International Factor Mobility

   1. International Factor Movement
 FPE  Factor Price Equalization: Although factor are immobile between countries, free trade of commodities will equalize factor prices under certain conditions, i.e., w = w* and r = r*, in which case there are no incentives for factors to move between countries.

          FPE is a fragile theorem. In the real world transport costs are positive. For typical bulky products, transportation cost is often more than 10% of the price. For instance, transportation costs of crude oil is $10-15 by rail, and $5 by pipeline, while the crude oil price is roughly $50 per barrel.

Since output prices are not completely equalized, free commodity trade will only reduce the gap in factor prices between countries. The domestic-to-foreign wage ratio (w/w*) may fall from 10:1 in autarky to 2:1 under free trade.

Alternative to Free Trade  Free factor mobility is an alternative to free trade
 Commodity price equalization (Mundell, 1957) Assume commodity trade is prohibited, but factors are mobile between countries. Free factor mobility insures factor price equalization. With identical technologies, commodity prices will also be equalized. That is, there is no need for commodity trade. In this case, factor mobility is a substitute for commodity trade. w = w*, r = r*

pi = w aLi + r aKi = w* a*Li + r* a*Ki = pi*.

That is, free factor mobility ensures that output prices are equalized in autarky. Thus, free factor mobility obviates the need for commodity trade.

If w = $20 and w* = $2 in autarky, Free Labor Mobility will equalize the wage rate somewhere between $2 and $20, say around $10 per hour.

Free factor mobility is better than free trade.

If we introduce an element of realism that transportation costs are positive and significant, then the world would be better off under international factor mobility. In the case of FT without factor mobility, transportation costs must be paid time after time. On the other hand, factors move only once.

Free trade may not completely equalize factor prices. In this case, there are gains from factor mobility (to be shown). International factor mobility guarantees a maximum value of world outputs.

In the real world, FM may not completely eliminate factor price differentials because of noneconomic factors such as national pride or preferences for domestic environment. FM may only reduce autarky factor price differences between countries. In this case, FM will reduce trade volume between countries. FM is a substitute for free trade.

Robert Mundell (left) receiving his Nobel prize in economics in 1999.

  2. Gains from Capital Mobility

Myth vs Reality

Burger King in Moscow

Starbucks in Qian Men Street, Beijing


Dependency Theory: Since the 1960s many governments of LDCs, especially of Latin America, restricted entry of foreign multinational firms, believing that foreign capital inflow will make LDCs dependent on America and Europe. Dependency Theory was developed in the late 1950s by Raul Prebisch, who was Director of the United Nations Economic Commission for Latin America.

Dependency theory asserts that LDCs remain less developed because of their dependence on developed economies. They argue that profits or surpluses will be siphoned off by multinational corporations. Workers and peasants will be exploited by foreign capitalists.

Source country: Politicians claim that foreign direct investment outsources jobs from America to other countries. Usually, there is more opposition to inward capital flow or foreign direct investment (FDI).

Reality: The following graphical analysis refutes this dependency theory. Both lenders and borrowers benefit from capital mobility.

To prevent capital outflow, tax incentives can be given to encourage domestic production.

 Functional distribution of income

Let national income be a function of domestic capital and labor inputs, Y = F(K,L).

Functional distribution of income views how income is earned, not by who earns income, whether income is earned by labor or capital.

Labor income = wL (triangle)

capital income = rK (rectangle)

(In LR equilibrium) Zero Profit implies: Y = wL + rK.

Total output = area of trapezoid, equal to the sum of the triangle (wL) and the rectangle (rK) in Figure 1.

In Figure 1, the vertical axis measures value of marginal product of capital (p x MPK), which measures firms' demand for capital. The vertical line shows the economy's aggregate supply of capital. The intersection of these two lines determine the equilibrium interest rate in the economy.

Figure 1. Distribution of Income

Labor share (wL/Y) steadily declined from 67% in 1952 to about 60 in 2010 in the United States. This is a global trend. The typical worker is gradually becoming a capitalist.

When K is immobile   
 K is mobile  
 Free Capital Mobilty  Country A: Labor income = wL

capital income = rK (r = r* is now the equalized interest rate)

Capital used in the domestic economy = K
Foreign investment of the home country = F (Total capital endowment = K + F).

Foreign investment income = rectangle rF.

Gains from factor mobility (US) = blue triangle

Gains from factor mobility (UK) = red triangle



  3. International Labor Movement

Workers migrate from a Source country to the Host country.

Migrants send home three times more money than countries receive in development aid, says World Bank

More than 200 million people (about 3% of the world population) live outside the country of their birth.

 Host country

Welfare of the host country

Not everyone benefits. (unskilled workers may lose)

Migrants lower the wage rate of the host country. ⇒ industries become more labor intensive.

Since some gain and others lose from any policy change, one can examine whether a representative citizen gains from allowing new immigrants.

 Assume  (i) the HC produces only one good, Q
(ii) each resident owns 1/L units of capital and labor (K/L,1)

Do home residents benefit from foreign immigration? Does GNP increase?

Yes. The representative firm will become more labor-intensive to take advantage of a lower wage-rental rate.


 1 = initial position, 2 = final position of all residents, 3 = intermediate position (of the original residents, excluding migrants)

Because of incoming migrants, the representative firm must become more labor intensive (taking advantage of lower wage rate). In the process, the output level rises (from point 1 to 3.)


  4. World Production Possibility Frontier without Migration
 How to construct WPPF (i) Choose one point on the PPF of country A.
(ii) determine the relative price, p1/p2 at that point.
(iii) Place the PPF of country B at that point.
(iv) Determine the free trade prodution point of country B. This point C is one point along the world production possibility frontier.
(v) Repeat this process for each point on A's PPF to obtain the entire world PPF.



  5. World PPF with and without Factor Mobility
Assume  two countries have different PPFs. 
World PPF  

In the segment 2-3, factor prices are equalized. Thus, factor mobility does not enhance the world output in the region where factor prices are equalized..

However, outside this region, factor prices are not equalized, and allowing factors to move between countries can increase the world output. FM pushes the world production possibility fronter outward.


The above Figure shows the effect of factor mobility when there is no region where FPE occurs. The smaller the region of FPE, the more factor mobility enlarges the WPF.

Free Trade vs Factor Mobility Free trade requires continuous transportation of goods, which contributes to global warming, whereas workers migrate once.

  6. Labor Market Effects of Migration
What happens to the North

Workers migrate from the South to the North.

Effect: Wage falls. (Workers lose)

Labor supply S shows reservation wage (the lowest wage workers are willing to accept a particular job) of the marginal worker.

US population = 320 million, immigrants =43 million (13%) in 2015.


However, the North's national income increases because immigrants earn labor income. I = w(L +ΔL) + rK.

Immigrants may depress domestic wage, but the overall effect on national income is positive (except for the case of immiserizing growth).


 Wage rises.

However, the migrants stay, and most of their income belongs to the host country. (GB was shrinking while the US was growing. People is power, and percapita GDP converges to the common level everywhere.)

Producer (employer) surplus the area below firm's demand curve for labor, above the market wage.
Workers' surplus the area above the labor supply schedule below the market wage. (Alfred Marshall)
 Gains from migration Assume migration equalizes wage. 
gain (d + e)
workers in the South
gain c
employers in the South
lose (c + d)
Net gain of the South
gain e
workers in the North (native)
lose a
employers in the North
gain (a + b)
Net gain in the North
gains (b + e)
In practice

Migrants do not return. They become residents of the host country.

Net effect: The Host country gains, but the Source country loses (in terms of GDP).

Steve Jobs's biological father is a Syrian immigrant.


  7. Public Finance Effects of Migration

The Source country loses income (because the immigrants left).

The Host country's income rises.

If the immigrants have a lower income in the new country, their arrival lowers average income in the host country. (if the immigrants become nationals of the host country)

Labor Income: The nationality of immigrants changes. Accordingly, their income stays in the host country, except remittances.

Capital Income: Income of the capitalists are sent to the Source country. The nationality of the capitalists does not change .

 Source country

Migrants do not pay taxes to the source country

They do not receive public goods of the source country. Revenue loss generally exceeds the gains from reduced congestion of public services.

income declines

remittances increase ($307 billion in 2009)

The source country had invested in the formation of human capital (public education). Thus, basically, outmigration is a brain drain.

 Host Country

(i) Immigrants are a fiscal burden in the SR, causing an increase in the service of public goods (e.g., in public schools)

(ii) They pay taxes (this is known to be greater than the increased fiscal expenditure)

(iii) Immigrants tend to be young adults . Human capital was accumulated at foreign expense. Roughly, the cost of raising a foreign-born baby till the kid acquires marketable skill is $400 - 500,000 ($250,000 till 17 + $100 - 300,000 or more for college) .

(iv) The cost of providing public service for immigrants is lower than that for nationals (foreign governments paid some fraction of it already).

(v) No reliable statistics on whether the crime rate of illegal/undocumented alients are higher or lower than native-born citizens. Studies are needed.

(vi) Non-violent Illegal aliens: pay all the taxes, but not entitled to any benefits.

L vs K mobility

Foreign investment can increase national income.

The source country loses labor income and hence GDP declines.


  7. Motives for migration
 Noneconomic factors

war (e.g., Afgan refugees)

political or religious persecution

e.g., The Mayflower in 1620 transported 102 English Pilgrims to New England.

Amish and Mennonites emigrated to Pennsylvania in the early 18th century.

 Economic factors

Wage differential plays a major role.

overall quality of life (environment)



  8. Guest Workers
 Guest Workers

US Temporary Foreign Worker Programs allow temporary migration of unskilled workers (1+ million visas were issued in 2014)

Guest workers are an important phenomenon in many parts of the world.


Migrant Latin American workers in US agriculture and light industry.

Bosnians, Serbs, Turks, and North Africans in Europe

South European and North African workers migrate to the labor-intensive industries of northern Europe. Legal arrangements

European Community provides unrestricted factor mobility among members. Italian workers are free to take jobs in Germany, for example.

 How does the Guest worker system work?

The host country government issues temporary permits to foreign workers to enter the country and take jobs (scientists = H1B, farm workers = H2A, other workers = H2B, H4 = family).

Major Sources: India, Mexico, China.

Theory: The host country can adjust the flow of migrant workers by controlling the number of permits.

Practice: Over 600,000 people overstayed US visas. 

 Effect on the host countries

They help the host countries control production costs and inflation.

The workers are generally unskilled.

They are willing to accept low wages that native workers would not want.
ex. farm workers, chambermaids, etc.
Florida farm owners complain about the competition of cheap Mexican tomatoes also hire Mexican migrant workers.

Increased ability to deal with macroeconomic disturbances.

use guest workers as buffer against economic fluctuations
In boom periods, the authorities issue more permits.
In recession, guest workers are sent back to the source countries.

 Effect on the source countries   Migrant workers receive better employment in the host countries. Migrant workers remit some of their earnings to the source countries. In 1979 Pakistan's remittances were 77% of the earnings from exports. (Labor migration becomes a substitute for exports)

Source countries face severe business fluctuations. In recession, the guest workers are sent back, aggravating unemployment. When they return, they bring alien tastes and habits.

"unskilled guest workers" in host countries can be a brain drain to the source LDCs.

 price instability and guest workers  Instability of the source country is generated by migrant workers.



  9. Potential or Perceived Problems of Immigrants
Complaints about immigrants  1. Immigrants bring foreign customs and religious practices.
Foreign religions

St. Mamertine prison in Rome, where Peter and Paul were imprisoned. They introduced Christianity to the Roman Empire. These immigrants changed the course of the Western history.

Industrial espionage and foreign spies

2. They may share strategic information with the source countries.

Foreign immigrants tend to facilitate industrial espionage for the source countries. e.g., German spies in the US during WWII.

Burdens on INS 3. They are a burden on the Immigration and Naturalization Service.

Influx of immigrants and visitors mean increased exports as they purchase US goods. However, government must also increase its public good expenditure to meet the needs of the immigrants and visitors.

The INS is understaffed and cannot handle the flow of foreign immigrants and visitors.