|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
FPE is a fragile theorem. In a world of many commodities and factors, free commodity trade may reduce the gap in factor prices between countries, but factor prices may not be completely equalized.
|Alternative to Free Trade||Free factor mobility is an alterative 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 =
pi = w aLi + r aKi = w* a*Li + r* a*Ki = pi*.
|In the real world, 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.
Even 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 may not eliminate trade completely, but will reduce trade volume between countries. FM is a substitute for free trade.
Robert Mundell (left) receiving his Nobel prize in economics in 1999.
Myth vs Reality
Burger King in Moscow
Starbucks in Qian Men Street, Beijing
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.
Source country: Politicians claim that foreign direct investment outsources jobs from America to other countries. (without outsourcing the firm may not survive.)
Reality: The following graphical analysis refutes this dependency theory. Both lenders and borrowers benefit from capital mobility.
Imagine how much Iowa loses if we reject foreign investments or investments from other states.
|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
|When K is immobile|
|K is mobile|
|Free Capital Mobilty|| Country A: Labor income
Workers migrate from a Source country to the Host country.
More than 200 million people live outside the country of their birth.
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)|
|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.
|Assume||two countries have different PPFs.|
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.
|What happens to the North||
Workers migrate from the South to the North.
Effect: Wage falls. (Workers lose)
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).
Producer (employer) surplus
the area below firm's demand curve for labor, above the market wage.
the area above the labor supply schedule below the market wage. (Alfred Marshall)
|Gains from migration||Assume migration equalizes wage.
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.
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. Nationality of the capitalists does not change.
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.
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.
(i) Immigrants are a fiscal burden, 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.
(iv) The cost of providing public service for immigrants is lower than that for nationals (foreign governments paid some fraction of it already).
(v) 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.
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.
Wage differential plays a major role.
overall quality of life (environment)
Temporary migration of unskilled workers
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.
The host country can adjust the flow of migrant workers by controlling the number of permits.
|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.
Increased ability to deal with macroeconomic disturbances.
use guest workers as buffer against economic fluctuations
|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
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
|1. Immigrants bring foreign customs and religious practices.|
St. Mamertine prison in Rome, where Peter and Paul were imprisoned. They changed the course of the Western history.
Today American Moslems are trying to build a mosque at Ground Zero.
2. They may share strategic information with the source countries.
Foreign immigrants sometimes serve as spies, although they can also be useful as spies for the host countries.
|Burdens on INS||3. They are burdens on the Immigration and Naturalization
4. Immigrants eventually mix with the domestic residents and affect the genetic pool of the host country. Some view this as a positive, while others view it as a negative.
Switzerland and Japan are probably the most restrictive, whereas the US is probably the most lenient country in terms of accepting foreign immigrants.