Feenstra Taylor Econ CH05

5
1
MOVEMENT OF LABOR Movement of Labor
AND CAPITAL BETWEEN Between Countries
2
COUNTRIES Movement of
Capital between
Countries
3
Gains from Labor
and Capital Flows
4
Conclusions
Introduction
From May to September 1980, boatloads of

refugees from Cuba arrived in Miami.
This would lead you to believe that these less-

skilled workers would drive down wages.
However, this immigration does not appear to

have pulled down the wages of other less-skilled
workers in Miami.
Explaining this effect is one goal of this chapter.
2008 Worth Publishers International Economics Feenstra/Taylor 2 of 114

Introduction
A similar situation occurred with the 1989

emigration of Russian Jews to Israel.
The immigrants were more highly skilled than the
existing Israeli population.
However, the relative wages of high-skilled workers in
Israel actually rose during the 1990s.
In other large scale immigrations, the wages of
domestic workers did fall.
Compare the predictions of short-run (specific

factors) and long-run (Heckscher-Ohlin) models.

Introduction
Then we will consider the effects of movement of

capital.
Foreign Direct Investment (FDI) occurs when a

company from one country owns a company in
another country.
Finally, we will discuss the gains to the host and

destination countries, and to the world, from the
movement of labor and capital.

Movement of Labor Between Countries
Migration is the movement of labor from the

Foreign country to the Home country.
The wages paid to labor and the rentals paid to
capital and land are determined by the prices of
goods purchased.
Prices of goods are determined by the world
market for those goods.
If prices of goods are fixed, how do the Home
wage and rentals paid change as labor moves
between countries?

Effects of immigration in the Short Run Specific-

Factors Model:
In the short run, only labor is mobile across industries.
Remember the resource equation: L = LM + LA
Determining the Wage

Assume the Foreign equilibrium wage, W*, is lower
than Home equilibrium wage, W.
Workers will migrate from Foreign to Home.

Figure 5.1 Home Labor Market

Effect of Immigration on the Wage in Home
We add the L to figure 5.1,
The PAMPLA shifts right by L.
The origin for manufacturing has not changed so PMMPLM
does not change.
Effect of Immigration on the Wage in Home

The new equilibrium Home wage is at B, at a lower wage.
The extra workers are shared between both industries since
both industries have more workers, but fixed amounts of
capital and land.
The wage declines due to the diminishing marginal product of
labor.

The marginal
Immigration
product oftotal
increases
laborby
labor curve
L,
Figure shifts right
shifting the origin
5.2 to 0A L
also by
Labor has
increased and
wages have
decreased at new
equilibrium, B

Immigration to the New World
APPLICATION
Between 1870 and 1913, 30 million Europeans
left their homes in the Old World to emigrate to
the New World.
The U.S. population increased by 17%.
The New World had higher real wages
In 1870, real wages in the New World were nearly 3
times higher than in Europe.
Over time capital accumulated, so real wages in
both locations grew, but at a slower rate in the
New World.

Immigration to the New World
APPLICATION Figure 5.3

Immigration to the US and Europe Today
APPLICATION
These days, we see migration from developing countries
to wealthier ones.
In many cases, the immigration includes a mix of low-skilled
workers and high-skilled workers.
In the U.S. much of the recent debate focused on the

issue of illegal immigration.
There are about 12 million illegal immigrants in the U.S.
This often obscures the fact that the majority of immigrants are
legal.
The combination of legal and illegal immigrants in the U.S.

creates a U-shaped pattern between the number of
immigrants and their educational level.

APPLICATION Figure 5.4

APPLICATION
Illegal immigrants into the U.S. compete primarily with the
lowest-educated workers.
Legal immigrants compete with workers at the highest
educational levels.
Under the specific factors model, the greatest impact on
labor will be for the lowest and highest educated U.S.
workers.
This is supported by the data.
The negative impact of immigration on wages is fairly
modest for most workers and is offset with capital moves
between industries as discussed later.

EUs New Tack on Immigration
HEADLINES
A new EU-wide green card would allow skilled workers already
in the 25-nation bloc to change countries without extra
paperwork.
Europe's work force is expected to shrink by 20 million between
now and 2040.
Businesses complain regularly about a shortage of highly skilled
personnel.
EU commissioner Franco Frattini has a vision:
A North African engineer could go to work in Europe, earn good
money, and return regularly to his hometown to start and maintain
a business.
Mr. Frattini uses the term brain circulation instead of the
accusatory term brain drain.
Other Effects of Immigration in the Short Run

U.S. and Europe have both welcomed foreign workers
in specific industries: agriculture and high-tech.
Why do they do so if those foreign workers compete
with domestic workers in those industries.
Answer: Immigration increases rental rates on capital
and land.
Rentals on Capital and Land

Given this, it should not be surprising that owners of
capital and land often support more open borders.
Need to consider the political economy of
immigration: lobby groups.
Effect of Immigration on Industry Output

We showed before that immigration led to an increased
labor force in each industry.
With more workers and the same amount of capital and
land, output rises in both industries.
Immigration leads to an outward shift in the PPF.
This result depends on the short-run nature of the
specific factors model.
If land and capital are not fixed, as in the long run, one
industry's output will rise while the other will fall.
Figure 5.5
Immigration causes an increase in

home labor which shifts out the
PPF, increasing production from A
to B,

Effects of Immigration in the Long Run
In the long run, all factors are free to move between
industries.
We now use the Heckscher-Ohlin model from before,
except that labor can move between countries.
Total capital: K = KA + KM earning rental R.

Total labor: L = LA + LM earning wage W.
Computers are capital intensive and shoes are labor

intensive.
As before: LS/KS > LC/KC and KC/LC > KS/LS
How is equilibrium affected by the inflow of labor into Home

due to migration?
Figure 5.6

Box Diagram
Figure 5.7 shows a new box diagram to help us answer
our question.
Length is total amount of labor at Home, L.
The vertical axes measure the total amount of capital,
K, at home, in each industry.
OSA shows the amount of labor and capital used in
shoes and OCA in computers.
The capital-labor ratio in each industry is the slope of
the respective industry line.
OSA is flatter, so capital-labor ratio in shoes is less than in
computers.

Labor allocated to computers
Figure 5.7 LC
L 0C
KC
Total Amount Capital

of Capital in allocated to
the Economy computers
A K
Capital
allocated to
shoes
KS
0S LS L
Labor allocated to shoes
Total Amount of Labor in the Economy

Determination of the Real Wage and Real Rental

Remember: W = P*MPL and R=MPK
If there is a higher capital-labor ratio, then MPL is higher
and MPK is lower.
Because each line in the box diagram is a particular
capital-labor ratio, it is also a particular wage and rental
rate.
Increase in the Amount of Home Labor

Immigration leads to increase in the amount of Home
labor to L = L + L.
Instead of allocating the extra labor to both industries,
we allocate it all to shoesthe labor intensive industry.

Increase in the Amount of Home Labor

Because both labor and capital increase in shoes, the
capital-labor ratio is unchanged.
Notice the slopes of the lines have not changed.
Since the capital-labor ratios are unchanged, so are the

marginal products.
Therefore the wages and rentals are unchanged.
When capital can move freely between industries,

immigration in the long run has no impact on the wage
and rental rates.

Figure 5.8 4. Decrease in Labor in the Computer industry
Increase in Home Labor

L L 0C
2. Decrease in
3. Increase in Capital in the
Capital in the K K Computer
Shoe industry B
industry
K K
A
5. Additional
1. Increase in
increase in Labor
Home labor due to 0S 0S L L in the Shoe
immigration:
industry
additional labor
(L) allocated to L
shoes
L

Effect of Immigration on Industry Outputs

Since the factors of production both increase or
decrease, it makes sense that output will follow the
same trend.
Since labor and capital moved to shoes, shoe output expands
and capital production contracts.
On our PPF, due to the increase in labor, the PPF shifts
out more in the direction of shoes.
Since prices are unchanged, the economy moves to
equilibrium at point B in Figure 5.9.
More shoe production and less computer production
This only holds in the long run.

Figure 5.9 The Long-Run Effect on Industry
Outputs of an Increase in Home Labor
Output of
Shoes, QS Relative Price of
Computers, PC/PS
Shift in Home An increase of both

PPF due to capital and labor in
immigration shoe production
causes an increase in
shoe output and a
decrease in computer
output
Output of Computers,
QC

Rybczynski Theorem:
In the Heckscher-Ohlin 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.
Factor Price Insensitivity:

In the Heckscher-Ohlin 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.

The Effects of the Mariel Boat Lift on Industry Output in
Miami
APPLICATION
Figure 5.10 panel (a) shows real value added in
the apparel industry for Miami and the average of
comparison cities.
Adjust for city size by looking at value added per capita.
The industry decline in Miami is slightly slower than in
comparison cities after 1980.
Panel (b) shows the output of a group of skill-

intensive industries.
These industries fell more rapidly in Miami after 1980.
These results support the Rybczynski Theorem

Miami
APPLICATION Figure 5.10 (a)

Miami
APPLICATION Figure 5.10 (b)

Miami
APPLICATION
Wages did not really change during this time.
Is this also from the Rybczynski Theorem?
During this time, computer use in manufacturing was
increasing significantly.
This increase was much slower in Miami than in similar
cities.
One explanation is that firms employed the Mariel
refugees and other low-skilled workers rather than
switching to computer technologies.
This is just another example of how the refugees could be
absorbed across many industries.

Immigration and US Wages, 1990 - 2004
APPLICATION
There has been slightly more than a doubling of
foreign-born persons in the U.S. in 25 years.
Table 5.1 reports the estimated impact of
immigration over 1990-2004 on wages of various
workers, distinguished by education level.
When we allow capital to grow in each industry to
accommodate the inflow of immigrants (second
approach), total U.S. immigration has a negative
impact on only the lowest and highest-educated
workers.

Immigration and US Wages, 1990 - 2004
APPLICATION Table 5.1

Movement of Capital between Countries:
Foreign Direct Investment
We can now look at how capital moves from one
country to another through foreign direct
investment (FDI).
When a firm from one country owns a company in
another country.
U.S. Department of commerce uses a 10% rule to

determine FDI.
If a foreign country acquires 10% or more of a U.S.
firm, that is FDI inflow to the U.S.
If a U.S. company acquires 10% or more of a foreign
firm then that is FDI outflow from the U.S.

Movement of Capital between Countries:
Foreign Direct Investment
Greenfield FDIwhen a company builds a plant
in a foreign country.
Acquisition FDI (or brownfield FDI) when a firm
buys an existing foreign plant.
Our focus here will be on Greenfield investment
FDI in the Short Run: Specific Factors Model

Manufacturing uses capital and labor.
Agriculture uses land and labor.
As capital moves into the economy, it will be used in
manufacturing, raising the marginal product of labor.
Therefore it will shift out the curve PMMPLM

Increase in the Capital Stock in the Short Run
Wage, W Equilibrium
PA MPLA An inflow of shifts
capitalto
pointthe
into B, increasing
wages and labor used
manufacturing
in manufacturing.
sector shifts out the
Labor
marginal is pulled
productoutof of
W B agriculture
labor curve so labor in
in that
that sector falls.
sector
W A
PM MPLM
PM MPLM
0M L L 0A
LM LA
Total Labor in the Economy, L Figure 5.11 (a)

Effect of FDI on the Wage

The equilibrium wage increases to W
More workers are drawn in to manufacturing,
decreasing labor in the agricultural sector.
Effect of FDI on the Industry Outputs

Since land has not changed, output of agriculture falls.
Since labor and capital increase in manufacturing,
output must increase.
No change in prices of goods.
As PPF increases, equilibrium shifts to B.

Increase in the Capital Stock in the Short Run
Figure 5.11 (b)

Effect of FDI on the Rentals

Fewer workers are employed in agriculture, as each
acre of land cannot be used as intensively.
Marginal product of land falls, therefore RT = PAMPTA must fall.
More capital and labor are used in manufacturing

RK = PMMPKM
Increases in labor and capital have opposing effects on MPKM
Ambiguous effect
We can use another method for rental on capital.

Calculate the revenue earned in manufacturing and subtract the
payments to labor.
If wages are higher, and all else is the same, there must be a
reduced amount of funds left over as earnings of capital, so
rental rate is lower.
Effect of FDI on the Rentals

We start at original equilibrium point A in Figure 5.12.
Assume capital stock expands from FDI.
Wages are held constant.
Labor used in manufacturing expands up to point C.
The capital-labor ratio for manufacturing is identical at A and C
therefore MPKM and RK must also be equal
If the manufacturing wage increases while holding

capital constant in that sector, we move from C to B.
With less labor on each machine, the MPK and RK must fall.
Because the rental rate on capital is the same at A and C but
lower at B than C, the overall effect of the FDI inflow is to
reduce the rental on capital.

Stock on the Rental on Capital

Increase in Home MPLM
Moving
In from A
the movement
Wage, W due to FDI PA MPLA to C,Cwages
from to B,
and hence
wages the
increase
capital/labor
and so does the
ratio do not
capital/labor
change
ratio From this we
W B can conclude
that rental on
capital is lower
W A C
at B than A.
PM MPLM
Therefore rental on
capital falls when the
PM MPLM capital stock
increases through
FDI
0M L L 0A
LM LA
L Figure 5.12
FDI in the Long Run
We continue with the same assumptions as

before.
Computers (shoes) are capital (labor) intensive.
Effect of FDI on Outputs and Factor Prices

Capital increase due to FDI.
Box panel sides expand with new origin at OC
OSB is shorter than OSA so less labor and less capital
are used in the production of shoes and output falls.
OCB is longer than OCA so more labor and more capital
are used and the output of computers rises.

FDI in the Long Run
Effect of FDI on Outputs and Factor Prices
Change in output is from point A to B in panel (b).
As the Rybczynski Theorem states, the increase in
capital through FDI has increased the output of the
capital-intensive industry and reduced the output of the
labor-intensive industry.
Because capital-labor ratios are unchanged, the wage
and the rental on capital are also unchanged.
In the long run model, an inflow of either factor of
production will leave factor prices unchanged.
For immigration, we found actual cases where wages
were reduced (short run) and where wages were
constant (long run).
There are fewer studies for FDI.
The Effect of FDI on Rentals and Wages in Singapore
APPLICATION
Singapore has encouraged foreign firms to establish
subsidiaries within its borders, especially in the electronics
industry.
Singapore has the fourth-largest amount of FDI in the

world.
What has happened to the rental rate and the wage?
Table 5.2, part A, shows much of this.

MPK has fallen due to diminishing returns.
Each worker has more capital, so MPL increases.
These are consistent with specific factors model.

APPLICATION Table 5.2 (a)

APPLICATION
Second approach to calculating the rental on capital.
If capital was rented instead of purchased, what would the
rental be?
If it invests PK at interest rate i, could expect PKi
We must also consider depreciation on capital.
Real rental is: R PK
(i d )
P P
Table 5.2 part B shows the growth rate in the real rental
computed from this formula.
Real wages grow over time.
This is not expected from our long run model.

APPLICATION
This is an indication of productivity growth

This leads to an increase in the MPL and in the real
wage.
Table 5.2 (b)

APPLICATION
In part B productivity growth is positive, but in part A it is
negative.
The idea that Singapore might have no productivity growth
contradicts what many believe about its economy and that
of other fast-growing Asian countries.
If there was no productivity growth then all growth is due to
capital accumulation.
FDI has no spillover benefits.
Most economists believe that productivity increased but

that belief is challenged by part A.

Gains from Labor and Capital Flows
Foreign investment and immigration are both
controversial policy issues.
Most countries have at some point controlled FDI but
later became open to foreign investment.
However, almost all countries impose limits on
immigration.
U.S. immigration controls were established by the
Quota Law of 1921.
Allows a limited number of persons arriving annually from
each country of origin
See text for more of immigration law history.
Why is immigration so controversial?

Some groups oppose the spending of public funds on
immigration.
Other groups fear the competition for jobs created by
an inflow of workers.
Immigration benefits the host country in the

specific factors model.
If immigrant earnings with Foreign income are

included then emigration benefits the Foreign
country, too.

Gains from Immigration
To measure gains from immigration we will use

the specific-factors model.
We look at the total world labor with the Home

and Foreign labor together: L + L*.
Home workers are measured from the left and

Foreign workers are measured from the righton
the horizontal axis.
We can see how many workers are located in

each country.

Gains for the Home Country
Even though all workers are paid the same wage. W, the
first worker had an MPL equal to W
Thus, MPL*P>W; immigrants raise the value of output more

than they are paid in wages.
Gains for the Foreign Country

We need to include the wages received by the migrants who
left when calculating Foreign income.
These wages are often returned to their families.
The difference between the wage earned by the migrants

and their Foreign marginal products is the gain to Foreign.

World Labor Market
Wage, W Foreign Workers move from
The
The Home
gains wage,
to Home W
Wage Foreign to Home untiland
determined
Foreign from bymigration
A, is
equilibrium is reached at
higher
can be than the Foreign
shown.
Gains to C, full migration, with
Home Wage W* at A*
A wages equalized at W
W
B
W C
W* A*
Gains to
Home
Foreign
Wage
0 L L 0
L L*
World amount of labor

Figure 5.14

Immigrants and Their Remittances
SIDE BAR
Immigrants often send a substantial portion of
their earnings back homeremittances.
The International Monetary Fund (IMF) estimates

that remittances were $126 billion in 2004, up
from $72.3 million in 2001.
The income sent home by immigrants is a larger

source of income than is official aid (Table 5.3).

SIDE BAR
Table 5.3

Immigrants and Their Remittances
SIDE BAR
The fact that immigrants return some of their income back
home may not be enough to compensate their home
countries for the loss of their labor.
To calculate the gains, we need to include all the earnings
of the immigrants in their home countries income.
In the case of highly-educated migrants, unless these migrants
return most of their earnings back home those countries lose from
the outflow of these workers.
Jagdish Bhagwati, an economist, has proposed that

countries impose a brain drain tax on the outflow of
educated workers.

World Gains from Migration

Combining the gains to the Home and Foreign
countries we obtain the triangular region ABA*, the
world gains due to immigration.
One way to think about world gains from migration is
that it equals the increase in world GDP due to
immigration.
In practice, however, there are other costs that
immigrants bear
Moving costs, payments to traffickers of illegal immigrants.
These costs must be subtracted from the increase in

GDP in order to obtain the net gains.

How Large are Moving Costs?
SIDE BAR
Illegal immigrants are often willing to make high
payments to traffickers to move from one country
to another.
Payments to traffickers are in Table 5.4.
Even legal immigrants face some costs of

migration, paying for transportation, legal
expenses, wage discrimination, prejudice, etc.
So moving costs are a lower-limit on the extra
income they expect to receive, added up over the
years they will be away.
SIDE BAR Table 5.4

SIDE BAR
When the costs of moving are high, then
immigrants need to work abroad for enough years
to more than cover these costs.
In order to both have the income needed to pay

costs and have enough working years left to make
immigration worthwhile we expect immigrants to
be middle-aged.
This supports evidence that immigrants are often in
their 30s or 40s.

Gains from Migration
APPLICATION
How large are the gains from migration?
Net gains to the U.S. in this case equal the

increase in U.S. GDP.
Table 5.5

Gains from Migration
APPLICATION Table 5.5

Gains from Foreign Direct Investment
Figure 5.15 shows the world amount of capital on the
horizontal axis: K + K*.
Foreign rental is higher than Home so capital will flow from
Home to Foreign.
As capital enters Foreign, the marginal product of

capital will fall as will its rental.
As capital leaves Home, the marginal product will rise

as will the rental.
World gains are A* BA.

Gains from Foreign Direct Investment
World Capital Market
Foreign
Rental, R
Rental
Home rentalwith
ratefull
(R) is
Gains to Equilibrium
Gains to Foreign and
lower than Foreign (R*).
Foreign capital flow be
Home can is at B with
shown
R* A* rents equalized
Capital will moveatfrom
R
Home to Foreign to
receive a higher rental
B
R C
Gains to
Home
R
A
Home
Rental
0 K K 0
K K*
Figure 5.15
World amount of Labor

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5

From May to September 1980, boatloads of

This would lead you to believe that these less-

However, this immigration does not appear to

Explaining this effect is one goal of this chapter.

2008 Worth Publishers International Economics Feenstra/Taylor 2 of 114

A similar situation occurred with the 1989

Compare the predictions of short-run (specific

2008 Worth Publishers International Economics Feenstra/Taylor 3 of 114

Then we will consider the effects of movement of

Foreign Direct Investment (FDI) occurs when a

Finally, we will discuss the gains to the host and

2008 Worth Publishers International Economics Feenstra/Taylor 4 of 114

Migration is the movement of labor from the

2008 Worth Publishers International Economics Feenstra/Taylor 5 of 114

Effects of immigration in the Short Run Specific-

Determining the Wage

2008 Worth Publishers International Economics Feenstra/Taylor 6 of 114

2008 Worth Publishers International Economics Feenstra/Taylor 7 of 114

Effect of Immigration on the Wage in Home

2008 Worth Publishers International Economics Feenstra/Taylor 8 of 114

2008 Worth Publishers International Economics Feenstra/Taylor 9 of 114

2008 Worth Publishers International Economics Feenstra/Taylor 10 of 114

APPLICATION Figure 5.3

2008 Worth Publishers International Economics Feenstra/Taylor 11 of 114

In the U.S. much of the recent debate focused on the

The combination of legal and illegal immigrants in the U.S.

2008 Worth Publishers International Economics Feenstra/Taylor 12 of 114

APPLICATION Figure 5.4

2008 Worth Publishers International Economics Feenstra/Taylor 13 of 114

2008 Worth Publishers International Economics Feenstra/Taylor 14 of 114

Other Effects of Immigration in the Short Run

Rentals on Capital and Land

Effect of Immigration on Industry Output

Immigration causes an increase in

2008 Worth Publishers International Economics Feenstra/Taylor 18 of 114

Total capital: K = KA + KM earning rental R.

Computers are capital intensive and shoes are labor

How is equilibrium affected by the inflow of labor into Home

2008 Worth Publishers International Economics Feenstra/Taylor 20 of 114

2008 Worth Publishers International Economics Feenstra/Taylor 21 of 114

Total Amount Capital

Labor allocated to shoes

Total Amount of Labor in the Economy

2008 Worth Publishers International Economics Feenstra/Taylor 22 of 114

Determination of the Real Wage and Real Rental

Increase in the Amount of Home Labor

2008 Worth Publishers International Economics Feenstra/Taylor 23 of 114

Increase in the Amount of Home Labor

Since the capital-labor ratios are unchanged, so are the

Therefore the wages and rentals are unchanged.

When capital can move freely between industries,

2008 Worth Publishers International Economics Feenstra/Taylor 24 of 114

Increase in Home Labor

2008 Worth Publishers International Economics Feenstra/Taylor 25 of 114

Effect of Immigration on Industry Outputs

2008 Worth Publishers International Economics Feenstra/Taylor 26 of 114

Shift in Home An increase of both

2008 Worth Publishers International Economics Feenstra/Taylor 27 of 114

Factor Price Insensitivity:

2008 Worth Publishers International Economics Feenstra/Taylor 28 of 114

Panel (b) shows the output of a group of skill-

These results support the Rybczynski Theorem