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MOVEMENT OF LABORAND CAPITAL BETWEEN

COUNTRIES

1Movement of LaborBetween Countries

2Movement of

Capital betweenCountries

3Gains from Laborand Capital Flows

4Conclusions

5

2 2008 Worth Publishers International Trade Feenstra/Taylor

Introduction Thousands of young Tunisians fled their country last week;

The same has been true for months in 1980 for Cubansarriving in Miami.

A similar situation occurred with the 1989 emigration ofRussian Jews to Israel.

Did this lead to lower wages of less-skilled workers in Miamior in Israel?

The answer is no! Explaining why is one goal of this chapter. In other large scale immigrations, the wages of domestic

workers did fall.

We will use the short-run modelthe specific factors modelto explain the case where immigration leads to a fall in wages

And a long-run modelthe Heckscher-Ohlin modeltoexplain why an increase in labor will not lower the wages.


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Introduction

After looking at what happens in the short run andlong run when labor moves across countries, wewill consider the effects of movement of capital.

Foreign Direct Investment (FDI) occurs when acompany from one country owns a company inanother country.

Finally, we will discuss the gains to the host anddestination 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 andland are determined by the prices of goods purchased.

Prices of goods are determined by the world market forthose goods.

If prices of goods are fixed, how do the Home wage andrentals paid change as labor moves between countries?

Effects of immigration in the Short Run Spcific-FactorsModel: In the short run, only labor is mobile among Home industries: capital

and land are fixed. Determining the Wage:

Total labor, L, is the amount used in manufacturing, LM, plus the amountused in agriculture, LA

L = LM + LA


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Movement of Labor Between Countries

Labor in manufacturing ismeasured from the left.

Labor in agriculture ismeasured from the right.

PMMPLM is downward slopingbecause as more labor is usedin manufacturing, the MPL andtherefore the wages fall in thatindustry.

PAMPLA is upward slopingbecause we are measuring LAfrom right to left: as LAincreases, MPL and wages inagriculture fall.

Equilibrium wage is at A where

the two curves cross. When wages are equal across

industries, there is no reasonfor labor to move betweenthem.



Determining the Wage We assume that the Foreign equilibrium wage, W*, is lower than

Home equilibrium wage, W.

Foreign workers will want to immigrate to Home and the Homeworkforce will increase by an amountL, reflecting the number of

immigrants.

Effect of Immigration on the Wage in Home

We add theL to the figure, The PAMPLA shifts right byL.

The origin for manufacturing has not changed so PMMPLM doesnot change.


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Immigration

increases totallabor by L,shifting theorigin to 0A

The marginalproduct of

labor curveshifts rightalso by L

Labor hasincreased andwages havedecreased at newequilibrium, B

NewequilibriumHome wage isat B.

The extraworkers aresharedbetween bothindustriessince bothindustries havemore workers,but fixedamounts ofcapital andland.

The wagedeclines due tothe diminishingmarginalproduct oflabor.

APPLICATION


Immigration to the New World

Between 1870 and 1913, 30 million Europeansleft their homes in the Old World to emigrate tothe New World.

The U.S. population increased by 17% and theU.S. absorbed the largest number of people.

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 inboth locations grew, but at a slower rate in theNew World.


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APPLICATION


Immigration to the New World

Large-scalemigrationcontributed to aconvergence ofreal wages acrossthe continents.

Comparing theactual real wageswith the no-migrationestimates, thegrowth of wages inthe New World

was slowed due toimmigration. Wages in Europe

grew slightly fasterdue to theemigration.

See textbook for todays immigration


Movement of Labor Between Countries Due to a shrinking workforce, OECD leaders are looking

for ways to attract talented foreigners.

The International Labor Organization is the internationalorganization dealing with workers in general not migrantsin particular. Migration policies are essentially up to eachcountry.

Other Effects of Immigration in the Short Run U.S., Canada and Europe have both welcomed foreign workers in

specific industries: agriculture and high-tech.

They do this even though those foreign workers compete withdomestic workers in those industries.

Therefore there must be benefits to the industries.

We can measure these potential benefits by the payments tocapital and landrentals.

Use the same two measurements for rentals as in chapter 3.


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Rentals on Land and Capital

Two ways to compute rentals: As the earnings left over in the industry after paying labor. As the marginal product of capital or land times the price of the

good produced in each industry. Under either calculation, immigration increases rentals on capital

and land. Given this, it should not be surprising that owners of capital and land

often support more open borders.

The restriction on immigration should be seen as acompromise between: Entrepreneurs and land-owners who might welcome the foreign

labor.

Local unions and workers who view migrants as a potential sourceof competition leading to lower wages. The immigrant groups themselves who might also have the ability to

influence the political outcome of immigration policy.



We showed that immigrationled to an increased labor forcein each industry.

With more workers and thesame amount of capital andland in each industry, outputrises in both industries.

Immigration leads to anoutward shift in the PPF.

With constant prices of goods,output rises - from A to B.

This result depends on theshort-run nature of the specificfactors model.

If land and capital are not fixedin each industry, as in the longrun, one industry's output willrise while the other will fall.


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Effects of Immigration in the Long Run

In the long run, all factors are free to move between

industries. We will ignore land to simplify.

As before, only capital and labor are used to produceshoes and computers.

This is similar to the Heckscher-Ohlin model from beforeexcept 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 intoHome due to migration?


Effects of Immigration in the Long RunLabor allocated to computers

Capitalallocated toshoes

Capitalallocatedtocomputers

Total Amountof Capital inthe Economy

Labor allocated to shoes

Total Amount of Labor in the Economy

L

K K

L

LS

LC

KC

KS

0S

0C

A

Length is totalamount of labor atHome, L.

The vertical axesmeasure the totalamount of capital,K, at home, ineach industry.

OSA shows theamount of laborand capital usedin shoes and OCAin computers.

The capital-laborratio in eachindustry is theslope of therespectiveindustry line.

OSA is flatter, socapital-labor ratioin shoes is lessthan in computers.

Box Diagram


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Determination of the Real Wage and Real Rental

The wages and rentals are determined by the marginalproducts of labor and capital.

The marginal products are determined by the capital-labor ratio in each industry.

If there is a higher capital-labor ratio, then by the law ofdiminishing returns, the marginal product of capital andreal rental must be lower and the marginal product oflabor and real wage must be higher; the opposite holds

for a higher L/K ratio. Because each line in the box diagram is a particular

capital-labor ratio, it is also a particular wage andrental.


Effects of Immigration in the Long Run Increase in the Amount of Home Labor

Immigration leads to increase in the amount of Home labor to L = L + L.

The axes in box diagram expand.

Instead of allocating the extra labor to both industries, we allocate it all toshoesthe laborintensive industry.

Moreover, some capital is withdrawn from computers and allocated toshoes.

To maintain the capital-labor ratio in computers, some labor will also leavecomputers to shoes.

Because both labor and capital increase in shoes, the capital-labor ratio isunchanged.

The additional labor in the economy is fully employed.

In the box diagram, we show the new origin for shoes OS due to theincrease in labor,L.

At point B, we have a new possible equilibrium.

Remember we said the slopes of the lines showed the capital-labor ratio.

Notice the slopes of the lines have not changed.


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A

L

L L

L

BK

K

K

K

0S0S

0C

L

L

1. Increase inHome labor due toimmigration:additional labor(L) allocated toshoes

2. Decrease inCapital in theComputerindustry

3. Increase inCapital in theShoe industry

4. Decrease in Labor in the Computer industry

5. Additional

increase in Laborin the Shoeindustry

Increase in Home Labor



Output of Computers,QC

Output ofShoes, QS

Relative Price ofComputers, PC/PS

Shift in HomePPF due toimmigration

An increase of bothcapital and labor inshoe productioncauses an increase inshoe output and a

decrease in computeroutput

The Long-Run Effect on IndustryOutputs of an Increase in Home Labor


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Increase in the Amount of Home Labor

Since the capital-labor ratios are unchanged, so are the marginalproducts. Therefore the wages and rentals are unchanged. This is a very different result from the short-run model. When capital can move freely between industries, immigration in

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

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: more shoe production and less computer production This only holds in the long run.


Effects of Immigration in the Long Run Rybczynski Theorem:

In the Heckscher-Ohlin model with two goods and two factors, anincrease in the amount of a factor found in an economy willincrease the output of the industry using that factor intensively and

decrease the output of the other industry.

Effect of Immigration on Factor Prices Notice that the change in outputs in the Rybczynski Theorem goes

hand-in-hand with the finding that wage and rental will not change

due to the increase in labor (or capital). That is because the economy can absorb the extra amount of labor

by changing output.

Factor Price Insensitivity:In the Heckscher-Ohlin model with two goods and two factors, anincrease in the amount of a factor found in an economy can beabsorbed by changing the outputs of the industries, without anychange in the factor prices.


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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.

Greenfield FDI: when a company builds a plant in aforeign country.

Acquisition FDI: when a firm buys an existing foreign plant.

E.g. inflow of investment into eastern Europe due to privatization.

Having capital move from high-wage to low-wagecountries to earn a higher rental is the traditional view ofFDI and one we will use here.

Our focus will be on Greenfield investmentthe buildingof new plants abroad. The questions are the same as forlabor migrations.


Movement of Capital between Countries:

Foreign Direct 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 inmanufacturing.

Additional capital will raise the marginal product of

labor in manufacturing. Therefore it will shift out the curve PMMPLM.


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0A0M

W

L

W

L

A

PA MPLA

LA

Wage, W

LM

Total Labor in the Economy, L

B

PM MPLM

PM MPLM

An inflow of capitalinto themanufacturingsector shifts out themarginal product oflabor curve in thatsector

Equilibrium shifts topoint B, increasingwages and labor usedin manufacturing.Labor is pulled out ofagriculture so labor inthat sector falls.

Increase in the Capital Stock in the Short Run



Increase in the Capital Stock in the Short Run

Effect of FDI on theIndustry Outputs

Since land has notchanged, output ofagriculture must fall.

Since labor and capital

increase inmanufacturing, outputmust increase.

No change in prices ofgoods.

As PPF increases,equilibrium shifts to B.


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Effect of FDI on the Rentals

Fewer workers are employed in agriculture, as each acre of landcannot be used as intensively. Marginal product of land must fall.

Rental on land, RT = PAMPTA If MPTA falls and PA is unchanged, RT must fall.

More capital and labor are used in manufacturing RK = PMMPKM MPKM falls due to diminishing returnsreduces RK.

As labor increases MPKM risesraises RK Unknown which effect is greater.

So we need another method for rental on capital.

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 is lower.

Since FDI inflow also reduces rental on land, then both rentals fall.



0A0M

W

L

A

PA MPLA

LA

Wage, W

LM

W

L

B

PM MPLM

PM MPLM

Increase in Home MPLMdue to FDI

C

Moving from Ato C, wagesand hence thecapital/laborratio do notchange

In the movementfrom C to B,wages increaseand so does thecapital/laborratio

From this wecan concludethat rental oncapital is lowerat B than A.

Therefore rental oncapital falls when thecapital stockincreases throughFDI

L

Stock on the Rental on Capital


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FDI in the Long Run

We continue with the same assumptions as before. There are two industries, computers and shoes, with two factors,

labor and capital.

Computers are capital intensive and shoes are labor intensive.

The initial allocation of labor and capital is at point A in panel (a)and the output of shoes and computers is shown by A on PPF inpanel (b).

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 O

SA 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 usedand 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 outputof the labor-intensive industry.

This change in output is achieved with no change in the capital labor ratiosin either industries: OCB and OSB have same slopes as OCA and OSA.


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FDI in the Long Run

Effect of FDI on Outputs and Factor Prices

Because capital-labor ratios are unchanged, the wageand the rental on capital are also unchanged.

In the long run model, an inflow of eitherfactor ofproduction will leave factor prices unchanged.


Gains from Labor and Capital Flows Foreign investment and immigration are both controversial

policy issues.

Most countries have at some point controlled FDI but laterbecame open to foreign investment.

However, almost all countries impose limits onimmigration.

Why is immigration so controversial?

Mostly fear of the competition for jobs created by an inflow ofworkers.

Does immigration provide an overall gain to the hostcountry, not including the gains to the immigrantsthemselves?

Are there overall gains to the destination country, in thesame way as we have found overall gain from trade?


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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 horizontalaxis.

We can see how many workers are located in eachcountry.

Wages at Home and Abroad As immigrants enter the Home country, the wage is reduced. The downward-sloping lineHome wage: W at point A. Foreign workers enter and labor force growsHome wage

reduced to W at B.

The same holds for Foreign: wage at W* at point A*. Labor force in Foreign shrinks and wage rises: W at point B.


Gains toForeign

Gains toHome


0 0

Wage, W

L L*

World amount of labor

A

A*

W

W*

L

CW B

L

HomeWage

ForeignWage

World Labor Market Point B isequilibrium withfull migration. Wages areequalized at W.

Equilibrium withfull migration isreached only inthe very long run.


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Gains for the Home Country

We need to measure the contribution of each Foreign worker to theoutput of one good or the other in that country. Home Wage = MPL*P

The first Foreign worker to migrate has a marginal product equal toW/P at point A.

As more Foreign workers migrate, the marginal product falls due todiminishing returns.

The immigrants marginal product is measured by W/P which falls fromW/P to W/P.

Even though all workers are paid the same wage W, the firstworker had an MPL equal to W/P.

The last worker has an MPL = W/P.

So there has been a gain in production for every worker up to thevery last worker.

The output of goods in the Home economy exceedsthe wage thatthey are paid.



Gains for the Home country The difference between the marginal products of the workers and

the wage paid is the gain for the Home economy.

Adding up all the gains from the Foreign workers, we get triangleABC. It is the Home gains due to full immigration.

Gains for the Foreign Country

We need to include the wages received by the migrants who leftwhen calculating Foreign income.

These wages are often returned to their families.

Even if the wages are not sent back, we still incorporate them inthe measure of Foreign income since that is where the migrantsoriginally came from.

Foreign Wage W* = MPL*P.

As foreign workers emigrate, MPL in Foreign rises, Foreign wagesrise from W* to W.


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Gains for the Foreign Country

Each of these higher marginal products between W*and W equals the drop in foreign output from workers

leaving.

The wage Foreign workers earn in Home is muchhigher than their Foreign marginal products of labor.

The difference between the wage earned by themigrants and their Foreign marginal products is thegain to Foreign.

Adding up all the gains to foreign immigrants we obtainthe triangle A*BC. This gain represents the earnings of the emigrants over and

above the drop in output that occurs when they leave Foreign.

SIDE BAR


Immigrants and Their Remittances

Immigrants often send a substantial portion of their earnings backhomeremittances.

The International Monetary Fund (IMF) estimates that remittanceswere $126 billion in 2004, up from $72.3 million in 2001.

The income sent home by immigrants is a larger source of incomethan is official aid.


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SIDE BAR


Immigrants and Their Remittances

The fact that immigrants return some of their income backhome may not be enough to compensate their homecountries for the loss of their labor.

To calculate the gains, we need to include all the earningsof the immigrants in their home countries income.

In the case of highly-educated migrants, unless these migrantsreturn most of their earnings back home those countries lose fromthe outflow of these workers.

Jagdish Bhagwati, an economist, has proposed thatcountries impose a brain drain tax on the outflow of

educated workers.


Gains from Immigration World Gains from Migration

Combining the gains to the Home and Foreign countries we obtainthe triangular region ABA*, the world gains due to immigration.

We can measure the area of this triangle but we need to know thedifference in wages before any migration and the number ofpeople who would emigrate.

One way to think about world gains from migration is that it equalsthe increase in world GDP due to immigration.

We can then say the difference between the Home and Foreignwages therefore equals the net increase in world GDP due to

migration. Adding this up across all migrants, we get the triangle ABA*, the

increase in world GDP and the world gains due to migration. In practice, however, there are other costs that immigrants bear

which would make the gains from immigration less than theincrease in world GDP. Moving costs, payments to traffickers of illegal immigrants.

These costs must be subtracted from the increase in GDP in orderto obtain the net gains.


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2

SIDE BAR


How Large are Moving Costs?

Illegal immigrants are often willing to make high paymentsto traffickers to move from one country to another.

Even legal immigrants face some costs of migration,paying for transportation, legal expenses, wagediscrimination, prejudice, etc.

So moving costs are a lower-limit on the extra income theyexpect to receive, added up over the years they will beaway.

When the costs of moving are high, then immigrants needto 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 immigrationworthwhile we expect immigrants to be middle-aged.


Gains from Labor and Capital Flows Gains from Foreign Direct Investment

We can show these gains as we did with immigration.

The next Figure shows the world amount of capital on the horizontal axis:K + K*.

Rental earned in each country is on the vertical axis.

Home rental is R, at point A.

Foreign rental is R* at point A*.

Foreign rental is higher than Home so capital will flow from Home toForeign.

As capital enters Foreign, the marginal product of capital will fall aswill its rental.

As capital leaves Home, the marginal product will rise as will therental.

Equilibrium with full capital flows is at B, where rentals are equal at R.

Gains to Home from capital outflow is the triangle ABC.

Gains to Foreign is the triangle A*BC.

World gains are A* BA.


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Gains from Foreign Direct Investment

0 0

Rental, R

K K*

World amount of Labor

K

CRB

A

A*R*

R

K

HomeRental

ForeignRental

Gains toForeign

Gains toHome

Equilibrium with fullcapital flow is at B withrents equalized at R

Home rental rate (R) islower than Foreign (R*).

Capital will move fromHome to Foreign toreceive a higher rental

World Capital Market

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