trade and factor mobility(1)

8/6/2019 Trade and Factor Mobility(1)

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Globalisation and multinational enterprises

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Outline of the lecturey motivation

y trade off between factor mobility and trade in different

theoriesy Heckscher-Ohlin-Samuelson

y Factor-proportions model

y Product life-cycle

y Income effectsy Specific factors model

y Economic geography

y empirics2


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Motivationy International factor movements are a pervaisive

and integral part of the world economy;

y Model of international trade tend to disregardinternational factor mobility and vice versa;

yAs the then President of Mexico Salinas saidduring the NAFTA negotiations: We want toexport goods, not people.

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Motivationy From a perspective of a firm, it is faced with a

choice of arms-length trading and multinational

productiony depending on transport costs and costs of establishing a

production facility abroad;

y depending on the motivation of MNCs they either invest

and trade in intermediates or trade back to the originalmarket or even trade to new markets (platform)

y depending on its ability to internalize its advantages

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Motivationy The rapid growth in foreign direct investment (FDI)

over the last few decades has occurred in the context of

reductions in barriers to investment throughout theworld, and the empirical evidence shows thatinvestment liberalization stimulates FDI;

y The effects of FDI can be wide reaching, with evidence

suggesting that FDI impacts significantly on trade,employment and factor prices;

yAccording to trade theory, whether foreign directinvestment (FDI) promotes or substitutes trade

depends on the motivation for FDI; 5


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Motivationy if FDI is vertical, where multinational firms

geographically split stages of production, this is likelyto stimulate trade.

y if FDI is horizontal, where multinational firmsproduce final goods in multiple locations, this is likelyto substitute for trade.

y unfortunately, it is not possible to separate the data

into horizontal and vertical FDI. However, theory doesprovide some guidance by linking the type of FDI thatis likely to arise to directly observable countrycharacteristics.

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Motives for FDI

y Policy framework

y Economic, political and social stability

y Rules regarding entry and operationy Standards of treatment of foreign affiliates

y Policies on functioning and structure of markets

y International agreements on FDI

y Privatisation policyy Trade policy

y Tax policy

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Motives for FDI

y Economic motives

y Business facilitation

y Investment promotion (image-building, investment-generating activities and investment-facilitatingservices)

y Investment incentives

y

Hassle costs (corruption, administrative inefficiency)y Social amenities (multilingual schools, quality of life)

y After investment services

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Economic motives for FDI

y Market seeking motive

y Market size and per capita income

y

Market growthy Access to regional and global markets

y Country-specific consumer/product preferences

y Structure of markets

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y Resource/asset seeking motive

y Raw materials

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Low-cost unskilled labory Skilled labor

y Technological, innovative and other created assets (e.g.brand names) embodies in individuals, firms andclusters

y Physical infrastructure (ports, roads,telecommunications, power)

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y Efficiency seeking

y Cost of resources and assets adjusted for productivityand labor resources

y Other input costs (transport and communication)

y Membership of a regional agreement conducive to theestablishment of regional corporate networks

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MOTIVES for FDI


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Two forms of international factor mobility (IFM):

y LABOR: worker migration (from low wage countries(developing countries) to high wage countries (developedcountries)),

y CAPITAL: capital investment tend to flow from low to high

return-to-capital countries:y FDI (foreign direct investment) long term investment into

firms with the aim of permanently benefiting the advantagesof being present in the foreign markets (greenfield, mergers &acquisitions),

y PI (portfolio investment) short term capital investment withthe aim of maximizing the return-to-capital (financialinvestments))

y IMF classification:

foreign ownership should exceed 10% of firm's equity


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TRADE AND FACTOR MOBILITY IN DIFFERENT

TRADE THEORIES

NEOCLASSICALMODEL (HOS MODEL)

y Free trade in goods leads to international equalization ofproduct prices, which in turn leads to international

(absolute and relative) factor price equalization.y Hence, given the FPE theorem (factor price equalization)

mobility of factors is not needed. Similarly, when there isa complete mobility of factors, no trade in goods isneeded.

y In the HOS model, trade and factor mobility areSUBSTITUTES: larger trade in goods leads to smallerfactor mobility and vice versa.


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Two implications of HOS model:

y Protectionism: volume of FDI and worker migrationsshould be very large (this thesis is only partlyconfirmed by huge migrations in the beginning of the20th century and in the 1960s and 1970s,

y Liberalism: volume of FDI and worker migrationsshould decline (this thesis does not hold asnotwithstanding trade liberalization in the second half

of the 20th century volume of world FDI has grownfaster than volume of world trade.


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FACTOR-PROPORTIONS MODEL

(Brainard 1993)

HOS model, amended with differentiated goods,

imperfect competition and intra-industry trade.

Implications of factor-proportions model (FP model):

y If two countries are similar in terms of FP:

y There will be no inter-industry trade nor FDI

y Intra-industry trade pattern prevails

y If two countries are very different in terms of FP:

y FDI flows are likely

y Exports will arise (inter-industry type) from host tothe home country

y Trade and factor mobility are COMPLEMENTS.


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INCOME EFFECTS LINDER THEORY

(Linder 1961)Countries similar in factor proportions (and in terms of GDPpc)will have similar structure of preferences. As a consequence,intra-industry trade will arise.

Implications of Linder theory:y Empirical studies show that the majority of FDI and trade

that arises due to FDI is within the advanced countriesgroup, i.e. between countries that are countries of origin aswell as countries of destination at the same time.

y Similarity in income levels, hence, motivates trade as wellas FDI at the same time, leading to COMPLEMENTARITYof both.


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Motives for foreign direct investment

Table: Geographical breakdown of sales of U.S. affiliates inEurope, 1966-93 (%)

1966 1977 1982 1986 1989 1993

Local markets 74 62 59 58 59 57U.S. 2 2 2 4 6 4

Other markets 24 35 39 39 35 38

Source: World Investment Report, 1998: 108.


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y in 1960s, serving the huge local markets in Europeseems to dominate (tariff and trade cost jumping

motive for FDI),y recently, market access motive seem to be partly

amended by efficiency motives (sales to other marketsincrease up to 40%).

y

U.S. affiliates in Europe engage little in exports back toU.S. (only 4%), indicating COMPLEMENTARITY oftrade and FDI


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Table: Export orientation of U.S. affiliates, 1966-93 (in %)

Source: World Investment Report, 1998: 108.

1966 1977 1982 1986 1989 1993

Advanced countries 20.4 33.1 36.6 39.3 38.0 40.6

Developing countries 8.4 18.1 22.0 32.5 36.7 38.7Latin America 6.2 9.7 11.9 20.0 22.0 22.2

Asia 23.1 75.0 60.6 67.5 64.4 64.4

Newly industrialized countries - 81.2 76.0 76.2 67.9 67.0


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Dominant motives of U.S. firms for FDI:y In advanced countries and Latin America: dominantmarket-seeking motives for FDI, i.e. access to localmarkets (in 1960s in 1970s export orientation of

affiliates was below 20% and 10%, respectively).y In Asian countries U.S. affiliates serve as export

platform (export orientation exceeds 65%, in Malesia,Singapur and Hong Kong it exceeds 80%), indicatingclear resource-seeking and efficiency-seeking

motives for FDI.


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Evolution of world trade and FDI

Table: Total world exports and FDI, 1961-1997

Volume ($ bill.) Growth (%)

1961 1975 1990 1997 1961-75 1975-90 1990-97

Exports 134 878 3485 5653 15.6 10.3 8.4

F I* 68 264 1675 3499 11.0 14.1 13.1

Source: Bowen et al., 1998: 465, World Investment Report, 1998: 2,* average of inward and outward FDI.


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y After the WW2 and esp. after the Kennedy round GATT(1964-1967), world trade has increased tremendously.

y

In contradiction to HOS implications, after 1975 FDI flowshave increased even faster.


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Global production sharing and the wage gap

(Feenstra & Hanson 2001)

y trade in intermediate inputs is a potentially importantexplanation for the increase in the wage gap between

skilled and unskilled workers in the U.S. andelsewhere;

y trade in inputs has much the same impact on labordemand as does skill-biased technical change: both of

these will shift demand away from low-skilledactivities, while raising relative demand and wages ofthe higher skilled

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y For full-time U.S. workers between 1979 and 1995, thereal wages of those with 12 years of education fell by

13.4% and the real wages of those with less than 12years of education fell by 20.2%.

y During the same period, the real wages of workerswith 16 or more years of education rose by 3.4%, so

that thew

age gap betw

een less-skilled and more-skilledworkers increased dramatically

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yWhat are the factors that led to this increase in skill-biased inequality between non-production and

production workers;y International competition from low-wage countries;

y Skill biased technological change due to increased use ofcomputers;

y

Trade volumes appear not to have been big enough tocause the magnitude of change noticed

y Composition of trade?

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y This means that outsourcing has a qualitatively similareffect on reducing the relative demand for unskilled

laborw

ith

in an industry as does skilled- biasedtechnological change, such as the increased use ofcomputers. (Feenstra & Hansen, 2001)

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Model is estimated in logs at the industry level, where:

IITij Grubel-Lloyd index of intra-industry trade in goodj betweencountryi and U.S.,

DGPLi difference in GDP per employee between countryi and U.S.,

DKLi difference in capital per employee between countryi andU.S.,

minGDPi GDP of countryi,

maxGDPi GDP of U.S. as the largest country,

FFij transport cost of goodj between countryi and U.S., (as aratio to the shipping value)

Dj set of industry dummies.


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y Two forms of intra-industry trade flows:

y MIITij: intra-industry trade flows of U.S. affiliates abroadand foreign affiliates in the U.S. (inter-affiliate trade),

y TIITij: total intra-industry trade flows between countryiand U.S.

y Model is estimated for trade between U.S. and 27 partner

countries using 3-digit BEA (64 product groups).


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Table: Estimates of characteristics of inter-affiliate trade (MIIT) and total intra-industry

trade (TIIT) in factor-proportions model

Dependent

variableMIIT MIIT TIIT TIIT

DGPL Coef. -0.0357 -0.0179

t-stat. -4.31 -2.17

DKL Coef. -0.0827 -0.0475

t-stat. -6.63 -3.73

minGDP Coef. 0.0607 0.0635 0.0257 0.0244

t-stat. 8.23 9.67 3.60 3.72

maxGDP Coef. 0.0234 0.0723 0.0036 0.0383

t-stat. 1.12 3.19 0.23 1.99

FF Coef. -0.0302 -0.0095 -0.0570 -0.0481t-stat. -3.08 -0.93 -6.08 -4.99

N 1132 1132 1620 1620

Adj.R2 0.179 0.197 1.156 0.161


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Parameter estimates for affiliate IIT and total ITTare similar:

yboth proxy variables for differences in relative factorabundance are significantly negative (in line withprediction of the model for total trade), whileMIIT ismore responsive than TIIT,yminGDPis in line with model predictions, but notmaxGDP,yin line with model predictions, transport costnegatively affect trade, whileMIIT is more responsive

thanTIIT

.


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TEST OF PROXIMITY-CONCENTRATION TRADE-OFF MODEL

(Brainard 1993b)

The model predicts that FDI increases in market access

barriers (transport cost, tariffs) and decreases in plant

economies of scale (horizontal FDI in order to serve local

market).

There is trade-offbetween increasing production cost

(less efficient use of economies of scale if production is

divided among many locations) and lower prices (trade

cost are redundant).Implications of the model: FDI SUBSTITUTES for trade

the higher the trade barriers and the lower the plant

economies of scale.


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Empirical tests give similar results for both forms of IIT,which is:

yin line with predictions of factor-proportion model for totaltrade,yopposite to predictions for inter-affiliate trade.

Moreover, there is surprisingly high correlation between both

dependent variables, which implies that factor-proportionsmodel with differentiated goods is not appropriate model forexplaining motives for FDI, where U.S. serve as target orsource country.In contradiction to the factor-proportions model, U.S. FDIseem to be motivated by similarities (not differences) inrelative factor abundances, where transport cost play animportant role.

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Model:

Dependent variables:

y

Outward side: share of affiliates exports in total U.S. exports(OUTSH) or export share in total U.S. sales in the targetcountry (EXSH).

y Inward side: share of foreign affiliates sales in U.S. in totalU.S. sales of that country (INSH) or import share in total U.S.

sales of that country (IMSH).Independent variables:

y similarity of preferences (Linder) oz. similarity in factorabundance: GDPpc in foreign country,

y trade barriers: transport cost (FF), foreign tariffs (FAT) andU.S. tariffs (USAT), non-trade barriers in U.S. (NTB),openness for trade and FDI (TOPN, FOPN), corporate tax(TAX), extent of $ depreciation in 1985-89 (EXR),

y economies of scale at the plant level (PSCL).


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Dependentvariable

OUTSH EXSH Dependentvariable

INSH IMSH

Const. Coef. -16.278 8.795 Const. -9.3942 2.5318

t-stat. -9.58 5.86 -6.26 5.41

FF Coef. 0.2202 -0.2573 FF 0.444 -0.081t-stat. 4.97 -6.08 6.2 -2.46

FAT Coef. 0.1793 -0.286 USAT 0.0295 0.0236

t-stat. 3.66 -6.16 0.29 0.59

GDPpc Coef. 0.7359 -0.0068 GDPpc 0.6336 -0.2465

t-stat. 5.61 -0.06 3.99 -6.93

EXR Coef. -0.2549 -0.0636 EXR -0.548 -0.0191

t-stat. -3.79 -1.01 -0.49 -0.97

TAX Coef. 0.9499 -1.6619 TAX 1.2944 -0.4071

t-stat. 3.08 -5.63 3.65 -3.46

TOPN Coef. -0.3338 2.3528

t-stat. -0.91 6.44FOPN Coef. 2.1405 -3.1672

t-stat. 6.93 -10.79

PSCL -0.1473 -0.0275 PSCL -0.1862 0.0922

-4.23 -0.8 -3.11 3.62

N 782 1059 N 513 1412

Adj.R2 0.196 0.177 Adj.R2 0.175 0.086


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Results indicate:

y Linder matters: similarity in income (preferences)increase affiliate sales and decrease regular trade

y Trade barriers matter: transport cost, tariffs as well asopenness for FDI increase U.S. affiliate sales abroad anddecrease regular exports, while trade openness decreaseU.S. affiliate sales and increase exports

y Economies of scale matter: significant plant economiesof scale decrease affiliate sales and increase regular imports


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y Markusen challenged Mudells (1957) finding thatsubstitution holds in the Heckscher-Ohlin-Samuelsonmodel;

y Under certain conditions, Markusen shows thateliminating barriers to factor movement results incomplementarity;

Markusens (1983) model

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y He states that the complementarity result in each ofhis models is based on the fact that eachequilibrium involves a country having the relativelyhigh price for the factor used intensively in theproduction of the export good (pp. 342-343).

y Thus, factors move to the other countrys sector thatuses them intensively, resulting in an increase in trade.This implies that trade and factor movement arecomplements.

Markusens (1983) model (source: Schiff, 2006)

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Markusen with trade policy

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Economic geography

y Economic geography uses concepts of returns to scale,transport costs, factor mobility etc. to explain thespatial distribution of economic activity

yActivity is not equally distributed across space, on theother hand, it is very lumpy

y Depending on the structure of the EG models, they

can imply substitutability between trade and factormobility as well as complementarity

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Economic geography

yAgglomeration forces (scale economies, intermediatesmarkets and factor markets) generate concentration ofeconomic and subsequently trade

y Factor mobility (these chase higher returns) alsocontributes to trade COMPLEMENTARITY

y If factors are not perfectly mobile across locations,

there will be less trade.

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trade and factor mobility(1)

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