INTERNATIONAL TRADE AND AGREEMENTS

Topic 7: International Factor Movements

 INTERNATIONAL TRADE AND AGREEMENTS

Topic 7

INTERNATIONAL FACTOR MOVEMENTS

A. OVERVIEW
This chapter is anchored on another integration called international factor
movements, or the transfer of factors across countries. It covers labor mobility, transfer of
capital through international borrowing and lending, as well as formation of linkages
through multinational enterprises.

B. OBJECTIVES
1. Be knowledgeable about the main concept of international factor movements.
2. Demonstrate understanding of the implication of the topic.

C. LEARNING OBJECTIVES

Through the course of this topic, the learners shall be able to demonstrate
knowledge of the main concept of international factors movements and to apply it to the
context of international trade and agreement.

D. INSTRUCTIONS
1. Kindly read and comprehend this topic, Topic VII: International Factor Movements.
2. Kindly prepare the Assignment. The deadline for submission is on or before November
14, 2022, 12:00NN. Kindly send your output to the Classwork Tab by attaching your
file on “Your Work” located on the upper right of the screen.
File Name: ITA_Topic I Output_Course-Year & Block_Surname, First Name,
Middle Initial (ITA_Topic 7 Output_BS Economics III_Desuyo, Shiela B.)
3. Should you have any questions or concerns, do not hesitate to message me on the
aforementioned e-mail address.
4. Enjoy your own pace, ‘cause learning is never a race. I understand that you are walking
on a rough patch during these hard and trying times. Do not forget to pause, breathe,
and carry on! You got this! ☺
 INTERNATIONAL TRADE AND AGREEMENTS

E. DISCUSSION

International Labor Mobility

Nowadays, almost every country imposes restrictions on immigration. Therefore, labor
mobility is less dominant than capital mobility. However, between the two, the former is easier
to analyze.

One-Good Model without Factor Mobility

How output depends on the supply of one factor

of production, holding the quantity of the other
factor fixed is shown by the production
function. Figure 1 shows how a country's output
varies as its employment of labor is varied,
holding fixed the supply of land.

The slope of the production function measures

the increase in output that would be gained by
using a little more labor, referred to as the
marginal product of labor (MPL). As the ratio
of labor to land rises, MPL is assumed to fall.
Figure 1. A country’s production function

As long as the economy is perfectly competitive, the

real wage earned by each unit of labor is equal to
labor's marginal product. The area under the marginal
product curve represents he total output of the
economy. Of that total output, wages earned by
workers equal the real wage rate times the
employment of labor, and hence equal the indicated
area on the figure. The remainder, also shown, equals
rents earned by landowners.

The marginal product of labor declines with

employment. The area under the marginal product
curve equals total output. Given the level of
employment, the marginal product determines the real
wage; thus the total payment to labor (the real wage
times the number of employees) is shown by the Figure 2. The Marginal Product of Labor
rectangle in the figure. The rest of output consists of land rents.

Assume that country A and country B have the same technology but different overall land:labor
ratios. If country A is the labor-abundant country, workers in country A will earn less than those
in country B, while land in country A earns more than in country B. This obviously creates an
 INTERNATIONAL TRADE AND AGREEMENTS

incentive for factors of production to move. Country A workers would like to move to country B;
Country B landowners would also like to move their land to country A, but we are supposing that
this is impossible. Our next step is to allow workers to move and see what happens.

International Labor Movement

Suppose that the workers are mobile across countries. Workers will move from country A
to country B. This movement will reduce country A’s labor force and thus raise the real wage in
country A, while increasing the labor force and reducing the real wage in country B. If there are
no barriers to labor movement, the same process continues until both countries have the same
marginal product of labor.

Three points should be noted about this redistribution of the world's labor force:

1. It leads to a convergence of real wage rates. Real wages rise in country A, fall in
country B.
2. It increases the world's output as a whole. Country B's output rises by the area under
its marginal product curve, while country A's falls by the corresponding area under its
marginal product curve.
3. Despite this gain, some people are hurt by the change. Those who would originally
have worked in country A receive higher real wages, but those who would originally
have worked in country B receive lower real wages. Landowners in country B benefit
from the larger labor supply, but landowners in country A are made worse off. As in
the case of thegains from international trade, then, international labor mobility, while
allowing everyoneto be made better off in principle, leaves some groups worse off in
practice.

International Borrowing and Lending

When we speak of international labor mobility, workers are physically mobile across countries.
However, international capital movement is not as easy as that. If, for example we speak of the
capital flows from the Japan to the Philippines, it does not mean that the machineries of Japan are
disassembled and shipped to the latter. Rather, what is referred to as the capital flows are the
financial transactions. These are:
1. A Japanese bank lends to a Philippine firm;
2. Japanese residents buy stock in the Philippines; or
3. Japanese firm invests through its Philippine subsidiary.
Let us give more emphasis to the first transaction wherein Japanese residents make loans to
Filipinos; In other words, the Japanese grant the Filipinos the right to spend more than they
earn today, given that a promise to pay in the future is made.
International borrowing and lending are forms of international trade, actually. It is not an
exchange of good for another at one particular time, but exchange of goods today for goods in
the future. This trade is called intertemporal trade.
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Intertemporal Production Possibilities and Trade

Any economy faces a trade-off between consumption both in the present and in the future.
Economies do not consume all of its output at once, but invest them. The more investment
undertaken in the present will yield a higher output in the future. However, to invest more, an
economy consumes less. Thus, a trade-off between present and future consumption is observed.

Hypothetically, there is an economy that consumes only one good, and this economy exits
only in 2 periods, the present and the future. Thus, there is trade-off between the productions of 2
periods. It can be presented through an intertemporal production possibility frontier as shown
in figure 3.

The shape of the intertemporal

production possibility frontier will differ
among countries. Some countries have
production possibilities that are biased
toward present output (country A), while
others are biased toward future output
(country B). In the absence of international
borrowing and lending, the relative price of
future consumption is higher in A than in B,
and thus if we open the possibility of trade
over time, country A will export present
consumption and import future
consumption.

Figure 3. Intertemporal Production Possibility Frontier

The Real Interest Rate

When a country borrows, it gets the right to spend or purchase at the present in return for
repayment in larger quantity in the future. It is computed as:

(1 + r) * Quantity borrowed in the present

Where:
r- real interest rate on borrowing

Since the trade-off is one unit of consumption in present for (1 + r) units in future, the
relative price of future consumption is 1/(1 + r). If borrowing and lending are allowed, the world
relative supply and demand for future consumption will determine the relative price of future
consumption and the world real interest rate. Country A, whose intertemporal production
possibilities are biased toward present consumption, will export present consumption and import
 INTERNATIONAL TRADE AND AGREEMENTS

future consumption. That is, country A will lend to country B in the present and receive repayment
in the future.

Direct Foreign Investment and Multinational Firms

Direct foreign investment are international capital flows in which a firm in one country
creates or expands a subsidiary in another. It does not only involve the transfer of resources, but
also the acquisition of control. This means that the subsidiary does not only have a financial
obligation to the parent company, but it is part of the same organizational structure. When is a
corporation considered as multinational? In the United States, if 10% or more of the stock of a
company is held by a foreign country, then it is a subsidiary of a foreign-based multinational. Also,
if it has a controlling share of companies abroad. Logic is that 10% is enough to have such effective
control. Direct foreign investments actually allow the formation of multinational organizations.

The Theory of Multinational Enterprise

Why is a good produced in two different countries rather than one? It is a question of
location. Why is production in different locations done by the same firm, rather than different
ones? That is a question of internationalization.

The location of production is often determined by resources. Alternatively, transport costs

and other barriers to trade may determine location. The factors that determine a multinational
corporation's decisions about where to produce are probably not much different from those that
determine the pattern of trade in general.

The theory of internalization is another matter. The output of one subsidiary is often an
input into the production of another, or technology developed in one country may be used in others,
or management may usefully coordinate the activities of plants in several countries. These
transactions tie the multinational firm together, and the firm presumably exists to facilitate these
transactions. Multinationals exist because it turns out to be more profitable to carry out these
transactions within a firm rather than between firms. This is why the motive for multinationals is
referred to as "internalization." There are advantages of internationalization for technology transfer
and vertical integration. The former explains that problems may be reduced if a firm, instead of
selling technology, sets about capturing the returns from the technology in other countries by
setting up foreign subsidiaries. On the other hand, the latter states that if firms are combined into
single “vertically integrated” firms, problems will also be reduced.

F. ASSIGNMENT
Identify two countries that display international capital movement. Indicate how,
why, how much and when was the factor movement made. You may present it through a
diagram.
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G. REFERENCES

Dixit and Norman. (1980). Theory of International Trade. Cambridge: Cambridge

University Press

Krugman, Paul R. (2003). International Economics Theory and Policy, 6th Edition. 75
Arlington St., Suite 300, Boston, MA 02116: Pearson Education, Inc.

Mankiw, N. (2012). Principles of Economic. Pasig City: Cengage Learning Asia Pte Ltd.
Philippine Branch.