real wages and income that the migrant worker can earn abroad during their remaining working life, over and above what they have earned at home; benefits for their children (such as education or opportunity for work)

Welfare Effects of International Labor Migration • Figure 12.2 • World of two nations, the world total labor OO’, OA belongs to nation 1’s labor, O’A belongs to nations 2’s labor • Value of the marginal product of labor (VMPL) represents the real wages of labor • In isolation, nation 1’s wages rate is OC (total product OFGA) with the total input of labor OA; nation 2’s wage rate is O’H (total product O’JMA). Nation 2’ wage rate is higher than nation 1’s • Under free international labor movements, AB labor flows from nation 1 to nation 2 so as to equalize at BE (ON=O’T)

FIGURE 12-2 Output and Welfare Effects of International Labor Migration.

Welfare Effects of International Labor Migration • Conclusion • The wages rise in nation 1 while fall in nation 2 • Total product falls from OFGA to OFEB in nation 1 and rises from O’JMA to O’JEB, a net gain for the world output is GEM • There is a redistribution of national income toward labor in nation 1 and toward non-labor resources in nation 2. • Nation 1 mAy also receive some remittances from its migrant workers • If AB had been unemployed in nation 1 before migration, the wage rate would have been ON and the total product OFEB in nation 1 with and without migration, and the net increase in world output with migration would have been ABEM (all accruing to nation 2)

Other Welfare Effects of International Labor Migration • The welfare effects of the migration of a highly skilled worker on the nations of emigration and immigration— Brain Drain(人才流失) Highly skilled personnel (scientists, technicians, doctors and nurses) have moved from developing to developed nations, or from Europe to US since 1950s and 1960s • Illegal migration Due to the high unemployment rates in developed countries, there is a strict limitation of migration • Immigration Law and Reform Case Study 12-5 (page 416)

Conclusion • International labor migration can occur for economic and non-economic reasons. When the decision to migrate is economic, it can be evaluated in terms of costs and benefits just as any other investment in human and physical capital • International migration reduces total output and increases real wages in the nation of emigration while it increases total output and reduces real wages in the nation of immigration

Conclusion • These changes are accompanied by a net increase in world output • The migration of highly skilled and trained people confers special benefits on the nation of immigration and impose serious burdens, in the form of sunk and replacement costs, on the nation of emigration. This problem is referred to as the brain drain

Chapter Summary • This chapter studies the international movement of resources, such as capital and labor • The international movement of resources can increase the world output and world welfare • The international movement of resources have different effects between flowing out nations and flowing in nations

Exercises Discussion Problems: Page 421 to 422 from 1 to 14 questions

Exercises Additional Reading For an overview of international resource movements, see: • R. Mundell, “International Trade and Factor Mobility,” American Economic Review, June 1957, pp.321-335 • “International Factor Mobility: A Symposium,” Journal of International Economics, May 1983 The classic article on the welfare effects of foreign investments is: • G.D.A.MacDougall, “The Benefits and Costs of Private Investment from Abroad: A Theoretical Approach,” Economic Record, March 1960, pp.13-35

Internet Materials • http://www.unctad.org/en/docs/wir99ove.pdf • http://www.oecd.org • http://bea.doc.gov/bea/di1.htm • http://www.ins.usdoj.gov/graphics/aboutins/statistics/index.htm

International Economics