Substitution
Substitution
Whenever the factor proportions vary widely among countries, there are pressures for the most abundant factors to move to countries of greater scarcity so that they can command a better return. Thus in countries with an abundance of labor relative to land and capital, there is a tendency for laborers in that country to be unemployed or poorly paid; if permitted, these workers will gravitate to countries with relatively full employment and higher wages. Likewise, capital will tend to move away from countries where it is abundant to those where it is scarce. Mexico is thus a net recipient of capital from the United States, and the United States is a net recipient of labor from Mexico.
If finished goods and production factors were both completely free to move internationally, then the comparative costs of transferring goods and factors would determine the location of production. A hypothetical example as shown in Fig. 6.1 should illustrate the substitutability of trade and factor movements under different scenarios.
Assume: (1) that the United States and Mexico have equally productive land available at the same cost for growing tomatoes; (2) that the cost of transporting tomatoes between the United States and Mexico is $0.75 per bushel; and (3) that workers from either country pick an average of two bushels per hour during a 30-day picking season. The only differences in price between the two countries are due to variations in labor and capital cost. The labor rate in the United States is assumed to be $20.00 per day, or $1.25 per bushel; in Mexico it is assumed to be $4.00 per day, or $0.25 per bushel. The cost of capital needed to buy seeds, fertilizers, and equipment costs the equivalent of $0.50 per bushel in Mexico and $0.30 per bushel in the United States.
If neither tomatoes nor production factors can move between the two countries (see Fig. 6.1a), then the cost of tomatoes produced in Mexico for the Mexican market would be $0.75 per bushel ($0.25 of labor plus $0.50 of capital), whereas those produced in the United States for the U.S. market would be $1.55 per bushel ($1.25 of labor plus $0.30 of capital). If trade restrictions on tomatoes were eliminated between the two countries (Fig. 6. lb), the United States would import from Mexico because the Mexican cost
of $0.75 per bushel plus $0.75 of transportation cost to move them to the United States would be less than the $1.55 cost of growing them in the United States.
Consider another scenario in which neither country allows the importation of tomatoes but in which both countries allow certain movements of labor and capital (Fig. 6.1c). An investigation shows that Mexican workers can enter the United States on temporary work permits for an incremental travel and living expense of $14.40 per day per worker, or $0.90 per bushel. At the same time, U.S. capital can be enticed to invest in Mexican tomato production provided that it receives a payment equivalent to $0.40 per bushel, less than the Mexican going rate but more than it would earn in the United States. In this situation, Mexican production costs per bushel would be $0.65 ($0.25 of Mexican labor plus $0.40 of American capital). U.S. production costs would be $1.45 ($0.25 of Mexican labor plus $0.90 of travel and incremental costs plus $0.30 of American capital). Note that each country would be able to reduce its production costs (Mexico from $0.75 to $0.65 and the United States from $1.55 to $1.45) by bringing in abundant production factors from abroad.
With free trade and the free movement of production factors (Fig. 6. Id), Mexico would produce for both markets by importing capital from the United States. According to the above assumptions, that would be a cheaper alternative than sending labor to the United States. In reality, neither production factors nor the finished goods that they produce are completely free to move internationally. Some slight changes in imposing or freeing restrictions can gready alter how and where goods may be produced most cheaply.
In the case of the United States, in recent years there has been more legal freedom for capital to flow out than for labor to flow in. As a result, there has been an increase in U.S.-controlled direct investment to produce goods that are then imported back into the United States. In fact, capital moves globally more easily than does labor. Furthermore, technology, particularly in the form of more efficient machinery, is generally more mobile internationally than labor. The result is that differences in labor productivity and cost explain much of trade and direct investment movements.
Whenever the factor proportions vary widely among countries, there are pressures for the most abundant factors to move to countries of greater scarcity so that they can command a better return. Thus in countries with an abundance of labor relative to land and capital, there is a tendency for laborers in that country to be unemployed or poorly paid; if permitted, these workers will gravitate to countries with relatively full employment and higher wages. Likewise, capital will tend to move away from countries where it is abundant to those where it is scarce. Mexico is thus a net recipient of capital from the United States, and the United States is a net recipient of labor from Mexico.
If finished goods and production factors were both completely free to move internationally, then the comparative costs of transferring goods and factors would determine the location of production. A hypothetical example as shown in Fig. 6.1 should illustrate the substitutability of trade and factor movements under different scenarios.
Assume: (1) that the United States and Mexico have equally productive land available at the same cost for growing tomatoes; (2) that the cost of transporting tomatoes between the United States and Mexico is $0.75 per bushel; and (3) that workers from either country pick an average of two bushels per hour during a 30-day picking season. The only differences in price between the two countries are due to variations in labor and capital cost. The labor rate in the United States is assumed to be $20.00 per day, or $1.25 per bushel; in Mexico it is assumed to be $4.00 per day, or $0.25 per bushel. The cost of capital needed to buy seeds, fertilizers, and equipment costs the equivalent of $0.50 per bushel in Mexico and $0.30 per bushel in the United States.
If neither tomatoes nor production factors can move between the two countries (see Fig. 6.1a), then the cost of tomatoes produced in Mexico for the Mexican market would be $0.75 per bushel ($0.25 of labor plus $0.50 of capital), whereas those produced in the United States for the U.S. market would be $1.55 per bushel ($1.25 of labor plus $0.30 of capital). If trade restrictions on tomatoes were eliminated between the two countries (Fig. 6. lb), the United States would import from Mexico because the Mexican cost
of $0.75 per bushel plus $0.75 of transportation cost to move them to the United States would be less than the $1.55 cost of growing them in the United States.
Consider another scenario in which neither country allows the importation of tomatoes but in which both countries allow certain movements of labor and capital (Fig. 6.1c). An investigation shows that Mexican workers can enter the United States on temporary work permits for an incremental travel and living expense of $14.40 per day per worker, or $0.90 per bushel. At the same time, U.S. capital can be enticed to invest in Mexican tomato production provided that it receives a payment equivalent to $0.40 per bushel, less than the Mexican going rate but more than it would earn in the United States. In this situation, Mexican production costs per bushel would be $0.65 ($0.25 of Mexican labor plus $0.40 of American capital). U.S. production costs would be $1.45 ($0.25 of Mexican labor plus $0.90 of travel and incremental costs plus $0.30 of American capital). Note that each country would be able to reduce its production costs (Mexico from $0.75 to $0.65 and the United States from $1.55 to $1.45) by bringing in abundant production factors from abroad.
With free trade and the free movement of production factors (Fig. 6. Id), Mexico would produce for both markets by importing capital from the United States. According to the above assumptions, that would be a cheaper alternative than sending labor to the United States. In reality, neither production factors nor the finished goods that they produce are completely free to move internationally. Some slight changes in imposing or freeing restrictions can gready alter how and where goods may be produced most cheaply.
In the case of the United States, in recent years there has been more legal freedom for capital to flow out than for labor to flow in. As a result, there has been an increase in U.S.-controlled direct investment to produce goods that are then imported back into the United States. In fact, capital moves globally more easily than does labor. Furthermore, technology, particularly in the form of more efficient machinery, is generally more mobile internationally than labor. The result is that differences in labor productivity and cost explain much of trade and direct investment movements.
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