12.5 International factor movements and foreign direct investment

International factor movements shape global economics by transferring labor, capital, and technology across borders. These flows, driven by wage differences, investment opportunities, and government policies, impact economies through remittances, brain drain, and foreign investment.

Foreign Direct Investment (FDI) is a key aspect of factor movements, explained by the OLI paradigm. FDI affects both host and home countries, influencing job markets, technology transfer, and global competitiveness. Understanding these dynamics is crucial for grasping international trade and comparative advantage.

International Factor Movements

Causes of Factor Movements

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• International factor movements transfer productive resources (labor, capital, technology) across national borders driven by economic disparities and opportunities
• Labor migration causes
  • Wage differentials between countries
  • Employment prospects in destination countries
  • Quality of life considerations (healthcare, education)
• Capital flows motivations
  • Interest rate differences across international markets
  • Investment opportunities in foreign countries
  • Risk diversification for investors
• Government policies influence scale and direction of movements
  • Immigration laws affect labor flows
  • Capital controls impact financial flows
  • Investment regulations shape foreign direct investment

Consequences of Factor Movements

• Labor migration impacts
  • Remittances boost economies of home countries (Mexico received $36 billion in remittances in 2019)
  • Brain drain or gain alters human capital stocks
  • Cultural and social changes occur in origin and destination countries
• Capital flow effects
  • Increased foreign investment in recipient countries
  • Technology transfer to developing economies
  • Economic growth potential for recipients
  • Heightened economic volatility risk
  • Possible economic dependency on foreign capital
• Income distribution changes
  • Mobile factor owners often benefit (skilled workers, multinational firms)
  • Returns to immobile factors may decrease (local land, unskilled labor)

Determinants of Foreign Direct Investment

OLI Paradigm and FDI Motivations

• Foreign Direct Investment involves substantial investment by a company from one country into a business entity in another country
• OLI (Ownership, Location, Internalization) paradigm explains FDI choices
  • Ownership advantages (brand name, technology)
  • Location advantages (market access, resources)
  • Internalization benefits (control, reduced transaction costs)
• Key FDI determinants
  • Market size and growth potential of host country
  • Labor costs in potential production locations
  • Natural resource availability (oil, minerals)
  • Political stability of investment destination
  • Regulatory environment favorability (tax policies, property rights)

Effects on Host and Home Countries

• Host country positive impacts
  • Job creation in local economies
  • Technology transfer to domestic firms
  • Increased productivity through competition
  • Integration into global value chains
• Host country potential drawbacks
  • Crowding out of domestic firms in some sectors
  • Environmental concerns from rapid industrialization
  • Over-reliance on foreign capital and expertise
• Home country effects
  • Increased global competitiveness for domestic firms
  • Expanded market access for products and services
  • Concerns about job offshoring to lower-cost locations
  • Tax base erosion from profit shifting strategies
• Net impact factors
  • Type of investment (greenfield vs. brownfield)
  • Sector involved (manufacturing, services, extractive)
  • Absorptive capacity of host economy (skilled workforce, infrastructure)

Factor Mobility and Trade Patterns

Theoretical Models and Interactions

• Heckscher-Ohlin model predictions
  • Trade in goods can substitute for factor movements
  • Factor price equalization possible through trade alone
• Complementarity between mobility and trade
  • Factor movements facilitate knowledge and technology transfer
  • Enhanced production specialization across countries
• Dynamic effects on comparative advantage
  • Factor movements alter countries' relative factor endowments
  • Changes in endowments shift comparative advantages over time
• Influence of product characteristics
  • Degree of product differentiation affects trade-mobility relationship
  • Presence of increasing returns to scale impacts production location decisions

Types of FDI and Trade Impacts

• Vertical FDI effects
  • Fragments production processes across countries
  • Increases intra-industry trade (components, semi-finished goods)
  • Contributes to formation of global value chains
• Horizontal FDI implications
  • Aims to serve foreign markets through local production
  • May substitute for exports from home country
  • Alters bilateral trade flows between countries
• Factor-specific considerations
  • Skilled vs. unskilled labor mobility has different trade effects
  • Physical vs. financial capital movements impact sectors differently

Policy Implications of International Factor Movements

Immigration and Capital Flow Policies

• Government policy challenges
  • Balance benefits of open factor markets against national concerns
  • Consider economic stability and sovereignty issues
• Immigration policy considerations
  • Address domestic labor market needs (skill shortages)
  • Account for demographic trends (aging populations)
  • Manage social integration challenges for migrants
• Capital account liberalization approaches
  • Implement gradual opening to minimize financial instability risks
  • Establish appropriate regulatory safeguards (capital controls)
  • Monitor short-term vs. long-term capital flows

FDI and International Coordination

• FDI policy instruments
  • Incentives to attract investment (tax breaks, subsidies)
  • Regulations to protect national interests (local content requirements)
  • Rules on profit repatriation and currency convertibility
• Role of international agreements
  • World Trade Organization shapes global investment framework
  • Bilateral investment treaties provide investor protections
  • Regional trade agreements often include investment provisions
• Policy coordination needs
  • Address tax competition between countries
  • Harmonize labor standards across jurisdictions
  • Develop common environmental regulations for multinational firms
• Policy effectiveness factors
  • Interaction with other economic policies (trade, industrial)
  • Quality of broader institutional environment (property rights, rule of law)
  • Consistency and predictability of policy implementation