Chapter 15
Multinationals and Migration: International Factor Movements
Overview
This chapter provides a survey of the economics of foreign direct investment (FDI) and the
economics of labor migration.
Foreign direct investment is a flow of funding provided by an investor (usually a firm) to
establish or acquire a foreign company or to finance an existing foreign company that the
investor owns. Ownership is important because the investor has or acquires the power to have a
substantial influence on the management of the foreign company. The share of the equity of the
foreign company that the investor must own to have substantial influence on management is
probably less than 50 percent. The standard (arbitrary) minimum amount used by most countries
to define FDI is 10 percent of the equity of the foreign company. (FDI may also refer to the stock
of such investments in existence at a point in time.)
A multinational enterprise (MNE) is a firm that owns and controls operations in more than one
country. Thus, FDI is a way that the parent company of the MNE can finance its foreign
affiliates. However, an MNE is more than just a way to move financial capital between countries.
The foreign affiliate (subsidiary or branch) often receives managerial skills and methods,
technology and trade secrets, marketing capabilities and brand names, and instructions about
business practices from its parent company. Often much of the financing of the affiliate is raised
locally, perhaps to reduce exposure to exchange rate risk or to the risk of expropriation by the
host-country government.
Industrialized countries are the source of most FDI, and most FDI goes into industrialized
countries (although recently the share going to developing countries has risen). Direct investment
is more important in some industries than in others. In manufacturing FDI is important in such
industries as chemicals, electrical and electronic products, automobiles, machinery, and food. In
services FDI is important in such activities as financial services, business services, and
wholesaling and retailing.
What explains why MNEs exist? Purely financial theories cannot explain MNEs because they
cannot explain why managerial control over the foreign affiliates, with its focus on production
and marketing, is necessary if the goal is only to move capital from one country to another in
pursuit of higher returns or diversification of risk.
A useful framework for understanding why MNEs exist stresses five elements. First, firms face
inherent disadvantages in operating affiliates in foreign countries. Second, to overcome the
disadvantages and to be successful with its FDI, a firm must have some firm-specific advantages
not held by its local competitors in the foreign country. These advantages may be technologies,
marketing assets, managerial capabilities, or access to large amounts of financial capital. Third,
location factors, such as comparative advantage or government barriers to trade, influence where
production should occur (export or FDI). Fourth, there may be advantages to using the firm’s
advantages internally within the MNE, rather than incurring the transactions costs and risks of
selling or renting these assets to independent firms (license or FDI). Fifth, FDI can be part of
global oligopolistic rivalry. (The box on CEMEX shows the roles of firm-specific assets and
oligopolistic rivalry in the growth of this MNE based in Mexico.)
The taxation of the profits of multinational firms raises important issues. Although the details are
overwhelming, the general approach to how the profits are taxed is that the profits of the foreign
affiliates are taxed by the host country and the profits of the parent company on its own activities
are taxed by the home country. To minimize total taxes paid worldwide, multinational firms can
try to locate activities in low-tax countries. More controversially, multinational firms can use
transfer pricing on transactions that occur within their global organizations to show more of their
profits in countries where the profits will be lightly taxed. Governments know this incentive.
They often attempt to police transfer pricing to assure that transfer prices are similar to market
prices, but this determination is often difficult, so the firms have some scope to manipulate
transfer pricing.
Multinational firms are active in international trade in goods and services, and about one-third of
world trade is intra-firm trade between units of multinational firms in different countries.
Although some FDI is a substitute for trade, because local production replaces products that
otherwise would be imported, FDI and trade are also often complements. This is especially true
when multinational firms exploit differences in comparative advantages by locating different
stages of production in different countries. It can also be true when better local marketing by an
affiliate leads to increased sales of some products that the multinational firm produces in other
countries, even if other parts of the firm’s product line are produced locally by the affiliate. Most
studies conclude that FDI overall is somewhat complementary to international trade in products.
Economic analysis indicates that the home (or source) country can receive net benefits from its
outward FDI, because the gains to the owners of the MNEs exceed the losses to workers and
other providers of resource inputs. There are several other sources of possible loss to the home
country. The government may lose tax revenues as profits are now shown in foreign affiliates.
Positive externalities may be lost when the activities are shifted out of the country. The
multinationals may gain too much influence over the home country’s foreign policies. While
there are some arguments for the home county to tax or restrict outbound FDI, the actual policies
of the major home countries are neutral to mildly supportive toward outward FDI.
Economic analysis suggests that the host country gains from inward FDI, even if the profits of
the local affiliates do not belong to the host country, and even though some local competitors
may be harmed by the competition from the affiliates. There is some case for the host-country
government to tax or restrict inward FDI, because of fear of the local political power of the
foreign multinationals, or to impose an optimal tax on the affiliate’s profits. But the FDI may
also bring technological spillovers and other positive externalities. In the 1950s and 1960s, host
governments, especially in developing countries, stressed controls and restrictions on the entry
and operations of MNEs. Since the mid-1970s host countries have generally been liberalizing
their policies toward inward FDI, and many actively compete for it by offering various forms of
subsidies to multinational firms that will locate new facilities in their countries.
The box “China as a Host Country” (another Focus on China) provides a look at the
second-largest recipient of FDI inflows in recent years. It shows applications of many concepts
developed in the first half of this chapter. It notes key features and issues, including that much
FDI into China comes from Taiwan and Hong Kong (including some that is “round-tripping”),
that protection of intellectual property is a major challenge for foreign firms, and that China’s
government has both policies that limit inward FDI and policies that encourage inward FDI.
The latter part of the chapter examines labor migration, including the benefits and the costs to the
migrants, the effects of migration on other groups and on the sending and receiving countries
overall, the fiscal effects of migration, and government policies toward migration. For the United
States and Canada, immigration was relatively large until the 1920s, was low in the 1930s, and
has been higher since the 1950s. For the shorter history of the European Union, immigration was
curtailed in the mid-1970s and early 1980s, but has increased again since the late 1980s.
The basic theory of migration is presented by picturing labor markets in the “North” and the
“South” of the world. Higher wage rates in the North provide the incentive for migration, but
migration is also limited by the economic and psychic costs of migration. The analysis shows
that migrants themselves gain, workers remaining in the South gain, employers in the South lose,
workers in the North lose, and employers in the North gain. The South overall (excluding the
migrants who have left) loses, the North overall (again excluding the migrants) gains, and the
world gains from this migration.
The basic analysis of the effects of migration indicates that the sending country loses economic
well-being. In addition, most emigrants are young adults, so the fiscal effect is also adverse. The
loss of future tax payments from these emigrants is likely to be larger than the reduction in future
government spending. The loss is likely to be especially large for the emigration of highly
educated people (the “brain drain”). On the other side, some sending countries receive
substantial remittances sent by the emigrants back to their family and friends.
The basic analysis of the effects of migration indicates that the receiving country gains economic
well-being. There are several other possible effects of immigration. First, immigrants often bring
external benefits through knowledge spillovers. Second, immigrants can bring external costs
through increased congestion and crowding. Third, immigrants can raise social frictions based on
bigotry, which can become severe during periods when the rate of immigration is high. In
addition, in a number of receiving countries the fiscal effects of immigration have become
increasingly controversial.
The box “Are Immigrants a Fiscal Burden?” summarizes studies for the United States and some
other high-income receiving countries. For a receiving country the fiscal effects of immigration
depend both on the immigrants’ payments of taxes and on how much expansion of government
spending on goods and services is necessary to provide these goods and services to the
immigrants while also maintaining the same level of consumption value to natives in the country.
Presumably, any transfer payments received by immigrants are an expansion of government
expenditures, but the effects on other government goods and services must be estimated. One
way to examine this is to look at a snapshot for a single year. According to a recent OECD study,
the net effect varies somewhat across receiving countries, and it is generally relatively small.
Another way to look at this is to examine the net effects over the entire lifetimes of immigrants
and their descendants. One comprehensive study of the United States concludes that the average
net fiscal effect is slightly negative for the typical immigrant and substantially positive for the
immigrant’s descendants. In addition, the study concludes that the net fiscal effect of the
immigrant depends on the immigrant’s level of education, used as indicator of labor skill and
earnings potential. Immigrants with a high school education or less impose a net cost;
immigrants with some college provide a net benefit. Because the average education and earnings
of immigrants has been declining relative to those of natives, for the United States since about
1980, the fiscal balance is probably shifting toward immigrants being a fiscal burden.
The analysis has implications for the policies used by receiving countries to limit immigration.
First, the types of immigrant admitted have an impact on which native group suffers loss.
Second, the types of immigrants admitted have an impact on the net fiscal effects. To gain greater
fiscal benefits (and to minimize the negative impact on low-skilled native workers who already
have low earnings), the receiving country should skew its immigration policies to favor young
adults with some college education. However, for countries like the United States, this would
mean shifting away from other worthy goals pursued by their current immigration policies,
including family reunification and assisting refugees.
Tips
Figure 15.1 has quite a bit of information that can be used to generate class discussion, including
the identity of the major home countries (why these are the major home countries?), the
relatively small amount of FDI into developing countries and more generally what countries and
regions host most FDI (why?), and the specific pattern of FDI for each home country (why?).
Migration is a sensitive topic, and any presentation needs to keep its scientific standards up, by
distinguishing what is known or plausibly estimated from what is common folklore.
This chapter can be assigned and covered in conjunction with the material on policy issues
(Chapters 8-14 of the book). Or, some or all of the chapter can be assigned with the material on
the pure theory of trade, if the goal is to link it closely to the issues raised in Chapter 5 (trade and
factor movements as substitutes), Chapter 6 (imperfect competition), or Chapter 7 (technology).