Chapter 5 :

International
factor movement
 Learning objectives

ü Identify the different types of foreign investment and the

welfare effects of capital movements.

ü Explain the motivation for labor migration and its effects

on participating countries.
 International factor mobility is the
movement of the factors of production
across borders

Factor movements include:

Introduction Transfer of capital

Labor migration

Transfer and diffusion of technology

The formation of multinational corporations (MNCs)

 International capital movement
Refers to the outflow and inflow of capital
between countries

Types of foreign investment

Foreign Direct Investment (FDI) Definition

Foreign Portfolio Investment (FPI)

International Private Loans

ODA
 FDI
FDI: a movement of capital that involves ownership and control
è usually taken in the form of multinational corporations (MNCs)

WTO: FDI occurs when an investor based in one country (home country) acquires an
asset in another country (host country) with the intent to manage that asset.

Vu Chi Loc (1997): FDI is a category of international investment that an investor in a

country invest the whole or a substantial part of a project’s capital amount in
another country to control or join in controlling for that project

Vietnam Investment Law 2005: FDI means the bringing of capital into Vietnam in the
form of money or any assets by foreign investors for the purpose of carrying on
investment activities

Inward FDI Outward FDI

Foreign capital invested in our country Capital we invest abroad
Magnitude of FDI flows
 The main FDI players

FDI inflows, top 20

host economies,
2019 and 2020
(Billions of dollars)

The first time

Vietnam has been
listed in the top 20
host countries
 The main FDI players

FDI inflows, top 20

host economies,
2019 and 2020
(Billions of dollars)
Foreign Direct Investment and Multinational Enterprises

Multinational enterprises: firm with production capacity in more than

one country
Ø A vehicle for international borrowing and lending
Ø They provide financing to their foreign subsidiaries

Why is direct foreign investment rather than some other way of

transferring funds chosen?
Ø To allow the formation of multinational organization (extension of control)

Why do firms seek to extend control?

Ø The answer is summarized under the theory of multinational enterprise.
Foreign Direct Investment and Multinational Enterprises

The Theory of Multinational Enterprise

Two elements explain the existence of a multinational

Location motive Internalization motive

A good is produced in two (or more)
different countries rather than one
because of:
§ Resources
§ Transport costs
§ Barriers of trade
A good is produced in different
locations by the same firm rather
than by separate firms because it is
more profitable to carry transactions
on technology and management.
§ Technology transfer
§ Vertical integration
 Types of FDI
According to entry modes:
q Green fields investment
q Merge & Acquisition (M&A)
According to perspectives of investors:
q Horizontal FDI
q Vertical FDI

According to Vietnam Investment Law in 2005

q Wholly owned subsidiary
q Merge & Acquisition (M&A)
q Business Corporate Contract (BTO, BOT, BT)
q Join Venture
 Greenfield investment vs. M&A
Greenfield investment:
a parent company establish new
operation /new production plans
/ subsidiaries in a host country.
è Usually require extended
periods of physical construction
and organization development.
Acquisition: purchase an existing
company or facility
è Physical assets already exist,
shorter time frame.
Merger: two firms join to form a
new, larger company
 Merger vs. Acquisition
MERGER
A B C
The consolidation or
combination of one firm
with another

ACQUISITION
A B A
The purchase of one
firm by another so that
ownership transfers
 L’Oréal Acquisitions

Source: L'Oréal Annual Report 2020

 Horizontal vs Vertical FDI
Horizontal FDI:
FDI in the production of the same or similar kinds of
products abroad (in host country) as in home country.

Vertical FDI:
FDI in an industry abroad that provides inputs into a firm’s
domestic operation
q Upstream Vertical FDI è provides inputs for a firm’s
domestic production processes
q Downstream Vertical FDI è sells the outputs of a firm’s
domestic production processes
 Horizontal FDI
Value Chain Value Chain
INPUT INPUT
Research & Research &
development development
Components Components
Horizontal FDI
Final assembly Final assembly
Marketing Marketing
OUTPUT OUTPUT

Operations in home country Operations in host country

 Vertical FDI
Value Chain Value Chain
INPUT INPUT
Research & Research &
development development
Upstream
Components Components
vertical FDI
Final assembly Final assembly
Downstream
Marketing Marketing
vertical FDI
OUTPUT OUTPUT

Operations in home country Operations in host country

 Wholly Owned Subsidiary

A firm (parent company) operates a busniess overseas and retain

100% ownership - we often call: 100% foreign invested company

It does not share It contributes all It assumes all

the organization the assets the risk
with another firm
 Joint Venture

A joint venture entails establishing a firm that is

jointly owned by 2 or more independent firms.

Each party Each party owns Each party

contributes a portion of the shares risk or
resources to the organization failure
organization
Potential Benefits of FDI to Host Country

Increased output
Increased wages
Increased employment
Increased exports
Increased tax revenues
Realization of economies of scale
Import of technical and managerial skills
Weakening power of domestic monopoly
 Potential Costs of FDI to Host Country
§ Adverse impact in the country’s commodity terms of trade
§ Transfer pricing
§ Decrease in domestic savings
§ Decrease in domestic investment
§ Instability in the balance of payments
§ Loss of control over domestic policy
§ Increase in Unemployment
§ Establishment of Local Monopoly
§ Inadequate attention to the development of local education and skills
§ Loss of natural resources
 Foreign Portfolio Investment (FPI)

IMF: FPI is the category of international investment that covers

investment in equity and debt securities, excluding any such instruments
that are classified as direct investment or reserve assets

Vu Chi Loc (1997): Foreign portfolio investment is the category of

international investment that an investor in one country buy securities of
enterprises in another country equal to or below a certain threshold to gain
profit but not control those security issuers
 Foreign Portfolio Investment (FPI)
FPI is not made with the aim of gaining a significant degree of
influence over the invested enterprise, but only with the
expectation of a higher return in the form of dividends or price
differentials èNo voice in management

Stock investors are usually financial institutions, institutional

investors, and individual investors.

Less stable, no technology transfer

 FDI vs. FPI
FDI FPI
Investor has significant
Investor does not have
Control and degree of control and
direct control/
management influence on the foreign
management of investment
management

Real assets (land, factories, Financial assets (shares,

Invest in
machines, knowledge..) bonds,..)

Term Long term Short and long term

Capital
Minimum Maximum
requirement
FDI vs. FPI
 “ is a form of international investment
in which an investor in one country
lends money to an investment
recipient in another country and
International earns profit via interest.

Private Loans
The currency can be
the currency of the host country,
or a convertible foreign currency
”
Government aid that promotes
and specifically targets the
economic development and
Official
welfare of developing countries Development
Assistance
(ODA)

Provided by official
agencies, including state
& local government, or by
their executives agencies
 Forms of ODA

financial resources are provided to

Grants developing countries free of interest
and with no provision for repayment

have to be repaid with interest,

Soft loans albeit at a significantly lower rate
than if developing countries
borrowed from commercial banks
 Concessional elements of ODA

1. Interest rate(%)

2. Grace period (i.e. the interval from commitment date to the

date of the first payment of amortisation)

3. Maturity (i.e. the interval from commitment date to the date of

the last payment of amortisation)

4. Concessional financial terms (having a grant element of at

least 25%)
Motives for International Movement of Capital
To secure To take Risk
access to raw advantage of diversification
materials low wages

01 02 03 04 05 06 07
To access To avoid Defensive MNC
growing tariffs and purposes to efficiency
markets NTBs prevent loss of over local
market share suppliers

All imply the seeking of higher rate of return

 Theory related to
international capital movements

Product Hymer’s Eclectic

life cycle market power approach of
theory approach Dunning
 Analytical effects of
international capital movements

• Value of Marginal product of Assume that:

capital (VMPK): an addition to Only 2 countries in the world
output that resullt from adding 1 Country 1
more unit of capital to production ª insufficient capital
ª attractive investment
(when all other inputs are held
opportunities
constant)
• MPK schedule: represents the Country 2
ª abundant capital
demand schedule for capital
ª poor investment
inputs opportunities
 Marginal product of capital
Marginal Product of capital (MPK)

GDP
MPK
K1 Capital (K)
 Capital Market Equilibrium
r B
output in country 1
output in country 2 r*
COUNTRY 1

COUNTRY 2
A C
r1
E
D
VMPK2 r1*
VMPK1
O k1 O'
Economic Effects of International Capital Flows On Incomes

r If capital can flow freely across international borders,

B k2k1 units of capital will flow from Country 2 to 1
because r1 > r1*. Eventually, r will fall in Country 1 and r*
rise in Country 2 until r = r2 = r2* in both countries.
COUNTRY 1

COUNTRY 2
C
A
r1
E
r2 r2*
D
r1*
VMPK2
VMPK1
O k1 k2 O'
Economic Effects of International Capital Flows On Incomes

r
B v After capital movement
+ output in country1 r*
output in country 2
COUNTRY 1

COUNTRY 2
A C
r1
F E
r2 r2*
D
r1*
VMPK2
VMPK1

O k1 k2 O'
Economic Effects of International Capital Flows On Incomes

r
B
r*
Overall, world output increases
COUNTRY 1

COUNTRY 2
C
A
r1
F E
r2 r2*
D
r1*
VMPK2
VMPK1

O k1 k2 O'
Economic Effects of International Capital Flows On Incomes

Total output (GDP) rises in Country 1,

There is a rise in
BUT:
both GDP and GNI
§ Income of owners of capital in
Country 1 falls, as interest rate falls of Country 1

§ Income of workers increases

Economic Effects of International Capital Flows On Incomes

r
B
Gain by labours in Country 1 r*
COUNTRY 1

COUNTRY 2
A C
r1
F E
r2 r2*
D
r1*
VMPK2
VMPK1
O k1 k2 O'
Economic Effects of International Capital Flows On Incomes

r
B
Loss by Capitalists in Country 1 r*
COUNTRY 1

COUNTRY 2
C
A
r1
F E
r2 r2*
D
r1*
VMPK2
VMPK1
O k1 k2 O'
Economic Effects of International Capital Flows On Incomes

r
B r*
Net income gain in Country 1
COUNTRY 1

COUNTRY 2
A
r1
F E
r2 r2*
D
r1*
VMPK2
VMPK1
O O'
k1 k2
Economic Effects of International Capital Flows On Incomes

r
B
r*
Loss by labours in Country 2
COUNTRY 1

COUNTRY 2
C
A
r1
F E
r2 r2*
D
r1*
VMPK2
VMPK1
O k1 k2 O'
Economic Effects of International Capital Flows On Incomes

In country 2,
Total output (GDP) decreases in Country 2,
GDP decreases
BUT:
whereas
§ Income of owners of capital in Country
2 rises, as interest rate rises GNP increases

§ Income of workers falls

Economic Effects of International Capital Flows On Incomes

r
B
r*
Gain by Capitalists in Country 2
COUNTRY 1

COUNTRY 2
C
A
r1
F E
r2 r2*
D
r1*
VMPK2
VMPK1
O k1 k2 O'
Economic Effects of International Capital Flows On Incomes

r
B
Net income gain in Country 2 r*
COUNTRY 1

COUNTRY 2
A C
r1
F E
r2 r2*
D
r1*
VMPK2
VMPK1
O k1 k2 O'
 International Capital Flows: A Summary

ü Both countries’ incomes (GNP) rise as a result of capital flows.

ü World output rises.
ü Capitalists in host country (Country 1) and
Workers in home country (Country 2) are injured.
ü Capitalists in host country (Country 2) and
Workers in home country (Country 1) are better off.
International Labour Movement
 International Labour Movement
WHY
MIGRATE?
Definition:
Mobility of highly
skilled labour or Country Country
migration between A B
countries
Why migrate?
motive for emigration from
Push the country of origin
factors • Poverty, riot,
unemployment, etc.

motive for emigration towards

the country of destination
• Higher wage, income,
Pull
higher standard of life
factors • Entrepreneurship/
managerial skills
 The Marginal Product of Labor

Marginal Product of labor (MPL)

Rents
Real
wage
Wages
MPL
Labor (L)
 Analytical effects of
international labour movements
• Value of Marginal product of Assume that:
labour (VMPL): a addition to Only 2 countries in the world
output that result from
adding 1 more unit of labor to Country 1
ª abundant labour forces
production (when all other ª low wage rate
inputs are held constant)
• MPL schedule: represents Country 2
ª lack of labour forces
the demand schedule for ª high wage rate
labor inputs
 Economic Effects of Labor Migration
B output in country 1 C
output in country 2
Income of
COUNTRY 1

capitalists

COUNTRY 2
w1*
Income of
capitalists

w1 Income of
labours
Income of MPL2 MPL1
labours
O L1 O'
 Economic Effects of Labor Migration

B If migration is possible, L2L1 workers will

C
move to Country 2 until the wage will be
the same in both countries: w2 = w2’
COUNTRY 1

COUNTRY 2
w1*
E R
w2 w2*

w1 G
I
MPL2 MPL1

O L2 L1 O'
 Economic Effects of Labor Migration
B In Country 1: GDP falls due to out-migration C

GDP loss
COUNTRY 1

COUNTRY 2
Capitalists’
w1*
income E R
w2 w2*

w1 G
Workers’ MPL2 I
MPL1
income

O L2 L1 O'
 Economic Effects of Labor Migration

GDP falls in Country 1 (out-migration

country), BUT:
Capitalists are hurt;
§ Wages rise for remaining workers.
§ It can be shown that the decrease in Workers are better off
the Country 1 labor force is greater
than the decrease in GDP, so per
capita income rises.
 Economic Effects of Labor Migration

B C
In Country 2: GDP increases
COUNTRY 1

COUNTRY 2
M Capitalists’
income w1*
E R
w2 w2*

w1 G
I Workers’
MPL2 MPL1 income

O L2 L1 O'
 Economic Effects of Labor Migration

GDP rises in Country 2 (in-migration

country), BUT:
Labor is worse off;
§ Wages fall.
§ It can be shown that the increase Capitalists are better off.

in Country 2 labor force is greater

than the increase in GDP, so per
capita income falls.
 Economic Effects of Labor Migration

B C
World income overall increases
COUNTRY 1

COUNTRY 2
M
w1*
E R
w2 w2*

w1 G
I
MPL2 MPL1

O L2 L1 O'
 International Migration: Other issues
v Migrants now in Country 2 may send remittances back to Country 1

• Country 1’ s per capita income rises by even more, and

• Country 2 ‘ s per capita income falls by even more.

v If the migrants are “guest workers” and they can be paid a lower

wage, it may be possible for capitalists in Country 2 to be better off

without domestic labor being worse off.
International Migration: Other issues

Impact of
migrants wage
discrimination
 International Migration: Other issues

v If the immigrants are low-skill workers,

the host country may experience rising
social costs.

v If the immigrants are high-skill workers,

the host country may benefit, and the
migrants’ home countries may suffer. This
is called the “brain drain”.