Question

1. How would foreign direct investment ( FDI) affect the income distribution between labor class and owners of capital and land under

a) specific factor model ( short term)

b) Heckscher-Ohlin model ( long term)

Please prove your statement with theoretical ground.

Answer 1

foreign direct investment ( (FDI

foreign direct investment ( (FDI) means companies purchase capital and invest in a foreign country. For example, if a US multinational, such as Nike built a factory for making trainers in Pakistan; this would count as foreign direct investment.

In summary, the main factors that affect foreign direct investment are

• Infrastructure and access to raw materials
• Communication and transport links.
• Skills and wage costs of labour

Factors affecting foreign direct investment

1. Wage rates

A major incentive for a multinational to invest abroad is to outsource labour-intensive production to countries with lower wages. If average wages in the US are $15 an hour, but $1 an hour in the Indian sub-continent, costs can be reduced by outsourcing production. This is why many Western firms have invested in clothing factories in the Indian sub-continent.

• However, wage rates alone do not determine FDI, countries with high wage rates can still attract higher tech investment. A firm may be reluctant to invest in Sub-Saharan Africa because low wages are outweighed by other drawbacks, such as lack of infrastructure and transport links.

2. Labour skills

Some industries require higher skilled labour, for example pharmaceuticals and electronics. Therefore, multinationals will invest in those countries with a combination of low wages, but high labour productivity and skills. For example, India has attracted significant investment in call centres, because a high percentage of the population speak English, but wages are low. This makes it an attractive place for outsourcing and therefore attracts investment.

FDI in the Short Run: Specific-Factors Model

Capital:-By carefully tracing through how the capital-labor ratio in manufacturing is affected by the movement from A to C (where wages and hence the capitallabor ratio do not change), and then the movement from C to B (where wages and the capitallabor ratio both increase), we conclude that the rental on capital is lower at point B than at point A. Therefore, the rental on capital declines when the capital stock increases through FDI

Effect of FDI on the Wage • As a result of the shift in PM • MPL M, the equilibrium wage increases, from W to W′. More workers are drawn into the manufacturing industry, and the labor used there increases.

Heckscher-Ohlin model ( long term)

The two curves never intersect