Will Factor Flows and Trade be Complements or Substitutes as Europe Enlarges Poonam Gupta and Ashoka

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Will Factor Flows and Trade be Complements or
Substitutes as Europe Enlarges?Poonam Gupta and
Ashoka ModyJanuary 30, 2006Warsaw
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As Migration Restrictions are Eased...

• Large likely welfare gains from income
  convergence.
• But politically sensitive costs in both receiving
  and originating countries.
• Can policy dilemmas be mitigated by trade and
  capital flowsor could these flows, in fact,
  aggravate the tensions?

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The Layard et al. vision

• ... the prospect of very large scale migration
  from East to West, ...
• ... could actually leave the remaining population
  in the East worse off, ...
• ... policy should try to bring good jobs to the
  East rather than workers to the West.
• ... the best single migration policy that could
  be put in place.

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Mexican PresidentCarlos Salinas de Gortari

• ...in the context of the North American Free
  Trade Agreement (NAFTA)
• Mexico wants to export goods, not people.

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Trade and Factors as Substitutes

• If trade primarily reflects factor endowments
• Factors move embodied in traded goods,
• Factor prices equalization eliminates the motives
  for movement of factors.
• Trade and factor flows are then substitutes
• More trade, smaller factor flows
• free factor flows, no basis for trade.
• Layard et al. trade-labor substitutability is
  desirable

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Complementarity Central Role of Foreign Capital

• Complementarity arises from technology
  differences many possibilities
• Possibility for new member states (NMS)
• Huge gap in capital/labor ratios and productivity
  vis-à-vis euro zone
• NMS Potential attractors of capital to exploit
  potential high returns benefitgtraise domestic
  productivity
• Capital also generates tradegtretains labor
• Hence, FDI and trade complement
• and so do FDI and labor (FDI substitutes for
  emigration)
• Factor/trade flows enhance income convergence

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Capital and Productivity Gaps
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Three Stylized Facts(Unconditional Relationships)

• NMS have deeper international linkages than
  emerging market peers
• FDI and trade appear to move together
• More FDI inflows into developing economies, less
  labor outflows (weak evidence)
• More FDI outflows from advanced economies, less
  labor inflows

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NMS Stronger International Linkages
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Cross-Sectional FDI and Trade correlation
appears strongest
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Time Series Emigration and FDI Inflows appear
weak substitutes
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Time Series Immigration and FDI outflows appear
stronger substitutes
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Empirical Approach

• Bilateral Flows in a gravity framework
• Same specification for trade, emigration, and FDI
• Focus on flows connecting 16 advanced and 28
  developing countries
• Smaller sample of advanced countries 11 EU-15
  countries

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Sequence of Results

• What do the gravity variables tell us about
  substitution/complementarity?
• Are the NMS different?
• What is the direct evidence on substitution/comple
  mentarity?

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Gravity Variables per capita incomes

• As countries become richer
• They trade more,
• They export and import more capital
• They import more labor, but export less labor
• Thus, income convergence
• more trade and capital inflows,
• less labor outflows

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Gravity Variables distance

• Negative coefficient on distance in FDI equation
• Surprise? If FDI were substitute for trade, FDI
  would go to longer distances to overcome
  transport costs
• If FDI were integrated into trade networks, then
  more FDI at short distances
• Implication European FDI with emerging Europe,
  highly trade oriented

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Are the NMS different?

• Yes
• Baltics trade and FDI high in full sample (dummy
  variable positive and significant)
• CEC-5 not significantly different in full sample
• Hence the high unconditional rates in raw data,
  mainly reflect European connections, especially
  physical proximity

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Trade, Labor, and FDI links (Tables 3 and 4)

• Most robust result
• FDI supports trade
• Trade supports FDI
• More trade less labor outmigration
• Weaker evidence more inward FDI, less outward
  migration
• Thus direct and indirect evidence that more FDI,
  associated with growth reduces migration pressure

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Conclusions

• Virtuous cycle
• More FDI, more trade, less emigration
• Increased per capita incomes,
• In turn, more FDI and trade supporting domestic
  labor absorption
• But this cycle can also work in reverse
• If growth falters and investment climate is weak
  less trade and FDI, migratory pressures
• Growth/productivity agenda crucial